Solid equity market performance during the first quarter reflected a recovery in global economic growth coupled with a supportive liquidity backdrop. Markets may be choppier into mid-year as economic momentum moderates but the liquidity indicators monitored here remain favourable, suggesting limited downside.
The revival in global growth following significant weakness in mid-2012 was foreshadowed by faster real narrow money supply expansion from last spring – real monetary trends lead the economy by about six months, according to the “monetarist” forecasting rule. Six-month global real narrow money growth, however, peaked in October 2012 and has continued to slow in early 2013 – see first chart. Allowing for the half-year lead, this suggests that economic momentum will start to fade again in mid-2013.
Global real money growth slowed in a similar fashion in early 2011 and early 2012 and equity markets subsequently corrected lower on both occasions. The 2011 decline, however, was more severe, with the MSCI World index falling by 23% in US dollar terms from peak to trough versus 13% in 2012, despite more significant economic weakness in the latter year. The likely explanation is that the liquidity backdrop was unfavourable in 2011 but supportive in 2012 – the gap between global real money growth and industrial output expansion was significantly negative for several months in early 2011 but remained mostly positive in early 2012.
Any coming equity market set-back may resemble the mild 2012 correction. First, global real money expansion remains respectable by historical standards – it is not, in other words, signalling major economic weakness. Secondly, the real money / industrial output growth gap has yet to close as it did in 2011 and 2012. Thirdly, the Federal Reserve and Bank of Japan (BoJ) are committed to further substantial liquidity injections – the market decline of 2011 may also have been influenced by the ending of US QE2 in June of that year.
The latter point is illustrated by the second chart, showing commercial banks’ holdings of cash at the Fed, BoJ and ECB along with projections based on announced US and Japanese QE plans. Combined reserves fell during the first quarter as Eurozone banks repaid borrowings from the ECB but US / Japanese liquidity injections should now dominate, resulting a new record being reached by mid-year.
Some analysts speculate that equities will receive additional “structural” support from a “great rotation” out of bonds but, even if true, this is probably of limited relevance for the near-term outlook. Retail buying of equities has picked up in early 2013 but inflows to bond funds have remained solid – any “rotation”, in other words, has been out of cash. Equity market outperformance reduces pension fund deficits and may, perversely, encourage more buying of bonds as liability matching becomes feasible.
Japan, Switzerland and the US were the best-performing markets in currency-adjusted terms during the first quarter, while the Eurozone periphery was again weak, along with emerging markets. This was similar to the ranking of real money growth at the start of the year – the US and Switzerland were then at the top, with the periphery at the bottom and emerging markets below the average. Japan’s outperformance partly reflected expectations of additional monetary policy easing in early April under the newly-installed BoJ leadership.
A key monetary development recently has been a sharp fall in US real narrow money growth – third chart. With Fed policy remaining expansionary, this was unexpected: it may partly reflect the removal of unlimited insurance of demand deposits at the start of the year but could also indicate a reining back of spending plans, perhaps in response to fiscal tightening. The size of the move argues against downplaying it – US economic performance may disappoint during the second half, with US equities underperforming.
Another notable change is that real money has resumed growth recently in the Eurozone periphery, led by Italy, although the rate of expansion is below the global average. The latest number predates the imposition of losses on Cypriot bank depositors, which could trigger renewed capital outflows, although this is not yet suggested by weekly ECB balance sheet data. Assuming no relapse, monetary trends suggest raising equity exposure while remaining underweight.
UK real money growth has also improved absolutely and relatively, despite the suspension of QE last November. Corporate liquidity is particularly strong – fourth chart. Institutional selling of UK equities, meanwhile, has abated: domestic institutions in aggregate were net buyers in the fourth quarter for the first time since 2010. These developments appear to support a higher UK weighting.
Japanese equities have been impressed by “shock and awe” BoJ easing but this has yet to be reflected in a pick-up in real money growth, which is in the middle of the global pack. The rally to date has been led by foreign buying – not usually a good sign – and some caution may be warranted pending either a relative correction or confirmation of monetary improvement.
Elsewhere, monetary trends remain favourable in Switzerland and Germany, with the latter dragging up the Eurozone core despite weakness in France and a slowdown in the Netherlands. Combined real money growth in the “E7” large emerging countries, meanwhile, is improving relative to the G7 as the latter slows, warranting consideration of an increased weighting, particularly following recent underperformance.
Bank of Japan securities purchases of ¥52 trillion in 2013 (up from ¥36 trillion under the Shirakawa plans) are equivalent to 4.6% of the M3 broad money supply measure. According to the Bank of England, QE “pass-through” to broad money has been about 60% in the UK. Applying the same figure to Japan suggests a broad money increase of 2.8%. There are grounds for believing that the BoE estimate is too high – a previous post argued that pass-through may have been as low as 20%, which if applied to Japan would imply an M3 boost of only 0.9%. Bottom line: suggestions of a 10% broad money rise over the next year are implausible. The FT’s headline about money in circulation doubling is highly misleading.
The Bank of Japan (BoJ) today announced a stepping-up of monetary easing but previous plans were already significant – the change is unlikely to transform Japanese economic prospects.
Under the new plans, the BoJ’s securities holdings will rise by ¥52 trillion* during 2013 versus ¥36 trillion implied by the superseded Asset Purchase Program (APP). The ¥16 trillion increase is of the same order of magnitude as rises of ¥10 trillion and ¥11 trillion in 2013 buying announced in December and October 2012 respectively under the previous supposedly-hawkish BoJ leadership.
The more significant elements of the new plans are:
Securities holdings will rise by a further ¥51 trillion in 2014 versus only ¥10 trillion implied by the APP.
The BoJ will now explicitly target monetary base expansion of ¥60-70 trillion yen per annum.
Treasury bill buying will be deemphasised and JGB purchases will no longer be limited to short maturities – this increases the likelihood that the BoJ will transact with non-banks, thereby directly boosting the broad money supply.
The first chart compares the new and old implied paths in 2013 for the BoJ’s balance sheet and bank reserves.
The acid test of the new policy will be whether it translates into a significant further pick-up in money and credit expansion. Annual growth rates of the various measures have lifted recently but remain unexceptional – second chart. Expanding the monetary base via securities purchases is no guarantee of broader money / credit improvement, as demonstrated by Japan’s prior QE experiment, as well as US and UK experience. The current plans, admittedly, are more ambitious. Qualified optimism seems warranted.
*The BoJ’s total assets are projected to rise by ¥62 trillion but this assumes a ¥10 trillion increase in lending to banks under the Loan Support Program – similar to the UK’s Funding for Lending Scheme. Such lending should be excluded from a “QE” reckoning.
The “MPC-ometer” model followed here is marginally more dovish than in March but still suggests a majority hold decision this week.
The small dovish shift mainly reflects better survey news on inflation – price expectations of consumers and CBI manufacturers eased in the latest polls. The activity inputs to the model are little changed from last month while financial market indicators remain strong, arguing for policy inaction.
The model excludes any money supply or credit quantity measure, based on their lack of influence on MPC decisions historically. The continued weakness of bank lending in February could conceivably cause some members who were previously unconvinced to vote for additional QE this month on the grounds that the impact of the Funding for Lending Scheme is proving disappointing. Such concerns, however, may be allayed by the credit conditions survey released today, showing a continued improvement in loan availability and pricing along with a pick-up in expected demand – see chart. (The view here is that the “creditist” focus of policy-makers and the media is misplaced and that recent stronger money supply expansion argues strongly against any further liquidity injection.)
The national accounts rental yield – actual plus imputed owner-occupier rents expressed as a percentage of the value of the housing stock – stood at an estimated* 4.0% at the end of the fourth quarter of 2012, the highest since 1999. This compares with a long-run average of 3.6%, suggesting that house prices are undervalued by about 10% relative to rents – see chart.
The rise in the yield from 3.9% a year earlier (i.e. in the fourth quarter of 2011) reflects a 7.3% increase in rents in the latest four quarters from the previous year offset by an estimated 3.3% growth in housing stock value.
The merits of the rental yield as a valuation metric were discussed in a previous post.
*The value of the housing stock is estimated after end-2011 by linking to the ONS (previously DCLG) house price index.