Market ignoring possibility that first Fed cut could be 50 bps

At the turn the year, when the consensus was that the Fed was merely in pause mode, Rareview Macro were forecasting that the Fed would cut rates in 2019, and they have continued to beat that drum all year. In a note last week, they argued that now the probability for a 25 bps September cut has reached about 70%, the highest of the year, markets may be underestimating the potential for an even larger cut. The issue is that the market is only pricing in a “probable” 25 bps cut, but “probably not” for a 50 bps cut being the first move. Yet it is uncommon for the Fed to cut in 25 bps increments, especially when they are “surprise” cuts, Rareview wrote in the note. When the Fed’s first cut is realized, the US fixed income curve will steepen like a freight train, the piece argues, meaning an ideal entry point exists

No equities bounce as long as semi conductors continue to fall

If you thought semi conductor stocks had fully re-priced, think again, writes Paul Krake from View from the Peak. He points out that in the rational world, a company that loses its biggest customer in its fastest growing market, would expect to be de-rated. That’s not been the case for US listed semi stocks. In fact, only one company in the Philadelphia Semi-Conductor Index, the Sox, is down on the year. While Krake appreciates that not every company on this list sold to Huawei, the fact that Intel is the only company with a negative return and a small one at that (3%), shows just how far to go we have in the adjustment cycle, he says. Sure, many global semi-conductor companies have sold off a lot from their highs but when those peaks were, in many cases, predicated on the earnings driven by Huawei stocking chips ahead of President Trump’s Executive Order, which then  plunged a stake through the heart of Huawei’s global ambitions, those highs were artificial, Krake writes. Huawei demand is lost demand and those optimists who believe that Huawei is a bargaining chip in a broader trade negotiation, miss the breadth of the structural re-calibration in the US-China relationship. Huawei will not be permitted to engage in the global 5G rollout, nor will US companies play a part in any of its other business lines and semi-conductor companies have lost this revenue.

European equities; still nailed on a perch

For investors the European Parliamentary elections leave them once again ‘stuck in the middle’ with no prospect of the creation of a functioning single currency zone or of returning to a collaboration of sovereign states within a common market, writes Russell Napier in the latest edition of The Solid Ground. Indeed, Napier argues that in many ways things have got even more difficult for those trying to create a single currency with supporting fiscal and political infrastructure. Now,  new schisms have opened in European politics – particularly, with the rise of the Greens. The ability of EU politicians to deliver anything is even more impaired than before these elections, at a time when the Euro and the Eurozone economy needs something to be delivered quickly. For Napier, this establishes the ground for some pretty bad outcomes. For the full note, all you need to do is register on the ERI-C platform here, to get free access to Napier’s regular newsletters.

Luxury sector set to fall on hard times

It is conceivable that some European industries may benefit from the trans-Pacific economic cold war, picking up business lost to their US and Chinese competitors as a result of the worsening tensions, write Gavekal. They say that aerospace and telecommunications equipment are too such sectors that spring to mind. But one sector that will not benefit is the European equity investor’s favorite: luxury goods. After a decade of consistent outperformance, European luxury goods companies now face tougher times ahead. The luxury sector has always been a leveraged play on Chinese consumption growth which has seen the MSCI EMU consumer durables and apparel sub-index comprising luxury goods companies become Europe’s best-performing sub-sector over the last 10 years. With a total return in US dollar terms of 526%, or almost 20% annualized, it has even outperformed the top two S&P 500 sectors: tech and consumer discretionary. Few would argue that there doesn’t appear to be much upside left in that trade now.

The membership economy; creating deeper ties in e-commerce

Barbara Gray, from the Pennock Idea Hub, brings an engaging and unique perspective at the point where technology and commerce converge and how this is being driven by the changing demands and tastes of consumers. She has written two books that explore and analyse Amazon’s business model. In her most recent research Gray shines a light on how more and more companies are embracing the membership subscription model as a means to deepen the emotional connection with their customers, increase loyalty and increase switching costs. The piece cites numerous examples of such a model, such as Uber which is looking at launching an Uber Eats Pass which it could potentially bundle together with its Ride Pass ridesharing discount subscription and Urban Outfitters is copying Rent the Runway and launching an apparel rental monthly subscription service.

Semiconductors as proxy for global durable goods demand

The semiconductor ecosystem provides clear and leading supply/demand signals for the global economy, says SouthBay Research, a firm which delivers actionable data and insight on labor and capital goods markets, the core elements of business and economic activity. SouthBay says the clarity of the signals comes from the oligopolistic nature of the sector, which lends itself to fast and easy communication up and down the semiconductor supply chain, and where its tight manufacturing process means lead times are significantly shorter than other manufacturing industries. Simply put, today’s equipment orders lead end-user demand by ~2 quarters.  And they lead the overall manufacturing sector because semiconductors are one of the earliest components in the supply chain, according to SouthBay. So investors should pay be paying a lot more attention to this, than some of the more traditional measures.  In their latest research, SouthBay says their data points to a bottom in the semi market in 4Q 2019, which points to a bottom in global manufacturing by 1Q 2020.

Will China dump Its dollars in trade retaliation? Or will USD strength continue?

There are growing concerns that an escalation in the US-China tariff spat will trigger retaliation from China in the form of forced sales of US Treasury debt, thereby triggering a lower US dollar. This not only seems impractical and so unlikely, but fundamentals, namely a global shortage of ‘safe assets’, the tight US Fed and rebounding US private sector cash generation, all should underpin a moderately strongly US unit, says Cross Border Capital. EM currencies are exposed to this threat, CBC adds, but a significant improvement in EM currency risk since mid-2018 suggests that any sell-off will be limited.

Manufacturing PMIs versus local surveys

Last week’s slump in the manufacturing PMIs raised market concerns of a further slowdown in US economic activity. Phil Suttle from Suttle Economics, in a note on Thursday, reckons that this should be countered by a slightly more optimistic outlook from the regional Fed surveys. He says it is always interesting to compare and contrast the Markit-PMI measures with more established/local surveys. His view is that the Markit measures capture more globally focused/connected firms (e.g. probably those more affected by a trade war) than the local surveys. Maybe the early May US surveys illustrate this, he says, as the slide in the US flash PMI is at variance with the pick-ups recorded last week by the NY and Philly Fed surveys. In another note on Friday, Suttle added that these divergences between manufacturing surveys add to the uncertainty. The flash PMI was far weaker than the average of surveys conducted by regional Federal Reserve banks (See this chart) The latter tend to correspond better to the ISM, so his reckoning would be that the ISM for May (next Monday) will look better than the flash PMI.

Low rates and currency volatility is a favourable sign for credit

Low cross-asset volatility has been good for high yield and credit outperformance, whereas high volatility has been bad, Ned Davis argues on May 23. The firm introduces its Cross-Asset Volatility Composite aimed at credit, carry, and leveraged-oriented traders. When the implied volatility of the options on Treasury bond futures dropped below one standard deviation from the mean, high yield outperformed Treasuries by 6% a year, the research finds. Currently, rates and currency volatility remain low, leading to a generally favourable environment for credit, the piece argues.

Europe has voted! Five key takeaways

Deutsche Bank say that the biggest surprise to come out of the European elections was perhaps the increased voter participation (largest in 25-years), which should be interpreted as as an indicator that Europe managed to mobilise its citizens after all, however, differences in turnout across the EU have been substantial, with particularly low participation rates among Eastern members and the UK, they note. In terms of the actual result, while there was no ”landslide” for the populists, there has been enough of a shift to upset the balance of power in the European Parliament. They highlight their 5-key takeaways from the election result. 1) The “grand coalition” of conservatives (EPP) and social democrats (S&D) has lost its traditional absolute majority in the next European Parliament. Together with the liberals and greens, pro-European groups will still hold a clear majority of two-thirds of the seats in the next EP. But policymaking for them will likely become more complex and require broader cross-party agreements and discipline. 2) With above 30% of seats, Eurosceptic and anti-establishment groups and (nonaligned) parties are estimated to have increased their weight in EU policy making over next five years. DB remain doubtful that these groups will manage to permanently overcome their (many) differences and use their leverage to promote their own coherent policy agenda. 3) Balance in the next EP will also depend on group formation over the next few weeks. Big questions remain, such as the planned joint group between the liberal ALDE and French President Macron’s Renaissance as well as the composition of Italian Deputy PM Matteo Salvini’s new far-right Eurosceptic alliance and the efforts of Five Star Movement to create a new (also Eurosceptic) anti-establishment group, potentially to be joined by Nigel Farage’s Brexit Party from the UK. 4) The increased fragmentation on the next EP will make the appointment of the next Commission President a potentially lengthy procedure. 5) A lengthy standoff between Council and Parliament as well as intense negotiations on the top jobs between leaders could push the appointment of the next Commission beyond October, and could thus impact market’s confidence and trust in the single currency.