It’s different this time in China, so don’t bet on property

China’s current round of stimulus is qualitatively different from that of 2015-16, and should not be measured against the previous cycle, Rhodium argues on February 7. Current policy support is stronger than the last cycle in some areas, such as fiscal policy, but more targeted, to limit debt growth. Policies toward the property sector and shadow banking are far more restrictive than in 2016, and are not about to change. While industrial output and credit growth are stabilizing, provincial credit conditions are highly uneven, the property sector remains a key headwind, and the financial system cannot resume its previous pace of expansion. The limits on policy support for the property sector and informal financing will curb the scale of the economic rebound, leaving it shallower and shorter in duration than in 2015-2016. Don’t bet on property in this context.

The rising tide of populism and what it means for equity returns

MI2 Partners focus on the rising tide of populism. Where has it come from, does it have legs, and if so, what are the macroeconomic implications? They ask whether this rise is merely a coincidence after a thirty plus year run of deregulation and unbridled laissez-faire economic policy. In tackling these questions, this piece first argues that since the 1980s, the roots of the equity bull market have been based upon a combination of factors, some political and some structural, which are now in the process of reversing. This shift will create serious headwinds to equities and poses a significant challenge to the dominance of passive strategies.

US earnings growth is still the only show in town

US earnings are stronger than those in the rest of the world, outpacing those of the international EAFE index which groups 21 major MSCI indices from Europe, Asia, Australia and the Middle East, Credit Suisse says on February 5. EAFE earnings are down 7.2% in the fourth quarter, compared with US growth of 11.7%. Japanese firms are missing their earnings forecasts by 7.2%, while European companies are falling behind by 8.0%. EAFE earnings growth lags the US in 9 out of 11 sectors, and is only growing faster in staples and utilities. While EAFE stocks are doing comparatively better in terms of revenue surprises, US companies are delivering more positive surprises at the bottom line. The overall picture remains the same even when US tax benefits are excluded, Credit Suisse says.

S&P500 can’t escape growing global headwinds

The US economy may be able to decouple from the global economy, but the S&P 500 cannot do the same, Yardeni argues on February 5. The global economy weakened significantly in late 2018, and is showing no signs of improving. Since almost half of S&P 500 revenues comes from abroad, global weakness will weigh on the 2019 growth rates of both S&P 500 revenues and earnings. The strong dollar is also a negative for both. Analysts, therefore, are likely to continue to cut their first-quarter forecasts. Yardeni is already predicting much slower revenues per share growth this year at 4.0%, compared with 10.7% through to the end of the third quarter of 2018. The analysts are considering lowering this given the weakening of global economic indicators.

Beijing may be pulling on levers that aren’t connected to anything

Western analysts are too optimistic in believing that Beijing has full control of all of the state’s financial and fiscal levers, and that the state is willing or able to support all credit in China, GlobalSource argues on February 1. The reality is that current Chinese stimulus measures are likely to be inadequate due to restrictions imposed on shadow lending. This is likely to mean a potential property market downtrend, defaults of property developer bonds, and a continued increase in SME defaults. The potential for bond defaults, GlobalSource suggests, has not been priced in to global Chinese credit.

Bearish signals in credit

Top Down Charts produces a weekly publication full of insightful charts and their own read of cross asset markets. Their recent analysis has made the argument that policy makers ought to take at least a temporary policy u-turn. In a note published on Feb 8th, they highlight some key indicators and charts in the credit markets that reinforce this. Here they show how global (DM focused) lending standards have tightened up into Q1. The fact that this also lines up with higher global monetary policy rates is also an issue, in that previous growth tailwinds have now fully turned. Their global credit spreads indicator also shows how spreads have widened out from extreme lows, which again represents tightening of financial/credit conditions. TDC also show how another area where the lending surveys are flagging/reflecting deteriorating conditions is with US High Yield credit. The move in a specific subset of the Fed senior loan officer survey: changing in spread vs cost of funding (in other words, degree to which banks are attempting to price in a credit risk premium into loan rates) has decisively woken up in the Q1 survey. In another section, TDC suggest that this will mean bond yields will drift lower (but valuations are expensive and sentiment is becoming stretched back to the bullish side).

Twenty disturbing charts that question the risk rally

In their weekly Investment Weekly,  Absolute Strategy Research show 20 charts which suggest that the macro environment is still highly challenging. In their words ”these are uncomfortable charts that challenge the Conventional Wisdom.” The Powell pivot has pleased markets, a US – China trade deal may be in the offing and the hope is that the rally in risk assets can continue for the next 3 months. ASR are wary of that view and they for readers of this report it maybe tempting to dismiss these charts, or to attribute them to idiosyncratic developments, or indeed, some of them may be too pessimistic, but in bringing these charts from a variety of sources, they argue that it is unlikely that they will all fail. The broad conclusion here is that the macro stress of Q4 could still spill over into the first quarter of this year. ASR note that December’s dreadful German New Orders are exactly the kind of shock they had feared.

Volatility Watch: When silence is nerves not calm

This time last year we got the start of the signal that lower and lower volatility wouldn’t be with us forever, with the biggest one day percentage move in the VIX and the subsequent immolation of the linked inverse ETN, the XIV, says Helen Thomas from Blonde Money. But, as she highlights in this note, the short volatility trade has been resurgent to the degree that the VVIX, which measures the change in the VIX (that is, the volatility of volatility) is at its lowest since July 2017. Thomas highlights a huge and lucrative market in trading derivatives on the S&P500 that is driving down the price of vol as market makers hedge their positions. This is all very interesting when you think about the plethora of event risks: earnings season in the US, a topsy-turvy Fed, Chinese growth disappearing, the UK weeks away from an unknown relationship with its largest trading partner, Germany in recession, and Italy inexorably and laughably stagnating into an inability to meet its EU deficit targets, writes Thomas. We have been here before of course. This was the story of 2017. The BTFD force is strong. But it’s supposed to be turning now that global QE is shrinking rather than rising, but it isn’t. Indeed, Thomas argues that while central banks are stepping back, the market is taking their place. It is mimicking the QE impulse. Last year should have shattered this self perpetuating low vol world, but memories are short and never more so than in risk management models. The 2017 paradigm still, just about, works. Until it doesn’t, says Thomas. And this is where the French bank losses (See Viola Risk Advisors below) present an inherent risk to the market, Thomas argues. While risk management systems will have been tightened up, this unfortunately just tightens the noose around the market’s neck. If banks can’t afford any more losses, they need to hedge more aggressively, but this exacerbates the breaking point too. If the market turns, they will have to cut their positions more aggressively.

Surprising investor complacency around the new ‘Cold War’

In recent weeks, markets and investors have been (rightfully) focused on the Fed’s shift to a more dovish tone, with some concluding that the risks presenting in fourth quarter 2018 have been successfully defeated, writes Luke Gromen of Forest for the Trees. However, while The Fed’s shift is undoubtedly bullish for risk assets, all else equal, geopolitical developments suggest all things may not be equal as the US National Security establishment appears to have decided to simultaneously de-globalize world markets AND accelerate a new Cold War with China. He produces a series of recent articles and announcements as evidence that this occurring. The bottom line, according to Gromen is that if the US national security establishment is indeed rushing headlong into both rapid de-globalization AND a new Cold War, it is likely going to take a lot more than a Fed pause to offset the chaos that could result. Gromen’s sense is that investor awareness about both the potential for de-globalization and a new Cold War is pretty high; but investors simply feel that it is un-investable until it is inevitable, so they are simply not able to factor it into their investment process yet. However, this implies that geopolitics are critically important to watch in coming weeks and months, adds Gromen, because it implies that if things go the way they appear to possibly be going, investors may at some un-foreknowable tipping point go from complacency to panic in remarkably short order.

French Banking: Massive Short Vol Losses; Short French Big Banks – BNP, SG

Viola Risk Advisors are specialists in analysing global financials, in both equity and credit. They have developed some unique metrics in partnership with the NYU Volatility Lab to monitor global systemic risk. This week they published a note providing a deeper look at French banks, following a flurry of losses linked to derivatives/structured products, that have been announced from the likes of Natixis, BNP and SG. Homing in on BNP, Viola say that while on-the-surface BNP’s bond spreads may now seem cheap to similar-risk level notes for global US banks and other big European banks, they still believe French bank equity derivatives loss saga will worsen and spook the debt and equity markets with more downside risk. This note ,published earlier in the week, argues that while BNP has good capital levels, the equity derivatives fiasco should worry more stakeholders as earnings were due to be announced. Today as it happens, and where the bank has announced plans to restructure its operations, and where ROE and revenue growth targets have been cut. There are shades of 2007/08 here again perhaps. Viola add that “Old-Age” fundamental ratios like credit quality/capital adequacy levels and liquidity risk do not capture this equity derivatives volatility risk and knock-on effects to the structured notes markets where BNP relies on it for funding and global wealth management offerings. Click below to enquire directly with Viola about their latest systemic readings on French banks. There’s been a substantial shift of late.