Roach
Check out this consensus viewpoint
Rather amazing I would say
Consensus
1) S&P to rise 6%
2) FED to keep hiking slowly but surely
3) Pensions are not a problem
4) SS is not a problem
5) The economy will keep growing nicely
6) Junk bonds are not in a bubble
7) Treasuries are not in a bubble but the 10 YR will ries to 5%
OTOH we have Roach preaching it is 1994 all over again and the FED is going to hike to the moon
I say they are both wrong, on about every point
======================================
Global: MacroVision 2005 -- The Elastic World
Stephen Roach (New York)
Our annual MacroVision event -- a day of internal deliberations followed by a day of thematic client debate -- painted a very different picture of the world than the one I embrace. There was a strong belief that macro tensions, however serious, can now be defused gently. That was thought to be generally true of markets, economies, and even geopolitical pressures. A year ago, while the MacroVision consensus was nervous about the ominous buildup of global imbalances, the group generally favored a "muddle-through" scenario. With another year of angst having gone largely for naught, there was new conviction in the case for a benign rebalancing. An elastic world can cope with almost anything, the crowd smirked.
This was the fourth year in a row we added a day of client engagement to our much longer-running string of internal discussions (now going on 14 years). I know of no better way to do "group macro." The first day is basically an offsite for Morgan Stanley's worldwide team of some 80 strategists and economists -- a group that focuses not only on countries and regions but also on equities, fixed income, currencies, emerging markets, and credit. Over the years, we have turned our internal deliberations into something of a vetting exercise -- scouring the macro landscape for the key thematic issues that we think will be most important in shaping financial markets in the year ahead. On the second day, we then present these themes to a diverse group of clients, with the admittedly lofty aim of reaching collective closure on the big macro calls. This year, our attendance was double the norm of the past three years -- a standing room only crowd of investors, corporate executives, fund managers, and government officials; about 60% of the group was from the New York area, 25% from elsewhere in the US, and the balance flew in from overseas. It was as lively and spirited a discussion on macro issues as I have seen.
The three topics we selected for debate spanned the gamut:
* Bond Bubble?
* After America
* Demographic Dilemma
In an effort to probe these issues from contrasting perspectives, each of the three topics was examined by two different groups of participants. At the end, a synthesis session brought all the findings together in an effort to identify the common ground of the macro debate, as well as the investment conclusions that could be expected to flow from this assessment. My colleagues Joachim Fels, Andy Xie, and Dick Berner provide details of each of these discussions elsewhere.
In a nutshell, the main conclusions were as follows:
First, this year's MacroVision consensus believed there is no bond bubble -- at least not in the traditional sense we might think of one.
That's especially true of government bonds, which were thought to be underpinned by generally well-behaved inflation, relatively well-positioned central banks, and a demographically inspired bid from pension funds noted below. Riskier assets -- especially high-yield, emerging market, and even investment-grade corporate paper -- were perceived as being more vulnerable. But any subsequent widening of spreads was not feared to be as market-disruptive an event as was the case in 1994 and again in 1998. The group felt that this would be the first Fed tightening cycle where someone didn't go through that proverbial windshield.
Second, there was little doubt as to who would take the baton in a post-US centric world -- it would be another encore for America. There was deep conviction that no one comes close to having such an ideal system -- especially in terms of technology, the work force, and America's unique risk-taking culture. Market depth and flexibility -- in both the financial and the nonfinancial realms -- was depicted as the icing on the cake for yet another run of US-centric global growth. Eric Chaney and I made the case for productivity convergence between the US and Europe -- as America eased off on IT-enabled capital deepening just when Europe was finally getting religion on this count. A few eyebrows were raised, but there was far more skepticism than conversion. The group felt any shifts in global leadership would occur at a snail's pace. Memories had apparently dimmed over how quickly the pendulum had swung away from Japan to Germany in the late 1980s.
Third, the demographic threat was generally not viewed as a serious problem for economies or financial markets over the next few years.
With the debate heating up on global pension reform and US social security privatization, we thought the time was finally right to grapple with this weighty issue. The group didn't bite. They argued that this should be viewed not as a demographic problem but as more of a regulatory and political challenge that had important implications for the social policies of immigration and retirement ages. The MacroVision consensus did concede that the asset-liability mismatch has important implications for moves into long-duration fixed-income assets, but concluded that any such shifts were likely to be glacial. As one investor put it, "The demographic clock has plenty of ticks until the alarm goes off."
These relatively benign conclusions fit well with the equally benign macro forecasts of the assembled group. We did a fair amount of polling over the two days -- not just to get a read on our clients but also to compare their prognoses with our own. In almost every case, the views of our clients coincided very closely with the consensus of Morgan Stanley's macro team. Highlights are as follows:
Most thought the Fed would continue with its measured tightening campaign, taking the federal funds rate into the 3.25% to 4.0% range by 31 December 2005; this was viewed as barely touching policy "neutrality," which was generally perceived to be near 4%. Yields on 10-year Treasuries were expected to rise toward 5% by year-end -- the same call the group made a year ago -- while yields on 10-year Bunds were expected to remain largely unchanged at around 3.5%. The dollar was expected by both groups to be little changed, with modest appreciation against the euro (1.25 at year-end) largely offset by depreciation against the yen (95); nor was China expected to change its currency policy in 2005. Oil price risks were skewed slightly to the downside, with $40 (WTI basis) the consensus target for 31 December.
Against this backdrop, the best guess for the year-end level of the S&P 500 was 1250 -- up a measly 6% from current levels and virtually identical with Henry McVey's target.
Given my concerns over the mounting tensions of an unbalanced world, the views of this year's MacroVision consensus very much resembled the "Goldilocks" scenarios of yesteryear -- modest moves in interest rates and currencies and only limited upside for the US stock market. Not a bad world but not a great one either -- perhaps "just right," especially considering the rather tenuous circumstances of massive current account disparities, subnormal real interest rates, and plenty of excess liquidity still sloshing around. That's not to say the group didn't uncover some very interesting trade ideas in these two days of deliberations. The euro/yen short was the most popular idea, as the onus of any further dollar adjustment was expected to tilt away from Europe toward the Asian currency block. Yield-curve flattening was generally favored more in US fixed-income markets than elsewhere in the world.
The consensus was not enthusiastic about US stocks, but it wasn't willing to embrace the possibility of a decoupling of global stock markets that would allow asset allocators to capture excess return. The "China factor" was viewed very differently this year: Last year's China euphoria has given way to skepticism -- concerns have arisen about China's persistent misallocation of capital and what that might mean for overcapacity in commoditized areas such as semiconductors and industrial materials.
There's always a risk that groupthink can produce tight results. Yet the bunching was more extreme this year than I can remember it in a long time. When that happens, I think it pays to be especially alert to the contrarian trades that would take a position against the MacroVision consensus.
Several such possibilities come to mind: overweighting European equities that would benefit from the productivity convergence theme; underweighting risky assets (i.e., high-yield and emerging market debt) where carry trades would unwind the most; underweighting financials that would get hit hard by a Fed tightening and by its concomitant impacts on carry trades; and overweighting cash and precious metals as safe havens in times of turmoil and uncertainty. To me, the ultimate paradox in this year's MacroVision is that investors are looking for baby steps on the road to rebalancing while the world is facing the ever-taut tensions of unprecedented imbalances. Implicit in this view is a global system that this group believes has come a long way from the "perfect storm" of late 1998 -- call it a "perfect normalization."
Maybe it will work out that way, but I continue to have my doubts.
My doubts are wedded in the simple observation that there is nothing static about the disequilibrium now afflicting the global economy. The imbalances are getting worse. That's especially true of saving disparities, as the US personal saving rate now flirts with zero and America's net national saving rate has averaged only 1.5% since early 2002. That's a record low in the modern-day, post-World War II history of the US economy and a record low in the even longer history of the world's leading economic powers. Saving-short nations put equally large claims on the rest of the world to fund economic growth. America has led the charge in demanding such external funding, and the rest of the world has willingly obliged. The record $60 billion US trade deficit of November and the related $81 billion surge in net foreign purchases of long-term US securities are symptomatic of America's absorption of more than 80% of the world's surplus saving -- in effect, redirecting non-US assets from foreign funding needs toward subsidizing excess US consumption. And, of course, the disproportionately heavy foreign flows into US fixed-income products help prevent US interest rates from rising, thereby perpetuating America's debt-intensive, saving-short consumption binge and fueling outsize appreciation in residential property that has now entered the bubble stage. Hardly a world of textbook stability!
Economics is not physics. Financial markets are not always governed by the strict and ironclad laws of science. But a system in disequilibrium -- and an ever-expanding disequilibrium to boot -- is ripe for adjustment. That's the question we put to the MacroVision crowd: What will it take to spark a restoration of equilibrium? There were no takers.
My own suspicion is that the Fed holds the key -- that it may be 1994 all over again but with an important twist. Courtesy of the December FOMC minutes, the Fed has told us with uncharacteristic clarity that the days of zero real interest rates are over. Moreover, by going public with its twin concerns over inflation and mounting speculative activity, the Fed is hinting that it may take more than a leisurely spin back toward neutrality to get the job done. As it did in late 1993 and early 1994, the Fed is sending a warning shot across the bow of the world's carry traders -- and no one is listening. The twist is that the Fed has created the very monster it is now trying to contain -- the asset-dependent American consumer who continues to be the major source driving the demand side of the global economy.
Over the past 50 years, Fed tightening cycles and financial crises of one form or another have gone hand in hand. The MacroVision crowd wants to believe that it will be different this time -- that the global economy and its financial market underpinnings are now elastic enough to find a relatively painless way out. That's not the way I see it. In my view, the extreme state of tension in the global economy and world financial markets challenges that presumption -- especially if the Fed now begins to act on its latest risk assessment. To me, this is potentially a lethal combination -- an unbalanced global economy being hit with a major monetary tightening cycle. It may be very wishful thinking to bank on the perfect normalization as these forces now get unleashed. |
