By Bilal Hafeez 03-12-2019
In: post, Newsletter

Bilal’s Top Picks: Big Equity Correction? / European Bank Woes / Japan and Deflation


(total reading time: 4 mins)

There appears to be growing concern of a large equity correction in 2020. Some argue that such moves happen even outside of recessions, while others argue that central bank balance sheet expansion is not so bullish. Moreover, the recent escalation in US-China tensions could also get worse with China attempting to lead the world body responsible for protecting intellectual property.

Meanwhile, the ECB thinks it has balanced its monetary policy and bank stability objectives well. And the Fed kind of agrees as they argue that European banks’ underperformance is less to do with low rates than with bank sector issues. McKinsey thinks that the European asset management industry is in for tough decade of cost control.

Finally, Japan may want deflation, how military spending helps R&D and could East Asia follow Latin America in social unrest.

Enjoy!

Bilal

Alongside increased reasoning for equity market corrections, this week we have a piece for bullish selective EM debt and complications of the CLO market.

We Don’t Need a Recession For a Reset in the Stock Market (A Wealth of Common Sense) Ben Carlson crunches the numbers and finds that 60% of double-digit equity market corrections take place outside of recessions. Therefore expect a big correction even if the US doesn’t formally enter a recession. [Bearish US equities]

Does The Return Of QE Mean Big Gains For Stocks In 2020? (Advisor Perspectives) Some argue that the stock market gains of the past 10 years were largely attributable to the massive expansion of central bank balance sheets. So the return of “QE-lite” by the Fed could be viewed as a positive for stocks. However, investors should be cautious.  On a rolling 12-month basis, historic data shows no consistent relationship between central bank balance sheets and stock markets. Watch economic growth indicators instead. [Bearish US Equities]

Remain Selective on EM Debt (Variant Perception) This piece argues that the top performing EM debt markets will be those that have simulative monetary policies, but contained inflation. The markets that stand out are India, Mexico and Indonesia. [Bullish Selected EM Debt]

Leveraged Loans – History Rhyming? (In The Long Run) The article draws a parallel between GFC’s CDOs mismanagement and today’s leveraged loans build-ups (particularly CLOs products). Author argues that CLO asset quality is underestimated. [Bearish US Credit]

Research supports that the banking union has achieved its stability objectives, but it has a limited ability to revive inflation through lower rates. Also, cases for negative rates working following recent turns by traditional doves in Europe (Riksbank & Bank of Italy).

The ECB After the Crisis (ECB Working Papers) The ECB makes the case that its expanded responsibility to ensure the stability of the banking system, through the establishment of the Single Supervisory Mechanism (SSM), is the most far reaching action taken by the Euro-area. They argue that they can keep monetary policy and supervisory roles separate. [Bullish EU Financials]

Generation War on Inflation: Optimal Inflation Rates for the Young and the Old (Dallas Fed) Dallas Fed computes the optimal inflation rates for the young and the old in Japan. They conclude that the “optimal” rate for the older generation is negative due to their nominal asset holdings. An ageing population may lead to lower expected inflation rates in the long term. [Bullish JGBs]

Labour market developments likely to contribute towards the increasing shift in populism and empirical evidence suggests the rate of productivity increases following defense spending.

Demographics and Technology Explain Secular Stagnation and More (Vox EU) Argues that lower fertility and population ageing are likely to generate more automation, which will lead to a reduction in GDP per capita growth and the labour income share. [More Populism]

Involuntary Part-Time Work a Decade after the Recession (Federal Reserve Bank of San Francisco) San Fran Fed identify shifts in the US labour market over the past decade.  The bottom line is that full-time work has become scarce and voluntary part-time employment has exceeded its pre-recession level. [More Populism]

The Intellectual Spoils of War? Defense R&D, Productivity and International Spillovers (NBER Working Paper) Empirical evidence from major OECD countries shows that a 10% increase in government-funded R&D in the defense sector generates privately-financed defense R&D by 4.3% and encourages private investments in other nations. [Bullish Big Military Countries]

Economies in East Asia should be proactive on policies to avoid Latam like social unrest and what do Michael Bloomberg’s philanthropic endeavours indicate?

East Asia’s Political Vulnerability (Project Syndicate) Korea University professor Lee Jong-Wha argues that East Asian countries could follow the path of Latin American instability unless policymakers change their policies. He argues the case for economic policies that reduce inequalities but are balanced with fiscal sustainability. [Bearish East Asia]

What Mike Bloomberg’s giving says about Mike Bloomberg (Axios) Bloomberg has donated to support numerous social development causes. This could help reveal his likely policies. His major causes include controlling the use of tobacco, tackling climate changes, road safety, and  urban development

Asset managers will have to implement AI-based cost reducing solutions to cope with structural shifts. Punitive regulation for credit market making activity has direct impact on liquidly and prices, and dealer inventory data now a major source of advantage.

Adapting to a New Normal in European Asset Management (McKinsey & Company) European Asset Managers were less affected by the switch to passive strategies and successfully dealt with the last decade’s macro structural changes. But  McKinsey argues the next decade will be more difficult. Profit margins are likely to fall not least because of lower bond yields. Therefore cost control will be key.

Commonality in Credit Spread Changes: Dealer Inventory and Intermediary Distress (NBER Working Paper) A broad financial distress measure and a dealer corporate bond inventory measure can statistically explain about 50% of the excess variation of credit spread changes beyond structural credit risk factors.

China is facing classic developing market issues; transitioning to a service-based economy and problems to protect IP.

China Issues Guideline for High-Quality Trade Development (gov.cn) The Chinese government looks to shift its trade towards services and implement more environmentally friendly policies for industrial production. [Bullish China]

China Bids to Lead World Agency Protecting Intellectual Property (Foreign Policy) China is attempting to lead the World International Property Organization (WIPO) – the UN agency responsible for maintaining standards and protecting IP. Part of the reason for this is that China has more of its own IP, which it wants to protect globally. But the US is naturally pushing back on China’s bid to lead WIPO. [Bearish Equities]