Global financial markets are now twice the size of the economy, interest rates continue to undergo ‘Japanification’ and investors are returning to the ‘secular stagnation’ theme.
These are some of the findings of Bank of America Merrill Lynch in its The Hitchhiker’s Guide to the Investment Universe report, which aims to offer a primer for investors on the size, composition, risks, returns, flows and valuations of bond and equity universe.
Below, FE Trustnet pulls out some of the most interesting charts that reveal how conditions currently look across financial markets. Next week, we will a closer look at how things are for stocks and bonds.
Global equity & debt securities outstanding ($trn)
Source: BofA Merrill Lynch Global Investment Strategy, World Federation of Exchanges, BIS
The first chart shows the total value of global stocks and bonds outstanding in financial markets today. This amounts to just under $175trn.
BofA ML pointed out that this is an eightfold increase from the $23trn in global stocks and bonds outstanding recorded in 1990.
However, the challenging conditions of 2018 meant the current level is lower than the $180trn seen at the start of last year.
Equity & debt securities as % global GDP
Source: BofA Merrill Lynch Global Investment Strategy, BIS, IMF
The bank’s report argued that the size of financial markets means they are still “too big to fail”. The above chart shows this in another way – the value of stocks and bond as a percentage of global GDP.
Global stocks and bonds outstanding are currently twice the size of the global economy, this data shows. Back in 1990, it stood at just 97 per cent.
The most recent peak in financial assets as a percentage of global GDP was in 2017, which at 226 per cent was just above the 2007 highs.
GDP growth expectations
Source: BofA Merrill Lynch Global Investment Strategy, Bloomberg
The three charts above reflect how the current economic cycle has been rather lacklustre even though the world’s central banks have used unprecedented measures in a bid to stimulate growth.
“This economic cycle has been characterised by stubbornly low growth, despite $12trn of central bank easing and interest rates at 5,000-year lows,” the bank’s analysts said.
“The US economic cycle is set to become the longest in history in July 2019 but US, eurozone and Chinese growth has repeatedly struggled to exceed expectations.”
Interest rate expectations
Source: BofA Merrill Lynch Global Investment Strategy, Bloomberg
Over the past 10 years, the ‘Japanification’ of global interest rates has continued to be a major force in markets, with yields across the globe declining.
Since 2014, US Treasury yields have been forecasted to end each year above 3 per cent but have failed to do so on each occasion. Meanwhile, the consensus has over-predicted German bond yields by an average of 100 basis points over the past six years, while the forecast of Japan government bonds’ yield stands at a “pitiful” 0.2 per cent for the end of 2020.
The ‘asset class quilt’ of total returns
Source: BofA Merrill Lynch Global Investment Strategy, Bloomberg. *YTD annualised returns, as of 21 Mar 2019
The above table shows the global cross-asset total returns since 2000, in US dollar terms.
If we focus on the annualised returns for the period since quantitative easing started in 2009, US stocks made 15 per cent, global high yield bonds 12 per cent and Treasuries 2 per cent; cash has been flat while commodities fell 1 per cent.
“In 2018, cash outperformed bonds and stocks for the first time since 2000,” BofA ML’s analysts added. “In 2019, commodities on course to be best-performing asset class for first year since 2002.”
Five-year rolling Sharpe ratio for major asset classes
Source: BofA Merrill Lynch Global Investment Strategy, Bloomberg
We can use this heatmap to assess the changes in annualised Sharpe ratios (which are a measure of returns relative to the risk taken) for major asset classes.
Over the past five years, US equities have generated the best risk-adjusted returns (0.9), followed by global high yield bonds (0.7), and emerging market debt (0.7). In the same period, commodities have generated the worst risk-adjusted returns (-0.4).
The quilt below reveals fund inflows and redemptions since 2008 for the major asset classes, shown as a percentage of assets under management.
According to BofA ML, the data for 2019 suggests that investors are returning to the ‘secular stagnation’ theme of yield through emerging market debt, government bonds and high yield bonds, while avoiding cyclical value via Europe and financials.
Investment fund flows since 2008
Source: BofA Merrill Lynch Global Investment Strategy, EPFR Global. *YTD annualised
BofA ML carries out a closely watched survey of asset allocators each month and one of the questions in this Global Fund Manager Survey asks what the most crowded trade in the market appears to be.
The below chart shows how this has evolved since 2013. Asset allocators, at various times, have considered short-Japanese yen (2014), long-US dollar (2014/15/17), long-high ‘quality’ stocks (2016), long-Nasdaq/Bitcoin (2017) and short-volatility (2018) to be the most crowded trade.
Evolution of Global Fund Manager Survey ‘most crowded trades’
Source: BofA Merrill Lynch Global Fund Manager Survey
Today, fund managers believe that being short European equities is the most crowded trade that can be made. Investors have been avoiding this part of the market of late because of stuttering economic growth and political risks.
However, BofA ML did point out that the consensus on the most crowded trade has been falling for some time and is currently at its lowest on record.