If not Egypt, what will stop risk asset rally?
Anti-government protests in Egypt gave financial markets a brief scare last week, but investors' sudden taste for safe-haven Treasury debt didn't last long.
February 04, 2011 / 08:39 IST
Anti-government protests in Egypt gave financial markets a brief scare last week, but investors' sudden taste for safe-haven Treasury debt didn't last long.
The US stock market hardly skipped a beat, either. Just days after plunging on the Egypt unrest, the Dow and S&P closed at 2-1/2-year highs, even as the uprising in Cairo wore on.Barely removed from the worst crisis since the Great Depression, markets appear impervious to risk. In the options market, the cost to buy insurance against sudden stock market slides have actually declined in the past two weeks.Still, some investors fear risk appetite is getting too big and say political unrest is one of many triggers that could spark a correction."Geopolitical issues are being brushed aside a little prematurely," said Brian Lazorishak, a money manager at Chase Investment Council in Charlottesville, Virginia. "And even when Egypt calms down, the problem is not gone. Sovereign debt problems are still out there and very real."Money poured into "risk assets" in the last quarter of 2010 after the US Federal Reserve pledged to keep interest rates low and pump another USD 600 billion into the US economy by purchasing more Treasury debt.Hopes the Fed's action would inject life into a sluggish US recovery helped spark what's turned into a five-month rally for the S&P 500 and enhanced the appeal of stocks, bonds and currencies from fast-growing emerging markets as investors sought higher yields.Emerging market equity and bond funds attracted some USD 149 billion in 2010, according to fund tracker EPFR Global, with total bond inflows nearly five times their 2009 total.But the most recent trend suggests that investors may be having second thoughts. Investors pulled USD 3 billion from emerging equity funds in the week ended January 26, EPFR said, the biggest monthly outflow since late 2008."Flows into emerging markets seem to have peaked in the fourth quarter, and events in Egypt have served to remind people that a lot of these emerging market assets come with an asterisk," said Cameron Brandt, global market analyst at EPFR.Threat on inflationMarkets' worst fear would involve a government hostile to the West taking over in Egypt, which could destabilize the region, drive oil prices up further and worsen global inflation, which is already on the rise.Indeed, higher food and energy costs explain why emerging markets have lost some of their shine, analysts say, and may have contributed to the timing of the unrest in Egypt.In a note to clients, BlackRock, the world's largest money manager with USD 3.3 trillion in assets, said that in developing countries higher prices have led "many poor and middle class residents to wonder if they will ever reap the full benefits of globalization."BlackRock urges clients to avoid countries with autocratic governments, high income disparity and surging inflation.Some traders said alarm bells started ringing even earlier. Ardor for Chinese equities began to cool in late 2010, while Indonesian stocks fell some 12% by mid-January.Markets fear Chinese anti-inflation measures could slam the brakes on growth, which would ripple through the region and undercut a growing source of demand for Western firms."Central banks are moderately behind the curve on inflation, so you're seeing emerging equities get hit," said Dan Dorrow, head of research at FX execution firm Faros Trading. "The risk is that will continue for several months."Pessimists can add funding troubles for US states and municipalities and a worsening of Europe's sovereign debt crisis to the list of possible corrective triggers.Even if the euro zone manages to stop a crisis that's already engulfed Ireland and Greece from spreading, some fear draconian spending cuts in Europe will chill growth."Think of how many governments across Europe are instituting significant austerity packages. That's got to impact corporates," a senior loan banker said. "There's a high probability that the fundamental credit performance of all these companies that we lend to could deteriorate."Stocks still soaringEnthusiasm for US stocks, however, remains strong, and investors are not convinced a correction is imminent. Corporate earnings look set for a record year, and economists expect the economy to grow at its quickest pace since before the financial crisis.Bank of America-Merrill Lynch reported late last year that only one in four active fund managers beat their benchmarks in 2010, suggesting a rush to make up lost ground in 2011."There is still a lot of money to go out of bonds and into stocks," said Eric Marshall, director of research at Hodges Capital Management in Dallas. "A small pullback or a pause would actually be good for cash on the sidelines to come in."The cost of acquiring a call option on the CBOE VIX volatility index to hedge against an S&P pullback has fallen sharply over the last two weeks, even as unrest in Egypt worsened.The open interest put-to-call ratio on stock index options is also below its level a year ago, suggesting investors don't feel the need to buy puts, or insurance, against a sudden market slide."Everybody has been talking about the correction for a good month or two, but the hallmark of a steady bullish market is when it doesn't sell off on bad news, which is what we've been seeing recently," said Randy Frederick, director of trading and derivatives at Schwab Center for Financial Research in Austin, Texas.But John Taylor, chief investment officer at FX Concepts, which oversees $8.4 billion in assets, is not convinced that the rally can continue much longer. "It means nothing" that the S&P is up 17% since December, he said. "It gives the feeling of robustness to the economy, but it has nothing to do with people's ability to spend money."While more than 70% of S&P 500 companies have reported better-than-expected earnings, the US jobless rate remains above 9% and raw material prices are rising."I'm not sure you can bleed much more out of the earnings stone," said Duncan Balsbaugh, market analyst at IFR, a division of Thomson Reuters. "Input costs for everything except labor are rising, so margins are going to get squeezed." Discover the latest Business News, Sensex, and Nifty updates. Obtain Personal Finance insights, tax queries, and expert opinions on Moneycontrol or download the Moneycontrol App to stay updated!
