23 March 2018

Market declines: US LIBOR or US trade war?.

Headlines scream trade war while a surge in US LIBOR is tightening US financial conditions

It is very easy to point the finger at US trade sanctions against China as a reason for the recent declines in equity markets. The prospect of a near-term confrontation, in respect of access to markets and IP protection (a free competition zone perhaps rather than a free trade area), is clearly unhelpful for global equity sentiment. China’s transition from a catch-up nation to an economic competitor always had to be resolved at some stage. However the second dynamic at work during Q1 18 is a rapid rise in US LIBOR, over and above that of official US interest rates. This is tightening monetary conditions rather faster than policymakers may have intended.

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20 December 2017

Canaries in the monetary coal mine?.

High profile difficulties in a hot corporate debt market are intriguing

Steinhoff and HNA Group are from different regions and sectors. Yet they are making the headlines for the wrong reasons as the market raises questions over their debt sustainability. What these firms do have in common is that have pursued a policy of debt-financed acquisitions during this cycle. Now, LIBOR rates are pushing markedly higher. These signals of tightening credit bear watching in our view, even if they are presently not a cause for immediate alarm. It is however our important to be alert to early signs of a turn in credit availability. This is likely to first occur at the margin of the credit risk spectrum, as in 2007/8.

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14 December 2017

Market volatility unsustainably low as bonds and equities diverge.

Bonds and equities appear to be simultaneously pricing two scenarios – so why is volatility so low?

There is now a growing disconnect between low global government bond yields which appear to indicate that the global recovery of 2017 may prove transient and high equity market valuations which discount an extended period of strong profits growth. In addition, starting from Q1 17 there has been an astonishing and sustained decline in equity market volatility. While there is nothing which suggests a market regime change is imminent, we continue to believe that re-normalisation of monetary policy is likely to result in the re-normalisation of volatility, bond yields and equity valuations over the 2018-19 period. This is not in our view a good time to be seeking to maintain returns by increasing portfolio risk.

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9 October 2017

Economic data surprising to the upside in Q3.

Strong PMI indices add weight to the case for tighter monetary policy

While valuation concerns for equity markets remain in place, recent economic data in the US and eurozone also points to something of a mini-surge in economic momentum over the last 3 months. PMI data has been coming in ahead of expectations and economic surprise indices have turned higher in all regions. During 2017, investors have had to balance their longer-term valuation concerns with generally robust profits growth and improving economic sentiment. While soft data such as PMI indices should not significantly shift portfolio asset allocations, a hiccup before the end of the year is now looking less likely.

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12 September 2017

Interesting times for central bankers.

If growth is picking up, why are bond yields still so low?

It appears the low volatility/high valuation regime in equity and credit markets is continuing into the autumn. This is despite an important and imminent US Fed balance sheet reduction announcement. Furthermore, October brings details of the ECB’s plans to reduce the net purchases of its own QE program. While central bankers are quick to claim credit for any improvement in economic conditions, the decline in long-term bond yields over the summer questions the durability of the expansion as the yield curve flattens. It also remains to be seen if investors will re-appraise the low level of risk premia in global markets as QE is withdrawn.

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17 July 2017

Fed policy: Don’t forget your flip-flops.

US inflation and growth numbers undershoot expectations

It is just a few weeks since the US Fed raised interest rates and central bankers globally opined on a removal of monetary accommodation (albeit slowly) as the global recovery gathered momentum. Unfortunately, some inconvenient facts are already casting their shadow. The Atlanta Fed US GDP nowcast for Q2 17 has fallen to 2.4% from 4% at the start of June, with disappointing US retail sales contributing to the downgrade. Furthermore, core CPI has undershot expectations with the year-on-year figure now at 1.7% for June, compared to 2.3% at the start of the year. Fortunately for central banks, the holiday season has started and the focus may be elsewhere. However, some re-calibration of the trajectory of US monetary policy may already be necessary.

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29 June 2017

A tipping point as monetary policy shifts.

Central banks on both sides of the Atlantic appear to be becoming more hawkish

In recent weeks, policymakers at each of the US Federal Reserve, Bank of England and ECB have become notably more hawkish. This is a new development as throughout the period 2010-2017 central bank balance sheets have been steadily expanding as the quantitative easing (QE) baton was passed around the globe. With asset prices rising strongly over this period many commentators have been quick to infer that the end of QE signals market trouble ahead. While certainly a headwind, we believe investors should not rush to judgement. There remain many acts to play out in this story before it is finished.

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12 June 2017

Fed rate decision: One and done - or not done?.

One and not done would spook markets in our view

On Wednesday 14 June, we believe the US Fed is highly likely to raise the target range for the federal funds rate by a further 0.25%. We believe the opportunity the move policy rates further away from the zero “lower bound” will not easily be passed-up as US unemployment figures improve and as importantly without spooking markets, which have priced this move in. However, a signal of “one and done” for 2017 – or at least “one and wait and see” will be critical to keep markets buoyant. In addition, investors will be watching for benign comments in respect of any adjustments to the Fed’s balance sheet policy.

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16 March 2017

Just what the Fed wanted.

A rate increase and a rising market – but was it really dovish?

Having primed markets to fully expect a US rate increase, the FOMC followed through on the 15th March. If the aim was to deliver a rate increase without abruptly causing tighter financial conditions (code for declining equity and credit markets), then it was mission accomplished. Following the FOMC announcement the dollar eased against other currencies, bond yields fell and equity markets gained. However, despite comforting language within the statement we detected a more strategic, rather than data dependent, direction for US interest rates in the press conference Q&A.

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28 February 2017

Market indices riding on political outcomes.

Is now really the time to throw in the towel on active management?

When Trump addresses Congress this evening, global investors will be looking for more than promises. US equity investors are now waiting to price in the delivery of markedly higher US corporate profits. Market indices look expensive and thus the fortunes of passive investors seem unusually reliant on political outcomes; is it really the time to throw in the towel on active management?

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23 February 2017

FOMC minutes: Fairly soon = March or June?.

FOMC minutes highlight risk market will be caught offside by Fed in 2017

The most recent FOMC minutes suggest to us that March is a live meeting for the next US interest increase, in contrast to market expectations which imply a less than 20% probability of a hike. We believe the market continues to underestimate the resolve of the US Federal Reserve to use the opportunity of low unemployment and close to target inflation to re-normalize US interest rates.

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16 February 2017

C’est l’économie… French and German bond yields diverge.

It’s not the unlikely election of Le Pen, it’s the economy ...

The recent divergence between French and German government bond yields has been widely attributed to a possible victory for the anti-euro Marine Le Pen in the French presidential election. In our view this is not the whole story. The widening gap in terms of borrowing costs also mirrors the increasing economic divergence between France and Germany. Therefore, the increased risk premium for French government debt should be expected to persist, even after the election of a mainstream candidate, adding to pressure on the euro project.

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15 February 2017

Yellen’s hawkish testimony: Rate increases ahead.

The strong performance of asset prices in the post-2008 era remains in our view largely attributable to lower than expected growth rates being offset by much looser than expected monetary policy. However, as expressed recently by Bank of England Governor Mark Carney “..we’re coming to the last seconds of central bankers’ fifteen minutes of fame”. If, as we believe, central banks are in the early stages of stepping back from unconventional monetary policy this is likely to have significant implications for asset prices.

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3 February 2017

Implicit forward guidance on asset prices?.

Outside Japan, global inflation measures have over the last 8 months been rising as fast as at any time in the previous 25 years on a headline basis. The US Fed has kept real interest rates much lower for much longer than in previous cycles and the orthodoxy in central bank circles still appears to be that interest rates should stay accommodative in order to avoid the risk of deflation with rates still close to zero. Keeping rates low as inflation and growth accelerates may feel pleasant for now but also runs the risk of Fed Chair Yellen’s “nasty surprise”.

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9 January 2017

Valuations trump noisy narratives: increased caution on global equities.

Price/book valuations point to sub-par equity returns over the next 12m

Judging only by current equity market valuations, global equity investors are significantly more likely than usual to achieve only below average returns over the next 12 months, if prior correlations remain a guide to the future. Average price/book multiples for world equities are once again at peak levels, similar to those prevailing in 2007 and 2000, and this is reinforced by a similar picture for P/E ratios. We believe investors should factor in the possibility that broad equity market exposure may result in weak or negative returns and stock-pickers cannot rely on a tailwind of benign markets over the next 12m.

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14 November 2016

Forward guidance - Trump style.

These are strange times in global markets. Trump’s election, previously feared as a universal negative for global markets, has been accompanied by remarkable strength in risk assets. We highlighted investor positioning as a factor last week but now question if there is there more to this rally? Could Trump’s fiscal policies represent a “whatever it takes” moment?

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10 November 2016

Trump’s double surprise.

It is quite clear that in the days leading up to the U.S. Presidential election, both markets and surveys got it wrong. Traditional polling once again failed to spot the depth of support for radical political change. This was after all the U.S., which has delivered the strongest post-crisis economic performance of any developed nation. 

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4 November 2016

BOE: Bank on track.

Today’s BOE decision represents a correction in UK policy makers’ thinking. The sudden stop in activity which was implied by the Bank’s August stimulus package has not materialised and the focus has instead returned to significantly above-target inflation by 2018. This is going to be supportive of sterling, especially as consensus views on the exchange rate had become so negative.

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31 October 2016

BOE leadership: Carney’s conundrum.

Mark Carney’s testimony to the UK’s House of Lords economic affairs committee was notable both in regard to his personal intentions and the future interaction between fiscal and monetary policy. In respect of the former, his emphasis on personal circumstances in terms of whether he wished to serve a full 8 year term at times felt uncomfortably close to sounding as if he wished to spend more time with his family. Even if this may have been unintentional it has contributed to the speculation over his future.

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21 September 2016

Just don’t mention the yen.

Today’s “Comprehensive Assessment” by the Bank of Japan of its stimulus efforts has in our view underemphasised the role of the weaker yen in bringing Japan out of deflation. The data show a very strong link between lagged moves in USD/JPY and Japan’s core inflation rate, Exhibit 1. Moves in the yen over the last year indicate that Japan’s core CPI may once again be falling back towards zero which may induce the BOJ to engage in further stimulus efforts. However, we wonder if the lower bound on interest rates is not the only constraint central banks are now facing.

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1 September 2016

UK economy and corporate profits: Refusing to follow forecasts.

Since July, there have been over 250 UK corporate earnings reports or trading statements, which we have been tracking for any sign of Brexit-related weakness. Within these corporate filings we can find little evidence, in either outlook statements or in managements’ referendum commentary, to suggest a slowdown in trading is underway.

On the contrary, over 80% of company earnings reports indicate that trading is in-line with earlier expectations. Furthermore, 16% of companies report that trading is ahead of expectations against only 3% reporting that trading has fallen below expectations. In addition, recent data on house prices and manufacturing surveys seem to confirm that fears of a Brexit-induced slowdown in the UK have proved overblown, over the summer at least.

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28 August 2016

Equity valuations – party like it’s 1999… and 2007?.

Amidst something approaching a euphoric relief rally in global markets following the UK’s vote to leave the EU, investors should not overlook equity valuation metrics, which have historically provided an excellent guide to returns over the long term. As Exhibit 1 shows, relatively low valuations preceded the bull markets in 1994-1999, 2002-2007 and 2009-2013. However, valuation metrics rarely form part of a market narrative and if they feature at all are often dismissed, usually as “it’s different this time”.

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10 August 2016

Gilt shortage: It takes two to tango.

Yesterday’s failure by the Bank of England fully cover its bond purchase order indicates that the re-introduction of QE has created a significant squeeze in the UK’s bond market.  This auction failure highlights a possible constraint on the BOE’s QE policy, at least until a more expansive fiscal policy delivers a significant increase in the future supply of gilts or substitute securities.

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3 August 2016

BOE: All priced in and nowhere to go?.

Investors hoping for another “get out jail free” card from the Bank of England tomorrow are likely to be disappointed. Expectations for a cut in interest rates are close to 100% and the collapse in gilt yields since the UK’s referendum highlights the belief that UK rates are now set to remain low for much of the next decade.

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22 July 2016

UK earnings trends - stable and few surprises.

There has been much speculation in regard to the economic and market impact of the UK’s vote to exit the EU. However, even four weeks after the date of the referendum, there is no hard data to rely on. In the circumstances, survey data may also be misleading, with the risk that it reflects a projection of the personal views of respondents rather than a cold analysis of future prospects.  However, early indications are that 2016 UK consensus earnings forecasts have remained stable, a continuation of the trend seen since February.

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21 June 2016

Brexit, Fed: a short squeeze.

If in the short-run the market is a voting machine, as attributed to value investor Benjamin Graham, yesterday’s 3% rise in European markets represents a vote of confidence in the Remain campaign winning the UK’s referendum on Thursday and a consistently more dovish US Fed for the remainder of the summer.

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13 June 2016

Fed boxed in by yield curve.

It is looking increasingly likely the US Federal Reserve has missed its chance to engage in a meaningful interest rate tightening cycle. Globally, 10-year government bond yields have fallen sharply – in many cases to new record lows, in part due to the recent US jobs data and in part the increasing uncertainty over Brexit. This flattening of the yield curve is a strong indicator for a period of sub-par US growth, even if survey data has, for now, improved somewhat during Q2. Whether or not we are looking at a technical US recession is perhaps, technical, as in any case a period of even weak growth is inconsistent with positive surprises for corporate profits and equities.

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17 March 2016

Was there a “plaza” accord after all?.

Yesterday’s FOMC statement and Yellen’s press comments were unequivocally more dovish than the markets and we were expecting. Going into the meeting there was a reasonable case for preparing the markets for a rate increase in early summer, given declining unemployment and increasing US core CPI. As it turned out, external factors – perhaps a euphemism for undesirable moves in global markets and the US dollar – were in contrast almost overplayed. For us, “Peak fear” was last month’s story, so why bring it up now?

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10 March 2016

ECB - Using the bazooka.

With survey data pointing to a marked slowdown in the eurozone manufacturing sector, Exhibit 1; forward inflation expectations at 1.4% significantly lower than at December’s meeting; and a cut in the ECB’s projections for economic growth from 1.7% to 1.4% for 2016, anything other than a forceful response would have been received very poorly by markets. This would in our view also have been tantamount to a policy error. But unlike December, this time markets got what they wished for – an increase in the size and composition of eurozone QE.

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RSS - Strategic Insight
Sector report cover
*Multiple Sectors
26/04/2018
Equity strategy and market outlook - April 2018

In this month’s strategy piece, Alastair George believes that with output gaps closed future monetary and wage growth developments offer only headwinds, both for markets and levels of corporate profitability over coming quarters. Uncertainty in respect of US trade policy risks a chilling of corporate optimism, leading to a shortfall in business investment and short-term economic momentum even if the probability of an all-out trade war remains remote. After the modest falls from the market highs recorded in January, global equities remain expensive compared to historical valuation levels, according to our estimates. Record profit margins also face risks from developments in trade policy and tightening labour markets. With Fed policy clearly remaining on a tightening track, we stick with our cautious view on global equity markets.

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