Commentary: French without Tears
Equity markets have started 2012 in finer fettle than for most of the second half of 2011, with global equities, as represented by the MSCI All Countries World Index (gross, sterling return) up 4.7% so far this month, with risk aversion falling, as measured by the Chicago Board Options Exchange’s Volatility Index (VIX) from 23.4 at the end of last year to 20.9 at the end of last week. The developed markets (MSCI World Index) are up 4.5%, led by the United States being up 6.7%, offsetting a weak start from France, Germany and Italy.
The MSCI Emerging Markets Index is up 5.8% in sterling, led by China (up 10.9%), Taiwan (+9.4%), Indonesia (+9.3%) and Brazil (+8.0%). The clearest sign that risk is being sought is the strong performance of the global banking sector, up 7.4% in sterling so far this year, although the broader distribution of equity performance is shown by the pharmaceutical sector’s +7.7%. Value is to the fore, outpacing growth so far this year, but large and small cap are broadly in sync.
It is of course very early days in the calendar year, a notch in time which appears irrationally and arbitrarily important to most investors, and the first significant reality bump occurred after the markets closed on Friday as the S&P ratings agency followed through on their December warning and downgraded the credit rating of France and Austria. However the yield spread of French over German bonds had been signalling for some time how investors were pricing the credit of one against the other. Of more concern may be the knock on effect on the credit rating of the EFSF, as it draws on the underlying credit ratings of the participating countries, and thus its effective spending power is reduced.
However the real impact may be the nudge to investors that while markets are currently calm, the Eurozone story is by no means over, with Greece still struggling to negotiate with holders of its bonds about the extent to which they accept a loss. As these negotiations falter, the prospect of Greek default and a disorderly exit from the Eurozone rises. The concerns about interbank liquidity in Europe still exist, but the ECB’s LTRO (long-term refinancing operation providing three year loans) has done its job in providing a much needed, and open ended, source of liquidity to European banks.
Elsewhere underlying US economic data continues to be broadly positive. The economic research house ISI report US dividends up an annualised 21% in the fourth quarter, US M2 money supply up 10.8% year-on-year, bank loans up, their truckers survey up to a reading of 56.9 compared with its recession low of 7.6. Their conclusion is that the US economy has become self feeding. It could disappoint of course, especially if the wash from a European recession hits US shores.
However the picture in Asia looks more positive and we will get further signals this week: Chinese GDP and industrial production data for Q4 2011, and UK inflation, all on Tuesday; US industrial production and producer prices on Wednesday, and US inflation and the Philly Fed survey are reported on Thursday. Friday sees Canadian inflation, UK retail sales and Taiwan’s industrial production reported.
According to FactSet, the MSCI ACWI stands valued at 11.4 times historic earnings, compared with the low of 7 times in 2008, whilst the MSCI EM index is on 10.1 times historic earnings. Europe ex UK is the cheapest region on headline numbers, at 9.7 times next year’s earnings.