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Research, News & Views from ASR for the week to July 20th, 2018
ASR Multi Asset Weekly. ECB QE ending, focus on bond supply from Stefano.
The ECB announced in mid-June that QE net government bond purchases will slow further in Q4, ceasing by the end of the year. QE has been a major factor driving European bond markets in recent years but going forward, Stefano argues, net government bond supply could be an important driving factor again (as it was historically).
• In the past few years, the ECB unconventional monetary policy measures have helped French bond yield spreads to Germany trade about 40bp tighter than suggested by France’s net government requirements relative to Germany. The EUR 100bn Germany/ France budget gap would have been consistent with the OAT/Bund 10y yield spread trading wider than last year’s levels.
• Spain vs. Germany would also show the 10y Bonos yield spread to Bunds too tight given Spain’s nearly EUR 80bn budget balance gap to Germany.
• Looking at Italy vs Spain, there is a flat budget balance gap which would suggest the 90bps 10y BTP’s yield premium over Bonos reflects Italian political risk.
• Looking forward, budget balance consensus forecasts for 2019 show France and Spain at 2.7% and 2.0% of GDP respectively, still faring worst in the Eurozone. France and Spain’s yield spreads to Germany look rich on this basis as well as by historical standards: Italy is looking the cheapest.
• Worth noting that Irish bond yields trading in line with ‘soft core EZ countries looks vindicated by Ireland’s improving budget position.
• Trade idea: We stick with Short OAT/ long Bund Sep-18 futures as an attractive hedge to core-periphery spread widening risk and France’s relatively worse budget position.
ASR Absolute Essentials from David McBain.
Equities. Pessimism on Japan versus AC World ex-Japan has hit stretched levels, albeit sentiment for Japan has improved in absolute terms. Sentiment on GEM Equities is above recent lows but remains poor.
Bonds. Speculators’ US10Y net short positions have become substantial. Sentiment for US10Y remains at neutral levels. Sentiment for Italian bonds has moved off recent highs.
FX. Optimism on DXY and pessimism on EUR/USD has receded, with 95 and 1.155 continuing to provide key resistance and support. Specs remain negative on CHF vs USD. Sentiment for GBP & EUR has improved taking it to neutral levels.
Commodities. Pessimism on Copper hit stretched territory last week, joining Gold, Silver & Platinum. Crude Sentiment has pulled back from recent highs. Specs made small cuts to their crude net long.
ASR Investment Strategy. How recent weather impacts on macro and markets from Ian.
• We have written before – HERE – how the Oceanic Niño index (ONI) has links to both economic activity and to financial markets. See this paper from the IMF too. The last El Niño effect peaked in 2016 and may have helped boost US GDP growth in 2017-18 along with commodity prices and bond yields.
• Metals prices relative to Foodstuffs are also positively related to the ONI with a 12-18-month lag.
• One tends to see positive returns for equities vs bonds 18 months following the peak in El Niño – as we have.
• But, as the ONI wanes, this would suggest a waning in growth which would tend to favour bonds vs equities.
• Temperatures have also been soaring in much of the Northern Hemisphere but temperature ‘anomalies’ have been on a rising trend, with all 18 of the 21st century being amongst the 19th hottest recorded.
• The trend rise in temperature has coincided with a rise in extreme weather and other geophysical events. This has implications for Construction beating Insurance and also suggests heightened bond and equity volatility and a rising risk of asset stranding. See HERE
Best regards, Verity
• In Q2 record temperatures were recorded in North America & Europe
• Ocean temperature & El Niño can help predict macro & market outcomes
• Expect weaker activity and risk assets as the 2016 El Niño boost passes
• Increased climate extremes will, likely, add to Bond and Equity volatility
Research, News & Views from ASR for the week to July 13th, 2018
ASR Economics Weekly. Trade fade, more to be played by Ben.For all the attention given to the strength of the US data, what is striking is the extent to which global activity data outside the US has deteriorated. Global trade growth rebounded in April which seemed to allay some fears about the underlying strength of global trade. We are more cautious, even when ignoring the potential for further trade tensions in coming months.
• On a quarterly annualised basis, global trade contracted by 5% in the 3 months to April. Our timely logistics data set which had given mixed signals in Q1 suggests that global trade growth is well past its peak.
• Air freight growth has moderated in Asia while European airfreight has also weakened.
• Our container shipping proxies are more volatile but having picked up c/o Chinese New Year, the global proxy has now slowed sharply c/o both weakening Chinese demand but also a slowdown in US container shipping activity, with annual growth, smoothed with a 3m moving average, now negative
• We expect global growth to slow in 2018 vs 2017, with weak global demand weighing on global trade.
• Slower global trade augurs badly for global eps growth: 12m forward EPS forecasts of 13.1% could pull back to low single digits.
Absolute Surprise. The Global Activity and Inflation expectations indicators have crossed over, as analysts expect a weaker growth vs inflation mix – unhelpful for equity multiples.
Absolute Essentials from David McBain
• In early June, we argued that Industrials metals were at risk from weakening momentum and demand-supply profiles. Their 9% underperformance vs Precious metals fits with a less supportive macro backdrop. Copper is nearing stretched pessimism territory as it tests 280 support, but with Industrial metals’ momentum now negative (now below 2½ year trendline support) and risks of slowing growth, any Copper rally may be short-lived. A break below 280 would target a re-test at 255-260. We retain our Short in Copper futures. Weak Industrial metals also ties closely with European Cyclicals vs Defensives.
• Dollar strength has taken the shine off Gold, but near-term support looks likely off $1250.
Absolute Newsflow from Richard.
Our Composite Newsflow Indicator (CNI) rose to 62.6 in June c/o the Inflation Newsflow. The Economic Newsflow remains weak – the Chinese component falling sharply – while the Earnings and Revenues Newsflow both fell.
ASR Multi Asset Strategy. Key Takeaways from Q2 (part 2) from Chris.
In last week’s MA Weekly, we focused on the tightening of global liquidity; less flexibility for EM policymakers; scope for global growth expectations to fall; whether US equities’ defensive qualities are sustainable; why US IG was such a poor performer in Q2. Here we look at 5 more takeaways
Gold is no hedge for protectionism or oil price gains. The 2 strongest macro relationships with gold prices over a long period have been TIPS returns and the USD TW index. Q2 was a poor quarter for gold. A strong USD pushed gold prices down while US 10y real yields were neutral / slightly negative. So far, technical support around $1250 has held. Our macro outlook lends itself to a modest bullish bias on gold from here, especially as sentiment has just moved out of stretched pessimism.
Commodity prices – supply side to the fore in Q2. Q2 was a mixed quarter for commodity prices (cf Nickel +12%, Zinc -12%) with supply side factors helping to explain the dispersion. Our PCA analysis confirms that common macro trends were not explaining commodity price moves as much as normal. We expect this to change as a slowdown in global growth becomes clearer: we retain a short Copper futures call as a play on this.
US Treasuries – supply to take a back seat. Interest in the topic of Treasury supply leading to much higher 10y bond yields was very high earlier in 2018 but, UST 10y yields failed to stay above 3% in Q2 (as Stefano argued here). Where a trend increase in Treasury supply may be having an impact is in the corporate bond market. Rising government and corporate supply and shrinking macro liquidity is a recipe for wider credit spreads which should continue in H2 unless GDP and FCF growth surprises on the upside.
Focus on what is not in the news! It is not always easy to make money from hot topics - recently, tariffs / protectionism / trade wars. What is not being talked about? We have received few questions about Japan or – until this last week – about the UK / Brexit. The lack of interest in the Brexit theme as a risk for Sterling in the short or medium term is reflected in the options market: EURGBP options look cheap. We like short GBP/NOK.
Individual country fundamentals do matter in EM. EM assets came under general pressure in Q2 but there were still opportunities to distinguish between EM using our EM Vulnerability index. cf our tactical Long BRL / ZAR trade which worked well and took profits. We still like Long RUB / ZAR on any retracement to 0.21. Long MXN / CLP should also have further to run
ASR Investment Strategy from Ian and Richard.
Chaotic UK politics point to chaotic Brexit and markets from Ian.
Recent Cabinet resignations in the UK have put the outlook for UK equities back centre stage. Despite persistent Brexit uncertainty and heightened volatility, UK equities have gained 25% since the 2016 referendum, but they have underperformed Global equities by 15% in dollar terms. This has justified an Underweight position for UK equities in a global portfolio, but investors are asking whether they are a cheap alternative to EZ or EM equities.
• Overall, UK equities have been supported by healthy EPS growth (trailing 16.3%) and forecasts (13.5% forward), reflecting commodity prices and currency exposure: 66% of FTSE 100 sales come from overseas, largely explaining the 40% outperformance of Internationals vs Domestics.
• But, commodity prices now suggest some downside risks for UK earnings and while further weakness in sterling is feasible (current account and fiscal deficits; relative weakness in UK activity; REER not particularly cheap), the upgrades / downgrades ratio suggest the market is already discounting a further 10% fall in sterling anyway.
• UK PEs are now at 16x (vs 21x in December), some 12% above their long-run average. It is only relative to Global valuations that the UK looks cheap. The danger is that the UK remains a ‘value trap’. The high weight of ‘Value’ sectors such as Oil & Gas (13%), Basic Resources (8%) and Banks (10%) mean that to see a sustained rally in UK equities we need not just a UK economic recovery but more of a synchronised global recovery, which we think is unlikely. We also believe that to invest in a region, one must want to buy the Banks. UK Banks have outperformed EZ banks in the last 3 months and CDS insurance is cheaper for UK Banks than US Banks, suggesting limited further upside.
• While the market may have ignored the political drama, UK Equity Risk Premia remain related to Policy Uncertainty: a rise in the latter could boost risk premia as Brexit approaches. For us, UK equities remain a value trap, albeit UK equities may still do better than Sterling or Gilts. Stay Underweight UK assets.
Why UK Policy Uncertainty is set to rise from Richard.
The UK’s new Brexit blueprint blueprint (UK remains, in effect, a part of the Customs Union while it awaits new technology to create a convoluted dual-tariff area and remains in the EU’s regulatory regime for goods and agri-food) is unlikely to be acceptable to Brussels in its current form: the EU27 must decide if they will accept a carve-out deal for goods. If they won’t, the risk of a ‘no deal’ outcome increases significantly. Even if the EU27 do not reject it, we think that uncertainty and fears over ‘no deal’ will rise through H2. Pushback from within the Tory Party is likely to make more concessions difficult to agree, while the Irish border backstop is no closer to being agreed. The biggest uncertainty facing markets is whether the final deal can get through the UK parliament. If and when they have a negotiated deal, none of the options facing the Government are that attractive. Our view is that they could hold the vote so late in the process that the alternative to supporting it, is no deal at all. This is obviously a very high-risk strategy and could create a volatile environment for UK assets heading into 2019. Theresa May will likely stay as the Tory leader, but we still fear that there is too much complacency over Brexit in financial markets which is likely to be challenged.
Best regards, Verity
• Despite persistent Brexit uncertainty and the UK government losing eight cabinet ministers in a year, UK Equities have gained 25% since the 2016 referendum.
• However, relative to Global equities the UK market is down 15% since 2016, tempting some investors to think about adding UK positions in their portfolios.
• UK PEs are now at 16x from 21x in December. However, this remains 12% above the 10 year average. It is only relative to Global valuations that the UK looks cheap.
• Although earnings growth forecasts remain robust at 13%, meeting these numbers is likely to require both weaker sterling and stronger global growth.
• We worry that the UK remains a ‘value trap’ given the high level of uncertainty surrounding Brexit and the need for Banks to be part of any UK outperformance.
• The Brexit White Paper has provided the UK with a more coherent platform from which to strike a deal, but there remains much still to do to avoid ‘no deal’.
• Pushback from within the UK and the need to agree new EU guidelines before negotiations can progress mean uncertainty is more likely to rise than fall.• We remain Underweight UK Equities and UK assets more generally.
Research, News & Views from ASR for the week to July 6th, 2018
ASR Economics Monthly. Twin risks of growth divergence from the Economics team.
• The global economy has become polarised in the decade post the GFC. China has become the key driver of the global business cycle, but global financial conditions have become more sensitive to US monetary policy.
• We are at an inflection point in global growth. The global manufacturing PMI looks to have topped out, global trade growth has moderated, and surveys of consumer and business sentiment look to have peaked. The slowdown in momentum looks to be broad-based in Asia and the Eurozone with the Global ASI close to its 2009 low. So too, the fall in global real M1 growth, the weakness in our global leading indicator and the likely headwind from the higher oil price all suggest downside risks, but consensus forecasts have, as yet, only been revised down marginally.
• Why have forecasts not come down? It likely reflects a view that a strong US economy will buoy overall global growth. Consensus forecasts for EZ and Asia have edged down a touch but have risen in the US (Atlanta NowCast expects 4% annualised growth in Q2). The prospect of more fiscal stimulus in 2019 and the higher oil price supporting US activity, have also fed into the idea that US growth has ‘decoupled’ from ROW.
• How long will this last? History suggests that divergences in growth rates tend not to last long.
• How might this recoupling occur? US strength could spill over to the rest of the world but in our view, China is the dominant influence. The Chinese economy has continued to slow in recent months (FAI, retail sales, air freight / container shipping). China is a larger trading partner than the US for 70% of countries around the world and is already acting as a drag on growth - Korean IP and export growth decelerating along with weaker EZ / UK / Japanese exports to China.
• We continue to think the PBoC’s apparent moves to ease monetary conditions are designed to provide the commercial banks with the capacity to re-absorb assets from the shadow banking system rather than stimulate the economy. Anyway, the typical lags would suggest that growth continues to slow further before any benefit from their easing measures in H1 2019. We expect a softening global growth picture to drag down the US in 2019 rather than the other way around.
• Growth divergence = tension. Stronger US growth relative to the world could have 2 effects:
• The US trade and current account deficits could widen, aggravating Trump’s protectionist stance.
• A stronger dollar. The dollar has become the dominant currency of choice for international borrowers over the past decade, with dollar denominated credit accounting for 75% of total foreign currency borrowings by the non-bank sector outside the US and virtually ALL the incremental growth in credit.
• The global economy has become more sensitive to changes in US monetary policy since the GFC and with the Fed signaling it could push rates into restrictive territory, the Chinese economy still slowing and the dollar appreciating, pressure on emerging markets could continue to grow.
• Two downside scenarios. Emerging market stress could become a fully-fledged crisis. If the Fed pursues a domestic mandate and keeps raising rates, then dollar debt and US corporate debt will become important pressure points.
ASR Multi Asset Weekly 10 Key Takeaways from Q2: part 1. From Chris.
Emerging markets still struggle for independence from DM policy.
In 2017/early- 2018, EM central banks were still easing policy, but this ended in Q2 as a result of some slowdown in global growth and also, more importantly, a stronger dollar. Dollar strength and the role it plays in a broader deterioration in global macro liquidity conditions has been the main driver of EM underperformance so far.
The importance of macro liquidity measures.
• We have seen an evaporation in the positive liquidity macro backdrop as global M1 continues to weaken through Q2. This switch from a risk-supportive excess liquidity environment has occurred earlier than markets expected. As global excess liquidity shrinks, it is logical to expect financial market volatility to rise, carry trades to struggle and major liquid currencies to outperform.
• Dollar strength in Q2 added further to this negative liquidity backdrop and presents a risk to the global economy given the build-up in dollar-denominated debt: it accounts for 75% of total foreign currency borrowing by the non-bank sector outside the US (vs 50% in 2008). US tax reform – and the repatriation of US foreign earnings (annualized rate of $633bn in Q1) has also likely played a role in undermining the non-US banks’ wholesale dollar funding and looks likely to have further to run.
Growth expectations have plenty of room to fall.
• The fact that Financials was the worst performing sector in Q2 is consistent with the view that the weakness in EM equity and bond returns in Q2 had more to do with deteriorating macro liquidity than slowing global economic growth. There were signs at the end of Q2 that growth expectations were ebbing - US 10y yields down 20bp from mid-May highs, copper prices down 10% and Global Materials underperforming.
• There is still plenty of room for global growth expectations to fall in Q3 given sharply negative Activity Surprises but very resilient Activity Expectations, so far. Weakness in industrial metals and cyclical equity sectors will likely extend into H2. We maintain our short Copper futures recommendation.
US equities showed their defensive qualities in Q2 –how sustainable?
• The US equity market validated ASR’s ‘overweight’ stance (3.1% return in Q2 vs MSCI ACWI ex USA -2.6%) c/o strong Tech and Consumer Discretionary stocks and less weak Financials than elsewhere. We remain Overweight the US but have highlighted potential risks – Challenging Groupthink and exposing the tail risks – of whether a Trade war could morph into a Tech war and whether Trump’s protectionism / isolationism moves to degrade the dollar as the world’s reserve currency.
• Still, against a backdrop of slowing global growth and tight macro liquidity conditions we favour the G3 currencies (EUR, JPY, USD) versus EM and Commodity currencies. Current trades are Long a G3 basket vs. CAD and long USD and SGD vs TWD.
US and Eurozone credit markets show different dynamics.
Our view in March that US Investment Grade bonds looked a better volatility adjusted short than US High Yield, but with an opposite bias in Europe, worked well in Q2. We reiterate our 2017 recommendation: long TIP (US TIPs ETF) against a short in LQD (US IG corporate bond ETF).
ASR Absolute Essentials EM equities oversold; Australia ripe for a Q3 reversal vs EM, from David McB
Equities. EM Equities sentiment has hit stretched pessimism territory but any contrarian support for EM equities could prove short-lived given negative momentum trends. If MSCI EM support c.1050 fails to hold, a move back towards 1000 appears likely. Optimism is stretched on Australian equities, with MSCI Australia also hitting stretched levels vs. the EM index in $ terms. Sentiment points to a Q3 relative reversal.
Bonds. Sentiment for US 10Y T-Notes and TIPs has improved. In Europe, optimism on Bunds is running at elevated levels but pessimism on Gilts has increased. Within corporates, HY optimism has receded from stretched levels versus investment grade. FX. Stretched pessimism on AUD/USD is consistent with still weakening EM currencies. AUD/NZD is heading higher, supported by a sentiment and relative economic tailwind. A move above 1.096 would target a 1.11 retest. Commodities. Gold pessimism is almost stretched, as it tests $1250 support, next likely support c.$1200 - $1220. Copper is also testing key futures support around 297. Crude oil optimism is back at elevated, though not extended levels.
ASR Multi - Asset Trade Idea Fading the BoE/ECB policy bias from Stefano.
• Monetary conditions are tighter in the UK than in the Eurozone, yet we have a hawkish BoE and a dovish ECB
• This has stretched UK/Euro yield differentials to wide historical levels. Fixed Income rather than Currency markets offer an attractive way of trading this story.
• Trade – Buying 2-year Gilts vs. selling September 2018 Bobl futures.
Best regards, Verity
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