Equities – The Believers Vs The Non Believers

Gold is like a religion. You are a believer or you aren’t.

It all started with Gold in April and now this belief system is imposed on almost all asset classes. To believe or not ?

Equity Markets

The Jaws Of Death Camp

“Today an investor can earn 2.7% from a ten-year Treasury. How many stocks can beat that? Just 267 — or half as many.
And if rates go to a “normalized” 4.5%, how many stocks will be able to beat that? According to FactSet, just 58 stocks out of 1500 offer a higher dividend yield. In other words, if an income investor’s hurdle rate rises from 1.6% to 4.5%, the number of stocks with dividend yields that can jump over it collapses by 90%.
The bond market has already started waking up to the new math. But the stock market just parties on.” Source : Marketwatch  http://www.marketwatch.com/story/fed-tapering-the-math-investors-need-to-know-2013-08-15?link=sfmw_sm

Another way of visualising rising yields.

“Rising yields are bullish purely because it tends to be indicative of rising inflation and growth expectations. Rising yields are bearish if it chokes the consumer and acts as a deflationary shock. ” Source : Marketwatch http://www.marketwatch.com/story/the-mother-of-all-divergences-2013-08-19?link=sfmw

 

Equities are defying potentially higher rates, almost as if they choose to believe it only when they see it.

Gibson’s Paradox Camp

Zico has another theory, not exactly his own. The Gibson Paradox.

This is defined in Investopedia as follows.

“An economic observation made by J. M. Keynes during the period of the gold standard that there is a correlation between interest rates and the general price level. Keynes’ finding, which he discusses in “A Treatise on Money” (1930), is a paradox because it is contrary to the view generally held by economists at the time, which was that interest rates were correlated to the rate of inflation.”

Thus inflation can remain low but interest rates and equity prices go higher.

“From a structural perspective, extremely weak pricing power throughout the world is indicative of a global economic backdrop characterized by oversupply and a lingering threat of deflation, not inflation.
Cyclically, the China/EM credit boom that has supported global growth since 2009 is at risk.
Meanwhile, credit growth in the advanced economies, while reviving, is unlikely to be strong enough to completely offset the slump in China/EM.
Altogether, these dynamics entail that Gibson’s paradox – a positive correlation between share prices and U.S. bond yields – will resume.
Even though U.S. bond yields will likely fall, EM stocks, currencies and credit markets will resume their downtrend.” Source : BCA Research

“the weakest link in EM is capital spending, not consumer demand. At the same
time, any upside growth surprise in the U.S. will also come from investment. So far, U.S. capital expenditures have been mediocre in this cycle, hence there is pent-up demand for investment. With the cost of capital being low and confidence improving, American businesses will likely boost their investments.
Business cycles are typically driven by swings in capital spending and inventory cycles rather than consumption. Consumption is a low-beta variable and does not fluctuate much.” BCA Research

Zico sees the situation of a pull back in equities as a buying opportunity, although no longer a broad based one. Selective stock picks into new growth segments will be the key – alternative energies (he likes Chinese wind farms), healthcare in US and China (towards aging concerns) and technology (he still likes Amazon and Apple).

What I Think

Which is really not that important unless it happens to be what some bank is telling their clients.

I have never seen markets so polarised. Market herds are easier to predict, Up and Down. Now it feels more like a tug of war between 2 religious camps – the believers and the non believers that will result in a painful outcome of losses and capitulation. The ultimate  losers will be investors with a credit event resulting that will test the willingness of the regulators/game masters on their resolve on whether they want to continue preserving the everything-is-alright facade or if they will admit that to err is to be human.

It is time to hedge credit risks.