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Weekly – Investment Adviser 29 August

PERFORMANCES 2019

Equities Bonds
MSCI World +12.1% CHF Corp +4.3%
S&P 500 +15.2% US Govt +8.8%
Stoxx 600 +10.4% US Corp +14.2%
Nikkeï +2.1% US HY +10.8%
SPI +20.9% EUR Gvt +10.5%
China +26.1% EUR Corp +8.1%
Emerging +0.0% EUR HY +7.7%
Currencies Commodities
USD index +2.1% Gold +20.5%
EURUSD -3.3% Silver +19.3%
EURCHF -3.5% Oil (Brent) +11.6%
USDCHF -0.1% CRB index +0.8%
USDJPY -3.4%
EM FX +4.0%

(Much) easier said than done…

Big gobs with short memories

Remember the raging debate in 2018 between the supply-side and other school of thoughts’ economists? For the former, the new Tax reform would improve the structure of the economy, by reviving the moribund capex cycle. Lower corporate taxes and other incentives would fuel a multiplier effect, hence sustainably higher growth – over 3% – for multiple years. That was wonderful in theory, but it proved much less so in practice. The 2019 data on capex have been dire, even in the segment of real estate, which should have benefitted from the dramatic fall of interest rates. Jobs repatriation to the US was supposed to be another collateral – though indirect – benefit from the reform. It is also, de facto, proving illusionary. US manufacturing is on the verge of recession, just one or two quarters after Europe, Japan (and China).

The results of US companies in Q2 have been impacted by rising costs and a slower demand. Their guidance is also very prudent. The odds of a new fiscal stimulus, with a Republican Senate and a Democratic House, are about nil. A dramatic collapse of the USD is also unlikely, in the absence of US interventions in the currency market.
UK, as a country, is divided as it has never been for decades, if not centuries. Growth is fading fast, investment is collapsing, and the very weak Pound is confusing monetary policy. ¨BoJo¨, despite his very confident rhetoric, has little chance to engineer a breakthrough before end of October.

The unrealistic promises of both Trump and B. Johnson are facing days of reckoning

 

Did Trump play his cards prematurely ?

US is losing edge in its showdown with China, with Trump’s multiplying U-turns. He is giving signs of impatience and tactical fatigue. China’s calm, gradual weakening of the Yuan and the acceleration of domestic fiscal and liquidity supports are putting Xi in a relatively more comfortable position.

Additional tariffs will raise consumer prices, by the way confirming that the US is far from immune to trade war. US farmers are angry because of falling income and tighter credit conditions. The conjunction of last spring heavy flooding and of unsold crops due to the trade war with China have created huge frustration. For example, corn prices lately experienced their sharpest fall in the last three years. The US department of agriculture had to pull all its staff from an annual US Farmers’ Tour because of violence threats made by farmers…

US Administration is getting growingly cornered, when it comes to stimulating growth. Lower policy rates are barely warranted by the current economic wealth and the constant bashing of the Fed finally provoked market’s anxiety.

The latest US polls are featuring a visible decline of Trump and of Republicans
Tories are also in bad shape in the UK
With growing China and EU resilience, status-quo is not an option for Trump and BoJo

  • A global recession will most probably occur next year, absent major U-turns by Anglo-Saxon populists’ leaders
  • Stay globally cautious, when investing in financial markets
  • We have a tactical GBP exposure

 

Currencies. China liberalization, really…

China announced the liberalization of its interest rate system on August 17th. The PBoC reforms the formation mechanism for its market-based Loan Prime Rate (LPR). The merger, or alignment, of the two interest rates – market rates and lending/deposit rates – should solve the longest flagged weakness of the Chinese system. The authorities probably see an urgency to improve the transmission mechanism from easier monetary policy into loans and economic activities as they are implementing measures.

The first 1-year LPR based on the new formation mechanism came in at 4.25%, i.e. a timid 6 bps cut. This should not materially move the market near-term. Still, it marks the start of the new formation mechanism. Going forward, if the PBoC adjusts open market operation rates – the medium-term lending facility rate – the transmission will be more effective. This may precisely increase the incentives for the PBoC to adjust rates.

With external headwinds and domestic needs to enhance credit activities, a continued easing from the PBOC to support growth is likely. A combination of both interest rate and quantitative measures are needed to help channel credit to productive areas. This takes it one step closer to a free-floating currency. Of course, progress will be slow.

Since then, Chinese authorities have retaliated. China has just announced it will impose 5% to 10% tariffs on $75 bn of goods along with resuming the 25% duty on US automobiles and auto parts from September 1st and December 15th. China did not immediately react to the latest 10% US tariffs on $300 bn goods and Trump’s unexpected tariff delays. Even though China’s tariffs are smaller than the US ones, this is not a big surprise. But nevertheless, a reminder that the trade war is alive and kicking. When China announces the first US names on its unreliable entities list, it will draw headlines and be negative for them. If China aims for companies that match the size and importance of Huawei, it will be big names. We still see very little sign of progress in the communication between the two sides.

The Yuan slides to a fresh 11-year low and the trade-weighted CNY basket dropped to the lowest level since 2014. This depreciation reflects the concern over the Chinese economy as the trade war drags on. While the renminbi is weakening it is not in a free fall. The PBoC will watch it closely and probably intervene if the depreciation accelerates. So far, it continues to set the daily fixing at a stronger level than the closing rate the day before using its countercyclical factor to signal it does not wish a too strong decline.

With the new system in place, the road is paved to ease monetary policy by guiding lending rates lower. The PBoC has had success in pushing government bond yields and money market rates lower, but not the lending rates to the real economy. The goal of the reform is to improve the transmission mechanism and lower further yields if needed.

  • Lower interest rate will not influence the USD/CNY
  • The USD/CNY will stay guided by the PBoC daily fixing
  • If PBoC eases its monetary policy, long-end yield will follow

Equities. One of the engines of the US stock market weakens

Share buybacks are slowing in the United States, which could increase volatility. The S&P 500 companies repurchased $166 billion in 2Q19 compared to $205.8 billion in 1Q19, the lowest amount since 4Q17.

A sign that companies are getting nervous about the trade war with China, the deceleration of profit growth and uncertainties about the Fed’s monetary policy. They will again favor liquidity.

Stock repurchases have been a powerful driver of the rise in stock market indices. Since 2013, according to Bank of America Merrill Lynch / EPFR Global Data, US companies have bought $4’200 billion of shares, whereas investors were not enthusiastic because the net outflows from funds / ETFs invested US stocks were $84 billion. Stock repurchases had accelerated in 2018 thanks to the tax reform.

The technology sector, which was a major contributor to stock buyback programs, slowed significantly in 2Q19, such as Apple, Oracle and Cisco.

But these share buyback programs also face strong opposition from the Democratic 2020-presidential candidates, wishing to restrict them to favor wages instead of shareholders. Republican Senator Marco Rubio has proposed less favorable taxation for investors when a company buys back its shares.

  • The slowdown in share buybacks should be confirmed in the second half of 2019

 

 

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