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In December’s Monthly we discussed the outlook for the currencies of countries perceived to have seen unsustainable housing booms in recent years – what ASR has termed the ‘CANNS’: Canada, Australia, New Zealand, Norway and Sweden. In a week in which our economists have expanded their suite of leading indicators to include Canada and Sweden, this piece updates our FX calls from December. We view CAD as the least attractive near-term and NOK as the least vulnerable. Meanwhile, we close our long SEK basket recommendation from a year ago as the Riksbank’s dilemmas intensify.
EQUITIES: US equity momentum style at risk relative to market (P1)
VOL: Rising VIX pushes bond/equity vol ratio down into reversal area (P3)
FX: GBP/USD optimism stretched as runs into 1.39-1.40 resistance area (P12)
Complacency a relative risk for US Equity Momentum styles
2018 has started with an unusual US equity combination of rising indices and rising volatility, with the VIX back above 12 for the first time in a couple of months. The relatively low CBOE Put/Call ratio suggests that the recent rise in the VIX has reflected increased appetite for call options rather than any rise in risk aversion. Sentiment measures still point to a notable degree of investor complacency.
In a relative context, US equity volatility is becoming reasonably extended versus bonds, with the ML MOVE/VIX ratio SBI last week dropping below 8. While not extreme, even sub-8 SBI levels have in the past 10 years been followed by an average 35% rise in relative volatility over the next 65 days (relative up on 92% of occasions). See page 4 for charts.
Chart of the Week: A continued rise in volatility might challenge momentum investors (see chart). In the past 12 months, the MSCI USA Momentum total return index has outperformed the MSCI USA index by 15%. However, as the relative nears 2008 historic highs, its own momentum is looking stretched. Since 1978, a 52W % change of 14%+ has been followed by an average -2.4% fall in the relative over the next 3M (down an average -3.2% over 6M). The momentum style is looking stretched in a relative context, based on MSCI USA indices.
Research, News & Views from ASR for the week to January 19th, 2018
ASR Economics Weekly
Why protectionism’s bite is worse than its bark from Michael.
Trade policy could become a key issue for investors in 2018. In Q1 we could see the NAFTA negotiations end in failure, the Article 50 Brexit negotiations will come to their ‘business end’ and we might even see a trade war between the US and China. Trump’s State of the Union address at the end of January could outline his trade plans. What could the impact be?
• The growth of Regional Trade Agreements (RTAs) has lowered ‘at the border’ trade barriers, helping reduce the cost of cross border trade. Protectionism’s impact is often assumed to be the reverse of free trade. But we think this approach is flawed.
• RTAs have encouraged greater trade integration and specialization with each economy exploiting its competitive advantage. Disrupting two integrated economies is more damaging than the reverse.
• Imposing trade barriers is disruptive but trade in services is very important for advanced economies and it has been removing non-tariff barriers (NTBs) liked harmonized regulations that has allowed services trade to flourish. For example, the NTBs facing US companies wanting to do business in the EU is equivalent to a 14.7% tariff. For the UK any deal that does not involve staying in the single market (ie no services integration) is a hard Brexit.
• Any prospect of retaliation or other multilateral agreements like WTO falling apart would multiply the impact.
• Trade policy could become an important investment theme as asset prices are sensitive to sudden changes in terms of trade while many corporates, dependent on long thin supply chains will also be vulnerable.
Absolute Surprise. Positive hard data has closed the hard-soft gap in the US. Consensus has reacted to this, pushing up 12m forward GDP forecasts. Data in Asia ex Japan has surprised to the downside in the past 3 months - the Korean and Taiwan ASI are down sharply.
Forecasts. Generally, we are higher than consensus on inflation forecasts across the board. We also remain higher than consensus on EZ growth in particular: consensus has seen upgrades to 2.2% for 2018 and 1.8% for 2019 whereas we look for 2.5% and 1.9%.
Multi Asset Weekly
Technical challenges facing bond and USD bears from David McBain.
We focus on bonds and the dollar from a technical perspective.
Key levels. In an echo of a year ago, US 10y yields are heading to re-test 2.6% which is a notable resistance level: a break above 2.6% would point to a re-test of 3%. Of course, 3% is a key level long-term level – a point which breaks or sustains the 35-year US bond bull market.
• The emergence of stretched pessimism in US and German bonds is consistent with deeply negative relative sentiment on Utilities and Telcos. It chimes with stretched optimism on Crude vs Gold.
• The role of activity and inflation surprises in driving bond sentiment is also increasing: of the two, activity surprises have the stronger correlation with the US 10y yield. The potential for macro surprises to provide a catalyst for swings in US bond sentiment is increasing.
What happened historically following similar strong Activity Surprises and a similar 3m performance by US 10y bonds, Gold and Crude? According to the Market Scenario Analyser (TRIAL here)
• Positive 3m returns on energy and precious metals
• Positive returns by US and German bonds
• A weak performance by Lumber and STOXX 50.
Bond positioning and sentiment. Specs’ positioning in US 10y bonds is not extended, as it is on US 2y, 5y and 30y bonds but sentiment is stretched and in the past 10 years, a move back below an SBI of 95 has been followed by a fall of 11bps over the next 30 days. A similar picture applies to German bunds. Clearly bond momentum is negative but sentiment indicators are consistent with near-term contrarian support emerging for US and German bonds against a backdrop of stretched pessimism.
As for USD, the BOE trade-weighted US dollar index is also dropping to 12m lows, close to an important technical level. It is not far from stretched pessimism levels – near to levels that see a bounce in the dollar index over the next 1-2 months and a consolidation on a 6-month view. USD momentum and sentiment are very negative, but history suggests that this degree of pessimism may be misplaced for H1.
Strategic Asset Allocation Weekly
Equity Valuations are at risk of macro disappointments by David Bowers.
• As Ian argued last week – HERE- equity valuations are in expensive territory, especially in the US: our composite valuation metrics are overvalued, the % of sectors on over 15x or 20x is elevated and US equities look stretched vs a 2.5% 10y Treasury yield.
• But valuation does not give you timing. Overvalued markets can get, and stay, more overvalued, especially in a world awash with liquidity. The challenge is how long to run with it. High valuations can be sustained by positive macro surprises but if the macro disappoints, then markets are at risk.
What tool can we use to target those macro surprises and the markets’ attitude to them? The ASR Reflation Trade Diffusion Indicator (RTDI - see HERE for the primer). Why?
• The RTDI is a multi-asset composite of ten classic reflation trades. When the RTDI scores +10, all reflation trades have worked over the past 6 months and vice versa. What is clear is that if the RTDI balance remains positive and positive surprises continue, stocks outperform bonds.
• Where to now? The RTDI hit 8 in December. Looking at history, it is more likely to be lower than higher in 6 months and it is plausible - if not inevitable - that it falls into negative territory.
• It is rare for the RTDI to pull back without a period of negative activity surprises. Given expectations have been raised, the risk of disappointment has also increased.
• The RTDI also has a good relationship with the diffusion indicator of the Manufacturing PMI: the RTDI stays positive when there is a broad-based improvement on the PMIs and vice-versa. We believe, however, that is not the level but the rate of change that matters and the risks from current heady PMIs is that they will not last as the EZ business cycle gets challenged by the appreciation of the euro and China growth moderates - as is becoming evident in already soft ASEAN PMIs.
• The most compelling fundamental macroeconomic indicator that suggests the breadth of the global recovery could deteriorate over the next 6 months is global M1 growth: the chart suggests our PMI diffusion indicator could fall significantly by and the RTDI could be in negative territory by mid-year.
Links between the RTDI and Markets from Dorothee.
We use the RTDI to gauge the breadth of the reflationary mindset in markets, to confirm or challenge our views and spot anomalies. Not surprisingly, the RTDI has a strong relationship with the ASR Composite Newsflow indicator, with the Global ERP, with the shifts between Cyclicals vs Defensives. Historically it has had a close relationship with Industrials vs Retail and our Global Sector proxy but in both cases, they have rolled down while the RTDI remains elevated.
Absolute Essentials from David McBain
• Bond pessimism is becoming stretched – see above. Investors should not discount the risk of a near-term bounce in bonds.
• FX Vol has become oversold- EUR/GBP 3M vol has dropped to 12M lows with pre-Brexit 2013/14 vol lows the next target. Current SBI levels are followed historically, by a 16% rise in vol over 65D.
• Equity optimism is stretched on several fronts. The Hang Seng China Enterprises Index SBI last week hit levels that have been followed by an average 3.2% fall over the next 30D on 81% of occasions. Overbought HSCEI also looks stretched vs the KOSPI.
• Other equity markets in stretched optimism include FTSE 100, the S&P 500, while optimism is high on EuroSTOXX and on the Nikkei 225. On sectors, optimism on Materials, Retail and Capital Goods looks stretched; pessimism is extreme on Food & Beverages, Household Products, Real Estate and Utilities.
• USD sentiment is deeply negative. GBP vs USD is close to stretched optimism as specs increased net longs in GBP as well as CAD and AUD: specs are already substantial net EUR long and net short in JPY.
• Oil optimism remains extended and is high on Gold and Copper. Specs’ copper net longs remain substantial.
Best regards, Verity
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