Market Update: February 2019

Feb 18, 2019 | Articles, Global Markets Update

Risk assets rebounded strongly in January after a horrific December (Fig 1). The MSCI ACWI gained 7.80% in January, its largest gain since October 2011. This came after December’s fall of -7.17%, the second-largest fall since May 2012. A more significant comparison can be seen in the US, with the S&P 500 seeing its best January since 1987 after its worst December since 1931. Similarly, global investment grade (IG) fixed-income (FI) gained 1.52% in January while global high yield (HY) FI gained 4.39% following December’s 2.52% and -0.75% respectively. The VIX index has also been registering higher ‘lows’ in January, adding to signs that volatility is indeed returning.

Fig 1: Risk asset performance in Dec ‘18 vs Jan ‘19        Source: Bloomberg

Risk assets were supported on two fronts in January, with the first being optimism around the US-China trade situation. The first major round of trade talks since the Trump-Xi truce took place at the start of the month and ended on an optimistic note. Our base case remains that a narrow trade deal will likely be done, though the US is after a wider deal that addresses structural issues. A dovish Fed also provided support to risk assets, alongside a weaker dollar for the most part of January. Within FX, Asia ex-Japan (AXJ) pairs were the main beneficiaries of the USD weakness as they rebounded from their 2018 lows. There was also volatility around the GBP as it followed Brexit headlines.

Tactically, we remain cautious as fundamentals continue to deteriorate, bar a robust US economy (January’s ISMs and NFP numbers imply Q1 GDP growth of c. 3%), as we continue to see global GDP numbers being downgraded to c. 4-5% growth, from +10% at end of Q3FY18. Historically, equities struggle in the face of deterioration in EPS and GDP forecasts so the billion-dollar question is – what are markets discounting? If the December fall was overdone and predicated on a recession and EPS contraction, then one wonders at what point will this rally run out of steam (barring a US-China trade deal later this month), given that investors have repositioned quite aggressively since Christmas Eve, which has reduced this underpin.

Other than trade, the only other clear positive is that almost no one is positive, with a majority remaining uncertain and fearful. It continues the tradition of this being one of the most hated bull markets and economic expansions of all time, just as these are one of the two longest such periods. Equity bull markets and economic expansions do not die of old age and it is hard to see signs of the euphoria typical of the final stages of a bull market.

Another factor we strongly think is being ignored by markets, is the continued evidence of a strong pick-up in fiscal spending that appears to be globally synchronised. No doubt this is helped by the fact that we are in election years in parts of AXJ, coming into European Union (EU) elections in May, and are at the start of the US election year campaigning. We expect the Federal fiscal boost to continue well into 3Q19, with a large chunk of tax rebates for households being mailed out in the next few months to help consumption.

We would note (rather cynically) that based on history, the prospect of additional, and thus higher, Federal spending into elections is quite high, notwithstanding a consensus view that partisan politics will stymie extra spending in an Infrastructure Bill. Markets rarely seem to understand that fiscal spending tends to be dynamic and we have evidence that fiscal spending is picking up globally, be it from the EU (Germany, Italy and France are all set to spend substantially more as a percentage of GDP as most likely will UK), China, India (we are seeing Modi’s Bharatiya Janata Party government boosting handouts to farmers) or Japan (the government is expected to boost spending, including a package to offset the GST-hike set for October this year). Should a US-China trade deal materialise, these drivers, as they materialise in better GDP numbers by 2H19, could power the next leg of the rally in risk assets in the medium-term but stoke inflation in the long-term.

Equities

• The S&P 500 (+7.87%) saw a broad-based rebound from December’s decline, although gains varied as Energy and Industrials powered ahead, leaving defensives like Utilities trailing behind (Fig 2). The Technology sector was slightly mixed after heavyweights such as Facebook guided for lower growth, weighing on sentiment across the sector. However, others such as IBM rallied after posting strong earnings beats and better-than-expected guidance for FY19. The Dow Jones (+7.17%) and Nasdaq (+9.74%) also experienced a similar rally in January.

Fig 2: Defensive sectors lagged in the S&P 500               Source: Bloomberg

• The STOXX 600 (+6.23%) also joined the rebound in global equities, with Telecommunications being the only sector to see a decline. This came after concerns over alleged spying by Huawei led to companies pulling out of ongoing 5G infrastructure developments (on top of pressure from the US), but also as investors grew weary of further delays and potentially higher costs in alternative providers. Within the index, just over 30% of companies have reported earnings, with 54.63% reporting an aggregate beat of +8.85%, and an aggregate earnings growth of +4.19%. On the other hand, over 44% of these companies saw earnings surprise to the downside.
• Nikkei (+3.79%, or +5.31% in USD adjusted terms) had a relatively poor performance against the broader MSCI AXJ (+7.79%). While the Shanghai Composite Index (+3.65%, or +6.40% in USD adjusted terms) lagged behind on continued USDCNY strength, the recovery in sentiment on Chinese equities was evident in the Hang Seng Index (+9.33%) which led gains across Asia.
• It is important to highlight that USD rates, relative to AXJ, are a good indicator in determining returns for equities in this region. Credit Suisse released an analysis some months back that showed AXJ equities outperforming their US counterparts by over 5% when the USD weakened by 5% or more, and vice versa when the USD strengthened. JP Morgan (JPM) backs this up in a research paper, showing that AXJ outperformed 100% of the time and on average by around 20%. Interestingly, many FX strategists are now predicting the USD to weaken significantly against currencies in AXJ, with the USD having been on a downward trajectory since October.
• A weaker USD coupled with far more stability in US equity markets (that have moved away from trade and bear market concerns) provide a scenario which is supportive for equities in AXJ. On top, EPS downgrades in this region over the past three months came in at -3%, which was less than the -5% decline in estimates for the S&P 500. The tail risk remains, however, that this could change rapidly, and that this market requires a close eye and strict risk controls.
• Looking specifically at China, it appears that markets seem to underestimate the degree of liquidity easing, tax cuts and reflation, in the same way that markets had arguably overestimated Trump’s one-off tax reforms in the 18H1. In our view, these are likely to cushion, if not support Chinese equities, and are drivers that other markets seem to be lacking.
• It was a somewhat eventful month for the US, after we saw resolution to the longest-running US government shutdown, but also as some economists continued to trim US GDP growth estimates for 18Q4 and 19Q1. Powell himself raised concerns over the potential impact of the shutdown, and some estimate that the shutdown may have trimmed 40bps off 19Q1 GDP growth alone.
• It is likely that markets continue to underestimate US political risks, with the recent government shutdown potentially a foreshadowing of an even larger tussle when government funding runs out in September. Additionally, developments around the Mueller investigation also point to a genuine risk that he may indeed have a ‘smoking gun’ tying Trump to the Russians, which could prompt the latter to shut down the investigation entirely. Either scenario could potentially trigger a constitutional crisis. The greater concern for markets, is Trump’s unpredictability which ratchets up as he comes under pressure, particularly if it relates to legal or constitutional pressures.
• Evidently, these looming risks are sufficiently negative to have significant implications for the US market, more so if we see both intensify at the same time which is not at all unlikely given Trump’s history. We need to remain cautious around 19H1 beyond these two risks as they exacerbate the broader US/global GDP slowdown, weaker EPS growth, and uncertainty over whether Powell made a mistake in tightening too far. Our base case remains that these fears are exaggerated and will likely be reduced over time as hard data provides greater clarity over direction and quantum.
• Given this, we are cautiously optimistic on a positive outcome on trade in the near term. Trump continues to face pressure from blame over the recent shutdown, weakness in the US equity markets have investors questioning the US growth outlook, while Xi is likewise tackling the impact of multiple factors which have led to China’s slowing economy. Both have incentive to ensure that some degree of progress around trade negotiations are secured at least in the near-term.

Fixed-Income

• Sovereign debt was relatively flat in January as the market turned mostly risk-on. US Treasury (UST) yields rose sharply at the start of the month as investors turned risk-on following a blowout in December’s NFP numbers and rotated out of the safer government debt. The UST yield curve saw a parallel shift downwards, with greater falls in yields in the 5Y to 10Y period (Fig 3), following a dovish announcement by the Fed that led markets to think that rate hikes might be on hold. Bunds sold off early in January, along with USTs, but yields trended lower through the month as weaker economic data weighed on sentiments.

Fig 3: Yield curve shifts lower in January                Source: Bloomberg

• Credit also saw a positive return across all sectors, as spreads eased lower after reaching 2016 highs in December. The risk-on mood saw US HY gain the most, finding support from fund inflows, steady US economic data, rising oil prices and a dovish Fed. The Bloomberg Barclays US HY index gained 4.52%, its largest January return since 2009 (Fig 4), with CCC-rated bonds jumping 5.29% while BB yields fell to a 4M low of 5.32%.

Fig 4: Junk bond comeback                  Source: Bloomberg

• Bloomberg data also showed EM debt issuance reaching $172bn MTD. This is more than any January on record as borrowers took advantage of the strong demand from the turn in sentiment toward risky assets in January.
• We think Powell’s dovish comments might not be entirely a good thing. Powell seems to have overcompensated for 4Q18, and is simply giving the markets what they want to hear with no clarity. The Fed’s pandering to markets led several sell-side banks like GS, JPM and BofAML to think that the UST 10Y yield might have peaked for this cycle, causing them to cut their year-end projections.
• However, we think the US economy remains robust, as evidenced by the strong January NFP and ISM manufacturing PMI numbers. This, coupled with the US Treasury’s expected issuance of $365bn in debt in 1Q19 ($8bn more than its previous estimate) to finance its widening deficit, should provide upside pressure for UST yields.
• We maintain our conviction in shorter-duration debt given its defensiveness against interest rate risk. We continue to like HY debt as we believe there is still room for growth, and fundamentals for the sector remain strong. Analysts have also expressed a similar view, with the likes of Wells Fargo and Barclays upgrading their annual forecasts of US HY returns to 9.9% (from 6%) and 6.5%-7.5% (from 3.5%-4.5%) respectively.

FX

• A dovish Powell caused weakness in USD during the start of January, which has been reflected in the recovery of AXJ currencies after last year’s decline. The DXY tested 95.300 twice – once during the first week of January and the other on 30^th This level is just above the 200DMA found at 95.371. We remain moderate dollar bulls on the basis that the US economy remains strong and positive data will lead the Fed to resume raising rates.
• JPY strengthened to 108 in the first half of January on dollar weakness, which is also a resistance level, ignoring the flash crash to 104.96 early January which resulted from trading on thin liquidity. Unsurprisingly, BOJ left rates unchanged and lowered its near-term GDP forecasts. This, along with relatively stronger data out of the US are factors that could lead the JPY lower to 110.
• Amongst AXJ FX, THB (+4.06%), IDR (+3.27%) and CNY (+1.94%) have been leaders YTD (Fig 5). Strength from the Thai baht has been attributed to the 25bp rate hike in December as well as an increase in Thai equity purchases from global funds.

Fig 5: AXJ FX total returns against USD as of 6th Feb ‘19              Source: Bloomberg

• CNY strengthened greatly to c.6.70 in January on dollar weakness and optimism around trade, weakening toward the end of the month as this sentiment waned. A few data releases also added to uncertainty over China’s economic trajectory, which also weighed on the currency.
• The course for AXJ FX will be dependent on three aspects, the Fed (US data), the CNY (US-China trade negotiations) as well as the Brent price. We may see some downside pressure over the next month or two until we see a recovery in macroeconomic data. USDCNY’s bounce off its 6.70 resistance in January (and a move back above the 200DMA) implies this. THB will likely hold against its 31.132 resistance, following BOT’s recent decision to leave rates unchanged.
• Much of the directionality for the EUR or the GBP lies in the fate of Brexit. We think that the BoE will unlikely change its monetary policy until there is clarity around Brexit. We expect an extension to Brexit’s deadline, hence reducing the likelihood of a ‘hard’ Brexit. This should be supportive for the GBP in the medium-term.

COMMODITIES – REVIEW

• Brent oil recovered from its 52W low of 50.47 in December to end January at 61.89 on the back of a weaker USD. Venezuelan sanctions contributed to the bullish sentiment around oil, with the cold spell in the US boosting fuel demand. This 15.04% MoM gain was its largest since April 2016, but it now struggles to move past a technical resistance level of 62.80.
• The oil rally since December’s low has also led to significant short covering. ICE data showed that shorts fell 27% in the week ended 29^thJanuary to their lowest point since October ’18, while long positions held by hedge funds increased by 15%.
• Oil will remain attractive below its technical resistance of 62.80, but the direction of oil will require clarity on key issues such as China’s economic slowdown and in turn, AXJ’s demand for oil; US’ output and OPEC’s ability (and Russia’s willingness to cooperate) to pull through with their cutbacks in production. These short-term headwinds may only be rectified as we move past 1H19.
• Gold began a new trend, borrowing strength from uncertainty and increased volatility in the markets as we ended 2018. The dim outlook for the dollar at the start of ‘19 also supported gold through the month, as it broke above the $1,300/oz level to end the month at $1,321. However, it failed to break significantly above the $1,320/oz level and pared some of the gains in the first few days of February (Fig 6).

Fig 6: 1Y gold chart               Source: Bloomberg

• Dollar strength was the main contributor in Gold’s recent losing streak, but the precious metal has followed its 20DMA rather closely, which suggests that the uptrend may still be intact (Fig 6).
• With investors betting that the Fed may now be on hold, and as the global economy slows and volatility picks up, gold offers an alternative safe haven to FI. Last year, speculative positioning was reduced substantially and central banks bought the most gold since ‘71. With these in mind, we may see gold push higher to test multi-year highs of around $1,360/oz.

CONTACT

We would be more than happy to have an informal chat about these and the other services we offer as well as the current opportunities we are looking at.

Market Update: January 2019

Jan 10, 2019 | Articles, Global Markets Update

Equities fell momentarily into a technical bear market on Christmas Eve amidst growing concerns that the Fed is raising rates into a slowing global economy, evidenced by weaker manufacturing and other various economic data released over the month. Thin trading through the month worsened the losses. The MSCI ACWI fell to 435.90, 20.84% off its 52W high, before ending the year at 455.66 to register a 11.18% loss for 2018. Most major equity indices also fell into a technical bear market over Christmas (Fig 1). However, the Fed also trimmed its 2019 rate increase projections to two increases from three and lowered the long-term equilibrium Fed rate to 2.75% from 3%.

Fig 1: Global equities fall into bear market over Christmas          Source: Bloomberg

There were several developments in the Sino-US trade situation as well. In the first month after Trump and Xi’s meeting at the G20 conference, we saw China cutting US auto tariffs from to 15% from 40% and making a huge purchase of US soybeans while Trump cited huge progress in trade developments after a phone call with Xi. There were concerns that the arrest of Huawei’s CFO might jeopardize the discussions, but these worries were short-lived.

Brexit developments, however, took a turn for the worse earlier in the month after May delayed a parliamentary vote on the Brexit deal, survived a vote of no confidence and stepped up preparations for a ‘hard’ Brexit. This chain of events led to a volatile month for the GBP, which traded -2.13% to a low of 1.2478 before ending the month almost flat.

We suggested last year might start well, turn tricky and become difficult, but we were surprised by the speed of the changes and, in particular, the severity of the fall in the S&P 500 in December. 1969 was the last time all asset classes struggled and cash outperformed. Our base case for 2019 is it will likely be an uncertain and volatile start but, as we potentially get more clarity over key risks, conditions may become more constructively for risk assets in 19H2.

We are not bearish and do not see a ‘smoking gun’ that will devastate markets. We believe markets are suffering another growth scare often seen since 2010, with 2017 the exception. We doubt a recession is imminent in the USA or globally, nor do we anticipate an earnings contraction either. We believe markets have already discounted a lot of bad news but are ignoring some positives, such as the largest, synchronized fiscal expansion since 2010.

Our base case is predicated on these assumptions: A Sino-US trade deal is desired by both the USA and China; a ‘soft’ Brexit is the probable outcome, albeit it could be delayed; Italy will agree a budget deal with the European Commission (EC) and remain in the EU; China will support its economy sufficiently to defend a 6%+ GDP growth and ensure CNY’s stability; the Fed will raise rates two times in 2019 and then be driven by the data; and that the US GDP will grow at a solid 2.5% in 2019 and global GDP growth will be solid. Should we be wrong and a ‘bear’ market in equities occur, we see a probable Powell ‘put’ limiting the downside.

Tactically, we see the first few months of 2019 as a ‘tricky’ period. Global GDP growth and EPS will slow, and it may take until late April – with Q1 results coming out – to provide jittery investors with a better clue as to the direction for US/global EPS. Likewise, we need to see the spate of GDP downgrades stabilize. Whilst we remain optimistic a trade deal will occur, Trump’s negotiating style may result in fears of a global trade war, including the risk of global auto tariffs, remaining high and this is most investors’ key risk.

Equities

• December was particularly harsh, as all three major indices in the US were down close to -9% over the course of this month. The S&P 500 saw a broad-based decline across all sectors (Fig 2), with Energy (-12.82%) leading losses as global oil prices declined on high inventory levels and weaker economic growth outlooks. Financials (-11.45%) and Industrials (-10.81%) were also particularly hard hit, no doubt a result of dampening expectations for interest rates, and the ongoing trade-related issues with China. 

Fig 2: All S&P 500 sectors ended December lower         Source: Bloomberg

• The Stoxx 600 had a relatively better month than Wall Street, falling -5.55% MoM to finish the year -13.24% lower. The index saw a broad-based decline, with Retail (-7.98%), Banks (-7.70%) and Autos (-7.21%) leading losses. It was also a down month for the FTSE 100, which fell -3.61% MoM.
• China A-shares fell 3.65% in Dec to end the year 24.60% lower, while the HSI likewise declined 3.78% to finish FY18 14.60% lower. Despite some positive developments around the 90-day US-China truce, an early rally by Asian equities quickly subsided as negative sentiment continued to weigh on investors, as evidenced by the -2.93% MoM decline in the MSCI Asia ex-Japan Index. Data releases did not provide much needed respite either – in China, industrial profits fell for the first time since 2015, as November trade data surprised on the downside as exports struggled despite tax rebates and a weak currency, while a slowdown in imports highlighted slowing global trade and a weakness in domestic growth.
• China’s Central Economic Working Conference was also held this month, with the outcome being a renewed focus in stabilizing economic growth through policy stimulus. There was also quite a bit of focus on PBOC’s newly announced Targeted Medium-Term Lending Facility, aimed to provide low-cost liquidity to smaller companies.
• The fundamental question for 2019 is whether the deteriorating growth environment will negatively impact US growth. The short answer is yes, but not materially. In a recent report, Goldman Sachs (GS) notes that slower global growth could affect US growth through 1) the reduction of demand for US exports 2) a reduction of US business investment spending and 3) tightening of US financial conditions. While we might see this play out over the course of 1Q19 (and GS predicts that this could trim 0.4% off US growth), the economy should be strong enough to cope with this negative drag (Fig 3)

Fig 3: US Growth Remains Solid                 Source: GS Global Investment Research

• Tail risks continue to be an escalation in the Sino-US trade dispute, and a sudden spike in inflation which could force the Fed to raise rates far more aggressively than the market currently expects. UBS predicts that this could result in a flat or inverted yield curve somewhere in the middle of the year, followed by sell-offs in the equity market, which could set the stage for an early recession in 2020.
• Brexit remains the biggest geopolitical risk in the Eurozone, because the outcome remains largely uncertain. While the impact may be more contained within UK/EU, odds are for a weaker and potentially volatile GBP as the process drags on, dampening Capex prospects and continuing the overhang on GDP growth. The next key date to watch is the week of 14^thJanuary, where May’s delayed ‘meaningful vote’ is scheduled to take place.
• Earlier in September, we posited that China’s policymakers faced an increasingly difficult balance between policy decisions, and that every subsequent move would result in elevated costs and risks. Daiwa highlights that we saw this unfold numerous times over the past few months, as the PBOC took to defending the CNY at the 7.00 mark. While a fall below this level would have negative implications (i.e. capital flight), the result has been 1) denying a downward adjustment which would have been supportive of export competitiveness and 2) Offsetting a good deal of stimulus effects from both fiscal and monetary measures, as we have observed from the continued weakness in data toward the year-end.
• We expect more guidance by the PBOC in early March, particularly around growth targets which are slated for announcement during the National People’s Congress meeting. It is widely expected that the government will maintain an expansionary fiscal policy and much like 2018, the consensus is for another four 50bps cuts to the Reserve Requirement Ratio this year. The positioning of the Chinese government has clearly turned toward an easing stance with more measures expected to come in 2019.

Fixed-Income

• Sovereign debt rallied sharply in December as weak economic data raised concerns of a global growth slowdown and increased demand for safe haven assets. The UST yield curve shifted lower through the month, with the 2Y UST yield falling 29.87bps, the most since June 2016, while the 10Y UST yield fell 30.37bps, its largest decline since January 2010. The 2Y-10Y spread remained largely unchanged at 19.64bps at the end of December. The Bunds yield also fell 7.1bps over the month and continued falling in the first week of January to reach its lowest level since April 2017. However, sovereign yields saw a pick up on 5^thJanuary after a strong NFP number and Powell’s reassurance that the Fed will not rush to raise interest rates helped ease concerns.

Fig 4: Bond spreads reach highest levels since ’16         Source: Bloomberg

• Credit also saw positive returns across the sectors, with spreads reaching its highest levels since 2016 (Fig 4). US IG bonds gained the most in December, with the Bloomberg Barclays Global US Corporate Total Return index up 1.47%, despite IG bond funds seeing six straight weeks of outflows (Fig 5). Investors withdrew $17.8bn from IG bond funds in December. This helped pare its losses in 2018 to -2.51%.

Fig 5: US IG bonds see six straight weeks of outflows   Source: Bloomberg, Lipper

• HY debt underperformed in December as it tracked equities and oil prices lower. US HY performed the worst in December, with the Bloomberg Barclays US Corporate HY Total Return index falling 2.14% while spreads widened to 526bps, just shy of the 30M peak set on 27^th December’s performance caused the US HY sector to end the year -2.08%, resulting in its worst year since 2015. HY bond funds also saw seven straight weeks of outflow, with $8.2bn withdrawn in December.
• However, issuance dried up in December. US IG bonds went through the last three weeks of December without any issuance and ended 2018 with $1.08tn in issuance, falling 11% from ‘17’s $1.21tn amidst a combination of higher borrowing costs and overseas cash repatriation. There was also no issuance of US HY debt in December, the first time in over 10 years.
• US HY now appears to be of value, given the levels it is currently trading at – 7.95% yield with a 5.26% spread. Sell-side forecasters are expecting US HY to bounce back in 2019 (Fig 6). Key drivers of US HY bonds – default rates, earnings, GDP growth, corporate cash flow – also look to be generally supportive. However, despite its cheaper valuations, US HY presents higher risk given the near-term uncertainty, higher volatility and tighter financial conditions. BofAML raised its US HY default rate estimate for 2019 to 5.5% from 4.25% and suggests a risk neutral spread of 5%, relative to 5.3% currently. It is necessary, even more so now, to be selective of better-quality names in this space. Given the amount of uncertainty in markets now, we continue to recommend sticking with short duration debt.

Fig 6: Sell-side expectations for US HY and Leveraged Loans       Source: Bloomberg

• European credit will likely be a difficult space to trade in this year as investor sentiment wanes. This year, the region faces risks in the form of Brexit uncertainty and a slowdown in global and European growth. In addition, with the ECB stopping net asset purchases and only reinvesting its maturing holdings, it removes a safety net of sorts, worsening liquidity in the space.

FX – REVIEW

• December’s biggest move in currencies was the USDJPY, which fell 3.42% in December, and continued its decline in early January to a low of 104.87 before recovering back to the 108 region. The decline came as disappointing US data sparked fears over a US slowdown, spurring a risk-off move to the ‘safe haven’ JPY.
• The JPM EM FX Index was mostly unchanged at 62.221, falling 0.5% for the month. Within the index, there was notable resilience in the USDTHB, which instead moved -1.02% from 32.885THB to 32.548THB, strengthening even further against the Dollar in early Jan to 31.965THB.
• This month also saw the DXY break its 50DMA support at 96.6 to fall -1.13% in December, finding a new support from its 100DMA at the 96.0 level. The EUR gained 1.33% against the dollar for the month, but also mostly from general Dollar weakness over slowing growth in the US.
• The base case this year is a complicated one, but we are more inclined to think the Dollar will likely end the year in a weaker position. While appearing to be overvalued on a fundamental basis, there are still too many reasons why uncertainties will keep its ‘safe haven’ status supported especially over the first half of the year.
• Moves in the GBP will still largely be dependent on news surrounding Brexit. As discussed earlier, a no-deal scenario could potentially send the sterling significantly lower from where it is now, and that situation might present a short-term opportunity for a tactical trade. Our base case is more likely a soft deal (rather than a no-deal situation), which should support the sterling as well as the euro.
• We are cautiously optimistic that EM Asia currencies could rise against the dollar over the next few months, if not more so in the second half of 2019. As we have witnessed over the course of 2018, this will also largely depend on how the CNY moves, as a no-deal trade scenario between the US and China could potentially send the Chinese currency below 7 and that would have a contagion effect onto the rest of Asia.

COMMODITIES

• The growth scare in December led Brent oil prices to extend its November losses, leading to an 8.36% loss over the month. Oil prices were volatile, initially supported by OPEC’s pledge to cut output after the meeting in Vienna before concerns around global growth and rising supply from Russia and US eventually weighed on prices.
• Gold gained significantly over December, rising 5.08% through the month past a key level at $1,250/oz, as markets saw a flight to safety amidst the uncertainties in the month.
• We are bullish on oil prices are see it averaging $70/brl with further upside from here. Our base case is for a Sino-US trade deal, hence reducing concerns of slowing global growth and offering greater clarity into oil demand. OPEC+’s agreement to lower output will officially begin this month and should provide support to oil prices.
• We see technicals supporting Gold from here on and expect it to trade in the range of $1,250 – $1,320/oz.

CONTACT

We would be more than happy to have an informal chat about these and the other services we offer as well as the current opportunities we are looking at.

Market Update: December 2018

Dec 12, 2018 | Articles, Global Markets Update

Global equity markets recovered slightly from the October sell-off, with the MSCI All Country World Index ending November +1.30%. However, while investors stuck with equities, global trade and geopolitical events led them to remain defensive. This month saw a continued rotation into defensive sectors like Health Care and Real Estate on the S&P 500, and the Telecommunications, Utilities and F&B sectors on Stoxx 600. The US mid-term election results at the start of the month saw the Democrats take the House while the Republicans retained control of the Senate. This was in line with expectations and helped provide an early boost to the US equity markets.

“Too late to buy equities, too early to buy fixed income (FI)” was a perceptive quote out last week. We think 2019 will be another tricky year after this year given the large number of uncertainties out there and a lack of predictable outcomes. In our view, no one (including the Fed), really knows what might happen to inflation next year with widely polarised views on how many Fed hikes there will be as there are a wide range of inflation expectations.

Markets were also focused on the meeting between Trump and Xi at the G20 summit. The meeting ended with a 90-day truce and set up a framework for future trade talks. We see this truce as a win for both parties in the short-term, given the avoidance of a trade escalation. However, in the longer term, this truce is simply a ‘pause’ in a very complicated dispute and does very little in reducing the substantial differences between China and the US. We remain cautious on whether any of the existing structural issues can be resolved by the end of the 90-day truce. One reason for this is the hostility present within the US administration against China.

Global trade, extending beyond the more well-publicized Sino-US squabble still remains largely uncertain. Sizeable geo-political concerns also remain, with unclear outcomes from Brexit; the Italian budget; Russia’s encroachment on Ukraine; and the powder keg that is the Middle East with its important links to oil prices. In FI, there are opposing views over developments in credit quality and on the favoured spot for duration whilst FX, unlike last year end’s strong consensus behind further USD weakness, appears to have little in the way of conviction.

Depending on the outcomes of these important, but uncertain, outcomes, there could be the need for speedy and material portfolio construction changes. As we’ve seen this year, 2019 could well be another year where making capital gains in equities might prove to be difficult, whilst owning FI might fail to preserve capital. The significant de-rating of equities, despite solid earnings growth bar Asia ex-Japan, provides us with reason to remain more weighted here than in FI, which we still see as a dangerous asset class outside short duration holdings where the risk is not rewarded by the yields. Given the difficulties going forward for traditional asset classes with weaker returns than normal and likely higher volatility, we continue to recommend diversifying into non-traditional asset classes as alternatives and private assets, and the use of significant tactical cash holdings from time to time.

Equities

Fig 1: S&P 500 Sector Performance in November                                                         Source: Bloomberg

• The S&P 500 gained 1.79%, with Healthcare (+6.83%) and Real Estate (+5.30%) as the biggest gainers in the index which saw gains across most sectors, with the exception of Energy (-2.20%), Info Tech (-2.12%) and Telecommunications (-0.68%). Likewise, the Dow Jones gained 1.68%, while the tech-heavy Nasdaq also managed to gain 0.34% to end the month on a higher close. [Fig 1]

Figure 2: S&P 500 Sector Performance in October

• As we highlighted last month, the divergence between growth and value extended through November, with the SVX Index (Value) closing +2.63% higher and the SGX Index (Growth) trailing behind at +1.53%. [Fig 2]
• Fundamentally, composite lead indicators in the US continue to reflect a strong economy, with nothing to suggest below-trend growth over the next few quarters. The ISM Manufacturing survey came in well above expectations, as production and new orders rebounded from a month ago while export activity held steady and respondents remained confident around business strength.
• GS sees single-digit absolute returns on the S&P 500 for FY19, with the view that US Equities are likely to provide a lower risk-adjusted return compared to its long-term average. In terms of allocation within the US, we are inclined to agree with the GS view to increase exposure to defensive assets within US, as with sectors such as Communication Services and Utilities, and continue to be much more selective when it comes to growth stocks, particularly within IT.

Fig 3: S&P 500 Sector Performance in November                                                         Source: Bloomberg

• The Stoxx 600 fell 1.14% in November, but we saw a marked difference in performance across sectors as Telecommunications (+8.62%) and Utilities (+3.41%) outperformed, while Basic Resources (-7.78%) and Oil & Gas (-5.87%) saw steep declines. Given our expectation of elevated political risks next year, we choose to remain underweight Europe in our portfolio allocations. In our view, the risk-reward still remains somewhat lacking in these markets, and until valuations decline lower or we are able to gain some clarity on these issues, we would avoid being too heavily allocated into this region. [Fig 3]
• Asian markets were largely focused around the outcome of the Trump-Xi meeting on the 30^th, where the announcement of the 90-day ceasefire sent most Asian markets higher early into December, with the exception of China A-shares which closed -0.57% lower on the month.
• In our view, the agreement between Trump and Xi was more symbolic rather than substantial, and that the Chinese came to the table from a position of weaker bargaining power to provide Xi some relief to focus on the domestic economy.
• The next date to look out for is December 20th, which is scheduled to be the Central Economic Working Conference, where the Politburo’s policymakers are likely to discuss growth and inflation targets for CY19, and any adjustment to policies which they will choose to undertake.
• Ultimately, the question now will be whether China can bring enough to the table to satisfy the U.S.’ concerns around industrial policy & IPR. Our economist foresees a long-drawn negotiation that lies ahead, and what we can expect from that is further market volatility as risks continue to rise around tariffs or threats around them.
• More broadly for Asia ex-Japan, we could very well be looking at the start of a bottoming process which has had seen some uplift from the recent ceasefire in the Sino-US trade conflict. At valuations that float around 11.5x FY19 P/E for MSCI Asia ex-Japan (AxJ), valuations remain at unjustified trough-like levels, which is a prime reason why we have moved from c. 50% to 5% cash in out Asia ex-Japan portfolio, and re-allocated back into what we view as a market with attractive risk-to-reward.

Fixed-Income

• UST yields traded higher earlier in the month after the mid-term elections and on technical factors, with the 2Y yield rising to a high of 2.97% and the 10Y at a high of 3.24%, just above a key resistance level of 3.2% [Fig 4]. However, markets perceived Powell’s speech late in the month to be dovish, causing the UST 10Y yield to fall significantly and end the month at 2.99%, while the 2Y yield finished just 20bps lower at 2.79%. The yield curve continued to flatten into early December.

Fig 4: Flattening yield curve                                                                                            Source: Bloomberg

• HY debt continued to lose the most amid concerns of slowing growth globally and in the US. The HY energy sector fell 3.58%, its worst since losing 8.41% in February ‘16 while CCCs led the decline in the general HY sector (Figs 5 & 6).

Fig 5: HY energy sector’s worst month since ’16                                                            Source: Bloomberg

Fig 6: CCC debt leads decline                                                                                        Source: Bloomberg

• The Fed will likely raise rates by another 25bps to 2.25%-2.50% when they meet later this month. Fed fund futures are pricing in a 78.4% probability of that at time of writing. The futures are also pricing in a 75.3% probability that rates will remain at 2.25%-2.50% after January ‘19’s meeting but is more uncertain about a rate increase in March ’19.
• Given the current environment, we recommend staying defensive by allocating to government bonds. We also prefer to remain at the front-end of the curve, given that the current yield spreads do not provide a sufficient yield pick-up to justify the duration risk in longer duration bonds.
• We remain positive on HY debt, albeit less so than in previous months. HY bonds have fallen recently and this pullback came earlier than expected. Yet, there is no sign of a collapse in earnings or an approaching recession. This supports the case that HY debt still remains an attractive asset class, though there is a need to be more selective on the companies we allocate to.

FX

• The USD had a volatile month with mid-term elections, tariff developments, dovish Fedspeak and what markets took to be mixed data releases. December opened with a 90-day ceasefire between Trump and Xi, amidst slowing momentum from October’s stream of strong data.Going into ’19, we expect more sensitivity from the greenback around data releases, given the Fed will also be largely data-dependent.
• The EUR saw a monthly high of 1.145 against the dollar, and a low of 1.12 before ending the month at 1.13, just 3bps from where it started. The EUR remains weighed down by political uncertainty, not least Brexit’s key vote on December 16, and a yet unresolved budget from Italy. It remains to be seen how these headwinds will weigh on the EUR, but we remain more concerned around the GBP which is currently sitting near a critical support at 1.27.
• CNY continued to decline throughout November, but found some artificial support from the 6.97 to 6.95 region before recovering to 6.83 just after the Trump-Xi meeting. Although CNY led most AXJ currencies lower, INR emerged victorious against its peers, ending November higher by +5.90%, supported by cheap oil prices to alleviate its twin deficits.
• Uncertainty around China’s growth given the challenges it will face might cause further doubt on the strength of the CNY. There also remains much uncertainty around EM FX as the spotlight is now on the fragile partnership that is beginning to foster between US and China.

Commodities

• As we draw closer to December’s Vienna meeting, investors have been notably wary with the release of inventory data and news around Russia, Saudi Arabia and potential changes on the supply-side. Despite the sanctions against Iran (albeit with waivers issued to eight nations), November saw Brent plunge from 72.70 (on Nov 1^st, Brent fell below its 200DMA for the first time since Aug ’17) to eventually form a short-term support at 59.
• December 2nd’s positive news gave a 5% boost to oil; a trade war ceasefire brought a short lived risk-on appetite to markets; Alberta’s oilfields cut their production by 350,000bbls/day, and the OPEC President hinted a likely production cut during the month.
• Looking ahead, directionality on oil prices could be largely driven by the outcome of the Vienna meeting on 6th Dec.
• In terms of support for Brent crude, we look to three factors in determining our stance 1) Demand is still growing, albeit at a far more muted pace than we had originally expected 2) Supply can and will be cut if necessary, and the OPEC alliance with Russia will be able to do this & 3) The market clearly underprices a risk premium that, in our view, is clearly more evident in the Middle East
• For the factors listed above, we continue to remain bullish on oil prices, with the view that over the next few months, Brent Crude should normalise closer to or above US$70/bbl as opposed to c. US$61 where it sits now.

CONTACT

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