Scratch an investor, and you will find two
models. One is a fair value
model, perhaps based on free-cash-flow or
earnings expectations, or breakup value. The other is based on liquidity. We suspect that
the latter is overwhelming the former in the emerging market equity
space.
The ECB and BOJ are easing policy
aggressively. The BOJ has indicated it will conduct a comprehensive
review next month. The only pre-condition BOJ Governor Kuroda has
indicated is that the BOJ will not do less.
The ECB will have new staff forecasts.
It is difficult to see a material change in its expected path for prices.
The risk is that the ECB announces another six-month
extension in its asset purchase program. It may have to
address the shortage of some sovereign issues. Although there is
speculation that it eschews the capital
key (A decision-making rule to determine which bonds to buy. The capital
key favors large countries, like Germany and France, over small countries), but we are not convinced it will be dropped.
Still,
any move that allows the ECB to buy more peripheral bonds will likely be understood
as another dimension of easing. Recall the meaning of
what Japan has dubbed QQE. One “Q” is for quantity, and the other is for quality.
The argument was that buying riskier assets (lower quality) that have can have a more direct and powerful impact
on prices of risky assets, and there is
more aggressive/potent than a QE buying the risk-free asset.
The Bank of England rejoined the QE
crowd. The apparently relative small float relative has revealed a
shortage that is manifest in the significant decline of yields. The Gilt
rally has been so powerful that it appears to have pulled down other yields
with it. It also will buy corporate bonds (GBP10 bln). It cut
interest rates by 25 bp and signaled the likelihood of another small cut, but
eschewed negative rates.
The Reserve Bank of Australia cut rates last
week, and the Reserve Bank of New Zealand is widely anticipated to cut rates
Thursday in Wellington. There is speculation that both central banks will cut rates again before the end of the
year. Meanwhile, the Fed funds futures do not imply confidence
(more than 50% chance) of a rate hike through next year.
equities. With interest rates lower for longer, emerging market
equities can be buoyed. The Great Graphic
was composed on Bloomberg. It shows
a weekly bar chart of the MSCI Emerging Market equity index. From a
technical perspective, it appears to have carved out a head and shoulders
bottom. The neckline was broken in
the middle of July. It has rallied for four weeks through last Friday and is five in the last six
weeks.
An important thing about chart patterns is the
measuring objective on the breakout. The pattern extends from the
head (~687) to the neckline (~850). The measuring
objective found by flipping the pattern over. It is a roughly 173-point pattern. Add that to
the neckline breakout, and the target is roughly 1023. That target is
about 13% above prevailing levels. The iShares MSCI Emerging Markets ETF
is EEM.