Japanese Equities Trading Cheap Relative to US Equities

Quant Insight’s research is built on an analytical framework for understanding asset price movements and valuations. Their research distils signals from its quantitative tool that covers thousands of securities in real time. The secret sauce is that they use algorithms to untangle and isolate which macro variables (typically correlated) that are driving asset prices. Another benefit is their ability to identify which assets will be most sensitive to changes in a particular macro factor. In a recent note they looked at the valuation of the Nikkei, which according to their model, both on an outright basis and in relative to the S&P500, is cheap and on an historical basis is nearing significant levels. So what can an investor do with this? Qi’s analysis points to key macro trigger points, which the Nikkei would be highly sensitive to (That’s because Qi’s R-squared measure is 89% and rising -suggesting macro is a key driver of price action) to macro dynamics. Click below to request more detail on this analysis and what these key macro drivers are for Japanese equities.

‘’Tariff Tantrum”: Higher Risk Premium on Equities, Higher Returns?

In this piece published yesterday Pravit Chintawongvanich from Macro Risk Advisors notes that equity risk premium has increased due to marginally higher risk of negative growth outcome (tariffs & potential trade war) and the continued executive branch unpredictability risk. This higher equity risk premium translates into lower equity prices, so it begs the question, how much more risk premium will the market demand? Chintawongvanich writes that we cannot actually observe the ‘equity risk premium’; we can only observe prices. However, looking at long-dated equity implied volatility can give an idea. If higher long-dated implied volatility reflects higher uncertainty about future prices, then it follows that a higher risk premium is priced into equities. Click below to request trial access to MRA to read the full note.

NAFTA Talks: What Really Happens Behind Closed Doors

On the heels of progress and cautious optimism emerging from the Montreal round of NAFTA renegotiations back in January, renewed tensions and uncertainty have entered the fray as the U.S., Canada and Mexico began the 7th round of re-negotiations in Mexico City early last week. To get some inside perspective, Hedgeye hosted a call last week with John Murphy – one of Washington’s top trade advisors – which covered a number of issues, scenarios and timelines. One key problem with the negotiations says Murphy, is that Canada and Mexico are being asked to give up benefits they have enjoyed for 20 years for nothing in exchange. Among other things discussed on the call are: 1) A snapshot of some of the main U.S. industries with the most at stake in the NAFTA modernization negotiations, 2) The major disagreements at this point in the negotiations. 3) Does The Trump Administration understand the severe damage it would cause to a number of corporations/states by walking away from NAFTA? 4) What do the Administration’s NAFTA proposals tell us about how it sees the world and what it is really trying to accomplish? 5) What businesses and industries have already been impacted negatively by these negotiations and how they may be affected going ahead and 6) Do elections in Mexico make a near-term deal more likely, or will we see this drag on into the end of the year? Click below to request access to the recording, Hedgeye will grant access on a case-by-case basis.

Underweighting Brazil: Pre-election Jitters

Credit Suisse’s equity strategy team came out with a fairly non-consensus call last week when they published a report in which they downgraded Brazilian equities to a 15% underweight stance in an emerging market portfolio from benchmark previously. It’s a high conviction call with CS citing as many as 10 factors. One of these is that CS now see the disinflation trade and bond yield/cost of equity compression as concluding. The Brazilian disinflation trade, say CS, was one of the most spectacular seen in emerging markets for a decade. CS note that downward revisions in the slope of the SELIC futures curve have slowed markedly versus the pace of the last 12 months, and their Brazil economists maintain a view that the current SELIC rate of 6.75% represents the trough in this monetary policy cycle and are anticipating the first central bank tightening of 25bps on October 31 this year followed by a further 50bps on December 12 to finish 2018 at 7.50%. CS clients can view the full Credit Suisse Plus.

Hedging Equity Risk in Bonds: Where’s the Sweet Spot?

The Capital Markets Outlook Group (CMOG) is a Boston-based research firm who are leading indicator specialists oriented to turning points. They tell us they have have identified the start and end of all economic stock and bond market cycles since 1992. In this note they write that from a cyclical perspective, the primary vulnerability for U.S. and global markets is the economic outlook. The economy is more vulnerable than the Fed and consensus believe, says Connie Everson, the founder of CMOG and author of this report. So this begs the question, how does an asset manager hedge that effectively, when recent experience shows that US Treasuries have been an ineffective hedge for equity risk, and where yields remain vulnerable to the potential rebalancing of risk parity portfolios? CMOG propose investors hedge via the short end of the curve instead, using a leveraged position. The short-end of the yield curve is the ultimate contrarian play, and potentially effective in a wider range of outcomes, if the recent short-term volatility turns into something more negative on a longer-term basis, says Everson. It also has a favorable carry, since short-term rates are lower than 2 and 5-year treasury yields. Click below to request trial access to read this full note.

FedWatch: Reason for Optimism, Powell May Cap UST Yields

A few weeks into Powell’s tenure there are already signs of changes in the way things are being done, writes Bretton Woods Research (BWR) citing recent remarks from Fed officials such as James Bullard, Philadelphia Fed President Harker and Minneapolis Fed President Kashkari, BWR say that the big takeaway is that independent voices are emerging at the FOMC for Powell to correct course with rate policy without being perceived as totally beholden to Trump’s desire for a “low interest rate” type of central banker. Yet, Bretton Woods argue that inflation fears are overstated. Part of this stems from the Fed’s inability to distinguish between “good” and “bad” price increases. Hawks suggests we are seeing ”bad” price rises. Bretton’s own analysis suggests this is not the case. Neither do they concur with the notion that Treasury yields are rising on the back of Trump’s budget deal. Bottom line, say Bretton Woods, assuming Powell was selected by Trump to prevent Fed policy from slowing the economy, tomorrow should provide something of a firebreak with rising Treasury yields. Click below to request trial access to BWR’s research to access the full report here.

FX: Systamatic Trading Strategies based off Bloomberg News Stories

Saeed Amen is the founder of Cuemacro. Over the past decade he has developed systematic trading strategies at major investment banks including Lehman Brothers and Nomura. In this piece he introduces the model for his systamatic trading strategy based on indicators using Bloomberg News stories. He outlines general steps needed to convert unstructured text data into structured data, which can then be aggregated into sentiment indicators for currencies. In particular, he notes how using a structured dataset such as Bloomberg News can help reduce the complexity of this task. He shows how a news-based G10 FX basket had risk-adjusted returns of 0.6 during Cuemacro’s sample, considerably outperforming a trend-following strategy (which showed losses) over the same period. He also showed that there was little correlation with a trend-following strategy, suggesting that a news-based strategy could offer good risk-adjusted returns. Click below to request access to this full note from Cuemacro directly.

Asset Allocation: More Equity Upside, Not so for Credit

JPMorgan’s Cross-Asset Strategy team believes the fundamentals of the equity market uptrend are intact for the 1-2 months of their portfolio horizon, and so they revert to their previous very bullish equity stance vs bonds in their main asset allocation trade. They increase their overweight equities recommendation back to +15% above benchmark from +12% last month, funded with cash which stays at -5% below benchmark. They introduce a big credit underweight (corporate bonds move from flat to -10% below benchmark while neutralizing a government bond underweight from -7 to flat) to hedge the bullish equity stance rather than as a standalone view on credit. JPM clients can view the full note on Morgan Markets, under the Global Asset Allocation section on the research portal. Click below.

Will Fundamentals Save High-Yield?

While the fundamentals for High-Yield credit still look quite positive, corrections in prices and spreads can create their own momentum, especially due to the speed of redemptions, write CreditSights in a recent report. This can happen despite an improving fundamental backdrop, and has happened before, notably in 2011, the report says. In a seperate report, Credit Sights looks at the recent performance of sector credit, mainly in the IG market, in which they include a comprehensive list of which sectors they think will outperform and which will underperform. They like the overall energy sector due to the improving oil price. Within that, they recommend credits from pipelines (including MLPs), while they think oil field service credits and E&P credits will perform in line with the market. Click below to request trial access to the reports: US HY: Equity Corrections HY Reactions and US IG Sector Recs: Strong Start in January.

AMLO’s Electoral Gifts Spell Danger For Mexican Assets

Andrés Manuel López Obrador (aka AMLO) is making all the running in upcoming Mexican elections this summer with his campaign platform known as: “Basic Guidelines for the  Alternative National Project 2018-24.” It’s an extensive platform of pledges that leaves no stone unturned, from free education up to university level, to paying wages to young people that neither study nor work, to building refineries, high-speed trains and a wide array of infrastructure projects, as well as protecting the environment, writes Rafael Elias from Exotix. As such, his proposals are unrealistic and unachievable, but that does not mean to say they will not be popular, Elias adds. Hence his lead in the polls. Put the lack of detail does not fill Exotix with much confidence, with so many contradictions riddled throughout AMLO’s plan, which Elias diligently dissects is this report. Given the curren polling Elias fears for Mexican assets. AMLO could prompt a shift away from Mexican assets and Elias is of the view that once investors have the opportunity to go through his platform (it was first drafted back in 2016, but over the intervening period Elias thinks that if anything it has become more radical), there could be a negative shift in sentiment away from investing in Mexican assets and the markets are likely to move in tandem with the polls if they continue to show AMLO leading the presidential election. Click below to request trial access to Exotix Research to read the full piece.