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Cross currents

July 19, 2013

ET

If you were a grown up ET immersed in finance and returning for a quick visit you’d be puzzled by the different signals of the  financial markets on planet earth. This week, the city of Detroit filed for bankruptcy and it is merely one of many localities in America that is facing the financial abyss.  http://www.cnbc.com/id/100898027  Yet, at the same time, the stock market in America rallied to new all time highs and economic indicators were neutral. The same economic reality is seen across America as wages are again, neutral. Take a look below and keep in mind that the “real growth” is measured by the seemingly low CPI.

Household income

Furthermore, global business sentiment is rather subdued as you can see here:

Global Business expectations

How about forward-looking GDP  that should point up if the stock market is rallying to new heights? Well, unfortunately, the GDP numbers don’t justify rising equities either as lower GDP means lower earnings…

GDP estimates vs. stock market

http://www.zerohedge.com/sites/default/files/images/user3303/imageroot/2013/07/20130718_dow.jpg

Perhaps, the rest of the world is growing so fast that the multinational corporations are benefitting from a global growth spurt? Unfortunately, that is also not the case as you can see record diversion of the S&P500 vs. Emerging Market stocks below, something we have not seen since the depth of the past financial crisis in 2009. If the rest of the world is growing robustly, emerging markets should be leading global equities.

Emerging markets vs. S&P500

Hinde capital, page 37 of http://www.scribd.com/doc/153909939/HindeSight-Investor-Letter-June-2013-Top-of-the-BoPs

The Great Rotation

It is rather puzzling how the global economy is doing poorly, sentiment is low and even safe haven governments are struggling yet the stock market in America is racing to new heights. Here is my take: Due to the held down (negative real) interest rates on all bonds and the expectation of rising rates down the road, bonds understandably have become the investment in the penalty box. Yield starved retirees and savers who used to deem the stock market too dangerous to be in have decided that the risk of owning staple dividend paying corporate stocks such as Coca Cola, Exxon, Johnson & Johnson etc. is lower than owning bonds of all sorts. Not only do safe bonds return a negative real rate of interest but now investors also have to worry about credit risk as we witnessed in Detroit. Given the fact that large corporate balance sheets are much healthier than public balance sheets and that these companies reward investors with equal or higher dividends than bonds, we witness a large rotation from bonds into quality stocks. Furthermore, there is little interest rate risk in these stocks as most large companies can pass on higher prices to the consumer while bonds get destroyed when inflation rises.

In my opinion, this will probably go too far and lead to a spectacular crash down the road. But for now, this is the world we live in and which was created by the central banks to instill confidence in the consumer. I sincerely hope that central banks will find a way out of the situation although I am not sure I can find a mathematical way out that is benevolent. As for investing, stay disciplined and diversified. There are many cross currents out there and you don’t want to be fully invested in what may turn out to be the under tow.

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