Global Markets
May 2012
Global Markets & Investor Flows
Risks and Opportunities
Samarjit Shankar
Managing Director
BNY Mellon
samarjit.shankar@bnymellon.com
Information Security Identification: Confidential
BNY Mellon iFlowsm Research
Global economy remains delicately balanced
Relapse v. rɪˈlæps;n. rɪˈlæps, ri læps
–verb (used without object)
-> to fall back into illness after convalescence or apparent recovery.
–noun
-> a return of a disease or illness after partial recovery from it.
Economic recovery has been multi-speed and uneven
Subdued global growth estimates by IMF and World Bank
Advanced economies facing short-term pain amid fiscal consolidation,
financial sector repair, subdued growth and still high unemployment
Extraordinary stimulus, both monetary and fiscal, likely to linger
Central banks remain in cautious mode, maintaining unconventional
stimulus measures (more QE?)
Emerging economies, the key locomotives of growth, feeling the pain now
Emerging market central banks volte-face – once grappling with inflation &
capital inflows, saw capital outflows toward end-2011, fresh buying in 2012
Global imbalances: re-balancing acts required; Investor bi-polarities
Investor Bi-Polarities
Risk appetite
Risk aversion
Glass half-full
Glass half-empty
Doves
Hawks
Developed Markets
Emerging markets
2
Deflation
Inflation
QE 3
QE exit
Bonds
Equities
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Growth
Recession
Real GDP Growth
Core Inflation
Bond Markets: fiscal stimuli, QE, but sovereign debt concerns abound
Credit markets have stabilized but not fluid yet; Bank lending remains relatively tight; Eurozone liquidity issues
Fiscal policies weigh stimulus vs austerity needs amid persistent concerns about sovereign debt sustainability
TED spread: 3m LIBOR less 3m T-Bill yields
Bond 2yr-10yr yield spreads
5yr CDS sovereign spreads
Equity Markets: wealth destruction, recovery, but been susceptible again
Developed equity markets have been recovering gradually, but recent setbacks amid growth concerns
Emerging equity markets have bounced stronger, but relapse has led to investors becoming very selective
% move since 1 July 2008: DAX, SPX, NKY
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% MSCI move since 1 July 2008: LatAm, Asia, E.Europe
About BNY Mellon’s iFlow – total assets monitored worth ~ $33 trillion
Global Custody: largest in the world at $25.8 trillion drawn from heritage Mellon & BNY Platforms
Market Penetration: Flows represent about 15-27% of tradable securities in most markets worldwide
Objective - based on tangible and concrete data, not surveys
Timely - investor flows: on a trade-date basis, updated daily;
- investor positions: timely updates of monthly shifts (equity, bond and currency portfolios)
Level of Detail - adds invaluable insight into market activity with unparalleled granularity
Comprehensive and Relevant Multi-Asset Perspective - encompassing Equity, Fixed Income & FX markets activity globally
History – Flows data extend back to 15-21 years’ history (Equities/Bonds to 1996, FX to 1990)
Performance & Risk Analytics – Mellon Analytical Solutions (formerly Russell/Mellon) & BNY Global Risk Services
•
Client relationships represent $8.9 trillion in assets under measurement
•
Investor positions vs benchmark (e.g. MSCI EAFE, BarCap Global Agg etc); What are my competitors/peers doing?
IMF GFSR: Correlation between BNY Mellon iFlow and BoP Flows
BNY MELLON Equity Flows vs Japan MOF Flows
indexed data, settlement basis for MOF data
40,000
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MOF DATA
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Information Security Identification: Confidential
Jun-12
Oct-11
Feb-12
Jun-11
Oct-10
Feb-11
Jun-10
Oct-09
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(LHS)
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-30,000
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-10,000
iFlow: where is the money going?
iFlow featured in the International Monetary Fund’s Global Financial Stability Report, Oct 2010
For example, net equity flows to Brazil reported by BNY Mellon represent about 10
percent of those recorded in the balance of payments, with a correlation coefficient of
84%. Similarly, net bond flows to Korea represent about 5 percent of those recorded in
the balance of payments, with a correlation coefficient of 61%.
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iFlow: strong bond & equity inflows in emerging markets
iFlow featured in the International Monetary Fund’s Global Financial Stability Report, Apr 2011
Debt inflows were particularly strong, with economies
that offered higher levels of risk-adjusted local
government bond yields (prior to the surge in capital
flows) attracting greater foreign inflows (Figure 1.33).
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The response of emerging market firms to equity and debt inflows has been strong.
Equity issuance rose to the highest levels ever in Brazil and China, and although in
India and Korea such issuance remained below pre-global crisis highs, it
surpassed pre-Asian crisis levels.33,34 Similarly, the supply of emerging market
external corporate bonds in 2010 surpassed historical records in aggregate, led by
Latin American corporate bonds.35 Figure 1.36 shows that large equity issuance
appears in some cases to have mitigated equity appreciation stemming from
strong foreign portfolio inflows. Brazilian firms issued actively through IPOs,
absorbing large inflows without stretching valuations. Some Asian corporate
markets have displayed a combination of price & supply responses.
iFlow: peripheral Eurozone debt firmly out of favor
iFlow featured in the International Monetary Fund’s Global Financial Stability Report, Apr 2012
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iFlow: What are our investor flow data telling us?
• Bond yields have diverged within the Eurozone – relative weakness in the periphery has led to a renewed spike in yields
• Yield differentials between Germany and especially Greece, Italy, Portugal, Spain and Ireland have widened again
• Lack of a coherent solution, policy discord, severe austerity – Spain: investor focus now; Greece: re-escalation of crisis; Italy:
contagion worries; Portugal: persistent funding concerns
• German bunds in favor as investors seek relative safety and liquidity, but safe-haven status starting to wane?
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Currency Markets: US Dollar at a crossroads
Fed Chairman Ben Bernanke stays the course on accommodative stance - “I think it’s a little premature to declare victory”
Challenging mix of a frustrating recovery and inflation – will price pressures prove transitory?
After a secular USD downtrend, a strong dollar trend emerged since in 2008H2, faded in 2009, re-emerged in 2010; USD down and up in 2011
Recent data on manufacturing, employment, consumer confidence – monetary accommodation to continue => but risk-off bouts buoy USD
FOMC to keep rates low; Operation Twist; Will QE3 entail more monetary easing?
US Trade-Weighted Major Currency Index
ISM Mfg & Non-Mfg; Consumer Confidence
10-year US TIPS-nominal Spread
Home Sales: Existing and New
USD total speculative positions (CFTC data) and DXY
Non-farm payrolls & Unemployment Rate
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iFlow Insights: Global Capital Flows and Investor Activity
• US Treasuries still sought; Cross-border investors prefer relative safety and liquidity
• US equities have been favored especially by cross-border investors, supporting benchmark indices
• USD buoyed by risk aversion, though Fed’s continuing monetary accommodation remains a weight
# announcements
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announcements
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S our c e : B l oombe r g
VIX (CBOE) Vol Index = pay for
insurance against equity losses
2011-12: VIX peaked at 29.40 just
after Japan’s quake/ tsunami in Q1,
fell below the 20.35 average over
two-decade history, spiked and fallen
10 Information Security Identification: Confidential
guidance
US Company Guidance vs. Earnings Estimates
EUR: renewed pessimism … what is that light at the end of the tunnel?
• Contagion fears as crisis spreads to ‘core’ from ‘periphery’; Policy discord a key concern
• Since mid-2010, the EUR benefited from oversold/undervalued asset markets; 2011 rekindled doubts
• ECB hawkishness also proved supportive for the Euro in 2010; likely to fade in 2012
• Eurozone’s two-speed economy may become one-speed as growth stalls; potential fallout from default?
•
EUR had provided only credible alternative (sovereign debt
markets that were deep enough) to USD for reserve managers
looking for an alternative home for their fresh funds.

EUR was being seen as “new DEM”? However, Greek crisis
was a sharp reminder that it’s the component of all its parts
(e.g., its also the “new GRD”, the “new ITL”, the “new PTE”).
•
2010: considerable anguish vis-à-vis sovereign debt crisis
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2011: contagion fears erupt
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
Ongoing policy discord about effective crisis prevention
mechanisms such as the EFSF
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Germany and France stock markets shed -30% in 2011Q3
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Austerity may further choke growth amid economic headwinds

Eurozone banking sector vulnerable – tight liquidity and weaker
credit creation further limits growth potential
Greece is the word

Deficit reduction disappointment

2012-14 financing gap is large; cannot access markets near-term

Recession may be deeper and longer; painful adjustment
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Germany’s hard stance; France differs; ECB adamant about no
restructuring or credit event
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Support for peripheral debt shown by China & other Asian nations
•
2012: Greek denouement – tragedy or the great escape?

Private bondholders negotiate; IMF reiterates caution

Spain: in focus now
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Parallelism/Contagion: Other Sovereign Debt Concerns?
Steady outflows from Spain and Italy in recent months; Greece and Portugal out of favor
Concerns about Dubai and Greece have been paramount in recent years. Lingering risks in other countries – contagion?
Fiscal accounts in focus; US/EU downgrades – Meaningful alternatives to holding sovereign debt as public debt burdens grow?
Since 10/1/2010: CDS (5 yr) percentage changes
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Central banks’ balancing acts in 2011-12; Currency tensions?
G-10 Policy Benchmark Rates
• Central banks in advanced economies dealing with growth moderation, rising
inflation
• Policy rates had converged at historic lows; some central banks started the
process of normalization but stopped short in their tracks; others continue
• Keeping options open for now:
 Monetary accommodation in place, keeping interest rates low
• US: May yet consider QE3 if core inflation remains low & labor market worsens
• UK: BoE may consider another QE despite up-tick in inflation; spending cuts
• Japan: Battling deflationary forces, lowered rates & raised asset purchases
• Switzerland: Mindful of deflationary pressures, CHF strength a major concern
Select Emerging Markets Currencies: Policy Rates
• Currency weakness either a consequence of monetary policy choices (such as
QE) or a deliberate policy in and of itself … currency as a policy weapon
• Investors’ erosion of faith in currencies as “stores of value”
• General discontent about competitive currency “devaluations”?
• Mar 2011: show of solidarity by G-7 – coordinated JPY intervention amid crisis
• Now, inflationary pressures a concern even as recovery threatens to stall
• Emerging markets central banks had been pro-active in tightening as growth
was relatively more robust; now rate hikes on hold as growth falters
US Growth and
Trends
U nite dInflation
S ta te s , S A
1 5 .0
1 2 .5
Stagflation
1 0 .0
7 .5
Percent
•US: Treasury Secretary Geithner: "We are concerned, as are many of China's trading partners,
that the pace of appreciation has been too slow and the extent of appreciation too limited.”
•Japan: Finance Minister Noda : “There is something unnatural about the fact that China can
buy Japanese government bonds while Japan cannot (purchase Chinese bonds). ….I do not
know what their true objectives are, but we would like to clarify their objectives.”
•China: Yao Jian, Commerce Ministry spokesman: it’s unreasonable for the US to level criticism
at China's exchange rate policy simply because of its trade surplus, and points to China’s trade
deficits with Japan & Australia as evidence that the CNY was not the root cause of the US
imbalance
5 .0
2 .5
0 .0
-2 .5
-5 .0
-7 .5
70
72
74
76
78
80
82
84
86
88
90
92
94
96
98
00
02
04
06
08
10
12
A ll urb a n co ns um e rs , U .S . ci ty a ve ra g e , C o ns um e r P ri ce s , A ll i te m s le ss fo o d a nd e ne rg y, Ind e x, 1 9 8 2 -1 9 8 4 = 1 0 0 [c.o .p 1 2 m o nths ]
N a ti o na l Inc o m e A c co unt, N a tio na l P ro d uc t A cc o unt, G ro ss D o m e s ti c P ro d uc t, O ve ra ll, To ta l, C o ns ta nt P ric e s , A R , U S D , 2 0 0 5 p ric e s [c .o .p 1 2
S o u rc e : R e u te rs E c o W in
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Gold as a safe haven and “store of value”
• Concerns about inflation
• Risk aversion – Eurozone (sovereign debt crisis); Middle East (political upheaval);
Japan (natural disasters)
• Broader lack of confidence as growth moderates and fiscal problems persist; US credit
rating downgrade
• Lasting store of value; an instrument to protect purchasing power of savings
• Central banks turning to gold both as an investment and as a means of diversification
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Gold prices have not just benefited due to US dollar weakness.
Gold prices have gained during periods of both US dollar
weakness and US dollar strength in recent years.
•
If almost all the major nations would like to benefit from more
competitively priced currencies then what can investors still buy
as a “store of value”? No surprises.
•
Will disinflationary trends curtail gold price upside?
PHYSICAL DEMAND FOR GOLD IN CHINA AND INDIA
During 2011Q1, gold consumption in China totaled 233.8 tons up from 158.9 tons a
year earlier – World Gold Council. Growth was more than triple the average 14%
annual pace since the nation’s market for the precious metal was deregulated in
2001.
As of end-May 2011, Industrial and Commercial Bank of China (ICBC – world’s
biggest lender by market value) set up 1.4 mln gold-linked accounts since their
introduction in Dec 2010
China has overtaken India to become the world’s largest physical investment market,
-- demand for gold jewelry increased 21 % to a record 142.9 metric tons and with
purchases more than doubling to 90.9 tons.
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USD weaker
- As of March 2011, held 27,219.8 metric tons (11.3% of total reserve holdings)
- Feb-Mar 2011: Mexico, Russia and Thailand added gold worth about $6 bln to their reserves
. Mexico bought 93.3mt, raising holdings from about 6.9mt
. Feb-Mar 2011: Russia bought 18.8mt to raise holdings to 811.1mt
Since 1/1/08:Gold Price and US Dollar Index (inverted)
. Thailand bought 9.3mt to 108.9mt
Multi-speed recoveries & policy divergence; commodity-cycle a key factor
• Emerging markets: most had enjoyed strong recoveries – led to a
structural increase in commodity demand, while supply responses
had been slow
• Weak USD has also kept commodity/energy prices buoyant
• Renewed investor buying in commodity-linked markets led to a
buildup of inflationary pressures
• Stalling global growth has removed a major price support; copper
and crude oil fell -17% in 2011Q3, worst quarter since 2008Q4
• Growth prospects and resilience in emerging markets a key focus
• Significant capital on sidelines may be deployed selectively
Jan 2012
April 2012
IMF: WORLD OUTPUT 2012 2013 WORLD BANK
2012
2013
1.3
2.2
-0.3
1.9
1.9
2.4
1.1
1.6
5.4
8.4
6.5
7.8
3.4
6.0
8.3
7.7
7.8
4.4
Advanced Economies
US
Euro Area
Japan
Developing Economies
China
India
ASEAN-5
Brazil
Commodity Index Comparisons
1.4
2.1
-0.3
2.0
2.0
2.4
0.9
1.7
OECD Countries
US
Euro Area
Japan
5.7
6.0
8.2
6.9
5.4
3.0
8.8
7.3
6.2
4.1
Developing Economies
China
India
East Asia and Pacific
Brazil
JOCIMETL (Journal of Commerce): Steel, Copper, Aluminum, Zinc, Lead, Tin, Nickel
SPGSCI & CRY: Grains, Soft Commodities, Livestock, Energy, PreciousMetals, Industrials
as of Dec 2009
S&P GSCI Agriculture, Industrial & Precious Metals sub-indices
G-10 FX Returns 9Mar2009 – 01May2012
Source: Bloomberg
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China – poised for growth; but is slowing to a more sustainable pace
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China is a key locomotive of global growth

Full-year 2011 GDP grew 9.2%, down from 10.3% in 2010

Trade surplus in 2011 fell to $155.14 billion from $181.51 billion in
2010, the smallest in six years

Foreign reserves fell to $3.18 trillion in 2011Q4 from $3.2 trillion in
2011Q3, the first quarterly decline since the 1998 Asian crisis.
•
Currency flexibility since 19 June 2010 has encouraged investors who have
been monitoring policy maker efforts to rein in overheating pressures such
as in bank loans, property
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Since Jan 2011, PBOC has raised benchmark rate 3 times and boosted
lenders’ reserve requirement ratios 6 times
•
The Shanghai Composite Index fell about 30% during Apr-Dec 2011 on
concerns about inflationary pressures and higher borrowing costs hurting
corporate earnings, but steady net inflows in place have seen the index
gain +11% Jan-Apr 2012
•
China’s changing growth model

Premier Wen says the main cause of the US trade deficit is not the
exchange rate of the Chinese currency, but the structure of investment
and savings

Premier Wen says China has made increasing consumption a longterm strategy
USD/CNY and Yuan NDFs for 1m and 1y
PBOC governor Zhou Xiaochuan said on April 16, 2011 at Boao Forum 2011
annual meeting that the exchange rate tool has been used to fight inflation
when he was interviewed by the media. He said, “The exchange rate is
actually already in use, the yuan has appreciated, and how to measure its
effectiveness in fighting inflation, usually is difficult. "
INTERNATIONALIZATION OF THE RENMINBI
Regulatory change: RMB settlement in Hong Kong September 27, 2010 onward – deluge of issuance as institutions tap the RMB market
Gradual liberalization of China’s capital account could see the CNY emerge as a viable longer term alternative in currency portfolios
PBOC Governor Zhou Xiaochuan - "When there is a certain amount of cross-border use of the CNY, there will be a natural demand that the CNY
will move towards full convertibility in a gradual and orderly manner."
HKMA Chief Executive Norman Chan
Hong Kong Yuan Deposits at a record USD 89 bln as of end-July amid companies’ demand for Chinese currency (up 82% YTD as of July)
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iFlow Insights: Commodity-linked markets slowly regaining lost allure
• Strong buying of ZAR, BRL & RUB as commodity prices rose from March ’09 lows; some profit-taking and selling,
inflows again; higher oil prices boosted especially the RUB, recent oil price decline hurt but renewed buying of late
• AUD, NZD had been in favor as G-10 ‘commodity-linked currencies’ but have lost ground in recent months as growth
outlook sours; recent Kiwi downgrade; CAD weighed by energy price moderation and risk aversion, but recovering now
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The thirst for yield: currency markets weighed by asset-markets’ sell-off
• Low rates in mature markets had boosted emerging markets capital inflows, investors pulled back, now slowly getting back in
High Yielding Emerging Markets Currencies vs USD
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The thirst for yield: Asia has been well-placed, but no longer remains insulated
• Domestic demand and regional trade key drivers
• Favorable growth prospects led to strong equity inflows since
March 2009
• Growth moderation concerns have afflicted the region
• Asia still relatively well-placed
Asia: price pressures
Asia FX Reserves: strong growth; stop and re-start
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Asia Currencies vs USD
Asia & other emerging local bonds: sentiment has soured a bit
• Emerging East Asia local
currency bond market grew
13.6% in 2010 to $5.2 trillion
• Local-currency denominated
debt instruments
• Large and liquid asset class
• Relatively high yields
• Central banks did not raise rates
aggressively in 2011
• Currency appreciation potential
• Improved credit worthiness
• Favorable growth differentials
• Recent inflation pressures have
damped investor enthusiasm
• Risk aversion has led to some
outflows, but inflows resuming
ADB Report
• Growth in the region has been marked
by improving maturity profiles for many
individual corporate and government bond
markets. This reflects improving structural
fundamentals as lengthened duration will
attract a greater diversity of investors.
• Foreign participation in the region's local
bond markets continued to expand as
investors hunted for yield and anticipated
gains from appreciation of the underlying
currencies. For example, foreigners held
30.5% of Indonesian government debt at
the end of 2010.
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Asian and other EM central banks: FX Interventions volte-face
• Significant amount of portfolio capital inflows
iFlow: Cumulative Equity Flows in Japan & South Korea
• China becoming more interested in neighbors’ asset markets

More buying of Japanese government bonds

Stepping up purchases of South Korean debt

Added MYR to small group of currencies allowed to be traded directly vs CNY
• Variety of measures to deter flood of inflows?

South Korea: Audit of lenders handling foreign currency derivatives

Brazil: tripled tax to 6% on foreigners investing in debt securities
• FX interventions to smooth local currency appreciation; but abrupt turnaround as EM central banks look to limit currency downside
iFlow featured in IMF GFSR
Report Oct 2010: In response
to increased foreign inflows,
policymakers in a number of
countries have introduced a
variety of measures. For instance,
authorities in Brazil, Indonesia,
and Korea introduced measures to
mitigate the impact of strong
capital flows on domestic
macroeconomic and financial
stability – precisely in countries
where the BNY Mellon iFlowsm
data found foreign equity inflows
had become especially persistent.
The measures in these countries
might have changed the overall
composition of capital inflows, but
they have not as yet significantly
reduced the persistence of equity
inflows.
21 Information Security Identification: Confidential
1 Jul ’08 – 28 Feb ‘09 1 Mar ’09 – 30 Apr ‘10
1 May ’10 to date
iFlow Insights: Bond Allocations by Currency 2007-12
• JPY-denomination shot up in Jul 2007, stayed at elevated levels, spiked in Jan 2008, and again Sep 2008 onward
• Periods of risk aversion: Higher Allocation to USD-denominated bonds as riskier positions were liquidated during equity
market sell-offs in Aug ’07, Nov ’07, Jan ’08 and Sep ’08 onward
• Investors favored the shorter end of the curve amid search for safety and liquidity
• Up-tick in EUR-denominated holdings in Jan/Feb ’08 => EUR/USD broke above 1.50 and 1.55
• Spike in EUR/USD in Dec ’08/Jan ’09 (1.25 to 1.45); JPY began losing its safe-haven allure during 2009Q1
• Reverse direction for EUR/USD in Aug ’07; also in Aug ’08 (1.56 to 1.46) and Oct ’08 (1.40 to 1.27)
• UK gilt buying outpaced CAD bonds during 2010H1, profit-taking on Gilts during 2010H2
• Canadian bonds have been out of favor lately, but slowly recovering
• USD-denominated bonds: steady appetite in recent months amid risk aversion, consistent with decline in yields
Cumulative Monthly iFlow:
Developed Bonds as of 01May2012
Bond Allocation by Currency
in US Global Fixed Income Portfolios (Jan 07=100)
155.00
145.00
135.00
125.00
115.00
105.00
95.00
85.00
75.00
65.00
Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09 Jan-10 Apr-10 Jul-10 Oct-10 Jan-11 Apr-11 Jul-11 Oct-11 Jan-12 Apr-12
CAD
EUR
GBP
JPY
USD
Source: BNY Mellon iFlow
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Interesting Juncture for Asset Allocations
•
•
•
•
•
•
•
•
Relative valuations: bonds in vogue again; equities have had a good run
Strange co-existence of risk aversion and risk appetite, former re-asserting itself
Continued low rates & additional QE prospects had fueled global liquidity
Positive for asset markets as QE-related currency debasement fears arose
G-24 emerging markets saw currency appreciation amid strong capital inflows
Risks: debt crisis contagion; growth setbacks; buoyant price pressures
Risk aversion and asset markets’ sell-off offers very attractive strategic plays
Equity upside as excess capital deployed; evidence of buying in select markets
• Emerging markets as an asset class attractive – both equities and bonds
23 Information Security Identification: Confidential
iFlow Daily E-Mail as of 25Jan2011
iFlow:
Key 2012H2 focus on whether investors
1. raise or reduce risky exposure
2. adjust asset allocations
3. become more selective
Strategic
Fundamentals
Tactical
Strategic
Strategic & Tactical
Allocations/Trading
Ideas
Portfolio Flows
Deviations
from Benchmark
24 Information Security Identification: Confidential
Tactical
P&RA
(formerly MAS/Russell Mellon)
• ASSET MIX
• COUNTRY & SECTOR
ALLOCATIONS
Equity/Bond
Positions
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