Weekly – Investment Adviser – 22 March 2019
|MSCI World||+12.1%||CHF Corp||+1.2%|
|S&P 500||+12.7%||US Govt||+1.2%|
|Stoxx 600||+12.6%||US Corp||+3.9%|
|China||+27.4%||EUR High yield||+4.6%|
A significant reversal
Trump’s ¨Victory¨ became Kim’s triumph
The vain US President boasted in the aftermath of the 2018 Singapore summit. He mentioned several achievements: end of North-Korea missiles tests, a gradual dismantling of Pyongyang’s weapons’ programs and a tentative denuclearization of the Korean Peninsula, in the medium-term. In practice, Donald’s June 13th tweet mentioned that “There is no longer a Nuclear Threat from North-Korea”. This proved one more Donald nonsense. In the real world, Kim defiance barely disappeared, civil and military nuclear efforts continued almost in broad daylight. North-Korea trade on China border re-accelerated markedly.
The US reduced its military presence and pressure in the Korea Peninsula and forced its ally, South-Korea, into a trade advantageous agreement. Economic sanctions were actually loosened. Anecdotally, several African governments – namely Egypt – finally refrained from scaling-back buying arms and doing business with Pyongyang!
Kim proved excellent in Public Relations. He brilliantly restored his image and that of his country US efforts to isolate North-Korea totally failed. US has now fewer options to achieve for it
China under-performance vs. the US ended-up in Fall 2018
MSCI pleased China – and implicitly its governance – when it decided very recently to significantly multiply the weight of the country in its famous (emerging markets) indices. This may indeed explain – in part – the sudden coming-back of A-shares over past months, courtesy of smart investors attempting to anticipate inevitable inflows from index trackers. But this does barely explain for the recovery of the – more internationally invested – H-shares. The Yuan has rebounded significantly against the USD over past couple of months, despite a still deceiving current macro picture of China. Markets seem willing to look beyond the valley and bet on Chinese reflation.
The epicenter of the equity and credit markets correction in Q4 was in the US, despite the country recent outstanding growth, corporate profits, employment and inflation. Looking carefully at other things, US trade deficit is… climbing, US farmers are experiencing unprecedented bankruptcies and real estate is seriously weakening. The Congress is no longer looking friendly to the Administration. Markets now discount benign / ¨return to the mean¨ perspectives for the US economy and markets.
For sure, Donald is going to face severe personal headwinds in 2019…
… but the US momentum and leadership peaked in 2018
North-Korea, trade war, oil, US deficit re-financing are various parts of one same problematic
Asian people pay close attention to symbols and images. Everybody noticed that Kim celebrated his 35th birthday in China, when visiting Xi, ahead of Hanoi one-to-one with Donald. On a relative basis, foreign central banks buy less USD and foreign investors are less keen on buying US Treasury.
Trump desperately needs a victory, a true one actually. He may ultimately renounce to tariffs (which is good news for global economy) in exchange of significant Chinese trade and capital inflows. This would ultimately reinforce China, while not prevent – later – a dramatic confrontation on structural issues like security, intellectual property, technology transfer, telecommunications, etc. Before that, USD reserve status might come under renewed attacks, not only from China, but potentially from other countries, including allies. Attacking Europe across the Board, with tariffs, might well be the ultimate over-reach / trigger.
A trade deal would be good – short-term – for the global economy
But, absent a much more comprehensive accord, it would resemble a US ¨capitulation¨ and prove just a temporary truce
- Many things are slipping away from US control, not for the better
- Enjoy markets’ ride for now, but stay vigilant: sovereign bond markets and Gold spell skepticism about future developments
- Despite recent rise of risky assets, the global investment regime remains complex and sensitive
Fixed income. Local EM bonds remain a pocket of value and diversification
In the first weeks of the year, looser global financial conditions and growing optimism about US-China trade negotiations have supported gains in EM local currency fixed income assets. Slowing global growth, however, represents an increasing challenge to those currencies, where recent performances have been surprisingly lacklustre.
Among the high-yielding EM currencies, for example, since early February carry returns have been more than offset by currency weakness in many cases. This may reflect already-long investors positioning or still-subdued EM growth prospects.
Inflows into EM dedicated debt funds were particularly strong in January and February. Despite a general slowdown in emerging economic data, as illustrated by the Economic Surprise Index deterioration, which is back to its 2018 lows, inflows have been significant.
China credit indicators have shown some early signs of stabilization, indicating that Chinese growth may be closer to the bottom. But the probability of a strong growth rebound remains low, especially given the reduced official growth target of 6.0-6.5%.
We are about to enter an intensive election period for emerging countries, particularly in Asia. Elections are scheduled in Thailand and Ukraine until month-end, in India and Indonesia in April, and in South-Africa and the Philippines in May. Local elections in Turkey in late-June complete the series. Thailand and Turkey will be under particular scrutiny, with incumbents expected to prevail elsewhere.
The risk backdrop has become a tad more challenging in recent weeks with the global central banks dovishness seemingly raising risks rather than opportunities at this stage. However, we continue to argue that EM opportunities still exist. A slow growth, low inflation and extra yield is the most attractive landscape to favor EM bonds.
At the exception of Turkey, India and Mexico – which represent together 12% of the Emerging currency local bond market – the other countries are offering higher prima in nominal and real terms than the US and other developed economies.
Furthermore, the correlation with core holding securities like US Treasury bonds is back to its past decade lowest levels, making EM local currency bonds an attractive bond portfolio diversifier.
- Emerging local currency bond extra yield, i.e. valuation, is still attractive
- It remains a good portfolio diversifier
Currencies. EUR/CHF is capped in a tight range
The next SNB meeting is on March 25th. Given the recent ECB Euro Area growth and inflation downward revisions, it looks unlikely that the SNB will revise up its growth forecasts and amend its wording. Even if the latest CPI data have slightly surprised to the upside at a modest 0.6% on annual basis.
For months now, the EUR/CHF is locked into a small range between 1.12 and 1.15. Even when market volatility spiked in S2 2018, the EUR/CHF remained stuck. Lately, its trading range has tightened again.
In real terms, the CHF does not look particularly expensive and the scope for material FX intervention by the SNB remains limited.
The SNB balance sheet remains the largest amongst developed countries at 118% of the GDP (or CHF 827bn). It has to be compared with 102% for the BoJ, 40% for the ECB, 23% for the BoE and only 19% for the Fed. This policy inertia is unlikely to change, eliminating a potential CHF-led impulse for a much higher EUR/CHF.
Any renewed deterioration in global risk sentiment, amid European elections, would lead to CHF outperformance.
Bets on weaker safe-haven currencies, namely JPY and CHF, have resumed this year in the wake of the risk-on stance return. However, the CHF positioning adjustment is lagging.
- Still some room for CHF positioning adjustment
- CHF weakness remains our central scenario. Wait for a breakup of the 1.14 upper hand range limit to reload the position
Equities. Could the S&P 500 recover up to its highest point?
The S&P 500 is on its resistance of 2’820 points; a break up would tentatively signal a return to the historical high at 2’930 points, an increase of 4%. The Brexit chaos, the new fight between the Trump Administration and the Congress on the national emergency law necessary for the construction of the “wall”, the technological war between the US and China and the endless history of an expected trade agreement between the United States and China does not really disturb the US stock market, nor the others elsewhere. Boeing’s failure could complicate trade negotiations between the US and China over Chinese imports of US goods: Chinese airlines and leasing companies are the largest orders, apart the US, of 737 Max.
The return of the Fed and the ECB to an accommodating and cautious tone is certainly a factor of support. However, for the S&P 500 to go higher, the economy has to continue to grow, even at a small pace, and also for earnings. Recently, US economic numbers were weak, but some data is starting to improve, such as in services, consumer durables or real estate. The rise in other risky assets, oil, copper, credit/HY, suggests that investors remain confident in economic growth. Bonds and gold give a more cautious message.
At the micro level, downward revisions in profit growth have stopped for a month. The end of the first quarter of 2019 is approaching, while Factset estimates a decline in profits of 3.6% and Lipper Refinitiv a decline of 1.3%. The strongest negative contributions will be Energy, Materials and Technology. In the 2nd quarter, the profits should again grow.
Senator Elizabeth Warren continues her crusade against the big tech companies, targeting Amazon, Facebook and Google in particular, and promises to dismantle them , if she becomes president of the United States, to promote more competition.
Should corporate results for Q1 19 surprise positively , the S&P 500 should return to its historic high. The participation rate was low during the rally for the first three months of 2019 and investors would be tempted to reduce their significant liquidity.
- Ongoing stock indices consolidation is favourable in the short term
- It might pave the way for a re-test of old highs, would fundamentals call for it
Equities. Boeing in turmoil
The Maneuvering Characteristics Augmentation System (MCAS) of the 737 Max 8 and 9 is in question. Before and after the 2 accidents of Lions Air and Ethiopian Airlines, several American pilots had reported a malfunction of this device. Boeing will install a fix in the next 2-3 weeks.
The 737 Max is the plane that has known / knows the biggest success, with 5,000 planes on order. According to analysts, the 737 Max should account for 30% of Boeing’s revenues and 40% of profits in 2020 when the 737 Max goes into full production. The total bill is difficult to determine, but of the 385 units in circulation, it is estimated at $2-3 billion, including compensation to airlines, and even $5 billion for some analysts. Air Canada, one of the companies most affected by this grounding, has announced a significant impact on its results in 2019. The cost will also depend on the duration of the grounding. But on the financial side, this serious crisis is manageable for Boeing, which generated operating cash flow of $15 billion in 2018 and free cash flow of $13.6 billion.
In terms of safety, the two accidents are major for Boeing, but it does not call into question the 737 Max program. In the single-aisle segment, there are only two manufacturers, Boeing and Airbus. There is also the Chinese Comac C919, but this plane is not yet on the market because of delays and orders come exclusively from Chinese companies. On the reliability of the 737 Max, Boeing will have to convince the regulator, airlines and end customers, those who board the plane. Once the problem is resolved, it is not certain that the Federal Aviation Administration (FAA) and the other regulators will immediately stop the grounding.
Boeing and the FAA seem to have been very complacent with the 737 Max allowing it to fly while pilots were not trained with the new software. The FAA’s strong reputation took a hit, while it was Donald Trump himself who gave the grounding order of the 737 Max.
The Boeing share price has fallen 11% since March 11th. The grounding could last between 3 weeks (the most likely scenario) and 2 months. The single-aisle segment is of major importance for both Boeing and Airbus as well as for the airlines.
We are starting to buy Boeing with a valuation of $450 per share
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