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Weekly – Investment Advisor – 12 April 2019


Equities Bonds
MSCI World +4.0% CHF Corp +1.5%
S&P 500 +15.2% US Govt +1.8%
Stoxx 600 +14.8% US Corp +5.3%
Nikkeï +8.5% US HY +8.0%
SPI +16.5% EUR Gvt +3.5%
China +32.8% EUR Corp +3.5%
Emerging +13.5% EUR High yield +5.5%
Currencies Commodities
USD index +0.9% Gold +1.3%
EURUSD -1.8% Silver -2.9%
EURCHF +0.3% Brent +32.1%
USDCHF +2.2% CRB index +11.2%
USDJPY +1.5%
EM FX +1.5%

Eagles, 1976

“you can check out anytime / but you can never leave”…


The “Hotel California” song features an idyllic place, where one arrives hair in the wind, under the sun, free as the air. Though romantic at first, it actually hides a much darker reality. It practically retraces the impossible escape of an individual, locked between the four walls of the hotel, which is actually a detoxification center.


Endless financial repression?

“Hotel California” is a metaphor of the addiction of developed countries to unprecedented monetary policies.

Japan and Europe are still trapped in an ultra-loose monetary policy regime, featuring nil to negative policy rates, hypertrophied balance sheets and highly distorted – not to say nationalized – government bond markets…

Negative yield Debt

The US economy is the healthiest among G20, by far. In short, this is the only country where the financial / banking sector dramatically recovered from the crisis and where the central bank managed to raise its rates to a neutral stance (real rates being slightly positive). As he did in 2018, Trump is again quizzing the Fed (no longer about the level of policy rates, but about the balance sheet). Unsatisfied with the ongoing pause of policy rates, US President wants quantitative easing to resume (i.e. further expansion of the balance sheet). This is – again – in perfect contradiction with ongoing policy stance of the Fed, which announced a gradual slowing down of QT (balance sheet contraction) …

  • Even in the US, the normalization of monetary policy is tentative, not to say elusive


¨New¨ backups for additional accommodation

A (supposedly) new school of thoughts – Modern Monetary Theory (MMT) – emerged lately in the States. It is suggesting forgetting about ¨classical¨ assessment of economic models. In short, the idea is that budget deficits don’t matter, as long as a) the economy still owns productive resources and b) inflation remains ¨sustained¨ and controlled. In such a framework, a country with monetary sovereignty could, limitless endlessly, print money to afford for its functioning. Sort of infinite QE. This theory is nothing more than a new version of the old quandary of deficit monetization.

In a preemptive move – designed to protect from policymakers interference – the Fed has recently decided to reconsider its inflation calibration process. It should deliver a new framework by mid-2020. By either averaging inflation over several years, or by targeting a certain price level to be achieved over time, it is in fact just trying to legitimate say 2,5%+ inflation over next decade.

The debate of engineering more inflation, one way or the other, will come into the fore in coming months in the US. It is bipartisan and belongs to the DNA of the United States where, ultimately, policymakers are elected to support the debtors interests before creditors. Indeed, for instance, Democrats as well as Trump administration support it. Leading US ¨progressives¨, who may well be in power from 2020 elections, actually recommend using Fed balance sheet as a cash cow to fund expansive new social programs.

  • Western countries will further miss inflation, because of prevailing structural headwinds
  • China is not immune to this process with its ageing population and economic transition

So far, so good Seems like profligacy will develop in Washington, one way or the other! Nevertheless, a confidence crisis is not around the corner in the dollar, even in this dedollarization process. The USD remains the world reserve currency. And the US government is still the cleanest


dirty shirt, when it comes to its debt rating and next years’ perspectives. Consequently, the world remains quite happy to absorb more dollar debt at a remarkably low yield.

The ultimate question is for how long? While it is adequate to prevent inflation from falling back to dangerous level, particularly at this late stage of the cycle (with lots of debt), the Fed is not immunized. It takes long to build credibility, but it can almost be destroyed overnight.

  • Trump complicates any tentative evolution of Fed policy – i.e. a new inflation targeting
  • Additional financial repression / unorthodox monetary policy will not restore inflation
  • But a trade war would ignite a Chinese deflationary shockwave to Western countries
  • The re-engineering of inflation will become a major / global political theme, particularly in times of (too) high debt


Fixed income. The credit market meltdown is not for tomorrow

In recent months, there has been a tremendous rise in talks about rising corporate debt. The US corporate indebtedness is flagged by many investors as the main potential catalyst of the next financial crisis. A record high leverage coupled with higher interest rates and an economic slowdown could trigger a spike in corporate defaults. The non-financial corporate debt to US GDP ratio has just reached a new historical high at around 47% in December 2018, exceeding the 3 previous peaks reached in 1990, 2001 and 2009.

US Corporate debt to GDP

share of BBB-rated names in the market and the concerns of downgrades. The first area of attention is not that relevant, given that banks are no longer the main source of corporate funding since Basel III reforms have tightened the banking sector constraints.

Companies have favored financial markets. The second point is more important though. According to S&P, Q1 2019 saw the most credit ratings downgrades for US companies relative to upgrades since Q1 2016. So, some risks are starting to materialize.

Ration of credit upgrades to download

Instead of focusing on the total amount of debt which is still expanding due to the banking reluctance to refinance the corporate sector, investors must look at the right metrics. Instead of comparing total debt to US GDP, investors should focus on corporate health metrics.

First, the interest rate environment remains exceptionally low, both in nominal and real terms, and will stay for a while. So, debt servicing and the refinancing will not be challenged shortly.

According to the latest Fed data, the balance sheets of American non-financial firms are healthy, their combined earnings before interests and taxes are big enough to pay the interest on this mountain of debt nearly 6 times over. This is already visible as the default environment remains benign. In February, according to Moody’s, the US high-yield default rate reached 2.7%, less than the 3.8% of February 2018. The default rate will average 2.1% in 2019.

total debt to profits

Furthermore, the leverage remains manageable. According S&P data, the debt to EBITDA ratio of the US BBB-rated corporate sector is at 2.2x. The ratio of corporate debt levels to corporate profits spiked leading up to every recession since the 1950s.

This ratio had certainly been rising fast up till 2015. Its upward trend has stalled since then, which emboldens the bullish case that corporate debt levels are not so concerning presently. Even if it has increased since the great financial crisis, the ratio is not significantly higher.

BBB rated issuer leverage

Finally, from a historical perspective, the S&P research shows that US non-financial corporate issuers rated in the BBB category have held firm over the past 35 years, even during periods of economic stress. So, corporate debt doesn’t look all that burdensome.

  • Elevated financial leverage is offset by a high financial coverage ratio
  • Remain long credit but more selective, favor BBB and BB


Equities. The worst season of earnings publication for three years begins

Factset has revised downward the decline in profits of the S&P 500 from -3.7% to -4.2% for the first quarter of 2019, dedicating the first decline since 2Q16 (-3.2%). But profits should already rebound in the second quarter, which should support equities; bottom-up analysts estimate the S&P 500 will rise 7.5 percent to 3’097 points within 12 months. The environment is brightening: a likely US-China trade agreement and a rebound of Chinese leading indicators. Wall Street climbed last Friday thanks to job creations above expectations and new pressure from Donald Trump on the Fed. Serious things will start this Friday with JP Morgan Chase, Wells Fargo and PNC Financial.

The most important of this earnings season will be the confirmation of a rebound in profits from the 2nd quarter of 2019. If this were not the case, we could witness profit taking. The combination of low interest rates and the absence of a macroeconomic shock help to maintain confidence in equities.

The low participation of institutional investors in this firstquarter rally is explained by their prudence given this very mature economic cycle. See graph.

Under 100, institutional investors reduce their expose to risky assets

  • Equities should continue to rise if the Chinese economic rebound and the recovery of profits since the 2nd quarter are confirmed



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