Wednesday, March 09, 2005


Bond markets in focus
Alan Greenspan spoke of “irrational exuberances.” That was back in 1996. At the time, he was referring to the looming stock market bubble. It was a rather unusual choice of words for the world’s most important central banker. Only recently, Greenspan told Congress of a “conundrum” he was pondering over. Even though he was referring to the bond markets this time around, the parallels with 1996 are obvious. And in light of the importance Greenspan attributed to bond markets in his speech, the use of the term went far beyond a mere extension of his jargon.

Here are only a few aspects to consider: Greenspan’s questions
1. If real Treasury yields decline, the market is apparently not concerned about future inflation. Does this mean that it is the market participants who are worried about economic growth, particularly since bond yields have gone down more than inflation expectations?
2. If investors were concerned about the sustainability of economic growth, why, then, are equity markets in relatively good shape?
3. If the economic situation was expected to deteriorate, why are credits spreads extremely narrow?
I have repeatedly pointed to imbalances, such as the fact that Asian central banks are buying U.S. Treasuries and are thus helping keep U.S. interest rates low. Greenspan says the extent of this effect is “difficult to quantify.”

Politically-correct words
Greenspan is well aware of the fact that one-dimensional chains of cause and effect can no longer be adopted indiscriminately in a globalized world. But could political grounds have led him to say that, within the world’s pool of savings, the U.S. could become dangerously dependent due to its deficits? Or, to put it differently: If – and Greenspan put particular emphasis on this – productivity gains in the U.S. resulted in a similar problem as in Switzerland, for instance, and the twin deficit continued to exist, the absence of Asian financiers could create tremendous problems for the world’s largest economy. Many “ifs,” but the problem clearly exists.

Conclusion: No panic over interest rates
I believe that the argument of globalized investments holds water and helps explain why the analyst community prematurely expected interest rates to be hiked far too aggressively at the long end.

Lower bond ratings
Furthermore, I am still convinced that emerging bond markets, with a few exceptions such as Hungary, offer sound opportunities.

Stocks remain attractive relative to bonds
Contrary to other regions, optimism about future earnings still seems to be intact in the U.S. and in Japan. Yet with the exception of Japan, earnings revisions could disappoint. Japan and emerging markets offer quite attractive valuations. Europe, however, currently only has the risk premium that speaks in its favor.
Written: LuisB