INVESTMENT FOCUS-Betting on policies, not their success
LONDON Oct 26 (Reuters) - Global investors seem happy to feed off central banks' reflation policies but not necessarily their eventual success.
Just a glance at this week's bout of earnings-related market angst shows how little conviction there still is in a sustainable global recovery -- or the fabled 'green shoots'.
In an otherwise punchy, policy-driven year of double-digit western equity gains, October is set to be first month in the red since May for both MSCI's all-country world stock index and U.S. blue chips in the S&P 500.
To keep that in perspective, this month's wobble of 1-2 percent pales in comparison with prior Halloween scares.
There was a 22 percent monthly drop on Wall Street during the October crash 25 years this week and there was a near 17 percent October drop after Lehman Brothers went bust in 2008.
But if investors have been happy so far this year riding waves of central bank money-printing or asset-buying from the United States, euro zone, Britain and -- likely yet again next week -- from Japan, they remain doubtful the hell-for-leather policy of reflation will succeed.
Positive economic surprises, including third-quarter U.S. and British economic growth data, and signs of economic bottoming in the latest Chinese or East Asian export data might also be good reasons for underlying bullishness. But markets continue to show caution.
Behaviour in the fixed-income markets shows it best.
With official interest rates bolted near zero and central banks directly supporting many key sovereign and asset-backed markets, there's been an indiscriminate scramble for any sort of extra yield on offer while the liquidity taps are full on.
The surge in demand for everything from emerging sovereign and corporate bonds to western junk bonds, where new dollar high-yield debt sales have jumped almost 40 percent this year to smash full-year records already at some $268 billion, has seen yield premia nearly everywhere get crushed.
This hunt has even stretched to crisis-tarnished collateralised loan obligations and seen sub-6 percent 10-year debt sales from the likes of Bolivia and Zambia.
While it suggests gung-ho risk appetite, however, some analysts are struck by the willingness to assume 'duration risk', or the risk to bond prices from higher interest rates in future.
This suggests an assumption of near-zero rates and money printing policies will persist for many more years.
And that in itself assumes central banks will not gain any traction in boosting growth or inflation over a similarly long horizon. What such a dearth of growth does to underlying credit or default risk is yet another point.
Graham Neilson, strategist at credit hedge fund Cairn Capital, said this is as much a reflection of increasingly tactical, short-term trading by investors who could switch back just as quickly. "The yield compression has overshot and needs consolidation," he said.
"But our core view is this crisis has seen the biggest, broadest, balance sheet destruction ever and history tells us any recovery from these events takes on average about 8 years start to finish," Neilson said.
"There will be a tipping point for reflation at some stage but we're nowhere near that point."
On the other hand, medium term interest rate risk can come from many quarters.
For example, Barclays said this week that a win for U.S. Republican presidential candidate Mitt Romney in next month's election could see a 50 basis point jump in 2015 Fed funds rate futures on an assumption he would propose a more hawkish replacement for Federal Reserve chief Ben Bernanke in 2014.
Are these long-term economic doubts evident in what has seemed like ebullient equity markets too?
So far, the third-quarter earnings season -- which is expected to see a 1.7 percent annual drop overall in S&P 500 profits -- shows some 40 percent of European companies and 30 percent of U.S. firms missing expectations, according to Thomson Reuters StarMine.
While that still leaves about two-thirds of companies meeting or beating forecasts, in line with previous quarters, more worrying is falling revenues and darkening outlooks from big "real economy" firms such as Caterpillar and Intel or Renault and Ericsson.
Partly in light of the latest results, JP Morgan Asset Management's multi-asset team this week highlighted its worries about equity market behaviour, saying "there are several features of the current revival that don't smell right."
The note by strategists David Shairp and Patrik Schowitz reckoned equity prices had run way ahead of broader risk appetite, which was evident mostly only in credit markets.
"Investors appear to have been reluctant in adding equity risk, adding to defensives but largely avoiding cyclicals," they said. "There will need to be rotation into higher-beta sectors, or the rally will peter out."
Bank of America Merrill Lynch's latest fund manager poll shows asset managers still underweight equities relative to historical positioning.
So is all the caution a reality check or does it reveal vulnerability in investor positioning if reflation policies start to work sooner rather than later?
Another U.S. election twist shows up here to. Both economic and earnings data this week shows businesses freezing capital goods expenditure, in part over fears over how a post-election U.S. government will deal with the looming "fiscal cliff."
But if that were to be resolved quickly, could there be a capex fillip to the economy and markets?
The Barclays strategists see Romney as more likely to dodge the looming fiscal drag of expiring tax relief and government spending quickly and they reckon a victory by him could see 10-year Treasury yields jump above 2 percent as a result.
Philipp Baertschi, global equities strategist at Sarasin, also thinks markets and chief executives may have become too bearish and the current market pullback will be short-lived.
"The uptrend on the stock exchanges, driven by the global economic upswing, should resume at the latest when the U.S fiscal cliff has been circumnavigated."