Monday Macro – Long run returns from the Global yearbook plus Ukraine update
A deeper dive into the Credit Suisse yearbook on why the equity risk premium is falling and why diversification makes sense. Plus some excellent links on Ukraine. Look out for a dollar squeeze
Apologies for adding yet more noise to your day but I thought it worth sharing a few updates from this morning.
First off if you want a razor-sharp analysis of what’s going on militarily in Ukraine now I cannot recommend highly enough this hour-long interview by the military analyst, Russian expert, and veteran Rob lee with Noah Smith. Watch now and be very frightened :
I mentioned the excellent New Lines publication and today they have a great article by veteran British reporter John Sweeny – you can read it here:
Here’s the money quote from Sweeny:
“The evidence is now overwhelming that Putin has made a miscalculation, that the Kremlin hopelessly underestimated the resilience of the Ukrainian people, underestimated the ferocious courage of President Volodymyr Zelenskyy, under planned the logistical nightmare of invading a huge country like Ukraine and never considered that Russian soldiers, ordered to invade Ukraine, might mutiny.”
I also think it’s worth noting this warning from the always-excellent Adam Tooze on the very real risk of a dollar squeeze. He’s basing his analysis on work by Zoltan Pozsar of Credit Suisse who has argued in his “Global Money Despatch”, Russia’s dollar holdings have been put to work increasingly not in the market for long-term government debt, but in short-term money markets
“All told, Pozsar estimates that Russia may be responsible for providing in the order of $300 billion in funding to short-term money markets. If that funding disappears overnight it may deliver a serious shock to the Western financial system. How serious remains to be seen, but the implication is that it is not only the Russian central bank that may come under pressure. Central banks in Europe and the Fed may need to stand by to make markets in the way that they did in 2020. And this is true more generally for global financial markets at a time of huge uncertainty. As at the time of the COVID shock we are seeing a surge of demand into dollars, as a global safe haven. That in turn puts pressure on everyone who has borrowed in dollars. This is a pattern we have seen repeatedly in moments of crisis since 2008: A global dollar shortage”
Long, long term returns from investing
‘Tis that time of the year when three of the world’s leading finance academics usher forth their analysis of long-term returns from investing. Yep, it’s time to visit the Credit Suisse Global Investment Returns Yearbook 2022 by Elroy Dimson, Paul Marsh, and Mike Staunton! To those that don’t know about this regular epic, it’s a great way of cutting through all the chatter of market noise to understand what returns have been from investing over many decades. The UK-based academics crunch through huge data sets for a huge variety of countries and always come up with some fascinating insights. This time the importance of diversification, between geographies and between asset classes, forms the centerpiece of the research. In total, the academics look at 35 Yearbook markets, 23 of which start in 1900. This year they’ve also added an additional 12 new markets and thus they have data on a total of 90 countries as well as 5 composite indexes.
And their insights? Here’s my ten-point summary…….
1. US RULES? Investors worry about the dominance of US equity markets but in reality as the chart below shows, US markets have dominated global indices for decades, and in fact in the 50s and 60s the US markets were even more dominant
2. LONG-TERM RETURNS. Over the long time span of the study, the Historical equity risk premium vs. bonds = 3.2%, while the historical equity risk premium vs. bills = 4.6%. Looking to the future, the academics expect a lower equity vs bills premium of around 3½%
3. GENERATIONAL RETURNS. Based on these projections, the current millennial generation are screwed. The chart below shows return experiences across generations. Note the complete absence of bond returns.
4. AFTER RATE RISES WHAT HAPPENS? The chart below shows asset returns after rate rises and falls. The bottom line? In the UK real returns from equities have fallen to just 1.2% with the US doing better at 3%. Invest in the US!!
5. DIVERSIFICATION STILL WORKS DESPITE THE OBVIOUS CHALLENGES. The authors conclude that diversification is still a free lunch. Investors can get the same return at lower risk, or a higher return for the same risk.
6. BUT DIVERSIFICATION HAS NOT PAID FOR US INVESTORS. The usual safe advice about internationally diversifying did NOT pay off for the US investor post-1974 largely because US returns were exceptionally high while US risk is relatively low.
7. BUT DIVERSIFICATION DID PAY OFF FOR UK BASED INVESTORS.
8. AS WE ALL SUSPECTED EQUITY MARKET CORRELATIONS HAVE DRAMATICALLY INCREASED. In fact, a helluva lot in the last few decades…scarily so
9. BUT EM EQUITIES ARE STILL A USEFUL DIVERSIFIER
10. BONDS ARE ALSO STILL A USEFUL DIVERSIFIER THOUGH LESS SO IN THE UK. Negative correlations since 2000 make bonds a hedge. Relative to 20th century averages, returns can be much higher for same risk. Stocks and markets more closely correlated during turmoil. Flights-to-safety make bonds a hedge
Every week, I’ll start with a dashboard of key measures. There’s no science behind this – it’s just the range of measures that I use to work out whether the markets look cheap, over-priced or anything in between. In the box 1 below, I’ve provided some of the explanations behind the measures used in the table.
My opinion:. Bearish. No change, although the SG sentiment indicator has ticked up to 0.30 but the bond markets are still signaling a significant threat of recession
Note 1: FAANG valuations - using TTM (historic and actual) earnings per share versus the share price. Source: Yahoo Finance.
Note 2: The Govie Spread - from YCharts. ‘The 10-2 Treasury Yield Spread is the difference between the 10-year treasury rate and the 2-year treasury rate. A 10-2 treasury spread that approaches 0 signifies a "flattening" yield curve. A negative 10-2 yield spread has historically been viewed as a precursor to a recessionary period. A negative 10-2 spread has predicted every recession from 1955 to 2018, but has occurred 6–24 months before the recession occurring, and is thus seen as a far-leading indicator. The 10-2 spread reached a high of 2.91% in 2011 and went as low as -2.41% in 1980’.
Note 3: Simple technicals. If a market is trading above its 20- and 200-day moving average, it is viewed as bullish, which is below bearish. A crossover (the market ducking below or above the 20- and/or 200-day MA) is regarded as significant.
Note 4: Volatility regime. I use a simple quartile system for the VIX measure of turbulence in the S&P 500 index. The long-term average is approximately 19. The third quartile is approximately 21.50, and the first quartile is approximately 13. Anything below 13 is regarded as very low volatility, anything between 13 and 19 is low volatility, anything between 19 and 21.5 is medium volatility and anything above 21.5 is high volatility.
Note 5: Equity positioning. This is based on the Deutsche Bank internal consolidated equity positioning, which is based on fund-flow indicators.
Note 6: Simple fundamentals. These measure the market-wide dividend yield and current 2021 price-to-earnings ratio of the S&P 500. The last two measure the Robert Shiller long-term CAPE measure of the S&P 500, which is available at http://www.econ.yale.edu/~shiller/data.htm. This is a smoothed out and adjusted long-term average for the S&P 500. There is also an alternative version, which includes changes in the corporate pay-out policy.
Note 7 : The SG Sentiment Indicator is a tool devised in the Cross-asset Quant Research team to measure market sentiment by looking at the short-term dynamics of six risk-related variables across different asset classes. It ranges between 0 and 1, with values above 0.70 indicating a risk-seeking market and values below 0.35 indicating a risk-averse market.