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Multi-Asset Team

Chris Turner
Head of Multi-Asset Strategy
Stefano Di Domizio
Head of Fixed Income Strategy
David McBain
Head of Technical Strategy
Zahra Ward-Murphy

Multi-Asset Research

Multi-Asset Products: Multi-Asset Strategy Monthly, Multi-Asset Strategy Weekly, Absolute Essentials, Trade Alerts, Weekly Wrap, Absolute Strategy Weekly.

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ASR Weekly Wrap from Verity
19 Jul 2019
: Verity Hunt

Research, News & Views from ASR for the week to July 19th, 2019

ASR Economics Weekly. Ten charts for 2019: a half-time update from Dominic.
In December 2018 we published the 10 charts that we thought would be key for forecasting 2019. We take a ‘half-time’ look at these charts and how accurate our views have been in 2019 thus far.  Most have proven good guides and still suggest caution: some worked less well but help frame the key issues for H2.
•   Global growth. We interpreted the weakness in global real M1 growth as a sign that monetary conditions were too tight. It has stabilized but at a low level, suggesting that the policy response might be insufficient to prevent a further slowdown in global growth. Policy stimulus by the Fed and the ECB may prove too little / too late. The  risk of recession remains elevated. Our Leading indicators continue to provide a similar message, with little sign of a turnaround, reinforcing the view that the next 6-9 months remains challenging for growth.
•   China. Chinese growth has slowed, but real estate investment has held up better than expected and targeted interventions have held financial risks in check. Tight monetary conditions weigh on corporates and local governments, but the PBoC has held rates steady: we think rate cuts now may wait until 2020. 
•   Fed policy. We underestimated the willingness of the Fed to turn aggressively dovish in such a short time. It looks highly likely that the Fed will cut rates at the end of the month, with more to come later this year.
•   EM. The Fed’s dovish turn has also allowed emerging market central banks to reverse some of their rate hikes from 2018, which has eased pressure on EM growth.
•   The dollar. The dollar remains a key barometer of whether the Fed has done enough as it gears up to ease. As expected, trade and technology tensions have persisted and this has led to a rise in precautionary inventories, putting upward pressure on the dollar and imposing tighter conditions on global manufacturers.
•   Europe. Our caution on Europe has been validated, with the ECB likely to act in some capacity in September. However the ECB’s options look limited and hopes of greater fiscal may take time to materialize. On politics, we were right not to expect a surge in populism in the European Parliamentary election, bar in Italy.

Investment Strategy Weekly. European size factor more attractive than US from Charles
•   US corporates have been accumulating debt at a high rate. Looking at a breakdown of the top 3000 companies, the top 500 have drawn down some of their cash reserves and taken on additional debt while the next 2500 companies, with few cash reserves, have increased borrowings substantially.
•   This is concerning given the latter group’s lower levels of profitability (EBIT margins of 5% vs. 12% for the largest 500 companies). US smaller companies have more than doubled their debt since 2012 to fund capex and M&A, yet EBITDA has barely risen.
•   US small caps underperformance vs. US large caps is partly due to poor fundamentals, but it is exacerbated by a structural disadvantage from their lack of benefit from buybacks. These currently total over $900bn. The portfolio rebalancing by passive investors strongly favours the large caps and has contributed to the de-rating of the non-S&P500 stocks vs. the S&P500. This long-held trade of favouring US Large vs. Small caps has worked well for our MA team.
•   European Small caps and European small caps vs. large caps might be an attractive alternative. With the top 600 European companies, the small quintile has better levels of relative profitability and is not heavily exposed to high debts.
•   Slower EZ activity has been a headwind to EZ small companies, but the EZ ASI has been improving, unlike the Global ASI: if we start to see positive Activity surprises, this should help the performance of EZ small caps. Nor do European companies face the same buyback recycling headwind, as buybacks are less than 1% of market cap.
•   We expect US small caps to continue to underperform vs. US large caps. European small caps, with better relative profitability and lower debt levels, look relatively attractive.

Multi Asset Weekly. Dollar: what do bears have to feed on? from Chris Turner.
The results of our Q2 2019 Multi-Asset Survey made for quite gloomy reading with global recession risks perceived to be rising. At the same time the Survey confirmed the continuation of a trend decline in USD sentiment and expectations of lower US 2-year yields. Chris looks at what has usually been associated with periods of a rising / falling dollar among a list of variables focused on rates and growth.
•   USD and global growth. Contrary to our MA Survey, Activity Surprises (ASI) and Activity Expectations (AEI) suggest that the dollar has tended to perform best when Surprises and Expectations are negative / falling. Currently the ASI is negative but the AEI is positive: this ‘pull’ may have contributed to the narrow trading range of USD over the last 5 quarters. Falling or negative earnings revisions are also usually associated with USD appreciation. The BIS work, as highlighted by Dominic last week, also suggested that rising precautionary inventories putting additional pressure on dollar financing and boosting the value of USD.  
•   The USD and US growth. Using these same data sets, there is little evidence of US growth (either in absolute or relative terms) mattering as much to USD as global growth.
•   USD and US yields. We have long argued that the best single factor for rationalizing DM exchange rates is real yield spreads, although the past 2 years have seen less of a close link than has historically been the case.
•   USD and current Fed / ECB policy. 2019 has seen a sharp change in US rate expectations but has, so far, proved to be a very neutral year for USD. Indeed, shadow rates have arguably done a better job of signposting the direction of EUR/USD than standard nominal and real interest rate differentials. It looks difficult for EUR to stage a strong rally while the ECB is perceived to be at least as dovish as the Fed. Anyway, the USD has tended to be weaker in the 3-6 months ahead of the first cut in Fed funds than in the 3-6 months after.
•   Where does this leave us on USD for H2? There is little in our Leading indicators to suggest a clear rebound in Chinese or World ex-US growth in H2. That being so, the USD may not exhibit a strong trend in H2 either with slower global growth and downward revisions to corporate profits forecasts favouring USD strength offset by some narrowing in the gap between US real yields and others. We continue to stress selectivity towards EM FX: we like high yielding IDR, MXN & RUB, while remaining wary of lower yielding / expensive Asian currencies exposed to weak global trade growth: we remain Long MXN/CNY, Long AUD/KRW and long IDR &MYR vs. TWD and THB.
•   Trade tensions and the euro’s evolving fundamentals. Over the past 2-3 years, trade issues have had a major impact on USD/EM exchange rates. If a US-EZ trade war escalates we doubt whether the EUR will behave like CNY or MXN. The EZ’s transition to being a net external creditor would improve its credentials as a ‘safe-haven’ currency. We look for EUR/USD upside to 1.30 on a 1-2-year view but we need upside EZ growth surprises and a Brexit resolution for the euro to rally: near term the EUR may be stuck in a range.  

ASR Absolute Essentials from David McBain
•   The rally in US equity indices is still not being confirmed by commodity trends, which continue to point to a tougher macro backdrop than the equities/bonds relationship is suggesting.
•   Despite US equity indices hitting new highs with the DJI breaking 27000 (next likely big resistance areas are 28500 and 30000), sentiment for S&P 500 and DJI is not yet stretched.
•   S&P 500 Transportation sector relative SBI dropped below 2. Sub-2 SBI levels since 2000 have been followed by an average 2.3% rise in the relative over 65D on 71% of occasions).
•   In FX, AUD/CAD and USD/INR have hit key support against a backdrop of stretched pessimism.

My best regards, Verity

Multi-Asset Strategy Weekly - Dollar: what do bears have to feed on?
17 Jul 2019
: Chris Turner, Stefano Di Domizio, David McBain, Zahra Ward-Murphy

• ASR’s latest Multi-Asset Survey extended the trend decline in USD-bullish sentiment in recent years, now alongside rising fears of global recession and expectations of lower US 2-year yields.

• We investigate what has actually been associated historically with US dollar weakness – and whether worsening US-Europe trade tensions or the start of a Fed easing cycle are likely to have a major impact on the DXY index.

Sentiment, Positioning and Risk Essentials - Contrarian opportunities in US Equities and FX
15 Jul 2019
: David McBain

EQUITIES: S&P 500 and Dow Jones Industrials optimism nearing highs (P2/5)

US: US ‘Themes’ close to stretched; SPX Transport relative oversold (P2/5)

FX: AUD/CAD, USD/INR and INR 3M Vol pessimism stretched (P4)

ASR Weekly Wrap from Verity
12 Jul 2019
: Verity Hunt

Research, News & Views from ASR for the week to July 12th, 2019

ASR Investment Strategy. Equity valuations at risk from H2 earnings from Ian
Global equities have gained 13% since the start of the year. The optimism about activity, trade and profits implicit in equities is, however, at odds with the pessimism about the outlook implicit in bonds, which have also rallied strongly. (See HERE). It reflects a major shift in Equity/ Bond correlations.
•   The main problem is that all the market gains in global equities have come from higher valuations, given EPS growth has fallen by 3% and dividends are up just 1%. This is true across markets.
What are the risks with these higher PEs?
•   Valuations are becoming demanding. US Schiller PEs at over 30x are back to 1930s levels and trailing PEs of 22x are above the highs of the nifty fifty period in the 1960s.
•   The rise in global valuations discounts a benign economic backdrop where EPS growth is healthy, and margins expand but that is at odds with the lower PEs implied by our 2 year ahead Recession Risk models.
•   The rise discounts a 10-point rise in the ISM and a V-shaped recovery in global trade which is at odds with our macro models. When such earnings and economic optimism disappointed in 1998 and 2000, for example, the downside was severe.
•   Nor do our models suggest that EPS will come through to support higher valuations: indeed, the opposite is true. CEO confidence is cautious (87 out of 113 companies offering guidance have guided lower according to FactSet) and we believe that the current bottom up IBES 12m ahead forecasts of a 6.6% rise in global EPS will likely turn into a fall of 5%, leaving valuations very exposed.
•   Rising PEs also imply an improving trade-off between real GDP growth and inflation but there is little evidence to support higher PEs in either activity or inflation surprises or consensus forecasts for GDP vs. Inflation.
•   The other key issue with equities rallying as bond yields fall is the shift in the Bond/Equity correlation that this implies. Such shifts are rare and tend to come with major regime shifts (2 in the last 70 years - the end of Breton Woods or the start of inflation targeting). It seems unlikely to us that the correlation between Bonds and Equities can fundamentally change until there is a more major policy regime shift. This is unlikely to emerge until after the next recession.
•   We are cautious given trend EPS growth tends to fall in late cycle and this negative EPS momentum when PE multiples are already high would suggest close to zero for 3-5 year returns.

ASR Economics Weekly. How trade tensions affect the global outlook from Dom and Michael.
Background. It’s now 18m since the Trump Administration started imposing special tariffs on imports from its major trading partners. China has been a key target, but parts of the EZ and Mexico have faced threats as well.
•   The measures imposed so far have already brought the effective US tariff rate up from 1.5% to 5% - a level last seen in the 1970s. What is very clear is that tariffs are now being utilised as a geopolitical weapon.
US-China relations. Investors have taken comfort in the ‘progress’ made at the recent G20 meeting. We are wary about assuming that US-China relations are back on track. For two reasons:
    •   First, the Chinese may be reluctant to make big concessions – if they do so, that might invite the US to try a similar tactic further down the road.
    •   More importantly, we believe that the US-China relationship has fundamentally changed: even if Trump was willing to do a deal, he could be constrained by the many China-sceptics within business lobbies, national security and parts of Congress, which may make it difficult for the Administration to back down
Where does that leave the global economy? There is a range of estimates of the impact of the tariffs, but the direct impact has likely been quite small. The OECD and the IMF have estimated the direct hit to global GDP has been in the region of 0.1 to 0.2 percentage points. But the indirect impact is hard to model but potentially much greater – up to -0.8% from Global GDP and >1% off US and China GDP, once a ‘risk premium’ or confidence shock is added in.
Is there any evidence of this ‘confidence shock’ effect? There is some evidence in the ISM and Beige Book with mentions of tariffs in recent months albeit the relationship between news on trade policy and measures of uncertainty is less clear.
What is the mechanism? Dom cites some work from the BIS (Hyun Song Shin), which looked at the interaction between global trade and global finance: international supply chains are working-capital intensive, and this working capital needs to be financed. Some 80% of global trade is invoiced in dollars. There is some evidence that inventory-sales ratios have spiked since the tariffs have been announced, which has put upward pressure on the dollar and tighter financing conditions have put more pressure on the manufacturing sector.
Conclusion. For us, we have been concerned about overly tight monetary policy. Far from being distinct from the trade war, it can be argued that the trade war has contributed to that. We also remain wary of being overly positive post the G20.

Multi Asset Weekly. Buy carry-rich Korea Treasury bonds from Stefano.
•   Dovish central banks have reduced bond markets’ supply of carry, but Korea Treasury bonds still offer global investors an attractive yield pickup.
•   The KTB market is liquid - over $500bn in size, with 50 issues outstanding and levels of volatility in line with that of DM bond markets.
•   KTB yields have fallen in line with global bond markets, albeit they have underperformed Treasuries in the recent rally. However, the slowing Korean economy would suggest potential for KTB yields to fall further.
•   KTBs are attractive for a global bond investor as the yield pick-up could be enhanced via lending USD in a KRW FX swap: once swapped into USD, 1.5% 5y KTB yields would rise to c. 2.7%. In the past, the 1y FX basis trading lower than 70bps negative seemed to trigger KTB buying interest.
•   On a relative value basis, currency hedged KTBs are offering EUR and JPY denominated investors the best risk-adjusted yields amongst global benchmark government bonds.

Absolute Essentials from David McBain
On Equities: MSCI AC World Index is at a notable resistance area around 530, with optimism now close to stretched. European equity vol hit oversold sentiment levels last week: since 2000, sub-3.5 VSTOXX SBI levels were followed by an average 27% rise in vol over 65 days, on 87% of occasions.
On FX: Pessimism is stretched on EUR/CAD and GBP/USD. Since 2009, sub-4 GBP/USD SBI levels have been followed by an average 1.3% rise in cable over 30 days, up on 72% occasions. However, failure to hold above 1.25 would point to a retest of 1.20 over the summer.

ASR/WSJ Newsflow Report
•   In June the ASR/WSJ Global Composite Newsflow Indicator (CNI) fell below 50 for the first time since 2015
•   Within the six sub-components: Economic, Earnings and Revenues rose while Labour Market, Inflation and Monetary Policy declined.
•   The Monetary Policy component was again the biggest mover, falling a further 16.6pts to 32.3: Monetary Newsflow at current levels has typically been associated with recessions.

ASR in the news this week…
•   Ian Harnett on CNBC this week, discussing ‘Global recession risks on the rise'
•   ASR Multi-Asset Survey coverage by John Authers - ‘Bloomberg Opinion

My best regards, Verity 
Multi-Asset Strategy Weekly - Buy carry-rich Korea Treasury Bonds
10 Jul 2019
: Stefano Di Domizio, Chris Turner, David McBain, Zahra Ward-Murphy
We argue currency-hedged KTBs are looking attractive to global bond investors on macro, carry and relative value
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