Global Markets May 2012 Global Markets & Investor Flows Risks and Opportunities Samarjit Shankar Managing Director BNY Mellon samarjit. shankar@bnymellon. com Information Security Identification: Confidential BNY Mellon i. Flowsm Research
Global economy remains delicately balanced Relapse v. rɪˈlæps; n. rɪˈlæps, ri læps –verb (used without object) -> to fall back into illness after convalescence or apparent recovery. –noun -> a return of a disease or illness after partial recovery from it. Real GDP Growth Economic recovery has been multi-speed and uneven Subdued global growth estimates by IMF and World Bank Advanced economies facing short-term pain amid fiscal consolidation, financial sector repair, subdued growth and still high unemployment Extraordinary stimulus, both monetary and fiscal, likely to linger Central banks remain in cautious mode, maintaining unconventional stimulus measures (more QE? ) Emerging economies, the key locomotives of growth, feeling the pain now Emerging market central banks volte-face – once grappling with inflation & capital inflows, saw capital outflows toward end-2011, fresh buying in 2012 Global imbalances: re-balancing acts required; Investor bi-polarities Investor Bi-Polarities Risk appetite Risk aversion Glass half-full Glass half-empty Doves Hawks Developed Markets Emerging markets 2 Deflation Inflation QE 3 QE exit Bonds Equities Information Security Identification: Confidential Growth Recession Core Inflation
Bond Markets: fiscal stimuli, QE, but sovereign debt concerns abound Credit markets have stabilized but not fluid yet; Bank lending remains relatively tight; Eurozone liquidity issues Fiscal policies weigh stimulus vs austerity needs amid persistent concerns about sovereign debt sustainability TED spread: 3 m LIBOR less 3 m T-Bill yields Bond 2 yr-10 yr yield spreads 5 yr CDS sovereign spreads Equity Markets: wealth destruction, recovery, but been susceptible again Developed equity markets have been recovering gradually, but recent setbacks amid growth concerns Emerging equity markets have bounced stronger, but relapse has led to investors becoming very selective % move since 1 July 2008: DAX, SPX, NKY 3 Information Security Identification: Confidential % MSCI move since 1 July 2008: Lat. Am, Asia, E. Europe
About BNY Mellon’s i. Flow – total assets monitored worth ~ $33 trillion Global Custody: largest in the world at $25. 8 trillion drawn from heritage Mellon & BNY Platforms Market Penetration: Flows represent about 15 -27% of tradable securities in most markets worldwide Objective - based on tangible and concrete data, not surveys Timely - investor flows: on a trade-date basis, updated daily; - investor positions: timely updates of monthly shifts (equity, bond and currency portfolios) Level of Detail - adds invaluable insight into market activity with unparalleled granularity Comprehensive and Relevant Multi-Asset Perspective - encompassing Equity, Fixed Income & FX markets activity globally History – Flows data extend back to 15 -21 years’ history (Equities/Bonds to 1996, FX to 1990) Performance & Risk Analytics – Mellon Analytical Solutions (formerly Russell/Mellon) & BNY Global Risk Services • Client relationships represent $8. 9 trillion in assets under measurement • Investor positions vs benchmark (e. g. MSCI EAFE, Bar. Cap Global Agg etc); What are my competitors/peers doing? IMF GFSR: Correlation between BNY Mellon i. Flow and Bo. P Flows 4 Information Security Identification: Confidential
i. Flow: where is the money going? i. Flow featured in the International Monetary Fund’s Global Financial Stability Report, Oct 2010 For example, net equity flows to Brazil reported by BNY Mellon represent about 10 percent of those recorded in the balance of payments, with a correlation coefficient of 84%. Similarly, net bond flows to Korea represent about 5 percent of those recorded in the balance of payments, with a correlation coefficient of 61%. 5 Information Security Identification: Confidential
i. Flow: strong bond & equity inflows in emerging markets i. Flow featured in the International Monetary Fund’s Global Financial Stability Report, Apr 2011 Debt inflows were particularly strong, with economies that offered higher levels of risk-adjusted local government bond yields (prior to the surge in capital flows) attracting greater foreign inflows (Figure 1. 33). 6 Information Security Identification: Confidential The response of emerging market firms to equity and debt inflows has been strong. Equity issuance rose to the highest levels ever in Brazil and China, and although in India and Korea such issuance remained below pre-global crisis highs, it surpassed pre-Asian crisis levels. 33, 34 Similarly, the supply of emerging market external corporate bonds in 2010 surpassed historical records in aggregate, led by Latin American corporate bonds. 35 Figure 1. 36 shows that large equity issuance appears in some cases to have mitigated equity appreciation stemming from strong foreign portfolio inflows. Brazilian firms issued actively through IPOs, absorbing large inflows without stretching valuations. Some Asian corporate markets have displayed a combination of price & supply responses.
i. Flow: peripheral Eurozone debt firmly out of favor i. Flow featured in the International Monetary Fund’s Global Financial Stability Report, Apr 2012 7 Information Security Identification: Confidential
i. Flow: What are our investor flow data telling us? • Bond yields have diverged within the Eurozone – relative weakness in the periphery has led to a renewed spike in yields • Yield differentials between Germany and especially Greece, Italy, Portugal, Spain and Ireland have widened again • Lack of a coherent solution, policy discord, severe austerity – Spain: investor focus now; Greece: re-escalation of crisis; Italy: contagion worries; Portugal: persistent funding concerns • German bunds in favor as investors seek relative safety and liquidity, but safe-haven status starting to wane? 8 Information Security Identification: Confidential
Currency Markets: US Dollar at a crossroads Fed Chairman Bernanke stays the course on accommodative stance - “I think it’s a little premature to declare victory” Challenging mix of a frustrating recovery and inflation – will price pressures prove transitory? After a secular USD downtrend, a strong dollar trend emerged since in 2008 H 2, faded in 2009, re-emerged in 2010; USD down and up in 2011 Recent data on manufacturing, employment, consumer confidence – monetary accommodation to continue => but risk-off bouts buoy USD FOMC to keep rates low; Operation Twist; Will QE 3 entail more monetary easing? ISM Mfg & Non-Mfg; Consumer Confidence US Trade-Weighted Major Currency Index 10 -year US TIPS-nominal Spread Home Sales: Existing and New USD total speculative positions (CFTC data) and DXY Non-farm payrolls & Unemployment Rate 9 Information Security Identification: Confidential
i. Flow Insights: Global Capital Flows and Investor Activity • US Treasuries still sought; Cross-border investors prefer relative safety and liquidity • US equities have been favored especially by cross-border investors, supporting benchmark indices • USD buoyed by risk aversion, though Fed’s continuing monetary accommodation remains a weight VIX (CBOE) Vol Index = pay for insurance against equity losses 2011 -12: VIX peaked at 29. 40 just after Japan’s quake/ tsunami in Q 1, fell below the 20. 35 average over two -decade history, spiked and fallen 10 Information Security Identification: Confidential
EUR: renewed pessimism … what is that light at the end of the tunnel? • Contagion fears as crisis spreads to ‘core’ from ‘periphery’; Policy discord a key concern • Since mid-2010, the EUR benefited from oversold/undervalued asset markets; 2011 rekindled doubts • ECB hawkishness also proved supportive for the Euro in 2010; likely to fade in 2012 • Eurozone’s two-speed economy may become one-speed as growth stalls; potential fallout from default? • EUR had provided only credible alternative (sovereign debt markets that were deep enough) to USD for reserve managers looking for an alternative home for their fresh funds. EUR was being seen as “new DEM”? However, Greek crisis was a sharp reminder that it’s the component of all its parts (e. g. , its also the “new GRD”, the “new ITL”, the “new PTE”). • 2010: considerable anguish vis-à-vis sovereign debt crisis • 2011: contagion fears erupt Germany and France stock markets shed -30% in 2011 Q 3 Austerity may further choke growth amid economic headwinds • Ongoing policy discord about effective crisis prevention mechanisms such as the EFSF Eurozone banking sector vulnerable – tight liquidity and weaker credit creation further limits growth potential Greece is the word Deficit reduction disappointment 2012 -14 financing gap is large; cannot access markets near-term Recession may be deeper and longer; painful adjustment • Germany’s hard stance; France differs; ECB adamant about no restructuring or credit event • Support for peripheral debt shown by China & other Asian nations • 2012: Greek denouement – tragedy or the great escape? Private bondholders negotiate; IMF reiterates caution Spain: in focus now 11 Information Security Identification: Confidential
Parallelism/Contagion: Other Sovereign Debt Concerns? Steady outflows from Spain and Italy in recent months; Greece and Portugal out of favor Concerns about Dubai and Greece have been paramount in recent years. Lingering risks in other countries – contagion? Fiscal accounts in focus; US/EU downgrades – Meaningful alternatives to holding sovereign debt as public debt burdens grow? Since 10/1/2010: CDS (5 yr) percentage changes 12 Information Security Identification: Confidential
Central banks’ balancing acts in 2011 -12; Currency tensions? • Central banks in advanced economies dealing with growth moderation, rising inflation • Policy rates had converged at historic lows; some central banks started the process of normalization but stopped short in their tracks; others continue • Keeping options open for now: Monetary accommodation in place, keeping interest rates low • US: May yet consider QE 3 if core inflation remains low & labor market worsens • UK: Bo. E may consider another QE despite up-tick in inflation; spending cuts • Japan: Battling deflationary forces, lowered rates & raised asset purchases • Switzerland: Mindful of deflationary pressures, CHF strength a major concern • Currency weakness either a consequence of monetary policy choices (such as QE) or a deliberate policy in and of itself … currency as a policy weapon • Investors’ erosion of faith in currencies as “stores of value” • General discontent about competitive currency “devaluations”? • Mar 2011: show of solidarity by G-7 – coordinated JPY intervention amid crisis • Now, inflationary pressures a concern even as recovery threatens to stall • Emerging markets central banks had been pro-active in tightening as growth was relatively more robust; now rate hikes on hold as growth falters G-10 Policy Benchmark Rates Select Emerging Markets Currencies: Policy Rates US Growth and Inflation Trends • US: Treasury Secretary Geithner: "We are concerned, as are many of China's trading partners, that the pace of appreciation has been too slow and the extent of appreciation too limited. ” • Japan: Finance Minister Noda : “There is something unnatural about the fact that China can buy Japanese government bonds while Japan cannot (purchase Chinese bonds). …. I do not know what their true objectives are, but we would like to clarify their objectives. ” • China: Yao Jian, Commerce Ministry spokesman: it’s unreasonable for the US to level criticism at China's exchange rate policy simply because of its trade surplus, and points to China’s trade deficits with Japan & Australia as evidence that the CNY was not the root cause of the US imbalance 13 Information Security Identification: Confidential Stagflation
Gold as a safe haven and “store of value” • Concerns about inflation • Risk aversion – Eurozone (sovereign debt crisis); Middle East (political upheaval); Japan (natural disasters) • Broader lack of confidence as growth moderates and fiscal problems persist; US credit rating downgrade • Lasting store of value; an instrument to protect purchasing power of savings • Central banks turning to gold both as an investment and as a means of diversification - As of March 2011, held 27, 219. 8 metric tons (11. 3% of total reserve holdings) - Feb-Mar 2011: Mexico, Russia and Thailand added gold worth about $6 bln to their reserves. Mexico bought 93. 3 mt, raising holdings from about 6. 9 mt. Feb-Mar 2011: Russia bought 18. 8 mt to raise holdings to 811. 1 mt Since 1/1/08: Gold Price and US Dollar Index (inverted). Thailand bought 9. 3 mt to 108. 9 mt Gold prices have not just benefited due to US dollar weakness. Gold prices have gained during periods of both US dollar weakness and US dollar strength in recent years. • If almost all the major nations would like to benefit from more competitively priced currencies then what can investors still buy as a “store of value”? No surprises. • Will disinflationary trends curtail gold price upside? PHYSICAL DEMAND FOR GOLD IN CHINA AND INDIA During 2011 Q 1, gold consumption in China totaled 233. 8 tons up from 158. 9 tons a year earlier – World Gold Council. Growth was more than triple the average 14% annual pace since the nation’s market for the precious metal was deregulated in 2001. As of end-May 2011, Industrial and Commercial Bank of China (ICBC – world’s biggest lender by market value) set up 1. 4 mln gold-linked accounts since their introduction in Dec 2010 China has overtaken India to become the world’s largest physical investment market, -- demand for gold jewelry increased 21 % to a record 142. 9 metric tons and with purchases more than doubling to 90. 9 tons. 14 Information Security Identification: Confidential USD weaker •
Multi-speed recoveries & policy divergence; commodity-cycle a key factor • Emerging markets: most had enjoyed strong recoveries – led to a structural increase in commodity demand, while supply responses had been slow • Weak USD has also kept commodity/energy prices buoyant • Renewed investor buying in commodity-linked markets led to a buildup of inflationary pressures • Stalling global growth has removed a major price support; copper and crude oil fell -17% in 2011 Q 3, worst quarter since 2008 Q 4 • Growth prospects and resilience in emerging markets a key focus • Significant capital on sidelines may be deployed selectively Jan 2012 April 2012 IMF: WORLD OUTPUT 2012 2013 WORLD BANK Developing Economies China India ASEAN-5 Brazil 1. 4 2. 1 -0. 3 2. 0 2. 4 0. 9 1. 7 OECD Countries US Euro Area Japan 5. 7 6. 0 8. 2 6. 9 5. 4 3. 0 Advanced Economies US Euro Area Japan Commodity Index Comparisons 8. 8 7. 3 6. 2 4. 1 Developing Economies China India East Asia and Pacific Brazil 2012 2013 1. 3 2. 2 -0. 3 1. 9 2. 4 1. 1 1. 6 5. 4 8. 4 6. 5 7. 8 3. 4 6. 0 8. 3 7. 7 7. 8 4. 4 JOCIMETL (Journal of Commerce): Steel, Copper, Aluminum, Zinc, Lead, Tin, Nickel SPGSCI & CRY: Grains, Soft Commodities, Livestock, Energy, Precious. Metals, Industrials as of Dec 2009 S&P GSCI Agriculture, Industrial & Precious Metals sub-indices G-10 FX Returns 9 Mar 2009 – 01 May 2012 Source: Bloomberg 15 Information Security Identification: Confidential
China – poised for growth; but is slowing to a more sustainable pace • • • China is a key locomotive of global growth Full-year 2011 GDP grew 9. 2%, down from 10. 3% in 2010 Trade surplus in 2011 fell to $155. 14 billion from $181. 51 billion in 2010, the smallest in six years Foreign reserves fell to $3. 18 trillion in 2011 Q 4 from $3. 2 trillion in 2011 Q 3, the first quarterly decline since the 1998 Asian crisis. Currency flexibility since 19 June 2010 has encouraged investors who have been monitoring policy maker efforts to rein in overheating pressures such as in bank loans, property Since Jan 2011, PBOC has raised benchmark rate 3 times and boosted lenders’ reserve requirement ratios 6 times The Shanghai Composite Index fell about 30% during Apr-Dec 2011 on concerns about inflationary pressures and higher borrowing costs hurting corporate earnings, but steady net inflows in place have seen the index gain +11% Jan-Apr 2012 China’s changing growth model Premier Wen says the main cause of the US trade deficit is not the exchange rate of the Chinese currency, but the structure of investment and savings Premier Wen says China has made increasing consumption a longterm strategy USD/CNY and Yuan NDFs for 1 m and 1 y PBOC governor Zhou Xiaochuan said on April 16, 2011 at Boao Forum 2011 annual meeting that the exchange rate tool has been used to fight inflation when he was interviewed by the media. He said, “The exchange rate is actually already in use, the yuan has appreciated, and how to measure its effectiveness in fighting inflation, usually is difficult. " INTERNATIONALIZATION OF THE RENMINBI Regulatory change: RMB settlement in Hong Kong September 27, 2010 onward – deluge of issuance as institutions tap the RMB market Gradual liberalization of China’s capital account could see the CNY emerge as a viable longer term alternative in currency portfolios PBOC Governor Zhou Xiaochuan - "When there is a certain amount of cross-border use of the CNY, there will be a natural demand that the CNY will move towards full convertibility in a gradual and orderly manner. " HKMA Chief Executive Norman Chan Hong Kong Yuan Deposits at a record USD 89 bln as of end-July amid companies’ demand for Chinese currency (up 82% YTD as of July) 16 Information Security Identification: Confidential
i. Flow Insights: Commodity-linked markets slowly regaining lost allure • Strong buying of ZAR, BRL & RUB as commodity prices rose from March ’ 09 lows; some profit-taking and selling, inflows again; higher oil prices boosted especially the RUB, recent oil price decline hurt but renewed buying of late • AUD, NZD had been in favor as G-10 ‘commodity-linked currencies’ but have lost ground in recent months as growth outlook sours; recent Kiwi downgrade; CAD weighed by energy price moderation and risk aversion, but recovering now 17 Information Security Identification: Confidential
The thirst for yield: currency markets weighed by asset-markets’ sell-off • Low rates in mature markets had boosted emerging markets capital inflows, investors pulled back, now slowly getting back in High Yielding Emerging Markets Currencies vs USD 18 Information Security Identification: Confidential
The thirst for yield: Asia has been well-placed, but no longer remains insulated • Domestic demand regional trade key drivers • Favorable growth prospects led to strong equity inflows since March 2009 • Growth moderation concerns have afflicted the region • Asia still relatively well-placed Asia: price pressures Asia FX Reserves: strong growth; stop and re-start 19 Information Security Identification: Confidential Asia Currencies vs USD
Asia & other emerging local bonds: sentiment has soured a bit • Emerging East Asia local currency bond market grew 13. 6% in 2010 to $5. 2 trillion • Local-currency denominated debt instruments • Large and liquid asset class • Relatively high yields • Central banks did not raise rates aggressively in 2011 • Currency appreciation potential • Improved credit worthiness • Favorable growth differentials • Recent inflation pressures have damped investor enthusiasm • Risk aversion has led to some outflows, but inflows resuming ADB Report • Growth in the region has been marked by improving maturity profiles for many individual corporate and government bond markets. This reflects improving structural fundamentals as lengthened duration will attract a greater diversity of investors. • Foreign participation in the region's local bond markets continued to expand as investors hunted for yield anticipated gains from appreciation of the underlying currencies. For example, foreigners held 30. 5% of Indonesian government debt at the end of 2010. 20 Information Security Identification: Confidential
Asian and other EM central banks: FX Interventions volte-face • Significant amount of portfolio capital inflows i. Flow: Cumulative Equity Flows in Japan & South Korea • China becoming more interested in neighbors’ asset markets More buying of Japanese government bonds Stepping up purchases of South Korean debt Added MYR to small group of currencies allowed to be traded directly vs CNY • Variety of measures to deter flood of inflows? South Korea: Audit of lenders handling foreign currency derivatives Brazil: tripled tax to 6% on foreigners investing in debt securities • FX interventions to smooth local currency appreciation; but abrupt turnaround as EM central banks look to limit currency downside i. Flow featured in IMF GFSR Report Oct 2010: In response to increased foreign inflows, policymakers in a number of countries have introduced a variety of measures. For instance, authorities in Brazil, Indonesia, and Korea introduced measures to mitigate the impact of strong capital flows on domestic macroeconomic and financial stability – precisely in countries where the BNY Mellon i. Flowsm data found foreign equity inflows had become especially persistent. The measures in these countries might have changed the overall composition of capital inflows, but they have not as yet significantly reduced the persistence of equity inflows. 21 Information Security Identification: Confidential 1 Jul ’ 08 – 28 Feb ‘ 09 1 Mar ’ 09 – 30 Apr ‘ 10 1 May ’ 10 to date
i. Flow Insights: Bond Allocations by Currency 2007 -12 • JPY-denomination shot up in Jul 2007, stayed at elevated levels, spiked in Jan 2008, and again Sep 2008 onward • Periods of risk aversion: Higher Allocation to USD-denominated bonds as riskier positions were liquidated during equity market sell-offs in Aug ’ 07, Nov ’ 07, Jan ’ 08 and Sep ’ 08 onward • Investors favored the shorter end of the curve amid search for safety and liquidity • Up-tick in EUR-denominated holdings in Jan/Feb ’ 08 => EUR/USD broke above 1. 50 and 1. 55 • Spike in EUR/USD in Dec ’ 08/Jan ’ 09 (1. 25 to 1. 45); JPY began losing its safe-haven allure during 2009 Q 1 • Reverse direction for EUR/USD in Aug ’ 07; also in Aug ’ 08 (1. 56 to 1. 46) and Oct ’ 08 (1. 40 to 1. 27) • UK gilt buying outpaced CAD bonds during 2010 H 1, profit-taking on Gilts during 2010 H 2 • Canadian bonds have been out of favor lately, but slowly recovering • USD-denominated bonds: steady appetite in recent months amid risk aversion, consistent with decline in yields Cumulative Monthly i. Flow: Developed Bonds as of 01 May 2012 22 Information Security Identification: Confidential
Interesting Juncture for Asset Allocations • • • Relative valuations: bonds in vogue again; equities have had a good run Strange co-existence of risk aversion and risk appetite, former re-asserting itself Continued low rates & additional QE prospects had fueled global liquidity Positive for asset markets as QE-related currency debasement fears arose G-24 emerging markets saw currency appreciation amid strong capital inflows Risks: debt crisis contagion; growth setbacks; buoyant price pressures Risk aversion and asset markets’ sell-off offers very attractive strategic plays Equity upside as excess capital deployed; evidence of buying in select markets Emerging markets as an asset class attractive – both equities and bonds 23 Information Security Identification: Confidential i. Flow Daily E-Mail as of 25 Jan 2011
i. Flow: Key 2012 H 2 focus on whether investors 1. raise or reduce risky exposure 2. adjust asset allocations 3. become more selective Strategic nalysis Quant A Fundamentals Tactical Strategic & Tactical Allocations/Trading Ideas Portfolio Flows Deviations from Benchmark 24 Information Security Identification: Confidential Tactical P&RA (formerly MAS/Russell Mellon) • ASSET MIX • COUNTRY & SECTOR ALLOCATIONS Equity/Bond Positions
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