Here below some final 2013 weekly reports from the majors sticking to the themes we have seen before. Inevitably they are forward looking into 2014.
Its clear on a macro market level (ie on major themes) the institutional teams are uniformly sticking to the over weight equities and under weight bonds but long junk. Under weight EMs and commodities. We have very little divergence now. Consensus has become the entire market which is, in itself, a risk event.
The ‘all in’ macro consensus is that the recovery will broadening and gather pace into 2014. Almost all participants are very unwilling to divert from this outlook as, simply put, those that did had a disastrous 2013. Few are now pricing in any other than this scenario that this Goldilocks recovery. It doesn’t mean this scenario can’t happen its simply that we should recognize that this is an exceptionally crowded trade now against a back drop of perpetually disappointing earnings in 2013.
On a micro level there are many unloved sectors that would benefit greatly from the recovery gathering pace. The UK retail sector is one of the cheapest developed cyclical market sectors as one micro example.
But its the macro and technical where the problems lie for 2014 and I’d like here to take a step back and throw up a few charts on the macro banking issues.
If the professionals are all in on record levels of leverage where will the new buyers come from is a good question to ask and here I’d like to look briefly at US Commercial bank balance sheets. (Accepting that they remain very opaque).
It is unlikely leverage and institutional balance sheets can grow much larger but do they don’t need to? In theory, the central banks multiple QE programs are forcing the banks to liquidate their bond holdings for new cash. But as we see below this has not occurred as yet due to new issuance from the treasury. As we step forward into 2014 there are some tail winds here as the Treasury is expected to issue relatively little new debt for 2014. As the Fed sustain its purchases (MBS inc T-bonds) at 75bn a month the US banks can become more aggressive net sellers. Its worth recalling here that the US Fed now owns 40% of all US government debt over 5yr maturity.
(Note, by the end of the Fed’s liquidity programs you have to wonder what number this ratio will be up to and what systemic risks this presents to all!)
Here Yardini’s latest look at Central Bank balance sheets
centralbankbalancesheet-27-12-13
Considering the macro and issues of deflation and inflation has the US Commercial banking system de-levered or not in recent years, ex the FED?
Some argue that banks have not de-levered and in fact equities and junk bonds have been the primary benefactors pushing up prices as supply of equity has not kept up with banking demand for non treasury assets. Have the banks delevered or simply sustained balance sheets and speculated by adding more risky assets? These are the trillion dollar macro questions we as investors if not speculators need to take a view on.
Since 2008 central banks have injected around 10trn into the banking system. When you consider global equity markets total capitalization is a mere 50 to 60 trn this represents a colossal liquidity injection if the bulk is channeled into equity markets.
A good question to ask here on the macro level is whether commercial banks have really de-levered? In double entry book keeping assets less liabilities should equal equity. So what do we see.
No question assets are booming in value. Ie the banks hold more assets than ever in fact. Not a usual sign of de-leveraging their balance sheets. But if liabilities have reduced perhaps they are holding more as reverses as therefore net equity in the business. If so we would expect to see equity in US commercial banks rising rapidly.
Equity is barely increasing at all. Therefore the data suggests US banks are barely de-leveraging at all. They are in stead increasing assets and liabilities. Assets slightly more rapidly than liabilities and therefore equity is rising but its at a much lower marginal rate than the assets they are buying. The Fed’s QE programs are simply shifting the commercial bank’s asset mix and weighting them towards risk away from treasuries, as the Fed purchases this supply, and towards more risky assets. An interesting trend in the age of austerity, de-leveraging and fiscal prudence? The data does perfectly contradicts the rhetoric in fact.
This chart above illustrates neatly that although the Fed has increased its balance sheet by 3.5trn in the last few years this has mainly be used to mop up new treasury issuance of debt as the public debt requirements have been so great in recent years. The banks have been net sellers but its represented a small decrease in their balance sheets due to the continual new issuance from the treasury.
Consumer lending remains weak and in real terms has declined in recent years.
Commercial loans have barely turned positive from the 2008/09 peak.
Together we can see the assets held increases by the banks has not occurred due to either consumer or commercial lending practices. Assets that have increased must be listed securities almost exclusively. This explains the positive flow of funds into global equity markets. What’s worse if equity has increased so little this indicates that liabilities have increased ie credit (and therefore balance sheet expansion) is funding these large asset purchases by the commercial banks.
On a global basis the expansion in assets by the commercial banks is even more impressive.
Its not exactly the deleveraging story we hear from Washington and across the financial media.
And we must recall here that lending and share of financial assets held by NBFIs (non banking financial institutions) is on the rise again according to many (official) sources inc the FSB. Nominally assets held by this shadow banking have increased considerably since the 2008 credit bust. Relative to GDP they have also started rising again. Even in developed countries, UK central bank as one example, is providing incentives to this sector to increase share of financial assets and lending. (The sector has a history of poor financial regulation). According to the FSB its asset size is larger than the banking sector itself.
Looking ahead can this growth in assets sustain by financial institutions? If regulators are prepared to turn a blind eye to balance sheet expansion then yes this can sustain.
According to Basel III definitions of core tier 1 capital most UK banks, as reported in march of 2013, had, on average, around 3% tier 1 capital to assets. Ie their risk asset exposures were 33 times tier 1 capital. And tier 1 capital includes government bonds, note, even of longer duration. Talk of balance sheet repair, on this data appears a little over stated.
Beyond this bond fund flows have turned negative as have returns for 2013. As rates step higher the great bond rotation is one area of potential positive fund flows for equities. Private investor participation rates continue to fall but as a group they are usually the last ones to enter the trend so fund flows could turn positive here also to provide the realization of the paper profit for the institutions in 2014.
This lull in market action over the Christmas and New Year holidays are a good opportunity to consider these macro issues. I will explore a few more of these themes over the coming holiday extension period. Soon enough the normal market noise and price action will be back with us and technical perspectives will dominate again.
Here a selection of some recent final week reports.
I have a number of 2014 “mm” multi market outlook reports to follow for the end of the day.
All the best
Rich