The Music Goes on and on

Buckle up and brace yourself for 2015
E.S. BROWNING DOW JONES JANUARY 02, 2015 2:39PM

THE experts said 2014 would be wild. They were right. They think 2015 will be wilder.

Stocks scared investors five times in 2014, with sudden pullbacks in January, April, July, September and December. Each time, the market soon recovered.

This year, with stocks more expensive than a year ago and with the market backdrop murkier, money managers are bracing for more and potentially bigger pullbacks.

“We have the view that investors need to buckle in,” said Lori Heinel, chief portfolio strategist at State Street Global Advisors, which oversees $US2.42 trillion in Boston.

Few money managers anticipate a recession, not in the US, at least. Most expect US stocks to finish the year with gains. Ms Heinel and others do, however, expect stocks to face a series of hurdles. Among the most prominent:

The Stern Parent: Until 2014, the Federal Reserve was an indulgent parent, showering investors with easy money and lots of support, notably in the form of massive bond-buying. Many believe that mix of low rates and cash-injection was the single strongest driver of stock prices. Now, the Fed is becoming a little stricter.

Barring an economic setback, the Fed will start raising interest rates this year. While the changes should be slow and mild, there is no getting around the fact that rising rates aren’t as good for stocks or bonds as lower rates.

One problem is that investors don’t know how much rates will rise, or how soon. This uncertainty is likely to fuel some market swings in 2015.

“The continued focus in the market is still very, very much on the Fed,” Ms Heinel said. If investors get the sense the Fed is being too aggressive or not aggressive enough, “it could wreak havoc with the market. It has for the last few years and there is no reason for that to change,” she said.

Europe’s Flirtation with Recession: “Europe has significant problems,” said Tony Roth, chief investment officer at Wilmington Trust, which oversees $US80 billion.

While US economic output has surpassed its prerecession high, that of the economies using the euro hasn’t, Mr Roth notes. A number of them are again flirting with recession.

That will hurt US multinationals because so many of them have extensive European business. Those multinationals dominate big US stock indexes. More trouble in Europe, be it energy-related, Russia-related or just demand-related, will affect US markets.

For now, US stocks have been beneficiaries of the European uncertainty, which keeps investors from shifting toward less-expensive European stocks. Foreign and US investors have been keeping money in US stocks, partly because they think it is safer and partly because they expect the dollar to appreciate against other currencies.

US stocks could lose this advantage, however, if investors become less worried about Europe in 2015.

China’s Slowing Growth: China no longer can generate the 10 per cent economic growth it enjoyed as recently as 2010. A December working paper by Chinese central-bank economists indicated growth likely will miss the country’s 7.5 per cent target for 2014 and fall to 7.1 per cent in 2015.

“The slowdown in Chinese growth is not priced in” to stock expectations, especially not in the Chinese market itself, said Anwiti Bahuguna, senior portfolio manager at Columbia Management Investment Advisors LLC, which oversees $US358 billion.

China is far from recession, but the growth slowdown is significant. If Ms Bahuguna is right, slowing growth could make waves in China, in the rest of Asia and in developing countries elsewhere that export commodities to China.

Moreover, Ms Bahuguna said, stocks in developing countries could be hurt more than in the US by Fed rate increases. Developing countries have been significant “beneficiaries of liquidity from the Fed,” Ms Bahuguna said. “The Fed can stop raising rates if it hurts the US economy, but emerging markets are not their mandate.”

At the same time, falling oil prices could provide significant help to economies such as India and China, said Mr Roth at Wilmington Trust. He hasn’t made the move yet, but if there are signs that those economies are benefiting, he said, he could shift some money there.

Russian Instability: Russia is a source of concern on two levels.

With an economy dependent on energy exports, Russia has been devastated by falling prices. Ms Bahuguna says it isn’t unimaginable that it could have to turn to the International Monetary Fund for aid.

There is the risk of a default “by Russia or a Russian corporation,” said Ms Heinel at State Street. “That isn’t our core call, but you can’t ignore the possibility.”

At the same time, no one knows how aggressive Russia could become in places such as Ukraine if its economic woes worsen. That uncertainty is part of the reason some investors are wary of investing in Europe, especially Eastern Europe.

High Stock Prices: The S & P 500 trades at 17 to 18 times its components’ profits for the past 12 months, Mr Roth calculates, “which is expensive by historical standards.” Going back to the 1920s, the average is closer to 15 or 16.

Mr Roth still expects US stocks to have a good year, in part because alternatives such as bonds are even more severely overpriced. “Where else is the client going to invest?” he said.

Still, high prices contribute to pullback fears and make it harder for stocks to rise much more quickly than corporate earnings. That makes Mr Roth think about shifting some money to the developing world.

“Because of valuation we will at some point have to go to emerging markets,” he said.

If others think the same way and shift more investment dollars abroad, that creates another obstacle to US market growth.

Dow Jones

(02-01-2015, 05:35 PM)greengiraffe Wrote: Buckle up and brace yourself for 2015
E.S. BROWNING DOW JONES JANUARY 02, 2015 2:39PM

THE experts said 2014 would be wild. They were right. They think 2015 will be wilder.
...

Happy New Year GG.

Wilder market for 2015, means more opportunities for value investors?

(02-01-2015, 09:17 PM)CityFarmer Wrote:

(02-01-2015, 05:35 PM)greengiraffe Wrote: Buckle up and brace yourself for 2015
E.S. BROWNING DOW JONES JANUARY 02, 2015 2:39PM

THE experts said 2014 would be wild. They were right. They think 2015 will be wilder.
...

Happy New Year GG.

Wilder market for 2015, means more opportunities for value investors?

Happy New Year. Have a healthy one CF and all.

GG has been telling a few buddies... GG is getting lost and trying to regain the bearings.

I think based on my previous theories and historical experiences wilder market may not necessarily spell opportunities for value investors. In fact, volatility is conducive for gutsy traders.

5 selloffs and subsequent recoveries have definitely embolden market participants. While I personally think that rate hike in US at the beginning may not tank the markets, rate rises to levels lower than last GFC peak over a period of time will eventually burst the bubble.

I have been monitoring several growing bubbles such as banks, defensive yielders and all their yield compression - share price performances have outpaced earnings and dividend growth. Until the next major crisis, value investors will have a hard time hunting down absolute values. At the moment, emerging values are more relative than absolute.

GG

Employment numbers are gradually looking better and there is less uncertainty in the market but there are still 2 important factors holding the Fed back.

1. Debt. The government is broke and living off debt. Low interest is in their interest. Until they can figure a way to reduce debt or generate enough tax revenue to start reducing their debt, low interest is good news.

2. Benign Inflation. No one's complaining but if they start raising rates aggressively, economy might roll backwards.

Rates will go up at a measured pace and there is nothing in the horizon that will prompt the Fed to act aggressively.

Brace for a volatile year, UBS chair Axel Weber tells investors
THE AUSTRALIAN JANUARY 13, 2015 12:00AM

Michael Bennet

Reporter
Sydney
UBS global chairman Axel Weber has warned investors to “buckle up” for a volatile and difficult year, laced with growing international currency tensions and diverging central bank policies.

Addressing UBS’s annual China conference where investors managing more than $US10 trillion in assets are in attendance, Mr Weber – a former president of the German Bundesbank – predicted the European Central Bank would unveil a “targeted” quantitative easing stimulus program at its meeting on January 22.

He also tipped the US Federal Reserve to begin raising interest rates in the middle of the year by 25 basis points, but said market expectations for a rapid “decoupling” away from policy in Europe and Japan was unlikely.

He said the chances of a second rate hike this year in the US would be “very data dependent”, with the halving of the oil prices in the past 12 months giving the Fed “optionality” to keep policy accommodative.

Along with the oil price, Mr Weber cited the rising US dollar as another major risk for economies dependent on dollar funding.

“I think what is most likely to happen is we will see…movements in some of the major exchange rates and that always has been coupled with increasing volatility with a high amount of uncertainty,” he said at the conference in Shanghai.

“So for me it’s very likely that current trends (on rates) as priced in are unlikely to materialise.

“I see a relatively high probability of some risks materialising this year…negative things happening in financial markets and when I talk about heightened uncertainty I usually mean there’s a big risk that even very bad things could happen in the market.

“So there’s a number of issues out there that I would recommend to investors to really buckle up and fasten safety belts.

“This is going to be a volatile year plagued with uncertainty and elevated fluctuations in volatility and foreign exchange markets impacting on the real economy. So it’s going to be a difficult year ahead.”

After last year ending its “quantitative easing” program of bond buying, the US Fed’s first interest rate hike from zero is shaping as one of the biggest events for a range of asset classes this year, including stocks, bonds and currencies.

Athanasios Orphanides, a former member of the governing council of the ECB and ex-advisor at the Fed, agreed lower oil prices and ongoing weak growth in Europe would allow the US central bank to raise rates more “smoothly” than previously expected.

He added the ECB will likely go the opposite way to the US and start expanding its balance sheet through its own QE program at its January 22 meeting, but the risk was that it was not large enough.

Mr Weber said the likelihood of QE in Europe had been largely “priced in” by markets and the bigger issue was economies undertaking structural reforms that had long been put off.

But he said Greece would ultimately stay in the euro and predicted the ECB’s QE program would focus on buying corporate debt and covered bonds, plus incentivising countries to reform.

“It will be more targeted, it will have some conditionality attached to it,” he said.

“Rankings of sovereigns will play a role in the size and they will try and allocate the biggest purchases to the higher rated sovereigns, so they put pressure on sovereigns to improve their government ratings through appropriate reforms.”

With China’s growth tipped to slow below 7 per cent this year, it was also diverging from the US, an “outlier” economy that is one of the few in the developed world experiencing strong growth.

But the US dollar bull market would raise global tensions, causing a “differential impact on commodity and oil dependent countries relative to those that are importers”, said Mr Weber.

“I see many of the G20 discussions in the future…will focus on exchange rates and spillover effects of currency policy and therefore I don’t think it will be quite as benign going forward and there will be more tensions internationally,” he said.

Chi-Won Yoon, UBS’s Asia Pacific CEO, said it was not surprising China was slowing after three decades of double digit growth and that there remained “palpable” optimism.

“We talk about slowing growth but the growth rate is still remarkable by any measure. There is greater currency stability than most countries in the region and most of all, there is enormous reform potential and commitment to reform,” he said.

The reporter travelled to Shanghai courtesy of UBS.

(04-01-2015, 12:12 AM)Big Toe Wrote: Employment numbers are gradually looking better and there is less uncertainty in the market but there are still 2 important factors holding the Fed back.

1. Debt. The government is broke and living off debt. Low interest is in their interest. Until they can figure a way to reduce debt or generate enough tax revenue to start reducing their debt, low interest is good news.

2. Benign Inflation. No one's complaining but if they start raising rates aggressively, economy might roll backwards.

Rates will go up at a measured pace and there is nothing in the horizon that will prompt the Fed to act aggressively.

Agree. I'm actually beginning to think that the Fed is aiming to normalise interest rates to positive real rates rather than just look at inflation per se, as per what the market is expecting.

People actuallly forgot that prior to GFC the lowest fed funds rate ever was 3%. I think fed funds incrementally going back to around 2% is palatable, as risk is being mispriced as per what David Einhorn has mentioned

How much confidence you have on Fed's confidence?

Unfazed by market swings, Fed sticks to mid-2015 hike scenario

NEW YORK/SAN FRANCISCO - Tumbling oil prices have strengthened rather than weakened the Federal Reserve's resolve to start raising interest rates around midyear even as volatile markets and a softening U.S. inflation outlook made investors push back the timing of the "liftoff."

Interviews with senior Fed officials and advisors suggest they remain confident the U.S. economy will be ready for a modest policy tightening in the June-September period, while any subsequent rate hikes will probably be slow and depend on how markets will behave.

While they are hard-pressed to explain why bond yields have fallen so low, their confidence in the recovery stems in part from in-house analysis that shows falling oil prices are clearly positive for the U.S. economy.

Internal models also suggest that a decline in longer-term inflation expectations probably does not signal a loss of faith in the Fed's 2-percent inflation goal.

Instead, the models attribute much of the recent decline in market-based measures of inflation expectations to increased investor confidence that prices will not spiral out of control, officials say.
...
http://www.todayonline.com/business/unfa...e-scenario

How long can the music keep going with the same model? (QE - carry trades build with cheap funding of the currency of QE country - bubble building in "defensive" equities and bonds)

Now that the ECB has joined the currency wars it would seem reasonable to assume that those side-effects will continue to build, the day of reckoning (if there is to be one) has probably been pushed out further and the consequences of something going wrong when the central bankers do try to begin extricating themselves from their monetary policy experiments would be scary.

ECB joining currency wars a scary thought
THE AUSTRALIAN JANUARY 27, 2015 12:00AM

Stephen Bartholomeusz

Business Spectator Columnist
Melbourne

Devaluing the euro improves Europe’s competitiveness. Picture: AFP Source: AFP

THE shift in currency relativities that has been occurring since the European Central Bank unveiled its €1.1 trillion ($1.5 trillion) quantitative easing program last week is an intended consequence of the ECB program. It is the unintended consequences that are, perhaps, more disturbing.

The obvious intent of the program was to devalue the euro. That is working, with the euro sliding against other major currencies even before the ECB formally announced it would buy €60 billion of European government bonds a month indefinitely.

There had already been a realignment of currency values occurring, with the end of the US Federal Reserve Board’s bond and mortgage-buying last year and an expectation of rising US official interest rates sometime this year pushing the US dollar up against most other currencies.

The impact of the divergence between US and European monetary policies has been seen quite starkly in the value of the Australian dollar, now below US79c but strengthening modestly against the euro.

The potentially bigger issue is the unintended consequences of the ECB’s policy.

The US QE program saw the Fed’s balance sheet expand by more than $US3.5 trillion as it tried to encourage rises in asset prices and flow-on effects from rising asset prices and cheap liquidity to the real economy.

Despite the recovery in the US economy, opinion is divided as to how significant a role QE has played in it after the initial infusion of liquidity helped lubricate and calm a financial system that froze in 2008.

Around the world corporates and households de-leveraged despite the availability of cheap credit and the most visible effect of the money-printing was a massive increase in financial activity and volatility as investors accepted increasingly exotic risk in pursuit of positive returns.

Institutions everywhere, it seems, were constructing carry trades based on, initially, near costless US funding and subsequently similarly cheap yen funding after Japan embarked on its version of QE.

It is noteworthy that the IMF said last year that, after shrinking slightly in 2008, the shadow banking sector — intermediation by non-bank institutions — has continued to grow and by the end of 2013 controlled about $US75 trillion of assets. In the US the shadow banking sector is estimated to be about 180 per cent the size of the banking sector.

QE is only part of the explanation for the continuing diversion of financial activity into the shadows of the less regulated parts of the global financial system. The other, obviously, is the bank regulators’ responses to the financial crisis and the continuing ratcheting up of bank capital and liquidity requirements now occurring.

In any event, the combination of the previous QE programs has exported ultra-low interest rates to the rest of the world, as well as massive capital flows and volatility. It has also, arguably, generated bubbles in many asset classes.

Some, like commodities, have collapsed, while there is an argument that the end of QE and the prospect of rising US interest rates have played a role in the extent of the plunge in oil prices. There was a significant element of “financialisation” of commodities encouraged by the QE programs.

The eurozone is now the latest of the major economic regions to join the currency wars. Devaluing the euro obviously improves Europe’s competitiveness.

There’s an interesting question as to how that might play into the Fed’s thinking about the timing of US rate rises if the US dollar keeps rising and threatening to undermine US competitiveness and growth, but a more directly euro-centric query is whether it will generate economic growth within Europe.

With fragmented bond markets that have relatively shallow liquidity and economies that rely on bank lending to small and medium-sized businesses far more than the US, Europe’s banks are trying to shrink their balance sheets to improve their capital adequacy. They are unlikely to go on a lending spree, just as the US banks didn’t respond to the Fed’s QE programs by dramatically expanding their balance sheets.

With pre-QE interest rates already at remarkably low levels, there also have to be doubts as to whether the ECB program will have a material impact on real economies within the eurozone, (although it has probably smashed Switzerland’s after the Swiss central bank was forced to remove the cap on the franc and the Swiss Franc soared).

The ECB program will, however, push near-costless money into financial markets, and not just Europe’s. The “unintended” consequences would be to keep some asset prices, most likely equities and bonds, inflated (or inflate them further) and generate flows of funds into unexpected places.

Given the likely divergence in rates and policy between the US and Europe, increased volatility is likely to be a byproduct of the ECB program.

It is also probable that European shadow banking (the size of Europe’s shadow banking has been about a third of that of the US) is likely to expand further, while the euro and yen will be the funding currencies of choice for the carry traders.

A likely strengthening of the US dollar and rates if the Fed does start to normalise its monetary policies will add another layer of complexity, risk and volatility to financial markets.

No one seems to know when or how central banks will be able to restore more conventional global monetary policy settings or what the unintended consequences of the prolonged period of unconventional policies might be when they do try to normalise them.

The potential for something ugly — another Lehman Brothers moment, when the global system was on the verge of melting down in 2008 — is on regulators’ minds.

The OECD’s William White recently described the world as “dangerously unanchored” in an interviewed with British newspaper, The Telegraph.

“We’re seeing true currency wars and everyone is doing it and I have no idea where this is going to end,” he said.

“It ain’t over until the fat lady sings. There are serious side-effects building up and we don’t know what will happen when they try to reverse what they have done.”

Now that the ECB has joined the currency wars it would seem reasonable to assume that those side-effects will continue to build, the day of reckoning (if there is to be one) has probably been pushed out further and the consequences of something going wrong when the central bankers do try to begin extricating themselves from their monetary policy experiments would be scary.

(13-01-2015, 10:21 AM)specuvestor Wrote: I'm actually beginning to think that the Fed is aiming to normalise interest rates to positive real rates rather than just look at inflation per se, as per what the market is expecting.

People actuallly forgot that prior to GFC the lowest fed funds rate ever was 3%. I think fed funds incrementally going back to around 2% is palatable, as risk is being mispriced as per what David Einhorn has mentioned

(Bloomberg) -- Federal Reserve Bank of San Francisco President John Williams, who will vote on policy this year, said raising interest rates in June would be a close call amid “strong momentum” in the labor market and weaker wage gains.

“I would expect by June that the argument pro and con for lifting off rates will be probably a close call” assuming that inflation doesn’t fall further, Williams said today in a telephone interview from his San Francisco office. “It’s a reasonable guess.”

His remarks dovetailed with earlier comments from Atlanta Fed chief Dennis Lockhart, also a voting member of the policy-setting Federal Open Market Committee this year, that rate liftoff in mid-2015 would probably be justified.

http://www.bloomberg.com/news/articles/2...abor-gains

Before people think Buffett is fear-mongering, UST30 at 60 is actually only 5.85% yield which is not abnormal historically prior to the US housing bubble. That's convexity risk at low yield

But I am getting the feeling that there is coordinated effort to support a rising USD, starting with SNB, then RBI, RBA, MAS and now PBoC. I think still think Fed will normalise i/r back to real rates level of around 1-2% ie nominal around 2%. The currency market is already talking. Might also be to prepare for RMB internationalisation

Buffett Says Tough for Fed to Lift Rates Given Strong Dollar (2)
2015-02-04 23:44:33.956 GMT


(Updates with Yellen’s comments in the fourth paragraph,
Treasury forecasts in the last.)

By Noah Buhayar and Daniel Kruger
(Bloomberg) -- Warren Buffett, the billionaire chairman of
Berkshire Hathaway Inc., said it would be “very tough” for the
Federal Reserve to lift interest rates this year because of the
stronger U.S. dollar.
“That would exacerbate the problem,” Buffett said in an
interview on the Fox Business network. “I don’t think it’ll be
very feasible to do. I think it would have a lot of
international repercussions.”
U.S. economic growth, outperforming most industrialized
counterparts, has helped push the nation’s currency higher than
it’s been in more than a decade against currencies of six trade
partners. That’s making it cheaper for Americans to buy imported
goods and helping to lower inflation that’s already below the
Fed’s goal, making it harder to boost rates.
Chair Janet Yellen said Dec. 17 that central bankers would
have to be “reasonably confident” that inflation would move
back to their 2 percent target over time to begin raising
interest rates, which have been near zero since December 2008 to
help spur the economy.
The dollar’s strength is pushing long-term Treasury yields
to record lows as overseas investors look to profit from the
rising currency. U.S. 30-year debt traded at 2.22 percent on
Jan. 30, the lowest yield since at least 1977 when the Treasury
began regular sales of the securities. The current 30-year bond
yielded 2.35 percent Wednesday.

‘Most Dangerous’

Buffett, 84, has long advised investors to steer clear of
bonds at their current low yields and in 2012 said they are
among the “most dangerous” of assets. Instead, he’s favored
picking stocks and buying whole businesses to build Omaha,
Nebraska-based Berkshire into the world’s third-biggest company.
Risks still lurk in buying debt, he said Wednesday.
“The last asset I would want to buy is a 30-year
government bond, but that’s a by-product of other policies which
make sense,” he said. “I don’t want a 10-day bond. There’s a
good chance, who knows what the probability is, but that a 30-
year bond, you know, with a 2 1/2 percent coupon, that bond
could sell at 60 very easily sometime in the not too distant
future. Who knows?” Buffett’s view of Treasuries is more pessimistic than those
of economists. Should the 30-year Treasury fall by year-end to
60 cents on the dollar, from about $1.14 currently, the yield
would climb to 5.86 percent, according to data compiled by
Bloomberg. The median forecast for the securities by 51
economists in a Bloomberg News survey published Jan. 15 is for
the yield rise to 3.35 percent.