State Street Global Market’s belief in inflation as the crucial economic indicator has been reflected in its research arm, State Street Associates, taking on a new partner, PriceStats, which produces daily price statistics, the first of its kind in the world. Amanda White spoke to the global head of research Jeremy Armitage.
For the first time since the summer of 2007, investors are becoming more discerning at a granular level, according to Jeremy Armitage, senior managing director and global head of research at State Street Global Markets.
The investment research and trading arm of State Street has a number of indicators driven by its original flow-based research, proprietary portfolio and risk management technologies, and trading optimisation, that track investor behaviour. For the first time in four years they are now showing that investors are becoming more selective and granular in their asset allocation, rather than the broad asset class trade-offs that have dominated asset allocation.
“Investors reacted to the Lehman crisis and liquidity event that followed, with a level of rebalancing we had never seen in our data set before,” Armitage says. “There had never been a point in time when so many of our indicators had either been at zero or 100. There was a tremendous flight to safety, which was reflected in the US dollar and US Treasuries.”
Now, he says, markets are normalising and different asset classes are behaving differently.
“Risk on, risk off was general, now it is a much more selective environment, equity markets and currency markets are much more normalised and investment opportunities are at a more granular level. Selectivity is a key theme.”
As part of that selectivity, the State Street’s research is taking on a new orientation, looking at what factors are driving countries and markets, and in particular what the effect of rising inflation could be.
“I argue inflation is the key economic variable: inflation drives policy interest rates, drives bond prices, currencies and equities. If you get inflation wrong it affects everything else. Information and analysis of inflation is critical,” he says.
To that end State Street Associates, the academic affiliate of State Street which Armitage was instrumental in founding in 2000, has added its first additional research partner since its inception. PriceStats joins Windham Capital Management and FDO Partners, as research partners at State Street Associates, bringing real-time inflation statistics into the equation.
“This is a game changer,” Armitage says. “A client can ring us up and say for example what happened to Japanese inflation the day after the earthquake.”
At the moment PriceStats, headed by research directors Roberto Rigobon and Alberto Cavallo, both of MIT Sloan School of Management, is measuring the daily inflation of US, UK, France, Germany and Brazil for State Street.
Armitage says that will be expanded to 30 countries in the next wave, including Australia, Japan, more emerging markets, the rest of Europe, and Canada.
In addition the group will write monthly inflation pieces as part of its In Focus which will focus on the investment implications as well as the academia of the trends.
“We will also be talking to clients about what’s useful for them with regard to inflation and feeding that into product development,” he says. “We’re taking leadership position on inflation.”
Armitage believes inflation is a global phenomenon in a way not seen since the 1970s.
“Now we need to understand where the flinch points are in the economy,” he says, adding one of the biggest trends to watch in the next 10 years will be the Chinese demanding wage increases and the price pressure that results from that.
Some sort of inflationary pressure can be seen across all investment markets, particularly emerging markets, but developed markets as well.
“Emerging markets were a safe haven in that they were perceived as a market that was going to perform well. The challenge is they’re relatively thin, with the market rallying strongly but get overpriced quickly, and so introducing risk,” he says. “Emerging markets can move very fast in both directions.”
This is due to inflation from the cross-border money, he argues, with the volume of money coming in to Brazil creating domestic inflation.
“So the government raises rates – it has five times already – which creates more investment opportunities, and we’ve seen massive demand for these products with returns of 12 per cent from markets like Japan.”
He also says the US has an inflation problem, despite a 9.1 per cent unemployment rate, because the price of consumed goods such as televisions is affected by China’s inflation.
“In the US you have inflation and unemployment but you can’t raise interest rates when 9 per cent of the population is unemployed.”
The State Street view on China is that while there are tremendous investment opportunities, there are also great risks.
“In the medium term one of our recommendations is to be long the Remnimbi. The Chinese Government is letting it appreciate, mindful a stronger currency not necessarily a bad thing. If inflation becomes a problem then this currency position is a bet,” Armitage says.
Overall State Street is neutral in terms of asset allocation but selectivity remains a theme.