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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
Essentials’ Sentiment Snapshot
Absolute Essentials is taking a brief summer break, returning in late-July.
This snapshot provides current market sentiment highlights. They are:
• Heading into this week, pessimism on EM equities is notable and stretched on Copper, while speculators’ net shorts on US10Y are still substantial (see page 2).
• In FX, optimism on DXY and pessimism on EUR/USD has receded, with 95 and 1.155 continuing to provide key resistance and support. On positioning, speculators are running with especially sizeable net shorts on CHF vs. the dollar.
• In equities, pessimism on Japan versus AC World ex-Japan has hit stretched levels.
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
• Drawing more messages for multi-asset investors from Q2 markets, we discuss: Gold is no hedge for rising protectionism or oil prices; the importance of supply factors for commodity prices; the inability of UST supply concerns to keep 10y yields above 3%; cheap EUR/GBP options; and the relevance of ‘relative value’ ideas in an EM sell-off.
• In a second piece, David discusses the deterioration in EM equity breadth indicators. In the case of China, they point to potential for a near-term bounce in the Shanghai Composite albeit underlying momentum remains negative.
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