Sunday, March 29, 2009

>Gem Trading Note (MERRILL LYNCH)

Inflection Points & Trades

Three big inflection points for markets in past 9-12 months
  • July 3rd ECB hikes rates (possibly one of great policy blunders of recent years); commodity prices peaked the very same day (Baltic Freight, Euro, inflation expectations peak same time); EM equities start to underperform as global growth expectations fall.
  • Sept 15th bankruptcy of LEH; initiates de-leveraging and vicious collapse in EM equities/currencies as growth expectations/risk appetite sinks and US dollar surges.
  • November 10th announcement of big Chinese fiscal stimulus; CRB troughs vs. S&P500 and EM starts outperforming again as global growth expectations find a floor. Chart 1 tells the tale...

Play a recovery in risk appetite
Last week's Merrill Lynch Fund Manager Survey showed a distinct gap between (recovering) growth expectations and (rock-bottom) risk appetite. But risk appetite turned up in the past week due to a) US/UK/Swiss/Japanese Quantitative Ease (QE) and b) US financial policy (PPIP) to reduce toxic assets. QE has caused a bounce in risk appetite. A genuine inflection point for risk (following bounce in growth expectations) would see:

1. Asset allocation by pension funds out of bonds into equities

2. Outperformance from banks, Europe & EMEA

3. Euro-yen taking out 200mda @ 138

4. 30-year US Treasury yields moving above 4%

5. Rise in US breakeven inflation rates which have strong correlation with many risk assets (e.g. Brazilian real – Chart 2)

MSCI EM index target is 650-700 or EEM at $28. Long Russia, China, Brazil our favored ways to play the story in EM

FMS highlighted improvement in risk appetite most positive for EMEA, Korea, Poland, banks, industrials, materials in EM

The trade ends when/if growth rollover later in spring (watch BDIY, China Ashares, China PMI, G7 demand, trade, housing and so on)

To see full report: GEM TRADING