Australia’s housing downturn will lead to increased savings, reduced household spending, and a recession later this year or early in 2020, writes Chris Watling from Longview Economics in a piece published February 12. Rising pressure on commercial bank funding costs will mean higher mortgage rates and ensure continued house price weakness after a long bubble. The big four Australian banks will have to refinance their bonds at significantly higher rates in coming years, Longview says, noting the strong correlation between house prices and consumer confidence. There is even a 20% to 25% chance that Australia’s housing downturn will create a systemic threat. Longview have kindly provided this report in full as a MIFID2 compliant sample. Click here to read. Also click here to view a short interview Watling gave to Livewiremarkets.com web site in Australia recently.
Luke Gromen of Forest for the Trees has written extensively about China’s attempts to de-dollarize, in its efforts to end the hegemony of the US. In this note he highlights the correlation between gold and the CNY, where he shows how for the 2nd straight time since the CNY entered the IMF’s SDR basket in 2016, a run on London gold vaults has served as a “governor” to effectively arrest a decline in CNY/USD as it neared 7.0. Gromen argues that China recognizes that it cannot possibly hope to beat the
US in an economic war using a weapon the US can print (USD), so China has tied the depreciation of its currency v. USD to the USD system’s Achilles Heel: Physical gold. What are the investment implications? Gromen says it suggests a greater likelihood of a “muddle along” scenario for China than many CNY bears might suggest, and point to a strategy of buying goldany time CNY/USD nears 7.0. If a “force majeure” or “reset” is triggered at some point (see note for reference to this definition), it would likely NOT be positive for the USD, but the ensuing bailouts/USD weakness would likely be positive for risk assets broadly and especially for EM’s, led by gold and then commodities.
In INTL FC Stone’s monthly flow report Vince Deluard looks at the question of who are the future buyers of US Treasuries. There’s been a lot of discussion about this, because the major buyers of Treasuries (the Federal Reserve and foreign central banks) are now selling. This is all part of the bigger de-dollarization story, which is now well underway, writes Deluard, and where foreign central banks are hoarding gold and will need to acquire Yuan reserves. Deluard observes that retail investors picked-up the slack in the fourth quarter, converting idle cash into short-term Treasuries, and he would expect that domestic pension funds may buy short-term Treasuries, but that will be at the expense of other assets, such as equities, he adds. But, it’s the long end of the curve where this squeeze will be most intense. Brace for steeper curves, says Deluard.
HY spreads have averaged about 550 bps for the last 25 years, but outside of recession periods, this figure has been more like 450 bps. 450 suggests a TTM default rate of about 3.5%, writes Strategas in their latest HYL update. With spreads now sitting near 400 bps, after a 130 bps rally this year, Strategas now see this level as a logical floor in 2019, and expect this rally to fade as well, absent a fundamental catalyst. Turning to defaults, they finished 2018 below 2.5%, with indications suggesting that early 2019 has seen this figure dip towards 2.0%. Strategas expect a decline in the 1H of 2019, vs 2018 levels, but eventually an uptick to about 3.25% by end of 2019. They say this is more bearish than consensus, but would still support a spread level of only about 425 to 475 bps, or roughly the non-recession average.
Debt levels and the ability to sustain them are not the same thing, Empirical Research argues in a piece published on February 13. Public US companies may have taken on more debt, but they have the quality of cashflow and interest cover ratios needed to justify it. The problem, rather, is in leveraged lending, where global issuance in 2018 was the highest for nearly two decades. Banking exposure to leveraged loans remains moderate and not enough to pose a systemic risk, though a wave of defaults would be likely to exacerbate a downturn, Empirical Research says. Three-quarters of the supply of leveraged loans in the US and Europe is tied to borrowers in cyclical businesses.
ECR takes a much more pessimistic stance in a note published on February 14. Supposedly one-off problems faced by European countries are symptomatic of wider structural problems that are not about to go away, the piece argues. German vehicle manufacturers have become complacent and are now being overtaken. In France, Macron’s reform agenda has been dented by the persistence of the yellow vests, and the president will have to scale down his ambitions. Brexit is tearing apart the fabric of the British economy, with voters free to choose between the deeply divided Conservatives and a Labour leader whose knowledge of Brexit is “deplorable”. Spain faces a political crisis and the likelihood of early elections. Against that gloomy backdrop, the euro is likely to decline against the dollar this year.
Anne Stevenson-Yang has been a long-term China bear, and in this note she argues that a revival of the bond market is pushing up credit in the short term, but it really represents one type of debt being substituted for another. Nor is the bank “recap” likely to help get money to the real economy. Stevenson-Yang argues that the culture at Chinese banks has changed, and, if authorities really want bankers to lend, they must change incentives. Thus far, they have been unwilling to do that. That means that China’s economy will likely continue in decline, until the tide of corporate and financial defaults swells to the point where authorities feel they have no choice but to launch a truly gargantuan stimulus, greater than the ¥6.4 trillion in stimulus monies issued in 2016
Yesterday’s Industrial Production number ( -4.2% YoY ) adds another data point to a European and German data set that displays a significant amount of downward momentum. As other Central banks pick up the dovish rhetoric, the ECB may be forced to to act to address reality and outlook, writes Matthew Guise from Cross Asset Macro. How should rates investors play this anticipated dovishness? Guise sees an opportunity for investors to buy the March Schatz on a Euribor Asset swap basis. That’s because, short dated German paper has cheapened significantly on an outright and asset swap basis over the past few months. This has taken Schatz asset swap to levels that appear to be disconnected versus other related instruments, he says. This plays well with the current narrative, adds Guise. Economic data momentum seems to be to the downside, which will ultimately force the ECB hand, and so in that environment he thinks German yields should be falling not rising, and when they do fall he thinks asset swaps will richen. Currently, on a cross asset basis, equities are rising, and bonds are cheapening, but Schatz is cheapening faster than bunds, so Guise reckons. the Schatz trade on asset swap looks like an attractive risk off position, because when risk turns because they will retain sensitivity to that move. Therefore, on a risk reward basis, it looks like a better trade that short eurostoxx.
Much has been written about the disruption taking place in terrestrial television and the rise of subscription video on demand services (SVoD). The question is how quickly this disruption is taking place? According to a new report from Rethink Technology Research, SVoD uptake is accelerating, and in terms of hours viewing per day, it will shortly draw level with broadcast TV globally by 2023. This report contains a global forecast by region of all SVoD usage to 2023, and shows the stark contrast between the heavily AVoD Asia compared to the SVoD frenzy going on in the US and Europe. Rethink sees 478 million SVoD subscribers today growing to 743 million by 2023, with China having the most SVoD subscribers by 2023, but North America still driving the largest dollar volume. The report highlights how Netflix alone has taken one hour in each subscriber home, each day. That’s a rise over the past two years from 30 minutes. But if Amazon, Hulu and a number of vMVPDs and some specialist live services each take an hour, pretty soon well over half of that advertising viewing time is gone. What does this mean for advertisers? Rethink argue that this will accelerate the drift to internet advertising, from TV.
Managing a Pan European equity portfolio has suddenly got harder, says Simon Goodfellow from Harlyn Research in a report published on February 7th. There have always been differences of opinion between UK and Eurozone investors as to which sectors are most and least attractive, but as Goodfellow sets out in this piece, these differences have become more marked in recent times when compared to the historical fluctuations that have been within a reasonable range, and which were much easier to navigate. For instance, writes Goodfellow, since the introduction of the euro, the sum of the positive and negative differences between his recommended sector weights for the UK and the Eurozone has averaged 33%, with one standard deviation limits at 23% and 43%. For most of 2016 and 2017, the level of divergence was well below average and it got close to its all-time low in December 2016. But since then, it has been moving higher, with a brief reversal in Q3 2018. It is now at a seven-year high, well outside its normal range with a score of 50%, he says. Of course, Brexit is part of the explanation, but he has no way of knowing how much until it is all over. Goodfellow says it would not be wise in these final, nervous weeks before B-Day to take any long-term decisions about how to build a sector-based portfolio in Europe. While Goodfellow admits that this approach is rather theoretical and that investors could for instance, track relative performance to identify the problem in the short term, such a method is virtually useless over the long-term because the investor would still need a way of accounting for portfolio risk and translating relative performance into sector recommendations. Harlyn’s process does this and can be used to compare any two indices at any point in time. Goodfellow says that even if investors don’t like Harlyn’s recommendations, they can take comfort from its conclusion that running equity portfolios in Europe is harder than normal.