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No, we’re not pointing to the hope expressed by many safari travellers to Africa of getting pictures of the lion, leopard, buffalo, elephant and rhino. We conduct a lessons learned exercise as we gage the impact of the five biggest central banks, we seek for the message behind the five biggest US market caps in the S&P 500 index and pause by listing the top and bottom five in 10-year rates across G20 members.
Over the past weeks, most DM central banks shifted away from full throttle emergency modus towards a controlled retreat away from a super-accommodative monetary stance. To the surprise of many, almost all bond markets rallied across the board. Tapering fears seem to have been a bad narrative. The possibly correct narrative reveals itself when aggregating the 5 biggest central bank balance sheets (FED, ECB, BoJ, PBOC and BoE). We arrive at just above USD 32 trillion. Expressed as a percentage of global GDP, that will end 2021 at around USD 95 trillion or approximately 33%. The growth of the stock across the big five remains remarkable. As pointed out previously it is not the flow (active asset purchases) metric and argument that keep long term rates at bay. It’s the gravitational pull of the combined, accumulated stock and reinvestment zeal applied over time that keep funding levels anchored and depressed at the longer end of yield curves. The near certainty that QE will come and go puts central banks with a key information advantage versus private bond investors. Japan takes the N°1 spot with a 133% number for the BoJ balance sheet as % of nominal GDP. The Eurozone tracks second at 64%. The US, Chinese and UK central banks stall at around 33% of GDP. The anchoring of US and UK long rates is indeed less prominent vis-à-vis Japan and the Eurozone. The Chinese capital account is still strictly under control of the PBoC and as good as closed. The PBoC dictates currency and rate levels. So even if we pass through a short episode of increasing rate volatility, the balance sheet web firmly contains long-term volatility. This reality might essentially prevent a proper bear market in fixed income.
Parallel to the growth of central banks balance sheets, we witnessed similar asset inflation in main equity indices. Often you read that both were feeding off each other and have moved in sync, but honestly that would be too easy and simplistic an explanation. The fabric of successful companies has been changing over the past 10 years. They share similar characteristics as they thrive and operate as platform companies. They operate as digital ecosystems matching buyers and sellers. Network effects accelerate their footprint causing them to gain and hold onto large market shares. Platforms are asset light, have low marginal costs and benefit from network effects. Platform business models are becoming increasingly diverse. White labels like Upwork online recruitment services, freemium-based platforms like LinkedIn, the private label approach by Amazon, API monetization, appearance of token-based models as Open Bazaar or embedded finance like Ant…the list is growing and their dominance across sectors will see continued growth. That phenomenon has impacted the S&P 500 index profoundly. Today five stocks (Apple, Microsoft, Google, Amazon and Tesla) account for about 25% of the S&P 500’s market capitalization. Tesla bypassed Facebook or I should use Meta Platforms over the past weeks. Last time such concentration across the top five occurred was from 1965 till 1975, an era that was dominated by AT&T and especially IBM. Their dominance did not disappear overnight. IBM was the largest market cap for 21 years. Apple has been holding that position ‘only’ over the past 10 years. Clearly when we would take platform-based business models as a sector we are morphing into a totally different public investment universe. Index composition is rapidly changing. That changes their risk-return profile. Adopting 20th century valuation models for 21st equity indices might be shortcutting on a changing reality. More research efforts are required in order to better understand current market events and valuations.
Moving over to rates we take a look at the 5 highest and 5 lowest 10-year rates across G20 countries. The G20 represents about 60% of world population making up 80% of global GDP and 75% of global trade. The highest USD denominated 10-year government rates are carried by Turkey at 6.30%, Brazil at 4.52%, Mexico at 3.00%, China at 2.88% and Russia at 2.66% (interpolated). That top group excludes Argentina as most USD government bonds are restructured and resort under the label ‘complex securities’. Effectively it is surprising that Turkey benefits from rather attractive external funding levels given the questionable standing of its central bank. Government budget control alongside a modest current account deficit trajectory keep credit risk contained. Brazil 10-year USD bonds came under pressure following a hawkish FED meeting end of September as well as rising fiscal policy risk. Mexico, China and Russia consolidate at or just below 3.00%. Interestingly, Indonesia and Saudi Arabia enjoy a similar 2.50% on their 10-year USD benchmark rates. In the bottom five, we find 10-year German rates close to -0.30%, France at +0.05%, Japan at +0.06% in JPY, the UK at +0.84% in GBP and Italy at +0.87%. Middle of the pack consists of US, Canada and Aussie 10-year rates within a 1.45% to 1.80% range in local currency. Ex-Turkey and Argentina, 10-year rates across G20 members fluctuate within a 5% range from -0.30% up to 4.5%. Dropping Germany and Brazil we arrive at a 0.00% to 3.00% range. On balance, convergence dominated divergence episodes. Most of the time divergence stress was short-lived and attracted an institutional yield-searching investor base. We detect little evidence that an upcoming less accommodative DM monetary policy stance will break the underlying convergence trend.
The five main economic indicators, growth, (un)employment, inflation, demand, supply and international trade represent the fundamentals that in isolation would provide us with a completely different picture than the one we described above. Persistently interventionist monetary and fiscal policies have reduced the signal value of economic data points.
Convergence between economic fundamentals and financial markets might not be for tomorrow. The ongoing 21st century business model revolution occurs the very moment the visible hand of public authorities tries to foster inclusive growth and social justice. Adding climate change challenges that require urgent address scares political leadership. A lot of pledges came across the G20 and COP26 wires. Pledges come with a bad track record. The big five representing 60% of global GHG (Green House Gas) emissions, China, the US, India, Russia and Japan have pledged with the brakes on. That sets us up for more, not less divergence between economic reality and financial market indicators across asset classes.