51 - JPM 21-03-14 Global Asset Allocation

www.jpmorganmarkets.
com
Global Asset Allocation
21 March 2014
Flows & Liquidity
Are equities expensive?
Nikolaos Panigirtzoglou
AC
(44-20) 7134-7815
nikolaos.panigirtzoglou@jpmorgan.com
J.P. Morgan Securities plc
Mika Inkinen
(44-20) 7742 6565
mika.j.inkinen@jpmorgan.com
J.P. Morgan Securities plc
Matthew Lehmann
(1-212) 834-8315
matthew.m.lehmann@jpmorgan.com
J.P. Morgan Securities LLC
Jigar Vakharia
(91-22) 6157-3281
jigar.r.vakharia@jpmorgan.com
J.P. Morgan India Private Limited
See page 17 for analyst certification and important disclosures.
- Taking into account the current low level of interest rates and
macroeconomic volatility points to a modest rather than an extreme
equity overweight by US households.
- Beyond uncertainty and the level of interest rates, equity valuations
also depend on earnings and earnings expectations.
- An update of our dividend discount model for the S&P500 suggests
that the S&P500 index is currently fairly valued.
- But coupled with declining earnings expectations, both equity
positions and valuations could become more overstretched quickly if
either macroeconomic volatility or interest rates start rising
significantly.
- This typically happens in the late phase of a cycle.
- EM equity ETFs keep bleeding, driven by China and Korea. The US
sees even stronger inflows.
- We mentioned last week that the equity allocation of US households (HHs)
as % of their financial assets rose to 34.1% in Q4 2013 which not only
exceeded its previous 2007 peak, but stands almost 11 percentage points
above its historical average.
- Admittedly such a simple comparison vs. this historical average does not
address the impact of low bond yields or of declining macroeconomic
uncertainty on equity valuations and investor positioning. In other words, the
medium-term target equity allocation of US HHs should be higher than
historical averages in a world of very low interest rates and very low
macroeconomic volatility. Taking this into account is even more important
for this indicator given its low speed of mean reversion.
- How big is then the equity overweight of US households if one takes into
account the current very low level of interest rates as well as
macroeconomic volatility?
- To answer this question, we regress the equity allocation of US households
shown in Figure 1 on three variables: the 10 year real UST yield, the
volatility of annual US CPI inflation and the volatility of quarterly US real
GDP growth. These are the variables we used in previous work to assess the
equity discount rate of the S&P500 index (A Fair Value Model for US
Bonds, Equities and Credit, Jan 05, Panigirtzoglou and Loeys.). The 10-
year real UST yield is measured by the difference between the quarterly
average of the nominal 10y UST yield and the 10-year inflation expectations
from Philly Fed quarterly Survey of Professional Forecasters.
Figure 1: Equity allocation of US
households
$%, sum of equities held directly or via
mutual fund shares or via Defined
Contribution plans divided by total financial
assets. HH equity allocation is on left axis
up until Q4 2013. Fitted values are based on
the following linear regression model:
US HH equity weighting = 0.368
(0.010)
-0.041 5yr US CPI infl stdev exp-weighted
(0.005)
-0.011 5yr US real GDP growth stdev exp-
weighted
(0.003)
-0.015 10-year real UST yield
(0.002)
(standard errors in parenthesis, Sample
period 1957 Q1 to 2013 Q4, R2-adj 57%,
Standard Error 0.047)
Source: Fed, J.P. Morgan
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
52 59 66 73 80 87 94 01 08
actual
fitted
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21 March 2014
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- Different to that paper, we measure macroeconomic volatility via the
exponential-weighted rather than equally-weighted standard deviation of
annual US CPI inflation or quarterly US real GDP growth, to reduce
sensitivity to more distant observations. The benefit of exponentially
weighted standard deviation vs. a simple (equally-weighted) standard
deviation can be seen in Figure 2 and Figure 3.The exponential weighted
metric is more sensitive to recent observations and as such it responds earlier
to changes in macroeconomic conditions. In addition, it does not suffer from
jumps when previous extreme observations, such as those immediately after
the Lehman crisis, drop out of the rolling 5-year window. We set the
exponential decay factor (lambda) at 0.95 for inflation standard deviation
(monthly data) and 0.90 for real GDP growth standard deviation (quarterly
data).
- Figure 2 and Figure 3 also show how low macroeconomic volatility is
currently. The volatility of real GDP growth (blue line in Figure 2) is the
lowest ever while that of CPI inflation (blue line in Figure 3) is very close to
record lows since 1950s.
- Regressing the US HH equity allocation on the above three variables we get
the picture shown in Figure 1. While there is still a positive residual, i.e. the
actual equity allocation is above its model-driven medium-term target (fitted
value), the magnitude of the residual at 3 percentage points is half of the 2007
peak and a lot smaller than the 11 percentage point gap vs. the historical
average. So taking into account the current low level of interest rates and
macroeconomic volatility points to modest rather than extreme equity
overweight. On the flip side, this overweight could rise quickly and equity
positions could look more overstretched if either macroeconomic volatility or
interest rates start rising, which typically happens in the late phase of an
economic expansion.
- While this exercise is useful in assessing the magnitude of US HH equity
overweight, such an overweight or underweight assessment is not the same as
concluding that equities are expensive or cheap. Beyond uncertainty and the
level of interest rates, equity valuations depend on earnings and earnings
expectations and one needs to use a fully fledged equity valuation model to
answer the question of whether equities are cheap or expensive. We used such
an equity valuation model before in A Fair Value Model for US Bonds,
Equities and Credit, Jan 05, Panigirtzoglou and Loeys.
- The starting point of this valuation model is the Dividend Discount Model
(DDM). Equity valuation is more complicated than bond valuation because of
the difficulty in measuring expectations of future cash flows, but ultimately
equities also need to be analysed in a present value model. That is, the equity
price is equal to the expected future cash flows (i.e. dividends) discounted to
the present using an equity discount rate (EDR). The equation below illustrates
the discounted cash flow model:
(1)
- where P denotes the equity price, E
0
is current earnings, k is the payout ratio, g
is the growth rate of dividends and EDR is the equity discount rate. The three
main components that determine the price are:
- 1) Current earnings E
0
, which is observable (albeit with a reporting lag), and
the payout ratio k, that is, the proportion of earnings paid as dividends, which
for simplicity we assume to be constant. We set the dividend payout ratio to
50%, the historical average of the dividend payout ratio for the S&P500 index
since 1950s. The payout ratio has been moving within a 0.40-0.60 range since
Figure 2: US real GDP growth volatility
Exponentially weighted standard deviation of quarterly
annualized real GDP growth (blue line) vs. a simple
(equally-weighted) standard deviation (black line) over
a 5-year rolling window, the exponential decay factor
(lambda) is set at 0.90 (quarterly data).
Source: J.P. Morgan
Figure 3: US annual CPI inflation volatility
Exponentially weighted standard deviation of annual
CPI inflation (blue line) vs. a simple (equally-
weighted) standard deviation (black line) over a 5-
year rolling window, the exponential decay factor
(lambda) is set at 0.95 (monthly data)
Source: J.P. Morgan
Box 1:
Equation of 5yr real earnings growth
5yr real earnings growth = 11.2
(1.5)
-0.48 past 5yr real earnings growth(-1)
(0.09)
-1.12 E/P(-1)
(0.17)
(in percent, annualised, standard errors in parenthesis, 4-quarter
moving averages were used for all variables in the regression, one
quarter lagged values of the explanatory variables were used as
earnings are observed with approximately a lag of one quarter)
Sample period 1961 Q1 to 2014 Q1
R
2
-adj 47%
Standard Error 3.3%
Source: J.P. Morgan
+
+
=
i
i
i
EDR
g E k
P
) 1 (
) 1 (
0
1
2
3
4
5
6
7
8
52 63 75 86 98 09
Exp weighted
Equally weighted
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
53 64 75 86 98 09
Exp weighted
Equally weighted
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21 March 2014
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1950s. Although it has fallen in the 1990s, this masks the increased share of
buybacks as a means by which companies returned cash to shareholders.
- 2) Expectations of future earnings which are captured by the growth parameter
g. Investors must project earnings into the indefinite future to determine
current prices. Investors usually focus on earnings projections for the next few
years only because it is difficult to project earnings far into the future and cash
flows in earlier years carry more weight on the price. IBES analysts provide
forecasts of earnings for 1, 2 and 3 years ahead, plus a long-term growth
forecast that corresponds to a business cycle period between 3-5 years. The
problem with long-term IBES analyst forecasts, however, is that they appear
way too high as they have been well above 10% consistently since 1985. In
addition, they were found to be biased and inefficient. For example see
Panigirtzoglou and Scammell, Analysts Earnings Forecasts and Equity
Valuations, Bank of England Quarterly Bulletin, Spring 2002. Inefficiency
implies that analysts neglected important information at the time they made
their forecasts.
- Given that we have no reliable measures of investors earnings expectations,
we are forced to make an assumption on how investors formulate their views.
For this we assume that investors are rational and do not make systematic
errors when predicting the future (i.e. deviations from perfect foresight are
random). Equity investors or analysts usually forecast earnings up to a
specified point in the future and then make assumptions about earnings growth
beyond that point. That is, they implicitly use two or more stages in their
valuation framework. We also follow this approach by employing a two-stage
dividend discount model.
- We assume investors formulate expectations in a rational manner. Although
there is some evidence of irrationality in investors behavior, as the
voluminous behavioral finance literature argues, over the long run investors
tend to adjust their expectations to more realistic levels. The burst of the tech
bubble in late 1990s is an example. In particular, we use a rational
expectations model for the real growth of earnings over the next five years
based on information available to investors at the time. Given the cyclical
nature of earnings, we found that a rational investor should expect periods of
high earnings growth to be followed by periods of low growth. That is, the
lagged 5-year growth of earnings had a significant negative coefficient in the
earnings forecast equation. Secondly, we found the P/E ratio lagged by one
quarter to be a strong predictor of future earnings growth, capturing the
multitude of factors that affect investors expectations and are embedded in
past prices. In particular, we found that a higher P/E ratio anticipated higher
future profit growth. By lagging the P/E ratio by one quarter we account for
the earnings reporting lag. At the same time we avoid circularity in
determining the equity price, as only lagged price information is used in
earnings expectations, which is one of the equity price determinants.
- The model is described in Box 1. It is a forecasting model in that it uses past
information to forecast the future. Both 5-year profit growth and the earnings
yield (i.e. the inverse of the P/E ratio) were found to be stationary over the
sample period and the regression is thus not spurious. The R2 is a decent 47%.
The standard error is 3.3%.
- To generate earnings growth expectations, we estimate the model recursively.
That is, only data up to the specified date are used. Box 1 shows the estimated
parameters using data up to 2014 Q1. Figure 4 shows the recursive 5-year real
earnings growth forecast vs. the realised value. The 5-year real earnings
growth rate exhibits strong cyclicality and the expected follows the actual
quite closely.
Figure 4: Recursive 5yr real earnings growth
expectations vs. delivered
Annualized growth
Source: J.P. Morgan
Figure 5: Implied S&P500 EDR and ERP from the
2-stage DDM
percent, The EDR is the sum of the two shaded
areas, i.e. EDR=ERP+10y real UST yield
Source: J.P. Morgan
Box 2:
Equation of EDR
Equity Discount Rate = 4.19
(0.13)
0.62 5y inflation stddev
(0.07)
0.15 5y GDP growth stddev
(0.04)
0.08 10y real yield
(0.03)
(in percent, inflation standard deviation is the standard deviation of
monthly data on annual inflation over the past five years, GDP
growth standard deviation is the standard deviation of quarterly
annualised GDP growth over the past five years, standard errors in
parenthesis)
Sample period 1957 Q1 to 2014 Q1
R
2
-adj 52%
Standard Error 64bp
Source: J.P. Morgan
-0.10
-0.05
0.00
0.05
0.10
0.15
56 60 64 68 72 76 80 84 88 92 96 00 04 08 12
delivered growth
expected growth over next 5 years
current Q1 14 expectation
-2
0
2
4
6
8
10
57 62 67 72 77 82 87 92 97 02 07 12
ERP
10y real UST yield
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21 March 2014
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- Figure 4 illustrates what the rational expectations 5-year real earnings growth
looks like when superimposed on actual EPS. It shows that at high points in
the earnings cycle, 5-year ahead expectations are less steep or point
downwards, while at low points in the earnings cycle they usually point
steeply upwards. That is, rational investors understand that profits move in
cycles and apply lower growth rates at high points in the cycle and vice versa.
Had we used a one-stage equity model, we would have applied always positive
growth rates at high points in the cycle and thus overstate the equity fair value.
- This rational expectations model currently points to very low, below 1%, real
earnings growth over the next 5 years. In fact 5y-ahead earnings expectations
have been declining since mid 2010 and are likely to shift even lower and
turn negative over the coming quarters due to the strong mean reversion
properties of the model.
- In the second stage, we assume that real earnings growth reverts to its long run
average since 1950s of g
LT
=2.2%. Using this two-stage equity valuation
framework along with the observed price, we can generate the implied EDR
using equation (1), which can be simplified (see Fuller and Hsia 1984) as
follows:
(2)
- where g
E
is the 5-year real profit growth expectation.
- The derived EDR and its two components, the Equity Risk Premium (ERP)
and the 10-year real yield, are shown in Figure 5. The ERP is the residual from
subtracting the 10-year real yield from the EDR. Figure 5 shows that the ERP
declined significantly in the late 1970s/early 1980s, driven by higher real rates,
and also in the second half of 1990s as a result of the equity bubble. The ERP
has been 2.5% on average since 1950s, but it has been lower in 1980s and
1990s than in previous periods.
- 3) The third component is the equity discount rate (EDR), the internal rate of
return for investing on equities. We relate the EDR to output and inflation
volatility as well as the long real rate.
- To model the EDR, we have a choice of treating it as a spread to bonds, thus
trying to explain the ERP, or explaining the EDR directly. We chose the latter
as we observe that the real bond yield is highly negatively correlated with the
ERP, such that a rise in bond yields does not have much impact on EDR.
Therefore, we cannot treat equities as a spread model to bonds.
- We found that a 100bp rise in the real bond yield pushes up the EDR by 8bp,
and that all other variables driving the EDR consisted of measures of risk:
volatility of real growth and volatility of inflation over the past five years. As
discussed above, we measure this volatility via exponential-weighted standard
deviation to reduce sensitivity to more distant observations.
- The presence of inflation variability may appear puzzling given that equities
are supposed to be real assets. But it likely reflects the impact of inflation
uncertainty on real variables like investment, output and real earnings. There is
extensive literature arguing that high inflation and inflation uncertainty,
frequently as the result of negative supply shocks in the past, increase macro-
and microeconomic risks and lead to restrictive macroeconomic policies, all of
which are consistent with a rise in investors required equity return. Equity
price volatility itself was not found to covary significantly with the EDR.
- The model is shown in Box 2. Figure 7 shows the actual and fitted values. The
Figure 6: S&P500 EDR
Actual vs. model fitted, in percent
Source: J.P. Morgan
Figure 7: S&P500 index
Actual vs. model fitted
Source: J.P. Morgan
( ) ( )
LT E LT
LT
g g g
g EDR
E k
P + +
= 5 1
0
-2
0
2
4
6
8
10
56 61 66 71 76 81 86 91 96 01 06 11
S&P500 discount rate
Fair Value
Actual-Fair Value
0
400
800
1200
1600
2000
2400
90 92 94 96 98 00 02 04 06 08 10 12 14
S&P500 actual
S&P500 fair value
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R2 is 52% and the standard error is 64bp. The fitted or fair value of the EDR
is close to historical lows due to record low macro volatility as well as low
real bond yields. Each 100bp rise in the 10y real bond yields pushes the
S&P500 EDR up by 8bp which costs a rather modest 3% on the S&P500 fair
value. What is more important for the S&P500 fair value in the model is macro
volatility which if it had to rise to the middle of each historical range over the
past three decades would reduce the fair value of the S&P500 by 20% or so.
- These fitted values of the EDR can be plugged into Equation 1 to derive a fair
value of the S&P500 index. This is shown in Figure 7. The current fair value
of 1936 is only 3.3% above the S&P500 index price. So according to our
valuation model, equities appear to be fairly valued.
- How has this model performed as a trading signal? The trading performance of
the signal generated from the EDR model is shown in Box 3. That is, we buy
the S&P500 when the actual EDR is half a standard deviation above the model
fair value and vice versa. The success rate is 55%, but the resulting IR is a
rather low at 0.15. It is smaller than a long only strategy of holding equities vs.
Treasury bills, which yielded an IR of 0.31 over the past fifty years. The
strategy performed poorly initially, during 1960s and 1970s, perhaps as it took
some time for this recursive model to learn. Unsurprisingly, this valuation-
based trading strategy as seen in Box 2 missed the equity bubble of the 90s.
However, from 1999 onwards, this strategy has strongly outperformed as it
almost tripled from its end-1999 level. In contrast, the excess return index
based on the long only S&P500 strategy rose by only 26% over the same time
period.
- Conclusion: Current equity prices and US HH equity holdings are not at
alarmingly high levels if one takes into account the low macroeconomic
volatility and bond yield environment. But coupled with declining earnings
expectations, both equity positions and valuations could become more
overstretched quickly if either macroeconomic volatility or interest rates start
rising significantly, which typically happens in the late phase of a cycle.
Judging by the recent evolution of macro volatility, which is still declining,
and the still low levels of real bond yields, it appears we have not yet
entered this phase.
EM equity ETFs keep bleeding, US see more inflows
- Cash flowed into all asset classes this week except EM. Bonds ETFs saw an
inflow of $1.4bn for the week ending Mar 19. Commodity ETFs saw inflows
for the 4th consecutive week, consolidating their trend reversal. Equity ETFs
saw the 6th consecutive week of inflows, $8.6bn for the week ending Mar 19.
- US equity ETFs have been receiving most cash with an inflow of $10.2bn for
this past week and $35.8bn over the past 6 weeks. US Equity ETFs have
effectively reversed all the outflows that had occurred in the last week of Jan
and first week of Feb.
- On the flip side, EM equity ETFs continue to see outflows, $2.4bn for this
week and $19.2bn since beginning of the year with not a single week of
inflows (Figure 8).
- Are there flow divergences within EM? To track flows across EM countries,
we make use of both ETF flows as well as foreign portfolio flows into equities
of certain countries which provide high-frequency balance of payments. These
flows are mostly related to foreign institutional investors (FII) and provide an
alternative means of monitoring flows, along with ETF flows which are mostly
driven by retail investors.
Box 3: Trading strategy from the S&P500 EDR
model
Trading strategy: buy the S&P500 when the
observed EDR is half a standard error (i.e. 32bp)
above the model fair value, and sell when it is
below. Funding is in 3m Treasury Bills.
Period: 1958 Q1 to 2014 Q1
Rebalancing period: 1 quarter
Success rate: 55%
Information ratio: 0.15
Excess return: 2.49%
Volatility: 16.6%
Source: JPMorgan
Figure 8: Equity ETF flows as % of AUM
Cumulative flow into US and EM equity ETFs as a %
of AUM.
Source: Bloomberg, J.P. Morgan
0
50
100
150
200
250
300
350
400
450
58 63 68 73 78 83 88 93 98 03 08 13
IR=0.15
Success rate=55%
trading rule that goes long equities when
the actual EDR rises 1/2 stdev above its
fair value and goes short when it falls 1/2
stdev below its fair value
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
Jan-13 Apr-13 Jul-13 Oct-13 Jan-14
EM
US
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- Figure 9 shows the 1-month and 12-month change in foreign equity
investments as a % of market cap and Figure 10 shows the 1-month and 12-
month ETF flows as a % of their AUM. FIIs poured money in most EM
countries over the past month with the exception of Korea. FIIs poured around
$2bn in Indian and $1.6bn in Indonesian equities whilst they withdrew $1bn
from Korean equities over the past month.
- China and Russia do not provide high-frequency balance of payments data, but
looking at their ETF flows, it seems that the investors have become
increasingly more wary about China. Chinese equity ETFs saw a net outflow
of $2bn (or 7.3% of AUM) over the past month. Interestingly, Russian equity
ETFs saw an inflow of $0.5bn since March 3
rd
, on bargain hunting, more than
reversing the outflows seen during January and February.
- Is there any difference in the pictures we get from FII flows (Figure 9) and
ETF flows (Figure 10)? The noticeable difference is in Brazil. Whilst FIIs
have invested over $0.5bn in Brazilian Equities over the past month, ETF
investors withdrew $0.4bn (or 6.0% of the AUM).
Figure 9: Equity investments by Foreign
investors - Balance of Payments data
As a % of Market Cap
Source: Bloomberg, Datastream, J.P. Morgan
Figure 10: ETF Flows
As a % of AUM
-0.5% 0.0% 0.5% 1.0% 1.5%
South Africa
Korea
Brazil
India
Turkey
Indonesia
1M change 12M change
-0.3 -0.1 0.1 0.3
China
Russia
Korea
Brazil
India
Turkey
I ndonesia
1M change 12M change
-111%
-46%
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Table A1: Weekly flow monitor
$bn, Includes US domiciled Mutual Fund flows from ICI with a one week lag and
globally domiciled ETF flows from Bloomberg. Current week data only includes
ETF flows.
Source: Bloomberg, ICI, J.P. Morgan
Chart A1: Fund flow indicator
Difference between flows into Equity and Bond funds: $bn per week. Flow
includes US domiciled Mutual Fund and globally domiciled ETF flows. Current
week data only includes ETF flows. The thin blue line shows the 4-week
average of this difference. The thick black line shows a smoothed version of the
same series. The smoothing is done using a Hodrick-Prescott filter with a
Lambda parameter of 100.
Source: Bloomberg, ICI, J.P. Morgan
Chart A2: Global equity & bond fund flows
$bn per year. Flows include global MF and ETF flows. MF flows are from ICI
(global flows up to Q313 is from ICI and data since then up to now is
combination of EFAMA and ICI). 2014 YTD flows are estimated. ETF flows are
from Bloomberg.
Source: Bloomberg, ICI, EFAMA, J.P. Morgan
Table A2: Weekly corporate flows
$bn, Gross bond issuance includes all corporates incl. financials. United States
issuance is all issuance globally by US companies and W. European issuance is
all issuance globally by W. European companies. M&A is announced deal value
and Buybacks are announced transactions. Y/Y change is change in 13 week
average of the deal values over the same period last year. Equity supply is
based on announced deals, not completed.
Source: Bloomberg, Dealogic, Thomson Reuters, J.P. Morgan
Table A3: Trading turnover monitor
3 month avg. USTs are primary dealer transactions in all US government
securities. JGBs are OTC volumes in all Japanese government securities.
Bunds, Gold, Oil and Copper are futures. Gold includes Gold ETFs. Min-Max
chart is based on Turnover ratio i.e. the ratio of monthly trading volumes
annualized divided by the outstanding amount. For Bunds and Commodities,
futures trading volumes are used while the outstanding amount is proxied by
open interest. The diamond reflects the latest turnover observation. The thin
blue line marks the distance between the min and max for the complete time
series. Y/Y change is a change in 3m average volumes over the same period
last year.
Source: Bloomberg, Federal Reserve, Trace, Japan Securities Dealer Association, WFE, J.P.
Morgan. * Data with one month lag
MF & ETF Flows 19-Mar 4 wk avg 13 wk avg 2013 avg
All Equity 8.66 7.8 4.9 6.0
All Bond 1.42 2.0 1.6 -1.2
US Equity 10.21 7.1 2.2 2.6
Intl. Equity -1.55 -0.1 2.6 3.6
Tax able Bonds 1.36 1.6 1.6 -0.1
Municipal Bonds 0.06 0.5 0.0 -1.0
-20
-15
-10
-5
5
10
15
20
25
Feb-07 Feb-08 Feb-09 Feb-10 Feb-11 Feb-12 Feb-13 Feb-14
0
Last observation: 19-Mar-14
588
452
-210
219 225
1
81
536
63
119
100
-171
674
505
283
855
155
41
-300
0
300
600
900
2006 2007 2008 2009 2010 2011 2012 2013 2014
Equity funds Bond funds
YTD
Equity Supply 21-Mar 4 wk avg 13 wk avg y/y chng
Global IPOs 24.3 9.2 4.6 225%
Secondary Offerings 3.50 7.8 5.7 24%
Gross corporate bond issuance
United States 14.0 39.1 28.3 -14%
Western Europe (bn) 18.9 21.3 20.4 2%
Japan 1.7 3.8 2.5 -26%
EM 9.4 17.8 13.5 -36%
Corporate announcements
M&A - Global 41.4 41.2 45.4 5%
- US Target 7.7 9.1 22.6 16%
- Non-US Target 33.8 32.1 22.8 -4%
US buybacks 1.63 3.3 6.6 -49%
Non-US buybacks 0.13 0.9 1.5 -30%
As on Feb-14 MIN MAX Turnover ratio Vol (tr) y/y chng
Equities
EM Equity 2.04 $1.24 21%
DM Equity 0.96 $3.65 22%
Govt Bonds
USTs 3.20 $2.12 -9%
JGBs 10.97 776 23%
Bunds 1.17 2.16 -15%
Credit
US HG 0.75 $0.27 4%
US HY 0.95 $0.13 18%
US Conv ertibles 2.26 $0.02 -8%
Commodities
Gold 33.59 $0.35 -43%
Oil 58.90 $1.68 -39%
Copper 3.52 $0.40 13%
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ETF Flow Monitor (data as of Mar 19)
Chart A3: Global Cross Asset ETF Flows
Cumulative flow into ETFs as a % of AUM.
Chart A4: Bond ETF Flows
Cumulative flow into bond ETFs as a % of AUM.
Source: J.P. Morgan. Bloomberg Source: J.P. Morgan. Bloomberg
Chart A5: Global Equity ETF Flows
Cumulative flow into global equity ETFs as a % of AUM.
Chart A6: US Equity Sectoral ETF Flows
Cumulative flow into US equity sectoral ETFs as a % of AUM.
Source: J.P. Morgan. Bloomberg Source: J.P. Morgan, Bloomberg
-35%
-30%
-25%
-20%
-15%
-10%
-5%
0%
5%
10%
15%
Equity
Bonds
Commodity
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
25%
EM
Global HY
Global HG ex-EM
-30%
-20%
-10%
0%
10%
20%
30%
40%
50%
EM
US
WE
Japan
-60% -40% -20% 0% 20% 40% 60%
Cons. Discretionary
Utilities
Cons. Staples
Telecom
Energy
Financial
Industrial
Healthcare
Materials
Technology
12M 1M
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Chart A7: Market health map
Each of the six axes corresponds to a key indicator for markets. The position
of the blue line on each axis shows how far the current observation is from
the extremes at either end of the scale. The dotted line shows the same but
at the beginning of 2012 for comparison. For example, a reading at the
centre for value would mean that risky assets are the most expensive they
have ever been while a reading at the other end of the axis would mean they
are the cheapest they have ever been. See explanation on the right for each
indicator. Overall, the larger the blue area within the hexagon, the better for
risky markets.
Explanation of indicators:
All variables are expressed as the percentile of the distribution that the
observation falls into. I.e. a reading in the middle of the axis means that the
observation falls exactly at the median of all historical observations.
Equity trading volumes: The Y/Y change in the average daily trading
volume of stocks on the NYSE.
Value: The slope of the risk-return tradeoff line calculated across USTs, US
HG and HY corporate bonds and US equities (see GMOS p. 6, Loeys et al,
Jul 6 2011 for more details).
Conti Explanation of indicators:
Positions: Difference between net spec positions on US equities and rates.
See Chart A14.
Flow momentum: The difference between flows into equity funds (incl.
ETFs) and flows into bond funds. Chart A1. We then smooth this using a
Hodrick-Prescott filter with a lambda parameter of 100. We then take the
weekly change in this smoothed series as shown in Chart A1
Economic momentum: The 2-month change in the global manufacturing
PMI. (See REVISITING: Using the Global PMI as trading signal, Nikolaos
Panigirtzoglou, Jan 2012).
Equity price momentum: The 6-month change in the S&P500 equity index.
Chart A8: Option skew monitor
Skew is the difference between the implied volatility of out-of-the-money
(OTM) call options and put options. A positive skew implies more demand for
calls than puts and a negative skew, higher demand for puts than calls. It can
therefore be seen as an indicator of risk perception in that a highly negative
skew in equities is indicative of a bearish view. The chart shows z-score of
the skew, i.e. the skew minus a rolling 2-year avg skew divided by a rolling
two-year standard deviation of the skew. A positive skew on iTraxx Main
means investors favor buying protection, i.e. a short risk position. A positive
skew for the Bund reflects a long duration view, also a short risk position.
Credit growth
Chart A9: G4 bank lending to households
In $bn, Quarterly changes in outstanding commercial bank loans to
households, adjusted for changes in exchange rates and MBS net issuance.
As of Jan. 2014.
Source: ECB, BoJ, BoE, Federal Reserve, Bloomberg and J.P. Morgan
Chart A10: G4 non-financial corporate
debt issuance
In $bn, Bank lending to and net issuance of secured, unsecured and
securitized bonds by US, Japanese and European non-financial corporates.
Bank lending is adjusted for changes in exchange rates, net bond issuance is
currency unadjusted. As of Jan. 2014.
Source: ECB, BoJ, BoE, Federal Reserve, Bloomberg, Dealogic, J.P. Morgan
Equity trading volumes
Positions
Inversed
Flows
Economic
momentum
Equity price
momentum
Value
0.0 0.5 1.0 1.5 2.0 2.5
S&P500
iTraxx Main
German Bund
EURUSD
Gold
Crude
20-Mar-2014
14-Mar-2014
-100
-50
0
50
100
150
200
250
Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13
Net G4 household bond +
MBS Issuance
3mth mv g avg
-150
-100
-50
0
50
100
150
200
250
Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 Mar-13
Net corporate bond Issuance
G4 commercial bank loans to non-financial corporates
3mth mv g avg for total
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Spec position monitors
Chart A11: Weekly Spec Position Monitor
Net spec positions are the number of long contracts minus the number of
short using CFTC futures only data. This net position is then converted to a
USD amount by multiplying by the contract size and then the corresponding
futures price. To proxy for speculative investors, commodity positions use the
managed money category, while the other assets use the non-commercial
category. We then scale the net positions by open interest. The chart shows
the z-score of these net positions, i.e. the current net position divided by the
open interest, minus the average over the whole sample divided by the
standard deviation of the weekly positions over the whole sample. US rates
is a duration-weighted composite of the individual UST series excluding the
Eurodollar contract. The sample starts on the 13th of June 2006.
Source: Bloomberg, CFTC, J.P. Morgan
Chart A13: S&P500 sector short interest
Short interest as a % of shares outstanding based on z-scores. A strategy
which overweights the S&P500 sectors with the highest short interest z-
score (as % of shares o/s) vs. those with the lowest, produced an information
ratio of 0.7 with a success rate of 56% (see F&L, Jun 28, 2013 for more
details)
Source: NYSE, J.P. Morgan
Chart A12: Spec position indicator on
Risky vs. Safe currencies
Difference between net spec positions on risky & safe currencies
Net spec position is calculated in USD across 5 "risky" and 3 "safe"
currencies (safe currencies also include Gold). These positions are then
scaled by open interest and we take an average of "risky" and "safe" assets
to create two series. The chart is then simply the difference between the
"risky" and "safe" series. The final series shown in the chart below is
demeaned using data since 2006. The risky currencies are: AUD, NZD, CAD,
RUB, MXN. The safe currencies are: JPY, CHF and Gold.
Source: CFTC, J.P. Morgan
Chart A14: Spec position indicator on US
equities vs. rates
Difference between net spec positions on US equities & rates
Similar to Chart A12, this indicator is derived by the difference between total
CFTC spec positions in US equity futures (in $bn) scaled by open interest (in
$bn) minus a duration weighted composite of UST futures and scaled by
open interest. The US equity is an aggregate of the S&P500, Dow Jones,
NASDAQ and their Mini index. The US rates series is duration weighted
aggregate of the UST2YR, UST5YR, UST10YR, UST long bond & the UST
Ultra long bond futures.
Source: CFTC, Bloomberg and J.P. Morgan
-3.0 -2.0 -1.0 0.0 1.0 2.0 3.0
3M Eurodollars
AUD
RUB
CAD
US 5YR
BRL
JPY
MXN
USD
Copper
US 10YR
US Rates (ex. ED)
US 2YR
Gold
Silver
NZD
US Equities
Wheat
EUR
GBP
Corn
CHF
VIX
Nikkei
US T-Bonds
Crude Oil
04-Mar 14
11-Mar 14
Standard devations from mean weekly position
-1.0 0.0 1.0 2.0 3.0 4.0 5.0
Financials
Discretionary
Staples
Health Care
Industrials
Energy
Utilities
Technology
Materials
Telecom
15/02/2014 28/02/2014
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
07 08 09 10 11 12 13 14
-20%
-15%
-10%
-5%
0%
5%
10%
15%
20%
93 96 99 02 05 08 11 14
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Mutual fund and hedge fund betas
Chart A15: Balanced fund equity exposure
Rolling 21-day beta of balanced MF returns to returns on the S&P500.
Balanced funds are top 20 US based funds by assets that have existed since
2006. It excludes tracker funds and funds with a low tracking error. The thin
black line is the average during expansion since 2006.
Source: Bloomberg J.P. Morgan
Chart A17: Hedge fund monitor
Rolling 21-day beta of macro and equity L/S hedge fund returns to returns on
the S&P500. The beta represents the average exposure of macro hedge
funds to equities over the previous 21-days.
Source: Datastream, Bloomberg, J.P. Morgan
Chart A16: Equity mutual fund beta to
Euro vs. US and EM vs. US equities
relative performance
41-business-day rolling beta of the average daily returns of 20 biggest US-
domiciled active equity funds against the daily relative return of Euro area vs.
US equities and emerging markets vs. US equities. The betas are based on
multiple regressions of the relative performance of the Eurostoxx50 vs. the
S&P500, MSCI EM vs. the S&P500 and the S&P500 outright performance.
Source: Bloomberg J.P. Morgan
Chart A18: Currency hedge fund USD
exposure
The rolling 21-day beta of the Barclay Hedge FX index with the DXY vs. the
net spec position in the USD as reported by the CFTC. Spec is the non-
commercial category from the CFTC. Last observation is Mar 11, 2014.
Source: CFTC, Datastream, Barclay Group, Bloomberg, J.P. Morgan
0.45
0.50
0.55
0.60
0.65
0.70
0.75
0.80
Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
-0.4
-0.2
0. 0
0.2
0. 4
0. 6
0. 8
Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Last observation:
Equity L/S HF: beta
to the S&P500
Macro HF: beta to
the S&P500
19-Mar-14
-0.05
0.00
0.05
0.10
0.15
0.20
0.25
0.30
0.35
Jan-11 Jan-12 Jan-13 Jan-14
EM
Euroarea
-1.0
-0.5
0.0
0.5
1.0
1.5
-50
-40
-30
-20
-10
0
10
20
30
40
50
Jan-07 Apr-08 Jul-09 Oct-10 Jan-12 Apr-13
HF beta to t he DXY
Net spec positions
in the USD
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Corporate activity
capex and cash flow as % of GDP
% of GDP, G4 includes the US, the UK, the Euro area and Japan. Last
observation as of Q3 2013.
Source: ECB, BOJ, BOE, Federal Reserve flow of funds
Chart A21: Global M&A and LBO
$tr. YTD 2014 as of Mar 21, 2014. M&A and LBOs are announced.
Source: Reuters ThomsonOne, J.P. Morgan
sector net debt and equity issuance
$tr per quarter, G4 includes the US, the UK, the Euro area and Japan. Last
observation as of Q3 2013.
Chart A22: US and non-US share
buybacks
$tr, YTD 2014 as of Mar 21, 2014. Buybacks are announced.
Source: Reuters ThomsonOne, J.P. Morgan
7.0
7.5
8.0
8.5
9.0
9.5
10.0
10.5
11.0
95 97 99 01 03 05 07 09 11 13
G4 Capex
G4 Cash flow
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
05 06 07 08 09 10 11 12 13 14
M&A ex-LBO (lhs)
LBO (rhs)
YTD
-1.0
-0.5
0.0
0.5
1.0
1.5
2.0
98 00 02 04 06 08 10 12
T
h
o
u
s
a
n
d
s
G4 net debt
i ssuance
G4 net equity
issuance
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
05 06 07 08 09 10 11 12 13 14
Non-US buybacks
US buybacks
YTD
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Pension fund and insurance company flows
Chart A23: G4 pension funds and
insurance companies equity and bond
flows
Equity and bond buying in $bn per quarter. G4 includes the US, the UK, Euro
area and Japan. Last observation is Q3 2013
Chart A25: Pension fund deficits
US$bn. For US, funded status of the 100 largest corporate defined benefit
pension plans, from Milliman. For UK, funded status of the defined benefit
schemes eligible for entry to the Pension Protection Fund, converted to US$
at current exchange rates. Last observation is Feb 2014.
Source: Milliman, UK Pension Protection Fund, J.P. Morgan
insurance companies equity and bond
levels
Equity and bond as % of total assets per quarter. G4 includes the US, the
UK, Euro area and Japan. Last observation is Q3 2013.
insurance companies cash and
alternatives levels
Equity and bond as % of total assets per quarter. G4 includes the US, the
UK, Euro area and Japan. Last observation is Q3 2013.
-150
-100
-50
0
50
100
150
200
250
Mar-99 Mar-02 Mar-05 Mar-08 Mar-11
Bonds
Equities
-600
-500
-400
-300
-200
-100
0
100
Dec-09 Dec-10 Dec-11 Dec-12 Dec-13
UK
US
20%
25%
30%
35%
40%
45%
50%
55%
Bonds
Equities
0%
4%
8%
12%
16%
20%
Cash
Alternatives
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European Funding market monitor
Table A4: Bank deposits and ECB reliance
Deposits are non-seasonally adjusted Euro area non-bank, non-government deposits as of Jan 2014. We take total deposits (item 2.2.3. in MFI balance
sheets minus deposits from other financial institutions, which includes deposits from securitized vehicles and financial holding corporations among others.
We also subtract repos (item 2.2.3.4) from the total figures to give a cleaner picture of deposits outside interbank borrowing. ECB borrowing and Target 2
balances are latest available. ECB borrowing is gross borrowing from regular MROs and LTROs. The Chart shows the evolution of Target 2 balance for Spain
and Italy along with government bond spreads. The shaded area denotes the period between May 2011 and Aug 2012 when convertibility risk premia were
elevated due to Greece exit fears.
Source: Bloomberg, ECB, National Central Banks, J.P. Morgan Source: Bloomberg, National Central Banks, J.P. Morgan
Chart A27: Euro area gross bank debt
issuance
Chart A28: Excess cash in the Euro area
banking system
Includes secured, unsecured and securitized issuance in any currency.
Excludes short-term debt (maturity less than 1-year) and self funded
issuance (where the issuing bank is the only book runner).
bn, Measured as the difference between the amount in the ECB deposit
facility minus that in the lending facility, plus the difference between the
current account reserves that banks hold with the ECB minus required
reserves. Last observation is Mar 20, 2014.
Source: Dealogic, J.P. Morgan Source: ECB, J.P. Morgan
bn Target 2 bal. Target 6m chng ECB borrowing Depo 3m chng Depo 12m chng
Austria -38 3 7 0.5% 2.5%
Belgium -16 -1 15 1.4% 5.0%
Cyprus -7 0 2 0.1% -25.3%
Finland 15 -12 2 0.8% 1.7%
France -48 8 66 1.5% 4.3%
Germany 499 -74 31 1.0% 2.0%
Greece -51 2 59 0.3% 0.5%
Ireland -69 7 37 0.3% 0.0%
Italy -190 44 224 -9.0% -31.6%
Luxembourg 106 5 2 -1.5% 3.5%
Netherlands 44 -18 11 -0.1% -0.2%
Portugal -59 6 47 -0.5% 1.3%
Spain -232 49 191 1.0% 4.2%
1.4
1.9
2.4
2.9
3.4
3.9
4.4
4.9
5.4
5.9
-800
-700
-600
-500
-400
-300
-200
-100
0
100
Jan-11 Oct-11 Jul-12 Apr-13 Jan-14
Spanish and Italian
Target2
10y Spanish and Italian
govt spread vs Bunds
5
10
15
20
25
Oct-12 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14
Periphery
Core
EMU bank unsecured gross
issuance
bn
0
100
200
300
400
500
600
700
800
900
Jan 11 Jan 12 Jan 13 Jan 14
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Japanese flows and positions
Chart A29: Tokyo Stock Exchange Margin
trading: total buys minus total sells
in bn of shares. Topix on right axis.
Source: Tokyo Stock Exchange, J.P. Morgan
Chart A31: Japanese equity buying by
foreign investors. Japanese investors'
buying of foreign bonds
$bn, 4 week moving average.
Source: Japan MoF, J.P. Morgan
Chart A30: Domestic retail flows
In JPY tr. Retail flows are from Tokyo stock exchange and FX margin trader
positions are JPM calculation. FX margin trader positions are in reverse
order. A higher number means a larger short and vice versa.
Source: TSE, J.P. Morgan calculations
Chart A32: Overseas CFTC spec positions
CFTC positions are in $bn.
Source: Bloomberg, CFTC, J.P. Morgan calculations.
500
1000
1500
2000
2500
3000
3500
0. 0
1. 0
2. 0
3. 0
4. 0
5. 0
6. 0
89 92 95 98 01 04 07 10 13
buys minus sells
Topix
-10
-5
0
5
10
15
20
09 10 11 12 13 14
Foreign investors' buying of Japanese equities
Japanese investors' buying of foreign bonds
-2
0
2
4
6
8
10
12 -0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0.0
0.1
0.2
0.3
0.4
0.5
Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14
Domestic FX margin traders
Japanese retail flow (4 wk avg.)
-250
-200
-150
-100
-50
0
50
100
150
200
250
-20
-15
-10
-5
0
5
10
15
20
Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14
Nikkei Spec position
CFTC JPY/USDnet spec positions
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Gold flows and positions
Chart A33: Spec positions
$bn. CFTC net long minus short position in futures for the Managed Money
Category.
Source: CFTC, Bloomberg, J.P. Morgan
Chart A35: Gold coin sales
Source: US Mint, Bloomberg, J.P. Morgan
Chart A34: Gold ETFs
Mn troy oz. Physical gold held by all gold ETFs globally.
Chart A36: Shanghai exchange gold
volumes
Thousand troy ounces.
Source: Shanghai Gold Exchange, Bloomberg, J.P. Morgan.
0
5
10
15
20
25
30
35
40
Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13
50
100
150
200
250
300
350
87 92 97 02 07 12
Thousand troy ounces
Last observation: Feb-14
0
10
20
30
40
50
60
70
80
90
Oct-03 Apr-05 Oct-06 Apr-08 Oct-09 Apr-11 Oct-12
0
200
400
600
800
1000
1200
1400
1600
1800
2000
Oct-03 Apr-05 Oct-06 Apr-08 Oct-09 Apr-11 Oct-12
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Disclosures
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