Has spring sprung?
Frogspawn, tadpoles, catkins, ladybirds, snowdrops and nest-building rooks are just a few signs that spring has sprung early this year. Indeed, some scientists are convinced that the traditional European winter is a thing of the past, such has been the impact of global warming.
The investment climate has been rather more frigid. Between September and December institutional investors staged a buyers strike. However, their mood seems to be following the seasons and has lightened steadily in the last few weeks.
For an unprecedented four months, between September and December, the regime map used by the strategy teams at State Street Global Markets to describe investor behaviour and the pattern of cross-border equity flows had been stuck in riot point. As the name suggests this is the most bearish of the five regimes represented by the map. It also tends to be the least persistent, so the four-month run of riot point regimes was a record-breaking period of risk aversion. However, the map has now shifted to leverage, marking the first improvement in risk appetite since the start of the credit crunch last August.
Some response from investors to the latest round of rate cuts from the Federal Reserve and Bank of England was likely. The timing and magnitude of the Fed’s 75 bps ease on 22 January was a much needed jolt of adrenaline. The move was little short of astonishing, the first inter-meeting rate cut since the aftermath of the 11 September 2001 terrorist attacks and the largest reduction in rates since the Fed starting targeting Fed funds.
This monetary stimulus, together with President Bush’s $145bn (€99.5bn) fiscal package, is aimed at avoiding a recession in the US. Time will tell if the Fed’s medicine works. However, it already seems to have sparked a more bullish mood among investors. In the two weeks following the Fed’s announcement selling turned to buying in euro-zone, Latin American and Japanese equities. It is the renewed buying of these markets that has tipped the regime map into leverage.
Though still highly volatile, markets too have responded reasonably well to the Fed’s move. In the immediate run up to the cut, the US S&P500 recorded its worst four-day decline since 2002, on 21 and 22 January, Japan’s Nikkei fell 9.3%, the largest two-day fall in 17 years and on 21 January the FTSE and Dax staged their largest fall since 11 September 2001.
By comparison the start of February was calm.
However, the shift to leverage does not mark the wholesale resumption of risk-seeking by investors. Rather than selling equities across the board, they have returned to selective buying. Interestingly, the strongest flows are into Latin America and Japan, two parts of the world that are remote from the epicentre of the credit crunch in the US and UK. Japan has fallen more than 25% from its recent July 2007 highs.
The same pattern of selective risk-seeking can be seen at the sector level. Buying has turned to selling for classically defensive sectors such as consumer staples, healthcare and utilities. But the message is also a mixed one. Flows remain negative for cyclically sensitive materials and IT.
Cheaper money and cheaper stocks seem to have combined to revive risk appetite. The three sectors that have the lowest market value to capital multiples have positive flows - financials, telecoms and consumer discretionary. The two sectors with the highest multiples - energy and IT - continue to be sold. The correlation between flows and market value to capital ratio has risen to 78%, the highest in a decade.
This does not necessarily mean that investors are optimistic about economic growth. Rather, sectors such as financials and consumer discretionary have already fallen below the market value to capital ratios seen in previous recessions. Since the latest wave of writedowns, little new has emerged from the credit crunch. Speculation about the future of the monoline bond insurers has been in the air for months. Investors are behaving as though the bad news is already in the price.
Leverage tends to be the most persistent of the five regimes. However, these are strange times. Riot point has tended to be the least persistent but has just had a four-month run. There has been only one time the regime has shifted from riot point to leverage and then back again. That was caused by an exogenous shock, the impending Russian debt default in August 1998. With the global economy slowing and the continuing threat of contagion from credit markets spreading, there is no guarantee that the current flirtation with risk will prove long lived. But for institutional investors and nature watchers, spring has come early this year.