The potential of Spanish government bonds identified by Unicredit is also picked up on by Oxford Economics on January 31. The analysis from Oxford goes further and argues that Spanish ‘Bonos’ have in fact decoupled from Italian BTPs and are now behaving more like OATs and Bunds. As such, they are strongly preferred to corporate credit, which is seen as exposed to a much wider range of risks. Corporates face limited profitability which will also hamper European equities, as well as geopolitical dangers. A large portion of corporate credit is rated on the cusp of investment grade, so a downgrade shock could bring about significant turmoil, and trade wars will hurt corporates more than sovereigns.
Government debt yields in EMU countries have already become less correlated with the end of ECB quantitative easing and this trend is set to continue, UniCredit argues on January 30. Investors are focusing increasingly on the specific fundamentals of government issuers, and UniCredit has produced a scorecard to try to identify promising trades. Intriguingly, Spain scores better than France, suggesting a possible long opening. This supposes, UniCredit argues, that Italian BTPs do not come under pressure again. UniCredit also warns that French debt is still favoured by very conservative investors, so a better play may be going long on Spanish versus Belgian debt. Investors can also consider going long Ireland versus Belgium at five years, or shorting Finland versus Austria at the 10- or 15-year tenor.
Sterling and UK equities are both very undervalued and euro denominated assets should be avoided, Russell Napier, author of The Solid Ground, argues on January 31. The markets will reward sterling and punish the euro area, with the risk of Irish bankruptcy a significant and under-appreciated danger. Napier acknowledges himself that his own preference for avoiding “compulsory European centralisation” may affect his analysis, and that he is much more interested in “representative democracy” than in finance. The markets, though, deal in what is, not in the diverse things that people may wish or imagine to be so. For access to the full note, you can register on the ERIC research platform, where the fortnightly The Solid Ground is available free-to-air.
The idea of Modern Monetary Theory is getting more and more air play these days, and gaining the attention of politicians, see this excellent blog post from the Macro Tourist. Perhaps populist politicians should be careful what they wish for, say Capital Economics, in a skeptical piece they put out last week. Running a government deficit (which the theory implies) when the economy has no spare capacity will feed inflation, and the idea from MMT proponents that governments would responsibly and reliably raise taxes to arrest demand when inflation threatens is unrealistic in the extreme. Even if they did, the private sector would be crowded out in a high tax, high spend economy. Governments that have relied on printing money have found it hard to kick the habit, Capital Economics says. That’s why central banks were created in the first place. Hyperinflation would be a danger if control over inflation was handed back to the politicians.
The Fed’s statement that it will be willing if necessary use its balance sheet to achieve an accommodative monetary policy is promising for emerging markets, Vanda argues on January 30, the day of the Fed’s release. The unspoken aim to get US equity prices up and the dollar down is a direct driver of emerging market equity inflows, the note argues. The environment is ideal for emerging market equities, and foreign investors have only just begun rebuilding their positions. A cautionary note for US equities is the rate of change in the US Treasury 10-year yield, Vanda says. An increase in the yield of a standard deviation or more (+30 bps) within a six-week period is shown as being bad for stocks, but in their CIO note, Vanda says that this isn’t in danger, given the relatively moderate rise in yields since last week. Indeed, investor positioning, particularly CTAs and hedge funds remains short, so its very much the pain trade currently.
Despite the January rally in global equities, the cyclical downtrend remains intact and may soon reassert itself, says Tim Hayes from Ned Davis Research. He continues to view the rally as a selling opportunity. Hayes argues that the improvement of indicators based on 50-day moving averages has not been confirmed by indicators based on 200-day smoothings. This is an indication that the rally has been driven by sentiment rather than an improving outlook for the fundamentals that underpin cyclical trends. Therefore, to have confidence that the rally is the start of a new cyclical bull market, you would need to see confirmation from those indicators. Otherwise one can expect a test of the December lows, in which case one would watch NDR’s new Bottom Watch report for evidence of a bottoming process. Subsequent confirmation from the long-term indicators would then indicate that a new bull market had gotten started
The Chinese slowdown could have serious negative consequences for world growth if it intensifies, says Adam Slater, lead economist at Oxford Economics. OE’s model simulations suggest that world growth could slow to a decade low of 2.3% in 2019 if Chinese growth slows sharply and could drop below 2% in the event of a combined slowdown in China and the US. While OE’s baseline forecast looks for Chinese growth to bottom out in Q2 but not rebound, contributing to world growth of 2.7% this year, there is a significant risk that things could turn out worse than this, says Slater. The dangers are especially acute for the industrial sector globally. Currently, the world manufacturing PMI is at 51.5, consistent with world growth near our 2.7% baseline forecast. But based on the trend in Chinese demand, this indicator could easily slip further to the 2016 low of 50.7, implying world growth around 2.5%; or even to 48-49, implying declining global manufacturing output and consistent with world growth of just 1.9-2.1%. Simulations using the Oxford Global Economic Model confirm the downside risk to world growth. The model suggests that a 1 percentage point (ppt) negative shock to Chinese GDP would cut world GDP by 0.2% in 2019-2020. Moreover, says Slater, the global slowdown would be worse still in the event of a combined negative shock to Chinese and US GDP. If both saw GDP fall by 2ppt relative to OE’s baseline forecast, world GDP would be cut by 1.5% by 2020, with growth in 2019 at only 1.7% y/y. Slater notes that with the world population growing by around 1.1% per year, this is close to the IMF definition of a global recession
Now that the phrase “peak of oil” has been cast aside, what new perspective captures the industry’s conditions? That’s the subject of new research from Inferential Focus. The research firm calls itself the first ”whole-brained investment consulting group.” That’s because the firm carefully reviews material from disparate sources with an eye toward integrating seemingly random, unrelated pieces of information into an intelligible whole. In this report they bring together multiple sources in order to answer some important questions about Oil and oil markets. How can we control the market with so many players with so many different needs and politics and so many alternative sources emerging and so many energy-efficiency moves happening in the marketplace? They also look at the situation of increasing supply going into an economic slowdown, which is not what OPEC and other oil exporters had planned. How can such a set of conditions be managed? The report asks. One key influences will be Geo-politics. This is discussed at length in an excellent report entitled “Crazy Times in the Oil Patch.”
So Trump was right and the Fed was wrong: the dollar is set to give back ground as Fed realizes the error of its excessively tight stance, according to Cross Border Capital. The Fed is already far too tight and will be forced to ease substantially over coming months because of a likely US economic slowdown. That will weaken the dollar, which Cross Border says is around 25% overvalued. The euro and gold are identified as likely beneficiaries, along with Asian assets and commodity prices. Investors could also try shorting the Dollar Index.
The pre-tax earnings of European companies are forecast to grow by about 10% this year, about twice as fast as those of their US and Japanese counterparts and about three times faster than the nominal GDP growth of the region. That looks unsustainable and complacent in the light of “scary” European manufacturing data, Empirical Research argues on January 24. An OECD leading indicator which tries to predict business cycle inflection points six to nine months in advance in November was near the worst decile of the distribution going back to the early 1980s. Yet on average analysts didn’t really change their estimates. Watch out for belated downward revisions creating more pressure on multiples.