Monthly strategy report february 2015
Transcription
Monthly strategy report february 2015
From pollen particles suspended in water to complex financial products: Brownian Motion Alejandro Vidal Crespo Service Director, Investment Strategy MONTHLY STRATEGY REPORT February 2015 Monthly Strategy Report. February 2015 From pollen particles suspended in water to complex financial products: Brownian Motion As you know, when we choose assets our contention is that the value of what we are buying is what interests us and sooner or later that value will become apparent. As a result, often we don’t become nervous over inexplicable movements in the market or, we take advantage of them to buy or sell depending on our valuations. In this article, we demonstrate how applied mathematics support our way of thinking... In 1827 the Scottish botanist, Robert Brown, was in his laboratory studying and classifying vegetable species. Upon observing a closed jar with pollen particles suspended in water, he noticed that the particles moved for no apparent reason in a dance which seemed endless and random. Initially, he deduced that the pollen particles, having come from an animate object, might contain a type of propulsion mechanism which caused them to move in this way, but his scientific curiosity led him to repeat the experiment with dust particles and he obtained the same result. This lead him to rule out the pollen’s self-propulsion, but he was unable to come up with a theory which would explain the origin and nature of the movement, although he described it empirically with incontrovertible detail. This observation was not entirely new. Lucretius had described a similar process in ancient Rome (60 BC), in dust particles suspended in air reflected by sunlight. Lucretius had already tried to link this movement to the nature of matter. In 1880 the scientist Thorvald Thiele came close mathematically to a description of the movement but it was not until 1905 when the great Albert Einstein fully defined it as a way to demonstrate that matter is made up of atoms and molecules which move in a chaotic manner. What happens to pollen particles in water that makes them move in this apparently senseless manner? What happens is that they are hit randomly and irregularly about their surface by the water molecules causing them to move in every direction and no direction at the same time in an apparently chaotic manner. However, it is only apparently chaotic because this imbalance of forces is only momentary. In an instant an imbalance can move the particle towards the right but it will quickly be offset by another imbalance which moves it in another direction so that if we take a large number of observations we will conclude that the sum of the imbalances approaches zero and the particle must return to its original place. Although the particle moves, it will do so without a defined trend and, moreover, the movements over short periods of time will tend to be identical in intensity. Beneath this chaos lies a mathematical pattern subject to a normal (or Gaussian) probability distribution and with an average of zero. This is the definition of the process known as Brownian Motion or the capacity to describe the movement or behaviour of things we do not know how will act in the very near future, where they will move completely randomly, but we will be able to predict how they will act over longer periods, since the sum of these small moments of chaos must approach zero. This idea is very useful for many things, among others, to describe physical processes such as diffusion or osmosis and, also, movements in financial markets. In the 1960s, two economists and mathematicians, Fischer Black and Myrton Scholes, worked on a Monthly Strategy Report. February 2015 mathematical model which would allow them to calculate the price of financial options. Until then, this type of instrument was priced through a very tedious process, essentially based on attempting to simulate all of the possible scenarios a very large number of times and taking the average of the results to determine the instrument’s fair value (applying what is known as the Law of Large Numbers). Black and Scholes used a model based on Brownian Motion to price options, since it simplified the calculation work enormously (they obtained a value so close that it could only be obtained through the repetitive methods if tens of thousands of observations were used, not the simplest thing to do with the calculation methods of the pre personal computer age). Furthermore, it allowed the options to be priced in continuous time and significantly reduced the possibilities of arbitrage in the market using a risk-neutral probability. Myrton Scholes, together with Robert Merton, (who applied the theory model to the real world) received the Nobel Prize for this work. Fischer Black was not as lucky; when they were awarded the prize in 1997, he had already passed away, although the model was named Black-Scholes in honour of both researcher and represents one of the greatest advances in the history of finance. Basically, it defines a long-term trend which will be altered in the short term by a Brownian process, unpredictable in short periods of time but which approaches zero at long term: market noise. However, aside from the precision and the simplicity of the application, the Black-Scholes Model presents various interesting possibilities regarding the behaviour of things in the markets. The first of these is that what a financial asset will do in a short period of time is random, the more unpredictable the asset, the more volatile (or of greater risk), but at long term, these movements approach a sum of zero, leaving the tendency at long term unaltered, which is influenced by fundamentals. The market sentiment, volatile scenarios, will tend to become diluted over time and their effect will be neutral to the extent that the investment fundamentals have not changed. Even without transaction costs, it will be very difficult for us to derive value from continually entering and exiting the market. The second is that a mathematical principle, known as the Markov chain is fulfilled. When something moves in a Brownian manner, the path it has followed to get to that point is irrelevant when predicting its next movement because it will once again be random and independent from the previous movement. Assuming that something will rise or fall because yesterday it did the opposite does not, in general, produce very good results over time if the valuations of the fundamentals remain unchanged. The markets celebrate the ECB’s stimulus measures Banca March Market Strategy Team: Miguel Ángel García, Unit Director, Market Strategy Rose Marie Boudeguer, Service Director, Research Service Pedro Sastre, Service Director, Market Strategy Alejandro Vidal, Service Director, Market Strategy Paulo Gonçalves, Technical Specialist, Research Service MONTHLY STRATEGY REPORT February 2015 Monthly Strategy Report. February 2015 The markets celebrate the ECB’s stimulus measures An auspicious start to the year in the markets... The elections in Greece and the ECB meeting were the protagonists in the markets. The European markets closed with gains, even disregarding the positive effect of the new stimulus measures. ...although political uncertainty continues to reign. Greece’s new government must negotiate new aid with the Troika... Political uncertainty remained with the early general elections in Greece. The elections ended with a comfortable win for Syriza (149 seats, very close to the majority). The new Greek government will be comprised of a coalition between Independent Greeks (ANEL), a party which only shares with Syriza the intention to renegotiate its debt and mitigate the adjustment measures imposed by the Troika. The first decisions adopted by this government (to raise the minimum wage, increase public contracting and stop privatizations) clash directly with the Troika’s criteria, resulting in significant uncertainty regarding the future of international aid. ...while armed conflict returns to Ukraine. Fighting has renewed in Ukraine. It continues to accuse Russia of supporting the Ukrainian separatists and the European Union imposed another round of sanctions. These sanctions and the decline in oil prices are punishing the Russian economy and Mr. Putin’s government adopted, on the one hand, a significant budgetary adjustment plan, cuts of up to 10% and, on the other, recapitalisation measures for banks facing difficulties (amounting to EUR 31 billion). In this context, the economy would shrink more than 3%. The ECB takes an important step with new monetary stimulus. The ECB did not disappoint expectations and announced a new plan to purchase EUR 60 billion in public and private debt monthly starting in March and lasting until at least September 2016. As a whole, these purchases exceed 10% of the eurozone’s GDP and confirm that the monetary authority will use all of the tools in its arsenal to avoid the risk of deflation and stimulate economic recovery in the region. Moreover, it reduced the costs to banks in the upcoming liquidity auctions (TLTRO). Other European central banks, whose currency was tied to the euro exchange rate also readjusted their monetary policies. The most crucial decision was made by the Swiss Bank which removed the floor on the Swiss franc (EUR 1.20/CHF), causing its value to soar with massive repercussions in the currency markets. The Fed did not provide significant clues. In the US, the Fed maintained its monetary policy but showed more optimism with regard to economic performance, indicating that growth is progressing at a steady pace. Likewise, it confirmed that it will remain patient with respect to raising official interest rates in the future. The IMF revised its forecast for growth downwards. At the macroeconomic level, the IMF lowered its global economic growth forecast to 3.5% for this year (three tenths less than its October estimate). The factors leading to this reduction are lower levels of investment and a weakening of the emerging economies which, as a whole, will Monthly Strategy Report. February 2015 grow 4.3% in 2015 (vs. 4.9% in 2014). By country, the upward revision of US economic growth stood out. Its GDP is expected to increase by 3.6%. It revised eurozone growth downwards to 1.2%, with Spain being the only large economy in the region with an improved outlook (up to +2%). In Asia, China could grow by 6.8% (vs. 7.1% in 2014) and Japan by 0.6% (vs. 0.8% in 2014). The US economy maintained a good rate of growth. US economic data continued to confirm its steady rate of growth with GDP growing in the fourth quarter at an annualized quarterly rate of 2.6%. Likewise, the unemployment rate at 2014 year end was 5.6% and 2.95 million jobs were created during the year, the best figure since 1999. With regard to prices, inflation eased by five tenths in December to +0.8% year-on-year, with a core rate of 1.6%. Confidence is improving in the eurozone but the fall in prices is worrisome. In the eurozone, the composite PMI rose in January to 52.2 (vs. 51.4 in 2014) improving business confidence. Consumer confidence also grew, likely a reflection of lower energy costs. The unemployment rate dropped by one tenth in December to 11.4%. The CPI dropped more sharply in January (-0.6% year-on-year), with core inflation moderating to +0.6% year-on-year, a historic minimum. Spain’s economic recovery is becoming a reality. Spain’s economy continued to recover with GDP growing at a year-on-year rate of 2% in the fourth quarter of 2014. Activity was bolstered by improved internal demand; retail sales increased in December by +6.5% year-on-year. The unemployment rate at 2014 year end fell by 2 percentage points to 23.7%, the first time, in annual terms since 2006. Prices fell faster with a -1.4% year on year CPI in January. The economic data from the UK was also positive. GDP grew by 2.6% year-on-year in the fourth quarter and unemployment dropped further. However, the low inflation rate (the CPI slowed to 0.5% year-on-year in December) provides the Bank of England more room for manoeuvre, a bank which decided unanimously to keep interest rates low (0.5%). The big emerging economies diverge: China achieves its objectives... The data for big emerging economies were mixed. In 2014 China grew by 7.4%, and although this is the slowest pace since 1990, it was in line with the Government’s objectives (7.5%). Retail sales and industrial production managed to pick up in December, data which confirms a marginal slowdown. ...while Brazil and Russia show greater imbalances. The data was less favourable for other economies, such as Brazil, where inflation continues to be high and its central bank once again raised interest rates to 12.25%, curbing growth. In 2014 Brazil’s government budget became imbalanced and it recorded a primary deficit (without expenditure on debt interest) of 0.34% of its GDP for the first in 18 years. In Russia, in addition to the deterioration of its activity, the rouble’s depreciation increased inflationary pressure (the CPI for December was +11.4% year-on-year). Uneven growth in the stock markets: European markets stood out positively. The year began differently on opposite sides of the Atlantic. The European stock markets were invigorated by the ECB’s new stimulus measures, with Euro Stoxx 50 up 6.5%. By country, the German stock market’s performance improved –up 9%– due to the increased weight of export Monthly Strategy Report. February 2015 companies which benefit from a weak euro. The Ibex 35, on the other hand, lagged a bit (+1.2% in the month). In the US, the stock markets were tempered by business results where forecasts for certain large US multinationals were weaker due to the negative impact the exchange rate was expected to have on their profit. In this context, the S&P 500 closed the year with a 3% slide. The MSCI Emerging Markets index rose 0.5%, but with uneven results according to region. There were sharp increases in Asia (MSCI Asia ex - Japan; +2%), while Latin America and Eastern Europe experienced declines. Bonds benefits from low inflation. The moderation of inflation at a global level –with lower energy costs– and an expansive monetary policy, continued to bolster bonds. 10-year German bond yields dropped by 24 b.p. to 0.3% and in the US to 1.64% (-53 b.p.). Spanish sovereign debt benefited from the ECB announcement and the index rose 1.4%, The credit market also recorded gains, especially that of the level of investment, which rose by 2.4% globally during the month. The euro depreciates as a result of the ECB’s measures, falling 7% against the dollar. The euro depreciated significantly when the ECB confirmed that it would adopt important stimulus measures entailing an increase in its balance sheet (more euros on offer). The dollar appreciated 6.5% against the euro which closed the period below EUR 1.13/USD. Likewise, the pound sterling appreciated 2.6% against the euro to stand at EUR 0.75/GBP The yen rose since the Bank of Japan did not announce new monetary stimulus, disappointing a portion of the market. It appreciated 8.4% against the euro, closing under EUR 133/YEN. The price of commodities continue to fall. Commodity prices fell even further. The increase in inventories and OPEC’s preservation of production rates applied pressure to oil prices. The price of a barrel of Brent crude oil fell 9% to $53. Diminished demand in China took its toll on basic metal prices. The exception to these drops in commodity prices was gold which closed with a revaluation of 7.7% to $1,276/ounce. Monthly Strategy Report. February 2015 Strategy for February 2015 ASSET ALLOCATION Positive Neutral Shares Negative Bonds Cash ASSET ALLOCATION Equities Positive Neutral Europe Japan Negative USA Emerging countries Bonds Peripheral Bonds Government Bonds (AAA, AA+) Corporate Debt “High Yield” Corporate Debt “Inv. Grade” Convertible Bonds Emerging debt The world’s central banks relax their monetary policies. In January it became clear that the majority of the world’s central banks are implementing more relaxed monetary policies. Together with cuts in interest rates in Switzerland and Denmark, and the ECB’s announcement that it will purchase bonds, another 15 banks –including those of Singapore, Peru, India, Canada, Australia and Turkey– have lowered interest rates this year. Thanks to inflationary pressures easing up, they have been able to use monetary policy to stimulate their economies and, at the same time, prevent their currencies from appreciating. The geopolitical risks will come mainly from Greece. Politics and geopolitics will continue to be crucial for market performance in the coming weeks, with the negotiations between Greece and the Troika taking front stage. Before the end of February, when the current aid programme will come to an end, they must reach an agreement which will provide financing to Greece, and the first decisions of the new Greek government to date have not facilitated a rapprochement. ...and Russia. At the same time, the tensions between Russia and Ukraine continue to generate uncertainty regarding their economies, significantly weakened as a result of the armed conflict, and also regarding the economy of the eurozone. Growth in the US will accelerate to 3.5%. At the macroeconomic level, in February, growth in the US should continue to be confirmed. Improvements in employment and the real estate sector, together with the drop in oil prices, will continue to be felt in relation to consumer spending and this year, growth is expected to reach 3.5%, close to its potential. The eurozone will accelerate to reach discreet growth rates. Although Europe will exercise less fiscal restraint than in recent years and this, together with the Juncker plan will allow for more investment in infrastructure and services, European growth will accelerate but below its potential, at a rate of around 1.1%. High unemployment is an obstacle for significant recovery in consumption. Monthly Strategy Report. February 2015 The growth forecast for emerging regions is varied. The economic outlook for emerging countries is mixed. Among the elite club –the BRICs– there are significant differences. China is expected to lower its objective for growth to around 7%, since authorities must prevent excessive stimulus from creating bubbles. India seems to be on the path to increase its growth rate to 6%, while Russia will suffer a severe recession and Brazil will only recover very gradually this year. Growth in developed countries without inflationary pressure. The acceleration of growth in developed countries will continue without inflationary pressures. The weak wage growth and the drop in the price of oil since mid-2014 have created a downward trend in prices which will remain at least until the middle of the year due to the base effect. The Fed will raise rates gradually given the risk to the global economy. In this context, we expect the Fed to very gradually raise interest rates this year given the continued risk to the global economy and the danger that the dollar will become too strong, threatening the US economy. The Bank of England could begin to raise interest rates at the end of 2015 or at the beginning of 2016. On the other hand, the ECB will begin its massive purchase programme in March and the Bank of Japan will continue to be committed to an ultra-expansive monetary policy. The dollar will continue to appreciate. In this environment, the interest rates on US and UK bonds will trend upward over the course of the year, while European and Japanese interest rates will remain very low. This means that the euro will continue to depreciate this year and could approach levels close to EUR 1.1/USD up to those levels, we continue to be committed to investing in dollars and, although to a lesser extent, investing in pounds. For the same reasons, we will avoid exposure to the yen. Liquid assets will continue to offer a very low return. Investment in liquid assets –cash or cash equivalents– continues to offer a very low yield, as returns on deposits, treasury bills and Euribor have fallen. Nevertheless, the deflationary context being experienced in Spain and Europe will enable real returns to be good. In this context, low-volatility absolute return funds contribute to complementing the treasury funds. Sovereign bonds from peripheral countries will continue to be backed by the ECB. The sovereign bond market continues to present attractive investment opportunities. US and German bonds offer very low yields and prospects for higher interest rates during the year lead us to fear a fall in prices not offset by the coupon. Returns on sovereign bonds from peripheral European countries have also plummeted but they are worth holding in the portfolio because they offer an additional yield and their valuation will continue to be backed by the ECB’s massive purchase of sovereign bonds. Among corporate bonds, high yield and convertible bonds provide more value. Corporate bonds continue to be vulnerable to increases in benchmark rates, although the economic context is favourable and the default rate is low. Bonds issued by companies with high credit ratings which offer very low returns and do not offset the risk of potential increases to interest rates are particularly sensitive. More value can be found in investment-grade, or high yield, bonds since they offer more attractive yields. Furthermore, convertible bonds provide more value, due to the fact that they have greater exposure to equity performance. The stock market offers attractive dividend yields and profits on the rise in a context of low interest rates and abundant liquidity. In comparison to the limited returns offered by equities, stock markets offer an attractive Monthly Strategy Report. February 2015 dividend yield, above all in Europe. To the above, it must be added that company profits continue their upward trend, as can be seen in the current earnings season which began in January. US companies are exceeding expectations despite the fact that the dollar’s strength limits their income. European companies are improving their income and cost prospects due to the depreciation of the euro and the drop in the price of oil. Thus, in an environment of low interest rates and abundant liquidity provided by the central banks, equity is one of the assets with the most potential. We prefer the eurozone, the US and Asia Pacific. The eurozone stock markets are attractive to us because they are improving their cost structure and their international sales, something US companies have already done and demonstrated the value of. Moreover, the price is attractive and they are backed by the ECB’s monetary policy. However, we continue to be optimistic about US equities due to their strong performance and economic prospects, despite a more adjusted price. We also believe a moderate emerging markets weighting is reasonable, particularly in the case of the Asia-Pacific region, because of its attractive valuation and the improved margins. Commodity prices should recover in the second half of the year. With respect to commodities, we believe that in the coming months they will be priced within existing ranges: the price of gold is limited by the dollar’s appreciation and the prospect of a rise in US interest rates. At short term, the excess supply will continue to apply downward pressure to the price of oil, but it should return to levels close to USD 75 per barrel at medium term. Some commodity weight in portfolios seems reasonable for diversification purposes, because of improved global growth expectations and because supply has balanced out and no longer seems excessive. Monthly Strategy Report. February 2015 Euribor Euribor 12 months (3 years) Currencies Government Bonds EUR/USD (3 years) 10 years government yields Corporate Bonds (1 year spread) Commodities Equity Indices Data: Bloomberg IBEX35 (3 years) Monthly Strategy Report. February 2015 Equity Indices performance (3 years) Monthly Strategy Report. 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