Sean Darby cites some previous Jefferies Research: ‘For an security to be truly ‘contrary’, it mustn’t be simply cheap but the asset class must be so loathed that investors who might recommend it would be subject to ridicule, rejection or actual banishment from the investment process altogether. Sentiment towards the security is so dire because investors have lost money (and peer group approval) trying to time the bottom of the market.’ Commodities, soft commodities in particular, are therefore fertile ground, excuse the pun. Darby highlights that an emerging El Niño, a CRB food price index that is bouncing off five-year lows and total grain net long speculative positions at more than nine-year lows, which would indicate that a long position in foodstuffs might be warranted. While lower energy prices have helped tame inflation concerns over the past year, investors have overlooked the fact that low food prices have also provided a downdraft to CPI. Bond investors beware, he writes. He cites the latest predictions by the USNOAA and the Australian Bureau of Meteorology which suggest that earlier forecasts of a ‘mild El Niño’ are likely to be far from the mark and that it will be much worse than expected. There is some interesting academic analysis in this report about what standard deviation surprises imply for real commodity price inflation too. Food for thought.
Rareview Macro has two definitions for the widely touted phrase ‘’pain trade.’’ One applies to the true meaning; lower prices, because that leads to investors actually losing money. The second applies to sales people on Wall Street – where they use the jargon to make them sound like a “cool kid” who is “in-the-know” for their hedge fund clients – who do nothing more than try to capture 60% of any market move up or down so they can justify their existence for a bit longer. So with that the ‘’cool kids’’ might be looking at yesterday’s ‘’Shenzhen-style’’ rally in European equities as that very ‘’pain trade.’’ They would be off the mark, says Neil Azous from Rareview, who argues real investors are much more concerned about the breakdown in the correlation of the European carry trade relative to the US dollar, and in this free-flowing piece he explains why. Firstly he provides a great chat that plots the European carry trade (DAX + 10-yr Bund) vs. US Dollar (DXY), which shows us the European carry trade, after some dramatic outperformance since the beginning of the year, how it turned in mid-April, the same day in fact that the USD began to falter. The point Rareview is making here is that while the immediate reaction to positive news pf a potential Greek deal is for stocks to move higher on the fear that investors don’t own enough risk, the real investors are waiting and watching for higher Bund yields, which will set off a big break higher in eurodollar, which effectively builds in a tightening of financial conditions. Now that would be the real pain trade, and very bearish for equities, he concludes. The ‘’cool kids’’ have a lot to learn.
We didn’t see much research (none actually) on the Congressional Budget Office’s (CBO) release last week of its annual long-term budget outlook, until we saw this piece from Wells Fargo’s John Silva entitled: ‘’Capitol Hill Update: Long-Term Fiscal Outlook Remains Bleak.’’ We thought it worth mentioning, even if this may not be on many peoples radars, because there is such a focus on fiscal responsibility in countries such as the UK, which is about to enter a new phase of austerity, and then of course Greece which is potentially headed for many many years of it to rectify its past profligacy, not to mention the European periphery at large. If you missed it, the latest estimates indicate that over the next 10 years, the debt-to-GDP ratio will rise to 78 percent of GDP and grow even higher, reaching 103 percent by 2040. Silva says that one of the little talked about parts of the CBO report was the section that discusses the economic feedback effects of federal fiscal policy, which they predict that by 2040 the debt-to-GDP ratio could be 107% rather than 103%. Wells Fargo say the nation’s fiscal policy remains on an unsustainable path, while congress doesn’t appear to have the will to address it, focusing instead on short-term patches.
We’ve touched on the theme of UK labour markets and whether the BoE needs to make a reassessment of its projected rate path in recent newsletters, and we do so again today after comments yesterday from the BOE’s Deputy Governor Cunliffe who noted that the U.K. was getting close to the end of spare labour capacity, and he added that they saw an “alignment of factors that suggest that productivity growth will start to move in right direction.” This was tempered by what they saw as a “more modest pickup” rather than “sustained burst of high productivity growth.” Deutsche Bank’s Oliver Harvey put out this piece which builds the argument that recent strong wage data and CPI numbers – that suggest headline inflation has troughed – mean that the pricing of the first rate hike (as futures markets suggest) in May 2016 will be far too late for the BoE to have responded. There are already rumblings from the last MPC meeting that some are beginning to acknowledge those risks, and that certain members of the committee will start voting for hikes again. Harvey also shows us a great chart on the correlation between the RICS price balance (rising) and GBP, and well as a chart of foreign inflows (also rising). So despite GBP TWI being back at cycle highs, Harvey reckons cable isn’t finished yet. We don’t have the link to the actual piece, but if you’re a DB client, in the FX blog section of the DB research Website, click on ‘’Two Sterling Snippets.’’
Since the end of World War II the average economic cycle has lasted 5-years, which means, statistically speaking, the global economy is due for another recession, writes Dario Perkins from Lombard Street Research. That was the concern after a poor 1Q for the US economy, but LSR argue that the current macro imbalances, a stronger dollar and lower oil prices, are relatively mild compared to the last cycle and are unlikely to tip the economy into recession. However, if they are wrong and a recession does eventuate, it would most likely be a mild one because these current macro imbalances are less extreme. Moreover, a recession is often worse in magnitude when it coincides with a downturn in the credit cycle. Clearly this cycle has been about deleveraging, not credit expansion, another reason not to be panicking. This is a quality piece of research because it contextualises the nature of the current economic cycle and why it differs from the previous cycle as well as providing some deeper historical context. It is easy to forget that the economic cycles of the 1990s and 2000s were exceedingly long in that context. Remember Gordon Brown’s great pronouncement? There are some terrific charts that help explain why a lower growth path (The new normal) could mean a higher frequency of recessions, and how different types of asset bubbles have a greater impact on reduced output (equity versus property). At the same time, Perkins warns of the limited policy options central banks have these days to combat a recession, and they discuss what some of these options might be.
Commodities have been something of a ‘’hero to zero’’ asset class, and yet despite the cheap valuation of commodities to more mainstream asset classes, such as equities and bonds, physical fundamentals in many commodities are still relatively weak, writes Deutsche Bank’s commodities Strategy team, led by Michael Lewis. The worst of the group this quarter has been industrial metals, but fortunes for some of these metals may be about to change, in particular Zinc, DB writes in its Commodities Weekly. This is down to a range of factors such as deficits, and mine closures. Lots of detail here on the physical aspects of this market to consider.
Even though “Grexit” has now entered the vocabulary of official policymakers, financial markets have not panicked. It could well be that the majority of investors consider that Greece, with its Balkan-style governance and administration of Marxists and anarchists, really is an aberration that deserves a special treatment, writes Francios Chauchat from GavekalDragonomics. This report emphasises the widening gaps between Greece and other perceived, or otherwise, vulnerable peripheral countries such as, Portugal and Spain at a political and economic level. The report reviews the events of the Cyprus bail in. They write that the Cypriot precedent demonstrates that in the absence of a direct impact, the implications of negative psychological shocks are unpredictable. Nasty domino effects may or may not result, and forecasting them is a highly speculative exercise. The report closes out with some ideas on hedging their overweight European equity position via the Bund market.
Last week BAML’s latest Fund Managers Survey showed that cash positions were at a six-year high, hedging activity was the most prevalent since the GFC, and a majority expected either Grexit or a default. BAML reckon that this cautiousness is reflected in the fact that European equities are little changed in the past week despite the deterioration in negotiations between the European and Greek negotiators. So what are the likely scenarios for equity market performance in the wake of a default, or a positive outcome? BAML suggest there perhaps a higher delta on the top side, and the explain in more detail in this piece. How to play this? Merrill suggest optionality is probably the best strategy, and the offer suggestions on structures to conclude the report.
UBS have done doing interesting comparison work on the similarities between the UK and US labour markets, with many if the indicators heading in the same direction and more or less at the same pace. The starkest thing to note, writes UBS’s David Tinsley, is that there is reasonable evidence that wage growth in both the US and UK is picking up. Yet, the market’s view on interest rate hikes is more equivocal about the timing of the first rate hike by the Bank of England, than it is about the Fed, say UBS. Why so? Read the report.
We highlighted last week the positive NAHB builder sentiment index for June, which seems under affected by the recent rise in US Treasury yields. So we thought we would point you to this piece by John Burns, of John Burns Real Estate Consulting. According to Maudlin Economics, Burns knows the industry better than anyone, and when he makes a call, he is typically early, and right. That is, US homebuilders are getting ready for a new construction boom, and it appears counterintuitive to most of the research on this subject.