Weekly – Investment Adviser 9 May 2019
|MSCI World||+13.2%||CHF Corp||+1.8%|
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|Emerging||+8.8%||EUR High yield||+5.3%|
Underlying market mechanisms
Traditional finance, based on the assumption of market efficiency and statistical optimisation, suggests that mathematics is closely linked to market trends. In practice however, there is evidence that successful investments also require different expertise and skills. Indeed, markets are significantly influenced by human psychology, risk aversion, “greed”, and “fear” amongst others.
“Behavioural ﬁnance has emerged as a new research ﬁeld in ﬁnance applying psychology to ﬁnancial decision making and ﬁnancial markets… behavioural ﬁnance has successfully addressed several observed anomalies concerning investors’ behaviour and asset prices”.
University of St.Gallen, 2012
The ever-increasing impact of social media on many aspects of our lives is a self-evident truth. The FOMO (“fear of missing out”) concept illustrates the “social anxiety” that comes from the continuous and real-time monitoring of other people’s life on social networks. Of course, these social media influence our investment process. The financial version of FOMO is the frustration that arises from lost opportunities, when one decides not to invest (staying in cash).
Admittedly, this phenomenon is more widespread in the United States (and possibly in China/South Korea), where the investment culture (in equities) is much more rooted. This has led to the development of “social equity trading platforms” in recent years with the famous dedicated websites such as e-Toro, ZuluTrade, Naga-Trader, etc. These sites make it possible to for inexperienced savers to copy the portfolios of famous investors and compete in ingenuity to encourage trading on the stock market!
US private investors, who had been heavily underweight since the terrible financial crisis of 2009, finally returned en masse to the equity markets in 2018, just before the two corrections in the first and fourth quarters. After these two painful episodes, they again left the stock markets in early 2019 and are now desperately watching the recent rebound…
US retail investors paid a heavy tribute to the FoMO syndrome in 2018
Institutional investors are not immune
According to the latest statistics, the majority of professional investors (pension funds, large fund managers, etc.) have reduced risk and have been underweight since December/January. They are still so today. As a result, only a marginal group of agile professional investors have benefited from the recent asset recovery. Among institutional investors, the Hedge Funds also missed the boat and kept their exposure (say their beta) well below normal levels.
When such underperformance lasts more than a quarter, another form of FOMO syndrome takes place. This one is linked to commercial factors and career risk. Indeed, the underperforming customers redeem from underperforming (and “failing”) funds. Fund managers coming late subsequently come under pressure from their hierarchy and ultimately risk being fired if it lasts too long.
Preconditions are in place for the return of underweight institutions to risky assets.
Too much of a good thing makes you sick
The alert for economic growth is over. Indeed, US GDP in Q1 was reassuring, China is recovering and the very first signs of a European turnaround have recently appeared. Therefore, in terms of sectoral performance, the theme of “reflation” (re)-begins to dominate….
China and the US appear to be on the verge of signing a trade agreement. If China – at least on the surface – makes significant concessions, one could even imagine that Trump would enter into positive talks with Europe and Japan.
Such an improvement in visibility would fuel an additional rebound in risky assets
Underweight institutions would have no choice but to re-enter markets massively
- It will be necessary to keep a cool head if the scenario of a boom in risky assets is confirmed in Q2
- If history is any guide, such sirens’ call should rather be used to reduce risks and take profits
Bond. The Fed is no longer on autopilot
There was no real surprise from the Fed. The FOMC unanimously upheld its unchanged range at 2.25 – 2.5%. The press conference highlighted the willingness to be patient despite Trump’s ongoing demands for an immediate rate cut. The general tone was optimistic and this certainly does not mean an inclination to reduce interest rates anytime soon. The Fed appeared somewhat more constructive on growth. Economic activity has been growing at a steady pace since March. However, the FOMC highlighted the slowdown in household spending and fixed business investment in Q1, which needs to be monitored.
The Fed does not seem to be concerned about inflation, although its preferred measure of core inflation, the PCE index, fell from 1.8% in January to 1.7% in February and then to 1.6% in March. However, during the press conference Powell seemed confident that this was due to transitional factor and that, thanks to the tightening of the labour market, inflation would return to the 2% target in the medium term. In addition, some of the risks that existed a few months ago (trade negotiations between the United States and China, a messy Brexit, etc.) have since eased according to the Fed.
The Fed also announced a change to the interest rate paid on reserves, lowering it by 5 bps to 2.35%, in order to keep the effective Fed Funds’ rate within its range. However, this is only a technical adjustment and should not be seen in any way as a policy easing.
The bond market continues to believe that growth and inflation will remain low and that the Fed will have to lower its rates later this year. However, improved financial conditions – lower borrowing costs, higher equity prices, a stable USD – should also support growth.
Rising labour costs could be passed on to consumers, much like higher energy prices. Gasoline prices have jumped 30% since mid-January, which will soon translate into higher transportation costs.
- Given the improvement in financial conditions, we see little reason for the Fed to lower its rates
Currencies. Too much bad news priced in the AUD
Despite some weak statistics, there are still some premises for a recovery. South Korean export growth picked up more than expected in April and seems to be beginning to corroborate the recovery observed since the beginning of the year in the semiconductor sector. The growth of exports in South Korea indicates a recovery in the growth of world trade. In addition, Asian PMIs further improved in April.
Given the recent weak data in Australia, the market is already expecting nearly 2 rate cuts this year. Low inflation in Australia is mainly a delayed consequence of the tightening of financial conditions in Asia in 2018.
The softer financial conditions seen throughout 2019 heralds a rebound in inflation. Inflation in Q2 will therefore be higher than in Q1. Thus, a revision of the current dovish market vision could support the AUD.
- If the sentiment continues to improve, this will be good news for the AUD/USD.
Equities. A USD 2 trillion spending plan for the US infrastructure?
The Democrats’ control of the House of Representatives forces Donald Trump to engage in constructive discussions with democratic leaders. They seem to have agreed on a USD 2 trillion infrastructure-spending plan. Nancy Pelosi and Chuck Schumer commented positively on the negotiations with the White House. In three weeks’ time, a new meeting is planned to discuss the financing of this programme
A shared 20% to 30% federal state/70% to 80% local governments would be a basis for discussion. Infrastructures such as roads, bridges, tunnels, airports, ports, water systems, public buildings and schools will benefit from this investment.
On the other hand, the Republicans, who control the Senate, are unlikely to support a USD 2 trillion bill that would increase the federal deficit and strengthen local governments’ dependence on the federal government.
Another problem will be the environment: the White House would like to include environmental deregulation in its infrastructure plan, which is obviously not acceptable to the Democrats.
The American Society of Civil Engineers (ASCE) estimates a cost of USD 4.6 trillion to rehabilitate the US infrastructure. USD 1.1 trillion is required for the renovation of roads and bridges, USD 380 billion for schools, and USD 473 billion for water treatment and distribution. There is a USD 2 trillion shortfall compared to current investments and public and private investments must increase from 2.5% to 3.5% of US GDP.
Funding for the infrastructure-spending plan will be difficult to address. Republicans do not want to deepen the federal deficit and many large American cities are bankrupt or almost. Nevertheless, infrastructure investments create jobs and improve the productivity of the economy.
For roads and bridges, one source of funding would be to increase the tax for the Highway Trust Fund by 25 cents per gallon, which today is 18.4 cents per gallon of gasoline and 24.4 cents per gallon of diesel; but Democrats believe that this would penalize the poor and the working middle class.
Some stocks reacted positively on the stock market following an agreement in principle between Donald Trump and the democratic leaders, such as cement companies Martin Marietta & Vulcan. Other securities impacted by this US infrastructure theme are steelmakers (US Steel, AK Steel, Nucor, ArcelorMittal) and engineering (Jacobs Engineering, Aecom).
Steel producers would be among the big winners of a huge infrastructure-spending plan. In the short term, the values seem interesting to us because steel prices are rising. In the United States, US Steel and AK Steel reported good results, exceeding expectations.
Prices are recovering thanks to a more favourable economic environment than expected. Global demand for steel is increasing, while China is still in a process of reducing production capacity to reduce pollution and comply with environmental regulations. China is the swing factor, as is Saudi Arabia for oil. In 2017, Chinese steel exports fell by 30%. A trade agreement between the US and China would be positive for steel prices.
Over the first three months of 2019, world steel production increased by 4.5% due to strong demand in Asia (+7% production). Overall demand increased by 2.1% in 2018 and 1.3% in the first four months of 2019. For 2019 and 2020, the Worldsteel association forecasts an increase in demand between 1% and 2%. The US is the most promising region among developed countries.
- It is difficult to play US infrastructure, considering the low visibility on financing
- Opportunity on steel, segment that is part of our Reflation theme and potential for a positive surprise with a trade agreement between the US-China
- Valuations :
- ArcelorMittal EUR 22
- Nucor USD 65
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