World stocks ignore history by retreating before expected interest rate hikes
November 10, 2009
By Alexis Xydias
Stocks around the world have fallen at the fastest rate since the worst of the credit crisis on concern that central banks will start raising rates, a signal that triggered the biggest rallies over the past three decades.
Before yesterday's gains, benchmark indices from New York to Tokyo to Frankfurt had lost 4.4 percent on average since October 19 on speculation that policymakers will curtail stimulus measures before the global economy revives. Historical data shows stocks have climbed 92 percent of the time in the six months before government borrowing costs began the biggest increases.
Time to buy
Federated Investors, Renaissance Financial and Citigroup say investors may miss out on more gains after $12 trillion (R90 trillion) in spending by governments worldwide pushed the MSCI World index up 65 percent since March.
Shares rise before central banks push up interest rates because markets anticipate economic expansion first, says Linda Duessel, an equity strategist at Federated Investors.
"You should buy stocks now," says Duessel. "There's an idea that they're taking away the punch bowl by indicating they're raising interest rates. But you can still get a decent rally after that."
The Standard & Poor's (S&P) 500 index rose an average 8.4 percent in the six months before the last five increases in the US Federal Reserve's target rate for overnight loans between banks and added another 82 percent in the bull markets that followed, data show.
Germany's DAX index has climbed 9 percent half a year before rates rose since 1988, while Japan's Nikkei À stock average has posted a return of 8.3 percent in data going back to 1973.
Fed chairman Ben Bernanke may start to increase borrowing costs in June, according to Fed funds futures prices compiled by Bloomberg.
Traders assign a 54 percent chance of an increase to at least 0.5 percent at the end of the Federal Open Market Committee's (FOMC's) meeting on June 23, when the American economy is forecast by analysts to be in its fourth consecutive quarter of expansion.
"You absolutely want to front-run the Fed," said Douglas Ciocca, the managing director at Renaissance. "If I see there's a small progression toward stimulus extraction, it says to me that the economy is being re-established on a much firmer footing, and that's positive."
The S&P 500 has declined 2.6 percent since reaching a one-year high on October 19 as reports on new home sales and consumer confidence trailed forecasts.
World takes a dive
The MSCI world index of 23 developed country markets has slipped 3.1 percent. Both gauges rebounded last week after the Fed said it would keep rates "exceptionally low" for an "extended period".
The steepest advance in US stocks since the Great Depression is fading as investors speculate that more spending will be needed to maintain the pace of growth. The S&P 500 posted its first monthly retreat since February last month.
European Central Bank president Jean-Claude Trichet said last week that he would withdraw some of the emergency measures aimed at ending the credit crisis and the Bank of England slowed the pace of bond purchases.
A day earlier, the Fed outlined the circumstances in which it would be prepared to raise interest rates.
Sydney's S&P/ASX 200 index has risen 1.8 percent since Australia became the first in the Group of 20 nations to boost rates. The Reserve Bank of Australia increased the overnight cash rate target on October 6 to 3.25 percent from a 49-year-low of 3 percent amid signs that the government's policies are helping contain unemployment.
While last week's FOMC statement said "economic activity has continued to pick up", investors would become convinced when policymakers took action, said Gary Pollack, the head of fixed income trading at Deutsche Bank's Private Wealth Management unit in New York.
"It would mean that the Fed feels comfortable that the economy as well as the financial system is strong enough to withstand higher interest rates," said Pollack. "That would be a positive for the equity markets."
Severe exception
The severity of the credit crisis might prevent equities from rallying this time, said Toby Nangle, the director of asset allocation research at Baring Asset Management in London.
More than $1.6 trillion of global bank losses over the past two years sent the S&P500 down 38 percent last year, the steepest drop since the Great Depression, and $15 trillion has been wiped out from stock market value since October 2007.
While the US economy grew a faster-than-expected 3.5 percent in the third quarter, reports in the past month have heightened investor concern that the recovery will be uneven.
Americans cut spending for the first time in five months and new home sales dropped in September.
UK gross domestic product unexpectedly contracted 0.4 percent in the third quarter, the British government said last month.
The Bank of Japan kept its benchmark interest rate at 0.1 percent on October 30 after consumer prices fell at a near-record pace in September.
"If central banks were to tighten, it would starve off the oxygen," said Nangle.
"To remove the accommodation, while it may be prudent, it would undermine equity markets."
The global economy's recovery might "run out of steam" and another recession might follow next year or 2011, billionaire hedge fund manager George Soros said at a conference on October 30.
Jeremy Grantham, the chief investment strategist at Grantham Mayo Van Otterloo, wrote last month that the rally would end and that "fair value" for the S&P 500 was about 20 percent below its level at the end of last week. "My guess, though, is that the US market will drop below fair value" before the end of next year, said Grantham.
"Corporate ex-financials' profit margins remain above average and, if I am right about the coming seven lean years, we will soon enough look back nostalgically at such high profits."
But Tobias Levkovich, a strategist at Citigroup, last month wrote that investors should buy stocks before rates rose. Since 1915, the S&P 500 climbed in 25 of the 38 years when the benchmark US discount rate increased.
Signs that the economy is growing enough to warrant higher interest rates may extend the S&P500's 58 percent rally since March, according to Michala Marcussen, the head of strategy and economic research at Société Générale Asset Management.
US policymakers have pledged to hold rates near zero for an "extended period" for six consecutive meetings.
"What the Fed is really telling us by not changing the rhetoric is, 'We are still worried about the credit channels'," said Marcussen. "We had a nice, strong rally. What's going to drive us from here? Maybe now the markets are waiting for the Fed." - Bloomberg
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