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By Gary Dugan, Chief Investment Officer, Private Banking, Emirates NBD
Liquidity continues to be the main driver of the rise in markets. Last week's European Central Bank (ECB) Long Term Refinancing Operation (LTRO) led to 800 banks receiving funding of an aggregate €539 billion for three years at a cost of just 1%. The banks are then going out and using the funding to buy Euro zone debt, which in turn drives down Euro zone bond yields. Italy has been the chief winner from the ECB's actions. The Italian 10 year bond yield has fallen by over 200bps since the start of the year.
Whilst the cash seems to be finding its way into the financial markets, the only way the market rally can be sustained is if the cash finds its way into the Euro zone economy and drives growth. Unfortunately Euro zone money supply growth - a good measure of the impact of money on the economy- is still weak. A growth rate for M3 (a broad measure of money supply) of just over 2.5% is very poor relative to many other parts of the world and not consistent with a recovery in the economy.
Liquidity will continue to play a major part in driving markets but after such a strong rally for markets to make progress needs ongoing upgrades to global growth forecasts. There is a new impetus in the emerging markets with strong industrial confidence indicators reported for Korea and Taiwan in recent days. In Korea the trade report showed exports up 33% at an annualized rate.
In Thailand industrial production was up nearly 20% month-on-month in January after an even stronger December. In contrast the US economic data has disappointed somewhat. The labour market continues to show improvement but industrial confidence slipped back after the recent strong consistent rise. In truth US economic data was so strong earlier in the year that it was going to be difficult for the data to keep matching best expectations.
Emerging market economies delivering growth surprises
The stronger data from the emerging economies is likely to reinforce the strong relative performance from emerging market equities and bonds. The only reservation we have is that the ongoing strength of the oil price could still deliver an inflation scare that slows the pace of monetary easing in many parts of the emerging world. The original reason investors piled into emerging markets over the turn of the year was the prospect for cuts in interest rates, and the belief that Europe's problems weren't going to do systematic damage to the rest of the world.
In just a few weeks many of those interest rate cuts have been more than discounted with the risk that the rise inflation may stop some of those cuts in interest rates from happening. Not only is inflation posing a potential problem but Brazil for example is also trying to cope with significant inflows of capital that has led to upward pressure on the Brazilian Real. The authorities have announced a series of measures to slow the rate of appreciation of the currency such as restrictions on companies issuing external debt as it encourages inflows of capital into the country. After such a strong start to the year there is a temptation to take profits on the Brazilian equity market.
In contrast to the challenges to the Brazilian markets, Russia asset markets could rally further post the emphatic win of Vladimir Putin in the Presidential election. In particular the Russian equity market could provide investors with further strong absolute gains. Russian equities trade on an exceptionally low valuation (P/E of 6.3x).
Staff
