WEEKLY – Investment Adviser 15 August
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High Frequency Noise
Troubled waters ahead for entrepreneurs
This is not new, global geopolitics has been particularly complex and potentially explosive in the past couple of years. In order to remove the often-seen bias judgment, we sometimes use – and refer in our publications – to the Geopolitical Risk Index GPR. This highly regarded index counts the occurrence of words related to geopolitical tensions in leading international newspapers. No surprise, it is still flying higher than in past years / decades.
But other sources of uncertainty, i.e. economic ones, have also emerged lately. Hard Brexit, Trade / Currency war, snap Italian elections, central bank’s independence, etc. There also exist an interesting index capturing it. Interestingly, it encompasses both developed and emerging countries since 1996. It relies on the Economist Intelligence Unit report, a leading firm in the field of country intelligence. It namely proved valuable in gauging the level of ¨heat / stress¨ that private sector / firms actually feel. In this respect, this is in interesting advanced indicator for investment / capex decisions.
According to Ned Davis Research, policy uncertainty has played an increasingly larger role in macroeconomic and investment performance. Indeed, elevated uncertainty has historically been correlated to sustained global economic decelerations and sub-par equity market performance.
Populist leaders – à la Trump, B. Johnson or M. Salvini – have markedly increased the actual political and economic ¨noise¨. Recurring tensions between the US and China too. The three of them are actually entering electoral campaigns. Odds are significant that they will rather radicalize their messages and actions, in order to galvanize their voters’ base. The latest prints of the GEPUI index – at around 300 – are clearly breaking-out out of its historic range. It is hard to imagine how it could recede in the coming months. The debate over ¨QE for the people¨, a Green New Deal, dismantling Maastricht treaty rules, MMT has just started. It probably needs a crisis to accelerate… This may reverse the current gloom and improve sentiment.
We are entering a High Frequency Noise period
Entrepreneurs will remain reluctant to set constructive medium-term plans / strategy
Global prudence, investment restraint, cost controls will continue to dominate
Capex, trade will remain very weak in the foreseeable future
- The ongoing deceleration of world economy will continue for some more months at least
- Markets need much bolder action than more accommodative monetary policy to regain confidence and resume their uptrend
- We reiterate our cautious asset allocation view: stay underweight risky assets
Currencies. A world of easing
The world has already started a major easing cycle. Dozens of central banks have already acted. Some countries cut rates to push down their currencies, other become obliged to do the same because their relative monetary policy stances became by the way too tight.
So far this year, more than 40 central banks around the world have already cut their key rates, cut bank reserve requirements, or both. This includes major economies like the US, China, India, Russia, Brazil, South Korea, and Australia. The ECB is expected to cut rates in September. Only 6 countries have raised rates, with Norway and Pakistan being the most notable economies to do so.
Only last week, 4 central banks have cut rates, mainly in the APAC region. The RBNZ move was the most surprising as no-one was expecting an easing of 50 bps. Exceeding market expectations of a 25 bps cut, the RBI decided to provide even more of a boost to the economy with a 35 bps cut. The Bank of Thailand and Philippines delivered both a 25 bps cut. It was probably the only moves that were fully justified.
- Such a synchronized global easing cycle is unusual
- Monetary policies will be less of an important currency market driver in H2
Fixed income. A bond bubble moment
The past few weeks have been quite hectic, with yields dipping even deeper amid equity market corrections. The German 10-year Bund yield reached -0.6%, all the German bonds, including the 30-year, are trading in negative territory and the US 30-year yielding is nearing all-time lows.
Government bond yields reflect the price of uncertainty. Even in Japan, after 2 lost decades, and the largest central bank balance sheet, long-end yields have never reached negative territory. The 30-year JGB reached a low point at 0.09% in 2016 and is currently trading at 0.22%.
These are stressful times. There is no time for waffling or for nuanced arguments. Confidence in central banks is nil. There are serious doubts about whether central banks can restore confidence or reflate.
Roughly $15 trn of debt have sub-zero yields, and investor appetite shows no sign of abating. In Austria, the 100-year government bond due next century (2117) is now trading at almost twice its face value.
While we have become accustomed to low and falling volatility in the bond markets in recent years, the great uncertainty about the economy, risk appetite and monetary policies indicates we could see bigger fluctuations for the remainder of 2019.
Based on data compilated by Consensus Inc., 73% of investors chase bonds. This is corroborated by the American Association of Individual Investors bullish sentiment on equities, which has just reached its lowest level since mid-2016, just before the Trump election. Furthermore, technical indicators, like the RSI, are highlighting that the US bonds are overbought. Historically, buying bonds when they are so loved is a complete and utter disaster.
The Fed is worried about deflation. So, is it time to worry about inflation, even more when inflation fears have never been so low over the last decade? The upcoming Jackson Hole symposium, on August 22nd to 24th, might be key.
Germany is considering ditching its long-cherished balanced budget policy to help finance a costly climate protection program with new debt. US inflation expectations are close to their lows. Investors are no longer expecting a trade deal agreement between the US and China. A lot of bad news are priced in.
- Yield cautiousness prevails
- A tactical US yield pull back is probable
Equities. Negative factors are accelerating
- The probability of a hard Brexit increases.
- Matteo Salvini blew up the government coalition.
- Fears of a Chinese intervention in Hong Kong are increasing.
- Tensions between India and Pakistan are coming back because of Kashmir.
- Donald Trump no longer wants a trade deal with China for the moment and announces a total embargo on Huawei.
- China will no longer buy US agricultural products.
- Japan takes South Korea out of its “white list”.
And all this during last week. Even if the results of the 2nd quarter are better than expected, we fear that the 2019 results will eventually contract. What we did not anticipate at the beginning of the year. With more volatility on currencies, stock markets could converge with the real economy. Stock indexes do not rise (never) in recessionary periods of profits.
Last week, the tech sector has plunged with the hardening of the US war on Huawei, European banks have suffered from the Italian political turmoil and mining companies have fallen due to a lack of trade agreement between the US and China.
In 2019, the Technology, Communications and Discretionary sectors still offered the best performances, but since May, marking the beginning of harder negotiations between Americans and Chinese and the embargo on Huawei, Healthcare, Utilities and Staples sectors have outperformed. This trend is expected to continue in the second half of the year.
In the current geopolitical environment, the defense sector remains interesting to invest; however, for many institutional investors and fund managers, it is difficult, if not impossible, to buy companies active in military equipment because of regulatory constraints (Oslo agreement) from custodian banks / fund management companies.
Should the situation deteriorate in Hong Kong, it could have a negative impact on Asian trade, as well as its financial and stock marketplace.
Gold and gold companies remain an excellent investment alternative, even if the gold ounce is technically overbought in the short term. The flows into ETFs invested in precious metals amounted to $9.7 billion in June, the largest amount since 2016.
- Focus on defensive companies which are immune to tariffs war like Nestlé, Mondelez, Disney, Novartis, Procter & Gamble, McDonald’s, Pernod-Ricard
- Buy physical gold (hedged USD) or / and Newmont Goldcorp / Barrick Gold
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