29th April 2013
Dan Morris, global strategist at J.P. Morgan Asset Management has been looking at the fact that while some assets are losing their safe haven status not all are. We include the full note below including the fact that based on valuations and future earnings, in his view, equities remain the best place to be.
“Is the Great Rotation leading to the Great Unwinding? The decline in the yen over the last several months is only partly a function of the Abe government’s plans to revitalise the Japanese economy. It is also a reversal of the appreciation the yen underwent during the financial crisis. The currency traded between 100 and 125 yen per dollar in the five years before 2008 and is now moving back towards that level. Gold is similarly giving up some of its safe haven gains as memories of the mortgage crisis fade and the eurozone crisis becomes ever less acute (see Figure 1). Equity indices have been more volatile recently but have managed to advance nearly 2% this month. Most notably, yields on European peripheral government debt have fallen to levels not seen in years. They, too, seem to be finally benefiting from the hunt for yield.
“But the unwinding is not universal (and certainly not complete). The curious part has been the behaviour of US Treasury, Bund and Gilt yields. Improving investor optimism during the first quarter led to rising yields for US Treasuries and declining yields for peripheral government bonds. But the pattern has since changed as peripheral yields have continued to fall while core sovereign debt yields have now started dropping, too (see Figure 2).
“What might explain the apparent disconnect? Quantitative easing (QE) is not an obvious candidate as the yields on US, UK and German debt have fallen largely in line even though the US is the only country where QE is underway. Nor can we look to the influence of Japanese investors fleeing the dismal yields in their own government bond market. The latest data show they are still repatriating funds held abroad as the yen declines.
“Economic growth expectations, on the other hand, have been softening as marginal data from China disappoints, worries linger about the impact of payroll tax increases and sequestration in the US, and Germany looks increasingly burdened by its neighbours’ slow growth. If this is the cause of falling yields, we believe that the trend is likely to reverse, however.
“While China’s first quarter growth rate was below expectations, domestic consumption increased and net exports contributed to growth for the first time in several years. The US GDP release also showed growth slower than economists had forecasted, but a look at the components is encouraging. Consumer demand thwarted the naysayers worried about high unemployment and a payroll tax increase by contributing 2.2% to growth in the quarter, above average and the second highest reading since 2006. Residential and business investment continue to grow, but net exports subtracted from growth as did government spending.
“The data for the UK economy indicated GDP growth stronger than forecasted, though at 1.2%, on an annualised basis, it is hardly robust. Germany is less likely to provide positive surprises given recent weak PMI readings for the manufacturing sector. But even if the outlook for growth is still cloudy, current yields on government debt are too low relative to inflation, and the continued ‘rotation’ and ‘unwinding’ fund flows should lead to a rebound in bond yields.”
“Investors in equities are buying a share in earnings not GDP. US corporations are again proving their ability to increase earnings even when economic growth is challenging. With more than half of the companies in the S&P 500 having reported (and two-thirds of the index market capitalisation), earnings look to grow by 2.3% instead of the 0.5% expected at the beginning of the quarter. Every sector has managed to beat analysts’ forecasts, with the index overall topping estimates by 4.7%. But all is not rosy, however. Revenues have risen by just 2%, largely in line with forecasts (excluding the energy sector), but the performance has varied across the sectors (see the orange diamonds in Figure 4). Moreover, company guidance has weakened below what we have seen in recent quarters. Consequently, earnings growth for the rest of the year is now likely to average 9% instead of 11% as originally hoped. The point, however, is that earnings will continue to rise, and thanks to good valuations, equities are still about the best game in town.”