Market Update: June 2019

Jun 13, 2019 | Articles, Global Markets Update

Equities were hit hard last month after sentiment soured after a rapid about-turn on a US-China trade deal that was expected to be signed. The US blamed it on a U-turn by the Chinese leadership that worried the deal, as it stood, might be seen as ‘humiliating’. Unsurprisingly, Asia Pacific (APAC) markets were hard hit with Hong Kong off almost 10%, MSCI Asia ex-Japan (AXJ) -9% and Nikkei 225 -7.5%. The exception was India after the BJP’s surprising landslide victory, which saw Sensex rise 1.75% for the month on the hope this will enable further reform progress. India was not alone in producing a positive election result as Australia, Europe, Indonesia, Philippines, South Africa and Thailand all exceeded expectations and helped equities and currencies. US markets were not spared with trade impacted Nasdaq off -7.9%, notably the semiconductor space, and S&P 500 off -6.6%. A further negative for US technology/social media are concerns around antitrust actions by the regulators that included Facebook, Google, Amazon and Apple.

Risk-off assets rallied with the US Treasury (UST) 10Y yield dropping quickly through the support at 2.30% towards a stronger support at 2.00% and the lowest since September ’17, whilst 10Y German bunds, in part around worries over Italy’s fiscal rectitude, rallied such that the yield fell into unchartered territory below the previous low at -20bps. US high yield (HY) fixed income (FI) belatedly saw spreads widen out by 70bps, led by weakness in CCCs that fell -2.2%. However, AXJ HY FI was resilient, gaining 8bps over May, helped by positive election results and a belief the key sub-sector, China’s real estate developers’ HY FI, would be defensive should a trade war continue as it is a sector that will gain from domestic reflation.

Gold, after being puzzlingly quiet, rallied, along with JPY, later in May with the former breaking through key resistances at $1,300 and $1,320. Apart from the ‘safe haven’ JPY rally, the USD gained 2.5% against CNY that fell from 6.74 to end at 6.90 but tested key support at 6.96 during the month on worsening trade news. Continued Brexit chaos helped sink GBP by over 3% towards YTD lows at 1.26. Oil was the worst performing asset class of all, with Brent oil plunging over 11% to break strong support at $70/brl then $68/brl to head to testing the next support at $60/brl, off a combination of rising US crude inventories, with US producing a record 12.5mn/bpd last month, forecasts of weaker global demand and concern that Russia might seek to increase its production amount at the next OPEC meeting this month.

Equities

• All three major US indices fell significantly in May, breaking their respective 200DMA support lines although there was some respite in a Fed ‘put’, after FOMC comments were released in early June which saw equity markets make a broader rebound with Powell’s comments helping to alleviate some selling pressure. Energy (-11.70% MoM) stocks were the biggest losers this month, led lower as oil prices fell on the back of concerns over the impact of US tariffs on global growth.

Figure 1: Relative performance of US indices                                                                                    Source: Bloomberg

• IT (-8.91% MoM) shares also saw a big fall, alongside the Nasdaq (-7.93% MoM) as growth stocks came off and investors fled into safe haven assets. Notably, a big contributor to weakness came from Semiconductor stocks, as the Philadelphia Semiconductor Index (-16.70% MoM) came off sharply from all-time highs after weaker guidance from Q1 earnings reports raised fears that an anticipated 2H19 recovery in the industry could be delayed. This weakness extended over the past week, following antitrust concerns over the reach of Facebook and Amazon which fell -7.50% and -6.11% overnight last week as the news broke (Figure 1)

• On the geopolitical front, headlines continued to be dominated by trade, first with the ramping up of tariffs on China, then subsequently an announcement on tariffs for all Mexican exports effective June 10th. Thankfully both US and Mexico reached a deal, with Trump removing the tariff threat ‘indefinitely’. He also delayed implementation of tariffs on numerous Chinese exports to 15th June from 1st June to allow exporters to bring their goods into US before the tariff rates are increased.

• Trade and US politics will drive short term directionality in the S&P 500. We think it is in a range of c.2,400-2,950 with upper bound capped by valuations and a slowing economy whilst lower bound by likely policy action by the Fed and Trump’s administration as neither has the intestinal fortitude to allow capital markets to suffer a ‘bear’ market. We see more negative, than positive, developments in the short term with the G20-Summit a possible flashpoint for further US tariff action towards China. We doubt an early resolution of the trade deal until closer to YE19 or Q1CY20.

• Whilst the Fed has talked more ‘dovishly’ of late we think the hurdle to cut rates is much higher than the FI markets predict and this opens up a ‘disconnect’ for risk assets whilst, should the Fed actually cut rates this year then this might worry equities as to what there is to fear driving the Fed’s action. Either option could lead to significant sector rotation.

• Sector action might be trickier as whilst this might have seen ‘growth’ sectors outperforms as IT the very real threat of antitrust action against some of the IT heavyweights, as Facebook, Amazon, Google and Apple, which has a rare degree of bipartisan support in Congress could complicate the past ‘norms’ plus ‘value’ is looking cheap relative to ‘growth’.

• We doubt Trump will be impeached but the threat of this remains that could add to his erratic decision making and use of trade, where the President has a lot of power under the Constitution, as a way to deflect attention from his domestic woes. As we head into the election year, there is a genuine risk, should Trump fall behind in the polls, of really bizarre behaviour and this is disturbing given Trump has extremists like John Bolton and Peter Navarro as senior advisers. On the flip-side, Trump arguably uses the level of the S&P 500 as a key barometer of his Presidency and this may, should S&P 500 fall sharply, see him shift towards more market-friendly ‘tweets’ including ameliorating his hardline trade approach.

• European equities also came off, with the Stoxx 600 (-5.79% MoM) led lower by Autos (-13.74% MoM) and Bank (-11.58% MoM) stocks. Unsurprisingly, defensive sectors like F&B (-0.07% MoM) and Real Estate (-1.36% MoM) outperformed, alongside German shares in the DAX (-3.48% MoM) index which were also noticeably resilient. Stoxx Q1 EPS, so far, have achieved its best result in two years.

• However, the outlook for earnings for the rest of FY19 looks to be far more challenging as data suggests economic momentum is eroding on both the continent and the UK despite positive metrics from rising wages and falling unemployment. For now, consensus is for +4% FY19E EPS growth but with Bunds yield below -20bps and slowing loan demand EU banks’ earnings look to be at risk plus there remains another EUR 400-500bn required in fresh equity capital.

• The region’s key focus this month centred around the EU Parliament elections, which saw Pro-EU parties largely staying in power. This helped alleviate concerns over a growing populist influence, although the results did seem to spur a shift in a number of constituent nations. There’s also a growing risk the battle over the appointments of senior positions in the 3 key EU institutions, as the head of the European Commission and Draghi’s replacement at the ECB, will be contentious and may result in a weaker Franco-German relationship.

• In addition, Austria’s Kurz was removed by a vote of no confidence, while Greece’s Tsipras announced a general election after Syzira disappointment in EU elections. To top things off, the European Commission sent a letter to Italy’s finance ministry, warning that it may take disciplinary action if Italy fails to justify its budget plans and sufficiently explain its deteriorating public debt and budget deficit.

• The worry is Italy’s shift towards growing support for The League, providing it with the desire to fight the EU over its higher than allowed fiscal deficit. The likelihood of the EU moving forward on further integration reforms necessary to address structural frailties in its undercapitalised banking system and fiscal system looks to be remote.

• Brexit developments were not particularly supportive either, with Corbyn calling off cross-party negotiations mid-month after six weeks of talks, calling May’s offer a ‘repackaged version of the same old dear’. May also stepped down as Prime Minister on 7th June but will remain at her position for as long as needed.

• It is unlikely we get a new party leader in place until September with the EU deadline looming on 31st October. The odds of both a ‘no’ deal or no Brexit have risen, as have those of a second referendum, but what the outcome will be is impossible to forecast with any accuracy. What is increasingly true is the two camps are increasingly polarised and May’s legacy, having frittered away the chance to get a compromise deal agreed when the sides still could have accepted one, is to have opened the door to Nigel Farage’s brand of boorish inflexibility making the FTSE 100 and GBP binary bets and likely a bitterly disappointed 50% of the population whatever the outcome.

• Whilst FTSE 100 might be a risky binary bet in the shorter term, should Brexit result in a major decline in GBP and domestic-demand related equities that might be a ‘bargain basement’ time to buy given institutions, notably FIIs, have been net sellers since the referendum and FTSE has world class companies as Shell, Diageo, BP, Llyods Bank to name a few.

Figure 2: Sensex outperforms in the Asian region while Chinese equities weigh                                        Source: Bloomberg

• Shares in Asia were likewise depressed, with the broader MSCI Asia ex-Japan logging a -8.94% decline, unsurprisingly led lower by the HSI (-9.42% MoM) although the Shanghai A-shares Index (-5.83% MoM) was comparably resilient despite the re-escalation of trade tensions which undoubtedly weighed on China-focused stocks (Figure 2). MSCI ASEAN (-4.76% MoM also fell, albeit from a lower base compared to the 1Q19 rally we saw in Chinese stocks.

• Sensex (1.75% MoM), however, outperformed the region, instead pushing into all-time high territory following a number of developments which helped buoy stocks against the selloff in global equities. One key overhang was eliminated this month, with Modi’s BJP winning a surprise landslide victory. The result was the first time in over 50Y a single, incumbent party has retained a majority in the Lower House since Indira Ghandi did in the early ‘70s and, given much of the success was due to Modi himself, reaffirmed his position as India’s reformer in chief. Arguably the more important development might be if, as seems likely, the BJP gains control of the Upper House by late ’20 that might see it then undertake the vital reforms needed of labour markets and in land acquisitions.

• Later in the month, we also saw Trump terminate India’s designation as ‘beneficiary developing country’, disallowing duty-free allowances on some 2,000 products that were being exported to the US.

• TOPIX weakened on trade related fears and poorer than expected Q1CY19 results but regained some ground after last month saw a record amount of share backs underpinning hopes Japanese companies are accelerating corporate governance and capital structures improvements that will continue to boost the underlying core ROE from a global low of 6% when Abe took over to 12% by FY22/23. Trump has tweeted the trade negotiations with Japan are going well that makes sense whilst US is preoccupied by China and the importance of Japan as a strategic ally in APAC.

• The recent elections in Indonesia, Philippines and Thailand were equity positive as the outcomes left incumbents in power with strengthened positions to undertake important economic reforms. Likewise, in South Africa Cyril Ramaphosa lifted the ANC vote share relative to ’16 local elections with the hope he has a stronger mandate to accelerate the critical reforms required and to clean up the corruption within the ANC left over from Zuma’s failed Presidency. Not all was rosy around political action in EM as in Brazil Bolsonaro’s bizarre behaviour, and those of his sons, is reducing the prospect of getting meaningful fiscal reforms through the notoriously irresponsible Congress whilst an election in the state of Cordoba, in Argentina, saw the Peronist party regain power from Macri’s coalition fanning fears a populist might win the October Presidential election. Lastly, Erdogan succeed in overturning the Istanbul city election result with a rerun 23/6 so delaying the possible start of much needed economic reforms at a time Turkey is on the edge of a full-blown currency crisis.

• A-shares outperformed HK last month helped by its higher inclusion in MSCI EM 28/5 and likely buying support from Chinese government backed funds. Our base case is the greater the trade related damage to the economy the more intense the fiscal and monetary policy reflation into the domestic economy and why we remain constructive on Chinese equities, including Banks, Insurance, Autos and Property that offer value but also in consumer related plays as Alibaba and Tencent. This might be why, despite weaker than expected official and Caixin PMI numbers for May, equities rallied on hopes this might see more stimulus and, sure enough, some positive pro-auto sector demand measures came out the next day!

Fixed Income

• Sovereign yields tanked in May amid worsening trade environments between US and two of its biggest trade partners – Mexico and China. The UST yield curve saw a parallel shift downwards, while the 3M/10Y spread turned negative again in the last week of May and remained below zero through the first week of June (Figure 3). The 2Y and 10Y ended the month at 1.9221% and 2.1246%, falling 34.40bps and 37.72bps MoM. These are the largest MoM falls seen in 4.5yrs and 10.5yrs respectively.

Figure 3: US Treasury yield curve                                                                                              Source: Bloomberg

• Powell’s statement on Tuesday (4th June) implied that the Fed is now opened to cutting rates if necessary. Recent comments from Bullard and other voting members of the Fed seem to echo Powell’s statement, raising expectations that rates will be cut this year.

• Inflation data have not been supportive too, with the US core PCE YoY remaining persistently below the Fed’s 2% target. The same has been apparent in Europe, with the core CPI YoY fluctuating around 1% in recent months. The May Eurozone core CPI fell sharply to 0.8% from 1.3%, leading German 10Y bunds yield to fall 21.5bps and further below zero to -0.202% – a new all-time low.

• Performance among credits were mixed – the risk-off mood in May saw a rotation to safer bonds. While spreads widened across all sectors, the rally in USTs was able to offset the slightly smaller spread widening of investment grade (IG) bonds. As measured by the Bloomberg Barclays indices, global and US IG bonds returned 0.68% and 1.43%, significantly outperforming their high yield (HY) counterparts (Global HY: -1.04%; US HY: -1.19%). In fact, May was US HY’s first MoM loss and its worst month since the rout in December last year. As expected, the CCC performed the worst with total returns of -2.73% and spreads widening 112bps.

• Asian USD debt and EM hard currency debt also managed to close the month higher while EM local currency debt was flat. Of notable concern was S&P’s decision to upgrade Indonesia’s sovereign credit rating by one notch to BBB after the re-election of Jokowi, citing prudent fiscal policy and strong growth prospects relative to its peers with similar income levels.

• We think USTs have been overbought and agree with houses like UBS and GS that the market’s reaction is likely overdone. To add on, the US economy is not all that bad, with recent economic data coming in mixed.

• We also do not think US HY debt will continue the trend it saw in May. We see fundamentals of the sector as still being supportive and think it is worth holding on to. However, we see no reason to add to it as its 8+% gain YTD limits the upside and its correlation to equities provides downside risks.

• Asian credit should continue to see strength in the short-term. Election positives from the results in the region should help support economic growth in the region and should be credit positive, especially for countries like Indonesia and India. In addition, a huge part of Asian credit, especially in the HY space, is made up of debt from Chinese RE developers, which are seen to be less affected by trade concerns. The sector might even benefit should the Chinese government decide to reflate the economy.

FX

• Volatility in the G7 pairs rose further in May amid the new trade developments. Concerns around global growth grew further and markets have priced in up to two Federal rate cuts by the end of ‘19.

• USD weakened and conventional havens, such as JPY and CHF, gained significantly. Weaker US data over the month further weighed on the dollar. CFTC reports show both CHF and JPY shorts unwinding with JPY shorts reporting -117k to -81k and CHF shorts from -52k to -40k (Figure 4).

Figure 4: Non-commercial positioning of haven currencies Source: Scotiabank FX Strategy,                    Bloomberg, CFTC

• AUD dipped from 0.7090 to 0.6109 in May. Weighed down by what was seen as an unlikely win by the conservative party, we now believe the 0.70 support will become a resistance between Q3 and Q4. We also think it is not pricing in the current weakness in the economy – economic momentum is slowing while the country experiencing a collapse in its housing market and risks from the US-China trade war.

• Sterling continued its descent and experienced a very depressing month of trading as Brexit continues to steer the pound. Theresa May’s resignation and what remains of the political leadership have all but confirmed the uncertainty in the pound.

• The Thai Baht stood out in terms of strength and finished +1.78% stronger against the dollar, supported by local bond purchases as well as relatively small equity outflows.

• We remain of the view that the dollar is the least bad currency amongst all developing markets FX. The US economy remains robust and we expect a likely rebound in UST yields, and a widening of real yield differentials, to support the DXY. Despite DXY’s fall below its 97.50 support, we think it is too early to call the end of USD strength, notwithstanding various FOMC members’ best attempts to talk it down.

• AXJ FX finished relatively flat against the wandering dollar bar the Chinese Yuan, which weakened -2.53% against the dollar amidst the re-escalation of the trade war. We continue to believe that the CNY will remain below 7 as its line in the sand as we believe China continues to be well-equipped to defend this level. CNY remains below a key resistance at 6.96.

Commodities

• We believe oil reacted more towards the build-up of US stock and the unwinding of gross long positions. Brent’s failure to break past $75 caused it to return to its $70 support. Concerns around global growth slowing also saw traders lower their net long positions, causing oil to end the month at $63. On technicals, we see $55 as the next potential support level for Brent oil. Should this level fail, we have a horizontal support at $45 that has held since ‘16

• We do not believe the weak oil price will persist given the tensions in the Middle East, OPEC’s clear commitment to production quotas – especially, Saudi Arabia – even if Russia seeks a release in the June meeting, supply side reductions regarding troubles in Libya, Venezuela, Algeria etc. and US sanctions on Iran. The extraordinary ability of US shale oil to increase production to a record 12.5mn bpd will cap the upside but, to a degree, limit the downside as producers are very quick to respond to price movement. At the year-end, environmental requirements will force ships to burn lower sulphur bunker oil that will increase demand for middle distillates by 2-3mn/bpd that is meaningful.

• Gold had a quiet start in May before ending $50 higher, in part due to its haven status as equities sold off amidst the trade war escalation, as well as a weaker dollar. Gold may well advance to test a multi-month high above $1,340/Oz and conditions are in place for this to go higher should we be closer to the USD peak at a time UST yields offer limited compensation and less capital upside. Speculative selling much of this year has removed a source of selling and might become a source of demand alongside steady EM central bank buying. As we enter a riskier global outlook gold’s insurance attributes and as a portfolio diversifier will boost its appeal.

Market Update: May 2019

May 14, 2019 | Articles, Global Markets Update

April found equities in good health, led up by the S&P 500 (+3.93% MoM) and followed by Stoxx (+3.23% MoM) on a combination of trade optimism, ‘dovish’ central banks’ rhetoric and better earnings off Q1FY19 results. Asia ex-Japan (AXJ)/Emerging markets (EM) equities lagged as USD strengthened and Q1 earnings were mixed, although Chinese equities saw a robust ‘beat’ on Q1FY19 results. Fixed income (FI) continued to see inflows to higher quality bonds as parts of the market worried about the risks in credit from a pick-up in defaults. 10y US Treasury (UST) yields recovered from recent lows at around 2.30% to trade in a range of 2.50% to 2.60%, and the UST 2y/10y spread widened out to 23.6bps, dampening talk of an imminent recession after yield curves inverted briefly.

FX saw volatility in several EM currencies around domestic political troubles including Turkey, Argentina – Peso fell to an all-time low – and Brazil. DXY gained through the month on relatively better US macro data relative to other developed markets (DM) and Powell was seen to be more ‘hawkish’ after last week’s Federal Open Market Committee (FOMC) meeting. GBP tested lows at 1.2900 but recovered over the last week to regain the 200DMA support after the Conservative party lost badly in the local elections, spurring hopes they might be more willing to compromise and reach an agreement with the Labour party. The Brent oil price tested 6-month highs above $75/brl after the US ended waivers for countries importing oil from Iran but signs of OPEC+ disunity, notably with Russia, and rising US oil inventories saw the price retreat towards support at $70/brl. Gold moved inversely to USD strength and higher UST yields to fall back below $1,300/Oz and test support at $1,270-80/Oz.

The key decision regarding risk assets is whether Trump and subsequently Lighthizer, are bluffing when threatening to impose 25% tariffs across all imports from China (including $325bn of tariffs they’ve not imposed so far) this Friday. US equities, USD and Gold’s immediate reaction suggests the base case is it is a bluff. Reading various US brokerages on the threat, most seemed to agree with the ‘bluff’ thesis too, with a view neither USA nor China, and that neither Trump nor Xi, want to let a deal fail given the economic and political damage of a failure at this stage. There was one exception to the ‘bluff’ thesis that noted – after contacting people known to them within the US administration’s trade team – that the US had become annoyed by China’s recent reversal on certain agreed points and remained stubborn over key issues such as subsidies to state-owned enterprises, technology transfers and its ‘Made in China’ industrial policies. The piece suggested that, rather than a bluff, the US was deadly serious, and this is a very real breakdown. We would not dismiss this alternative thesis out of hand. We have reiterated several times there was a material risk, about 30% to 40%, a deal would not happen in H1CY19 given the red lines for both countries and the political need for both Trump and Xi to satisfy domestic audiences. On top, in the US, there is clearly a view this is the US’s best opportunity to challenge China’s trade practices and require structural changes before it is too late.

On a medium basis, assuming the trade news works its way out, there are two more fundamental risks, to our cautious view. The first is that Q1 EPS results materially ‘beat’ lowered consensus, hence resulting in decent upgrades to earnings forecasts (ERR). ERRs have been falling for several months, with S&P 500 Q1 consensus cut by over 10% from levels forecasted at the end of September ’18, so it is of note that LGT thinks the ERR for S&P 500 ticked up since results started. S&P 500 has moved sideways since results began, with top-line numbers mostly below expectations, but strong results from the likes of Facebook and Microsoft helped US equities.

The second risk is that falling GDP forecasts stabilise, or even get revised upwards. Thus, it is of interest that Goldman Sachs (GS) have raised their US GDP forecast for ’19 and ’20 to 2.4% and 2.5% (GS rightly noted, if they were to be right, that this might suggest the Fed has become overly cautious). Likewise, sell-sides strategists are noting that China’s reflation is working, and both UBS and HSBC have revised forecasts up to 6.5% for ’19 from 6.2%. Separately, GS sees EU GDP stabilising in Q2 whilst UBS thinks Q1 numbers will surprise to the upside. Overall, GS thinks the global economy will recover from Q2 onwards and pick-up into H2. Should ERRs inflect positively and GS be correct about the imminent recovery in GDP, then equities will be able to ‘bridge across’ to a better H2 and the rally could continue, although it implies UST will sell off. Both Credit Suisse (CS) and UBS have increased their equity allocations last week for the reasons above.

However, the ’bridge’ argument is not our base case. We see a correction as quite possible and have some sympathy with a John Auters piece that argued markets have rebounded too quickly from the sell-off in Q4. He thinks that valuations are not supportive, that we are later in the economic cycle and that he thinks the next move will be to correct sharply again. John suggests markets are more like a boy on the slide and that he will slide down again once he gets to the top. We have completed – fast – a perfect slide to the bottom and then back to the top since September. We are more in the ‘slide’ camp than the bridge over to a better H2, but are well aware there’s a danger of underestimating the resilience of S&P 500 earnings and the strength of the US economy (and at the same time overestimating the same for Europe and Stoxx). The old adage, ‘Sell in May and go away’, might have more relevance this year again!

Given it is a 50/50 bet as to whether Trump is bluffing or not, it would be foolish to be buying into these moderate declines outside A-shares. We had deliberately built up cash levels across portfolios YTD and thus are decently defensively positioned. This month, as noted before, is quite perilous so acting too quickly is likely to be a mistake. For now, we will ride the volatility and not do too much.

Equities

• Shares in the US continued their steady climb into the midst of earnings season, with the S&P 500 (+3.93% MoM) and Nasdaq (+4.74% MoM) inching into all-time high territory, while the Dow Jones Industrial Average (DJIA) (+2.56% MoM) has come close despite having lagged YTD (Figure 1). This underperformance has been largely led by earnings’ disappointments in blue chips like 3M and Intel, but also as shares in index heavyweight Boeing suffered amidst uncertainty around the 737 MAX.

  

Figure 1 Total returns YTD of major US indices                                                                           Source: Bloomberg

• As of 3rd May, 78% of companies in the S&P 500 have reported earnings for 1Q19, 76% (above historical average) of which have reported aggregate earnings beat while 60% (mostly in-line with the historical average) reported a positive revenue surprise. So far this quarter, the index is tracking a -0.8% earnings decline which will mark the first YoY decline in earnings for the index since 2Q16.

• The key data release this month was a 1Q19 GDP surprise, coming in at +3.2% against estimates of a +2.3% increase, though this was mostly driven by ‘transitory’ factors related to trade and inventory which added an estimated 1% to the headline figure. Stripping these anomalies out might suggest a reading that was mostly in-line if not slightly lower-than-expected, although we would highlight that Q1 data has had a major problem with accuracy for years.

• US-China trade news will dictate the shorter-term outlook for the S&P 500. Our base case is that a deal will be struck as it is in the economic interest of both countries, and the political interests of both Trump and Xi, to do so. However, both sides have ‘red lines’ and there is a material chance, perhaps as high as 30-40%, a deal cannot be agreed upon, and that the US will impose 25% tariffs across all imports from China.

• Additionally, Trump must, by 18th May, decide whether to impose auto tariffs on global imports to the US. We think he might hold-off doing so to Japan as both countries are in talks, but it is highly probable Trump will impose tariffs on EU with Germany a notable target, although we think a resolution could be quite fast. In the event of a resurgence in trade tensions, the S&P 500 will prove relatively defensive.

• European equities followed their US counterparts higher in April but led by a steep recovery in Autos (+9.31% MoM), and sizeable gains in the Technology (+7.68% MoM), Banks (+7.54% MoM) and Industrials (+7.28% MoM) sectors. Defensives like Health Care (-1.90% MoM), Real Estate (-1.21%), Telcos (-0.64%) and Utilities (-0.34%) underperformed amidst the broader market rally.

Figure 2: Stoxx 600 Total returns against EU indices in April                                                        Source: Bloomberg

• Across indices in the region (Figure 2), the German DAX (+7.10% MoM) was a clear outperformer on a total return basis, followed by the French CAC 40 (+4.93% MoM) and while Spain’s IBEX (+4.56% MoM). Despite more confirmation around a Brexit delay and as tail risks of a ‘hard Brexit’ subsided, the FTSE 100 (+2.28% MoM) still underperformed quite significantly in April.

• After the ECB turned markedly more ‘dovish’ last month, helping fuel a rally in Stoxx and a weaker Euro, attention going forward will be on what action this might imply with some more bearish strategists anticipating ECB may have to resume QE before the year-end given a weak EU economy.

• Stoxx earnings revisions saw the strongest pick-up in the last week in over ten months and Q1FY19 might be the best quarter for results in two years. It remains to be seen if actual results confirm this recent optimism that appears at odds with very weak economic data – especially in exports and manufacturing.

• The hope is the weakness in the EU economy will be temporary and more a short-term cyclical downturn in manufacturing that is linked to trade disputes and that China’s reflation, with a three to six months lag, will show up in better EU data during Q2. However, if the US-China trade deal fails and the US imposes auto tariffs on EU, an industry which employs over 1mn people in Germany alone, it is possible EU could fall into a recession.

• In Asia (and amongst the bigger global indices), Japan’s Nikkei (+4.97% MoM) has been the quiet outperformer ahead of their ‘Golden Week’ holiday which ran from April 27th to May 6th, while the Shanghai Composite Index (-0.38% MoM) closed the month flat despite having pushed YTD highs over the course of this month (Figure 3).

Figure 3: Underperformance of A-shares in April                                                                          Source: Bloomberg

• ASEAN countries were also noticeably weak, and have been an underperformer so far this year, not least weighed down by continued strength in the US Dollar and relatively higher oil prices (Figure 4).

Figure 4: YTD underperformance of MSCI AC ASEAN Index                                                      Source: Bloomberg

•  With 40% of MSCI China and 100% of A-shares having reported Q1FY19 results, the weighted median company ‘beat’ was 8%+ and the best quarterly results since Q2FY18, although this follows-on from Q4FY18 where profits fell 44% YoY. These robust results will support Chinese equities as the market offering the best EPS growth of any major market this year at +11% and these may be revised up as tax cuts, boosting profitability and consumption, started on 1st May. Outside of China, early AXJ/EM results have been quite mixed and the bias overall is disappointing so far.

• May will be a key month for elections in Asia ex-Japan. We get results in Thailand on the 9th (there is a risk they are annulled), Philippines Senate elections, Indonesia by the 22nd – Jokowi is likely to win by 8-10% and that is positive for local equities – and India on 23rd. Of these, the Thai and Indian elections have binary implications for markets – the risk for India’s risk assets, and INR, is the BJP loses substantial ground (in UP it may lose 48 seats to end up with 30 of the 80 seats in the lower house) that it can only form a weak coalition government dependent on unreliable regional parties and that Modi is replaced as Prime Minister.

Fixed Income

• Sovereign rates were largely driven by economic data in April. A mixed bag of results over the month saw UST yields trade within a 20bps range throughout the period. However, the UST yield curve shifted upwards from the belly of the curve all the way to the long-end, thanks to support from strong manufacturing PMIs at the start of the month. Larger shifts were seen in the long-end, with the 10y and 30y yields rising 9.7bps and 11.4bps MoM respectively (Figure 5). This led to the yield curve steepening, with the 2y/10y spread rising from 14.3bps at the end of March to 23.6bps by the end of April. Similarly, the 5y/30y spread rose from 58.1bps to 65bps while the 3m/10y spread rose from 1.7bps to 8.5bps.

Figure 5: Upward shift in the yield curve in April                                                                           Source: Bloomberg

• European sovereign yields also received a boost at the start of the month after a stronger Chinese manufacturing PMI raised hopes that Europe will benefit from a stronger Chinese economy. However, mixed data thereafter led the Bunds yield to repeatedly test the 0% level through the month. There was only one instance of a significant break above the 0% level after better-than-expected economic data, but the yield failed to sustain the break and fell back towards the 0% level. Bunds yield ended the month 8.3bps higher MoM.

• US high-yield (HY) was the best performing FI sector. US HY debt gained 1.42% MoM in April amid a supply shortage. Issuance in April was at $17bn – the lowest YTD. According to Bloomberg, most deals were oversubscribed, by multiple times with almost all trading above the issue price. April also saw the first PIK offering, hence suggesting that investors might be beginning to be more open to riskier assets and possibly explaining why the CCC space (+2.03% MoM) was the best performing sector within US HY (Figure 6).

Figure 6: CCC outperforms all other HY sectors                                                                           Source: Bloomberg

• Trade tensions could well see 10y UST retest the YTD low and key resistance at 2.30% after breaking below the 2.50% support post-Trump’s tariff threats. Likewise, Bunds 10y yield might go back into negative territory – not least if the US imposes auto tariffs in next week or so.

• There are two major areas of concern in credit should a recession occur and default rates rise, with the first being the huge amount of debt (c$2.2trn) in the BBB space that accounts for 50% of total US IG outstandings. Some are speculating up to $1trn of this is vulnerable to being downgraded to junk that would be disruptive given existing HY FI outstandings of around $1trn. CLOs are the other area of rising concern given that the amount issued is similar to HY FI after huge new issuances in the last two years, but the danger is much of this is poorer quality paper (84% is covenant-light) by highly leveraged companies often (over 6x EBITDA). In contrast, HY FI credit fundamentals are improving as companies deleverage, reduce new issuance and use new debt to refinance more expensive, older debt.

• We continue to highlight, in contrast to the perception EM FI is riskier, that the better credit fundamentals of EM FI – be it sovereign or corporate credit – are being underestimated. EM has lower debt to GDP than DM while EM corporates are deleveraging faster than DM corporates. Debt servicing drivers are also stronger, and demographics are superior to DM where the latter face genuine risks of unsustainable fiscal deficits in the future from unviable pension obligations and entitlements and limited political will to tackle the unpopular choices to rectify the imbalances. We remain positive, structurally, on EM FI with our preferred exposures in shorter duration EM HY FI. We would not chase it should spreads fall further but are comfortable collecting the coupon.

FX

• Volatility in the G7 pairs recovered slightly in April due to AUD and GBP. The Fed continued to remain dovish however the dollar continued to display strength on the back of strong housing and employment data. The DXY traded to a 2-year high of 98.33 on the 26th April, breaking a resistance of 97.70 and is currently maintaining at this level. The biggest winners in April were EM currencies as investors were attracted to yields.

• At the beginning of May, the trade-spat spooked investors. This caused indices to dip lower and JPY to strengthen as investors looked for haven assets. April remained a quiet month except for this, along with AUD and GBP.

• EUR continued its long-term downtrend this month against a stronger USD as traders focused on disappointing industrial data from Germany and strong US consumer data. EUR ended April flat at -0.03%.

• Within a 52-week range, CFTC reports show the EUR remains the largest net short hold with JPY and CHF near their largest net short hold. MXN remains net long as investors seek returns from interest rates. 

Figure 7: CFTC 52W net-short positions

• DXY broke out above resistance at 97.50 to climb above 98 and a test of previous strong resistance at 100.50 was on the cards but recent events have seen it retrace back to 97.50 acting now as key support. The underlying trend for DXY remains up still and so a retest of 100.50 level remains the base case. We are USD ‘bulls’ until it is evident we should not be – not least because most other DM currencies all appear to be less liked be it housing crises weakening the CAD and AUD; weak data impacting EUR and JPY; political headwinds exist for several EM currencies.

• We expect the EU-wide election to be the next major test of the EUR hovering around key support at 1.12 as strong gains by anti-populist parties could see it break below 1.11 and possibly test stronger support in the 1.07-1.08 range. On a more positive note, should the UK Conservative and Labour parties reach a bipartisan deal on BREXIT a likely stronger GBP would boost EUR and reduce economic risks.

• Trade risks boost USD at the expense of EM/AXJ currencies, especially CNY, which has been rooted to around the 6.70 level for months but has now weakened and broke through a support at 6.75. However, the key support is the 200DMA at 6.86, which we expect to fail if a US-China deal falters or fails. A weaker CNY, arguably as important these days as USD for EM currencies, would pressure down AXJ/EM currencies at a time when many central banks, such as the Bank of Korea, are sounding more ‘dovish’ or acting as the Reserve Bank of India has.

Commodities

• Brent continued its momentum from March and gained +11.87% before topping off and ending April +7.72%. Brent returned some of its gains as it failed to breach a key technical resistance of $75, thanks to Trump’s tweet and claim that he demanded OPEC to lower their oil prices. Oil is currently held by the 200DMA acting as a support at 69.24. We currently see a few factors in play against oil falling lower, but continue to believe these biases are overshadowed by the massive rate of which US shale oil is being produced.

• We continue to expect Brent oil will trade in a range of $60-75/brl with upside capped by rapidly expanding US shale oil production and signs that Russia might be unwilling to follow Saudi Arabia’s line on OPEC+ quota discipline as it is wary of losing further market share and a slowing global economy. At the lower end, weaker prices would curtail some US shale output, while OPEC+ would become more sensitive to lower prices relative to higher numbers used to calculate fiscal budgets.

• Gold ended the month flat, developed extensively in its technicals. Following the strength of USD, Gold had a tumultuous period in April. The next support is found at 1,253 after breaking its support at 1,293. We continue to see dollar strength on the back of higher USD real yields and therefore we expect gold to weaken relatively. The next support for gold can be seen at its 200DMA, 1,253.

• On technicals, we see a head and shoulders variant of which the neckline, shown in red below (Figure 8), has recently broken. We believe that this trend will now act as a resistance.

Figure 8: Gold prices see a ‘head and shoulders’                                                                          Source: Bloomberg

• Gold has been in a downtrend since testing recent multi-year highs at $1,340/Oz but appears to have found support at the $1,270/Oz level and may well be buoyed by trade tensions in next few weeks. One prominent sell-side house forecasts it will be back at $1,340/Oz during Q2CY19 and go through $1,400/Oz in the medium term as USD weakens and UST yields fall. It has been quite clear, of late, Gold prices have closely moved, inversely, to moves in USD and UST yields YTD and we expect this to continue.