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Head of Quantitative Strategy
Richard Mylles
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Aaron Thompson
Zahra Ward-Murphy
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Equity Strategy Research

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ASR Weekly Wrap from Verity
14 Sep 2018
: Verity Hunt

Research, News & Views from ASR for the week to September 14th, 2018

ASR Economics Weekly. Trade slowdown – no let-up in sight from Ben.
•   Global trade growth ground to a halt in H1, with volumes edging back marginally, the second weakest H1 since 2009. The slowdown has been broad-based, but two regions have been notably weak – Japan and the Eurozone: net trade detracted from EZ headline GDP and did not contribute to Japanese GDP at all.
•   Early indicators suggest this weakness could persist into H2. Air freight proxies decelerated in July. German industrial orders fell in 6 of the last 7 months, while orders from outside the EZ were down 2.7% in July while the typhoon in Japan is likely to hold back the trade data in September.
•   The potential US/China trade tensions add to the gloomy outlook.
•   There may be some glimmers of hope in that the German weakness, exacerbated by car manufacturers selling down inventories ahead of changes in emissions regulations, could reverse; freight rates suggest global shipping could improve helped by an upswing in the Smartphone cycle; if PBoC stimulus kicks in sooner than expected then the deceleration in trade growth could stabilise.
•   But short-term, an upturn looks unlikely. New export orders in the Global PMI at 50.3 are barely growing while commodities point to a weak trade environment for some months yet.  

ASR Multi Asset Weekly. Global bonds: yield-enhancing ideas from Stefano.
A long period of low yielding fixed income has increased the appetite for yield-enhancing strategies for bond investors. Exploiting the yield pick-up and currency returns from foreign bond investing offers investors ways to boost expected returns. We introduce a global bond screening tool, a graphic framework that helps rank government bond markets according to risk-adjusted yields, either on a hedged or unhedged FX basis.
•   We consider the 9 largest developed country bond markets with a total notional value of USD 23.5trn.
•   The analysis framework. We look at investing in bonds from the point of view of USD, EUR, GBP and JPY investors. We plot 10y benchmark government bond yields and the same bond yields expressed in domestic currency against the risk from holding those bonds as proxied by the 5y annualised volatility of the daily returns. 
•   For USD investors, hedging the currency exposure of their foreign bond holdings are likely to achieve both higher yields and lower volatility: EUR and KRW currency-hedged bonds look attractive: Italian bonds 6% USD yield is also attractive, but the volatility is much higher.
•   For EUR investors, the yield pick-up offered by most foreign currency government bonds is not attractive both on a FX hedged (too low yields) and unhedged (too low volatility) basis, apart from FX-hedged Korean Treasury bonds, offering a small yield pick-up relative to Bunds. The 30-year UST is more attractive, than the 10-year, offering a higher yield/lower volatility combination relative to Bunds.
•   For GBP investors, currency-hedged foreign bonds generally look more attractive than unhedged bond positions, but unhedged US Treasuries are certainly attractive.
•   For JPY investors who are large holders of global bonds ($2400bn), FX-hedged South Korean bonds and Italian bonds (3.2% JPY yield) are attractive especially given low holdings (Italy represents 2.2% of their foreign bond allocation) but 10y UST, unhedged, still look the most obvious Japanese investing option near term, given the strong negative correlations between UST and USDJPY returns.  
•   Conclusion, for global investors FX unhedged US Treasuries, followed by BTPS and then FX hedged Korea Treasury bonds are the best investing opportunities. The analysis is also helpful in understanding and anticipating global bond market trends more generally.

ASR Absolute Essentials from David McBain. SBI Summary charts now available daily here!
Equities. EuroSTOXX pessimism is once again stretched: in the past 10Y, sub 5 SBI levels have been followed by an average 1.9% rise in the index over the next 30D. But, current negative momentum suggests a rally could be short-lived: – a break below 3300 in EuroSTOXX 50 would target a 3100 retest. EM equities are also oversold on sentiment, but still at risk of further downside.
Bonds. EM sovereign bonds hit oversold sentiment levels last week. US 10Y Treasuries’ sentiment has edged back to modest pessimism level as specs sharply increased their net short position.
FX. US dollar index optimism is elevated, but down on recent highs. Pessimism remains notable on both GBP and EUR versus USD.
Commodities. Oversold Copper set to test key support c.255- failure to hold above 255 would point to a retest of 240. Silver and industrial metals’ sentiment is also now stretched.

ASR Investment Strategy. Technology: what’s there not to like? from David Bowers.
We are more cautious on the Technology sector than consensus, with a Neutral rather than Overweight position. We worry that investors are taking Tech outperformance for granted and fear that the risks are building. We see five concerns:
Baseline probabilities.
•   Year to date, US Tech has outperformed the US market by 8%, Global Tech has outperformed global equities by 11%, while the FAANG cluster has beaten the US benchmark by 20% this year.
•   Looking at how often the sector has outperformed on a 6-month rolling basis, the figures for Tech are striking. Over the last 10 years the Tech sector has outperformed 79% of the time and over the past 5 years it is over 90% of the time. These historic probabilities are rare and can, at least, generate behavioural biases and breed complacency: in the decade to 2010, the BRICS outperformed on a similar basis by 77%, but have underperformed ever since.
A change in perceptions by consumers.
•   The sector is starting to face some ‘trust issues’. While trust remains high, the Edelman Trust barometer shows less confidence about the next wave of innovation / AI / blockchain, while there is growing concern about ‘fake news’ with a backlash if consumers start to feel exploited by technology.
A change in perceptions by investors.
•   There is also a challenge from the GICS changes with the creation of a new Communications Services sector and the reclassification of Facebook, Alphabet and Netflix into the sector. Tech will become more cyclical and less defensive, making it more of a play on new economy capex. It may lead to some reassessment of valuations, while it could raise regulatory risks given the Communications area is very highly regulated and the FCC could extend its jurisdiction.
Greater regulatory risk, particularly from the EU.
•   In terms of regulating the services that run on the internet, US anti-trust is relatively toothless, but as we wrote HERE, the EU could be a tough regulator, given the difference between the EU and US definition of anti-competitive behaviour, which focuses more on market structure and on non-price measures rather than the US focus on a price-based definition of consumer welfare. The setting of technical standards could also be a point of greater contention.
The risk that Tech is dragged into US China trade conflict.
•   Globalisation and Technology are inseparable. This wave of globalization has been driven by a collapse in communication costs c/o technology. The rise of Tech has arguably, as its counterpart, the decline in US labour’s share of national income, but those workers have found a voice in the current Administration.
•   Tariffs may be treating the symptom rather than the cause. It is hard to see what form a government interference in Tech and technological innovation could take, but it may come from regulation around Tech as a ‘national security issue’ given the growing role that Tech is playing in the defense and national security space. It is possible that a Trade war becomes a Tech war as the US tries to deny China access to its technology supply chain.
•   This may seem far-fetched, but it is a tail risk worth considering, especially given Tech outperformance and US outperformance have gone hand in glove over the last decade.

ASR/WSJ Newsflow from Richard
The Global Composite Newsflow indicator rose to 64.6 in August (vs. 64), diverging further from the Global Manufacturing PMI which fell to 52.5 vs. 52.8. In the past 5 months the key upward driver of the CNI has been Monetary Policy and Inflation, while the real activity data has been less robust.

Best regards, Verity

ASR Investment Strategy - Technology: What’s There not to Like?
13 Sep 2018
: David Bowers, Ian Harnett, Dorothee Deck, Charles Cara

We Remain More Cautious on the Sector than the Consensus
We see five risks. First, the historical baseline probability of Tech outperformance has reached levels last seen in the ten years running up to the peak of the Tech bubble in 2000. High baseline probabilities are rare and can generate significant behavioural bias.

A Change in Perceptions by Consumers
Secondly, the sector is starting to face ‘trust’ issues – around “fake news”, data privacy, and how AI might change society. This opens the possibility of a consumer backlash.

A Change in Perceptions by Investors
Thirdly, the sector could be challenged by the reclassification of key names out of the Technology sector and into the new Communication Services sector.

Greater Regulatory Risk – particularly from EU
Fourthly, with that reclassification comes the threat of greater regulatory scrutiny as key stocks are moved out of a lightly regulated sector (Technology) and placed in what may be the second-most regulated sector after Financials, namely Communications.

Risk that Tech is Dragged into US-China Trade Conflict
We worry that investors are underestimating the potential for the Tech industry to get drawn into the US-China trade conflict, the backlash against globalisation, and the rise of the military-digital complex (MDC) – the ultimate form of ‘regulatory capture’.

ASR Weekly Wrap from Verity
7 Sep 2018
: Verity Hunt

Research, News & Views from ASR for the week to September 7th, 2018

Strategic Asset Allocation.
Q3 Asset Allocation: Risk aversion set to intensify from Ian / the ASR team. PODCAST from Ian.

Overview. 2018 has been a mixed year for risk assets with DM equities and Oil the best performers, but EM equities and Industrials the worst performers. The divergence in performance is typified by the gap that has opened between the S&P (regaining its January 26th peak) and the Rest of the World (in correction territory). The key to this divergence has been the degree to which economic activity / the policy response has diverged between the US and the rest of the world, c/o slower growth in China, higher US rates and higher oil prices.

Three key themes to dominate Asset Allocation in the coming year….
   Theme 1: The impact of ‘peak growth’ both for US activity and Global EPS, limiting risk tolerance.
   Theme 2: Too much dollar debt: this is not just an EM issue. Some DM economies are exposed to a stronger USD and rising rates e.g. CANNS, France.
   Theme 3: Liquidity tightening as QE is scaled back or reversed and rising volatility.
Strategic Asset Allocation Investment conclusions. Our three themes leave us with a defensive bias. We are cautious but not yet max defensive. We suggest underweighting Equities, Commodities, Credit and Real Assets, preferring Bonds and Cash.

Underweight Equities. When monetary conditions tighten, as reflected by a decline in real M1 growth, and when our ‘early warning’ and leading indicators and trade growth decelerate, investors have historically tended to see Equities underperform Bonds. The growth and inflation mix looks set to worsen in the next 12m, undermining equity multiples. With the peak in the EPS cycle at hand along with tighter liquidity, the upside looks limited.

• Equity Regions. We are Overweight US (positive momentum vs global activity, supported by strong EPS growth). We have a modest Underweight on EZ equities (strength of euro in 2017 and slowing trade growth will limit EPS growth. Attractive valuation but political risk may limit upside near term). We are Neutral on Japan (lagged effects of Yen may limit EPS growth albeit signs of inflation pressures emerging). Underweight Asia ex Japan (slowing China growth may impact while Trade wars and dollar debt will limit upside). Underweight EM (rising dollar debt. Trade wars and slower global growth will hinder interest in EM.) 

• Overweight Bonds. US Treasury yields failed to break through 3% despite real GDP growth of 4%+. The combination of weaker growth, crowded short positions and low sensitivity to Fed rate hikes, makes US Treasuries look attractive near 3%.

• Underweight Credit. High leverage and a skewed distribution of debt within the corporate sector threatens credit as liquidity tightens and growth slows. While a fall in Treasury yields might seem to take pressure off credit, if this fall is due to growth disappointments / a rise in unemployment, then there will be pressure on HY vs. IG and on credit spreads generally. EZ credit looks less risky than US credit.

• FX. Underweight EM and Commodity currencies: Overweight USD. Stronger US growth and tighter monetary policy vs ROW provides upside risk for USD vs. EM and commodity currencies; it is harder to see large gains vs. major DM currencies.

• Underweight Commodities. Given our caution on risk assets, we are underweight commodities. We see limited upside for energy prices and expect to see Oil prices end the year in the lower end of the $65-75 range. We prefer Precious Metals and Agricultural commodities to Industrial Metals.

• Underweight Real Assets. Our Real asset Index (REITs, Quoted Infrastructure and the LPX Private Equity Index) has been highly correlated with Equities vs Bonds since 2007. If Hedge funds were included, it would confirm the correlation, making it unclear how much diversification Real Assets really provide in portfolios. Real assets provide protection against inflation but rising real yields / tighter liquidity may undermine performance.

• Overall, we are cautious, but we have not yet moved ‘max defensive’ in our allocations. To do that we need to be more certain that US unemployment is likely to rise in the coming 6-12 months rather than 2 years out. While there are some worrying signs from our recession risk models, it is too soon to be max defensive.

Structural Asset Allocation: This section illustrates our longer term (5y) perspective. Structurally we are positive on equities but from lower levels given risk of recession in 2020/2021. Longer-run, we expect bond yields to rise, limiting their appeal. We are cautious on Credit given high valuations and recession risk and we see better opportunities in Real Assets too. Longer-term we expect USD to drop back from current levels.
Asset class returns and Global factor returns.

ASR Economics Weekly. Italy budget should delay its day of reckoning from Michael.
Near term risk for Italy overdone?
The upcoming Italian budget, to be debated later in September has put BTPs back under the spotlight and seems to be serving as a focal point for fears about redenomination risk. We do not think this is justified as we do not think that a rules-busting budget would trigger Italy’s euro exit.
The government could easily phase in some of its big-ticket policies and stay within the 3% deficit limit which could provide some relief for BTPs. We think a moderate budget is more likely than not.
But we remain of the view that there are risks for Italy 12-18 months out. A modest budget would invite political pressure to implement these policies next time; the PMIs suggest the recovery is not that robust; the ECB’s asset purchases will finish at year end, removing an important buyer of BTPs; we may see a less sympathetic ECB president post Draghi; immigration may prove a more effective vehicle for Euroscepticism than complaints about the euro. The government may have less fear of taking on the EZ/ the market in the future.

Multi Asset Weekly. Currency strategy update: Sterling – positioning for (EUR) parity from Chris.
Our 3 major FX themes are unchanged, but we make some changes to the expressions of these themes.
Favouring G3 (EUR, JPY, USD) over DM Cyclical/ commodity and EM currencies has been a core strategy against a backdrop of slowing global growth and tighter macro liquidity. This has worked well. In order to avert further bouts of weakness EM and DM cyclical/commodity currencies (cf our CANNS) we need to see a clear recovery in Chinese growth momentum and a more dovish Fed, neither of which are expected imminently.
• We maintain the G3/ CAD trade: Canadian housing remains a weak spot (v. stretched affordability) while our Canadian LI points to slower real GDP growth from Q4. We maintain our EUR/KRW calls trade.
• We take profits on short TWD vs. a basket of USD and SGD. It has worked well, and we are nervous of better Asia tech-related data while the Chinese authorities seem to have called a ST halt to CNY weakness.
• We take profits on EUR/SEK calls: the Swedish krona has very weak but sentiment on EUR/SEK is in extreme optimism and we take profits with 2 months left before November expiry.
Sterling to remain vulnerable even if a ‘no-deal’ Brexit is avoided.
• We are taking profits on short GBP / NOK (NOK has done well since last December but weakness in credit growth suggests downside risks to domestic demand / rate expectations). We switch our focus back to EUR/GBP for a bearish GBP trade. GBP’s prospects look poor: the UK is the only developed economy with household, corporate and public sector financial deficits while uncertainty on Brexit could stretch for months. Trade: Buy EUR/GBP 0.97 1y calls, funded by selling 0.84 1y puts and 1.01 1y calls.
Differentiating between EM currencies using our Vulnerability index and valuations.
• We maintain a short ZAR vs. RUB recommendation; we introduce a stop on long BRL/COP given BRL volatility; Our Long MXN/CLP has done well (+12%). Suggest closing the trade on a close below 34.90.

ASR Absolute Essentials from David McBain.
Equities. Equity market sentiment outside the US has become less supportive with sub 50% of 37 non-US indices now having SBIs of over 50. Bonds. EM bonds are near stretched pessimism territory but with momentum so negative the risk is any near-term rally will be short-lived. Commodities. Crude sentiment continued to improve as specs increased their net longs. Sentiment for Gold and Copper remains deeply negative. FX. Oversold AUD/CAD is nearing the low end of its 6-year range. CNY/KRW is at a key support level.

MULTI ASSET SURVEY – do participate! This ‘wave’ will be interesting given: (1) the mixed signals re the global business cycle; (2) the sell-off in EM; (3) the failure of 10yr Treasury yields to sustain yields over 3%.


Best regards, Verity

ASR Weekly Wrap from Verity
31 Aug 2018
: Verity Hunt

Research, News & Views from ASR for the week to August 31st, 2018

ASR Investment Strategy Weekly. How the US Can Underperform if Equities Fall by Ian Harnett
Overweight US Equities vs ROW has been a key call for ASR in 2018, delivering an 8% gain relative to a 5% loss for Global ex US Equites.
History tells us that US Equities only underperform 28% of the time in falling Global markets. Investors are wondering when, if ever, it will make sense to underweight the US?
When US markets have underperformed during corrections / bear markets, certain conditions have been apparent:
   • US $ weakness with US real rates falling vs rest of the world;
   • Rising oil prices;
   • Financials outperforming Healthcare;
   • Ex US ROEs outperforming US ROEs.
One might argue there are different factors in play this time around ... the US is now an oil producer, the Tech sector is under pressure from regulation and China, as well as President Trump.
For the US market to falter, we would need real interest rate differentials to move against the US, presumably due to stronger inflation than elsewhere, or weaker growth.
So while the US market can underperform in a modest downswing for Global equities, it remains a low probability event. Underperformance typically requires non-US ROEs rising more rapidly than those in the US and Financials beating Healthcare. That tends to be a world where Global growth and Equities are rising, not falling.
We remain convinced that being underweight the US in falling markets continues to be a risky strategy.

ASR Multi-Asset Weekly. Regime risk to equities/commodities by David McBain.
Since April 2018 global activity expectations have been positive whilst economic surprises have been negative. Our analysis looks at the market implications of this backdrop since 2000. The 13 and 26-week forward returns for the various asset classes favours Bonds & the US$Within Equities, EM Equities have been particularly weak.
This macro regime has historically proved particularly important for commodities. It is a likely constraint for commodities as an asset class, with precious metals performing somewhat better than industrial metals. We have a preference for precious metals vs industrial metals.  Aside from this analysis, our view is further supported with industrial metals facing several other pressures:
   • A deterioration in industrial metals’ supply-demand profile;
   • The declining path of global leading indicators which is consistent with precious metals outperforming vs industrials;
   • The recent signs of a slowdown in Chinese economic activity.

ASR Absolute Essentials from David McBain.
EM equities have found some contrarian support but, strongly negative underlying momentum suggests rallies may be short-lived. Meanwhile overbought USA/EM relative has hit a key resistance zone. The USA/EM Equity relative tends to provide a lead of around six months on the US dollar: something to watch! Further on USD, the breakdown in EUR/USD below 1.155 has failed to hold, with the cross-rate back above 1.166. While pessimism has eased, EUR/USD net short positioning is not at levels that would point to contrarian support.
Dollar developments remain a key near-term driver for Gold, a sustained DXY reversal will likely be required for Gold to sustain a break back above $1200, with $1250 the next technical level beyond that. 

Best regards, Carly and Beth pp Verity

ASR Investment Strategy - How the US Can Underperform if Equities Fall
30 Aug 2018
: Ian Harnett, David Bowers, Charles Cara, Dorothee Deck

• As the S&P regains levels last seen in late January, World x US Equities remain in correction territory - a reminder that overweight the US has been key in 2018.

• Given that the US also outperforms in 2/3rd of the periods when equities fall, investors are wondering when, if ever, it will make sense to underweight the US?

• What is notable about the 28% of down markets when the US underperformed the RoW was that the US dollar tended to fall over 70% of the time (albeit only 3.2%).

• For the US market to falter, we need real interest rate differentials to move against the US, presumably due to stronger inflation than elsewhere or weaker growth.

• A higher oil price has been present 60% of the time when the US underperformed in down markets. However,with the US now an oil producer, even this may change.

• Some investors look to Tech to be the cause of such underperformance. The lesson from 2000-2002, when US Tech fell 70%, was that the US market outperformed Global Equities by 12% (even when Tech was 35%, not 20%, of the US market).

• While the US market can underperform in a modest downswing for Global equities, it remains a low probability event. Underperformance typically requires non-US ROEs rising more rapidly than those in the US and Financials beating Healthcare. That fits with a world where Global growth and Equities are rising, not falling.

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