(total reading time: 9 mins)
US stocks have surged to new all-time highs while US bond yields have fallen below 2%. In the past, strong equities were associated with higher yields, but that’s clearly not the case right now. This reveals the influence of expected low policy rates from central banks on asset markets. This week’s two major announcements, first that President Trump wants to nominate two apparent doves to the FOMC (Judy Shelton and Chris Waller), and second that the probable successor to Draghi as ECB president is Christine Lagarde, only add to the drumbeat of dovish news. It also helps that the G20 meeting ended with US and China truce.
Part of the reason for the outperformance in risk markets like equities is probably due to the bearish bias of investors. In our new report on investor positioning and thinking, compiled using Macro Hive web traffic data, we find that investors are positioned for lower equities and higher yields and are particularly attracted to bearish risk market stories. From this, we also expect that the latest BIS annual report, which paints a gloomy picture for world, will be of significant interest. In our blog round-up, we’ve included a piece called “Is the Stock Market Overvalued? “ that provides a counter-point, arguing that equity valuations are not stretched.
Dollar turning point
Our data also reveals that the market that investors are most divided over is the dollar’. Short-term players like hedge funds are bullish on the dollar, while longer-term players are bearish. In our second opinion piece, this time by Emerging Market (EM) specialist Henrik Gullberg, a bearish dollar case against EM currencies is outlined. This dove-tails nicely with an earlier opinion piece on Trump’s weak dollar policy. We also highlight a blog , “China’s Bizarre May Intervention Numbers” that indicate how much control Chinese authorities have over their currency, a control that reduces the risk of disruptive yuan moves and lowers a risk to EM currencies.
Our third opinion piece is on UK pensions. Jason Simpson, UK rates specialist, describes the frustration of UK pension funds who get within touching distance of balancing their assets and liabilities, only for a rally in the bond market to undermine their hard work. He suggests this will lead to more demand for long-date bonds.
Finally if you fancy a distraction from macro, take a read of my latest personal blog which provides an easy entry point to poetry for the uninitiated: Love Life, Love Poetry
That’s all for now.
What Investors Are Thinking: The June Scan (3 min read) We’ve analysed Macro Hive data, checked investor positioning and determined what investors care most about it. Investors are short rates and split on the dollar and so unsurprisingly, our articles on Fed dovishness and Trump’s weak dollar policy were the most read. Outside of these two, each region had different topics of interest. In the US, investors were most interested in FX carry and alternative data. In Europe, they were interested in BoE policy and Europe’s trade woes. Finally, in Asia, they were focused on risk markets whether equities or FX carry. (Bilal Hafeez | July 4)
Dollar Weakness To Help EM FX (3 min read) All the stars seem to be aligned for prolonged dollar weakness: benign inflation, weak but not recessionary growth, Fed dovishness, growing twin deficit concerns and Trump’s weak dollar policy. This is good news for EM currencies. (Henrik Gullberg | July 4)
The Struggle To Overcome Pension Deficits (3 min read) Just as UK pension funds thought they had finally got their books balanced after years of sponsor contributions and asset growth; yields began rallying again. This has seen the overall pension deficit reach £70bn in May from flat in April. Thankfully for sponsors it is not as big as the £400bn deficit reached just after the 2016 BoE rate cut. But with Brexit uncertainty, possible rate cuts, low inflation and more QE stimulus talks, the pension fund industry may focus on hedging liabilities. This will likely support the long-end of the yield curve and widen the 10-30y spread. (Jason Simpson | July 4)
For details: Which Countries Own the Most U.S Debt?
(total reading time: 9 mins) US stocks have surged to new all-time highs while US bond yields have fallen below 2%. In the past, strong equities were associated with higher yields, but that’s clearly not the case right now. This reveals the influence of expected low policy rates from central banks on asset markets. This week’s two major announcements, first that President Trump wants to nominate two apparent doves to the FOMC (Judy Shelton and Chris Waller), and second that the probable successor to Draghi as ECB president is Christine Lagarde, only add to the drumbeat of dovish news. It also helps that the G20 meeting ended with US and China truce. Pessimistic investors
For details: Which Countries Own the Most U.S Debt?What Killed (Wounded?) The Value Factor? (Capital Spectator, 4 min read) Value investing seems to have lost some of its appeal. Compared to growth stocks, its underperformance run is the longest over the past four decades and has persisted since the 2007 crisis. A recent report from J.P. Morgan is shining light on the structural headwinds causing trouble. They claim that technology is a big one – the so-called legacy market leaders haven’t fully jumped on board the automation and social media trend, suffering both poor fundamental and market share declines by disruptors. Index investing in passive instruments has surged, taking away the appeal of stock by stock fundamental value hunt. Long periods of cheap debt and loose monetary policy has also led to favouring growth stocks. All the above is further fuelled by the slowest economic recovery since WW2 and a move to bond proxies. For a bounce-back in value strategies, J.P. Morgan suggests the following conditions are needed: regulations that foster competition, a saturation of passive funds, less political uncertainty and the return of the business cycle (i.e. a downturn). Guide to the Markets Report, Q3 2019 (J.P. Morgan, Report) In its latest deep dive into the markets, J.P. Morgan provides a detailed insight into the state of equities, fixed income, and both the US and global economy. In equities, they highlight how profit margins are coming under pressure as a result of higher wages, interest, and raw material costs. Coming out of the financial crisis, the main driver of EPS growth was margins. Over the course of the business cycle, this has shifted much more towards revenue growth and buybacks. While emerging markets tend to trade at a discount to US equities, they are currently at one of their cheapest points in recent history – 0.5x Price to book. In fixed income, J.P. Morgan highlight how corporate debt has continued rising, reaching over $10tn whilst at the same time dealer inventories have fallen sharply since the crisis, meaning risks of low liquidity in adverse conditions. Also, Baa-rated bonds, the lowest investment-grade bond credit rating in the investment grade index, are near all-time highs. At the same time, the duration of the investment-grade corporate credit universe duration has also risen meaning that investment-grade corporate bonds are more sensitive to movements in interest rates. Is the Stock Market Overvalued? – Update July 2019, and 10-Year Real Forward Return Estimate (iMarketSignals, 5 min read) A useful study of how to use Shiller Cyclically Adjusted Price to Earnings Ratio (CAPE) for trading equities. The current value suggests a 20% overvaluation. But a more reliable signal can be garnered from comparing the current value to its 35-year average. The ratio of the two is currently 1.2, which historically has been associated with returns of 6% over subsequent years. For reference, at the height of the .com bubble in late 1999/early 2000 the ratio reached 2.5. Digital Currency Areas (Vox CEPR Policy Portal, 7 min read) This thought-provoking piece considers the impacts of digital currency areas on the international monetary system. A digital currency area (DCA) is a network where payments and transactions are made digitally by using a currency that is specific to this network. These are either new digital currencies like Facebook’s Libra or closed networks that use existing official currencies like Ant Financial in China. The article argues that DCAs will compete on economies of scale (and scope) rather than macro-economic performance as in traditional currency areas. There are concerns, however, that this type of competition may not complement the differing regulatory and economic frameworks that exist across different jurisdictions. This gives rise to the digital paradox: DCAs will break barriers and cross borders, but due to this dissimilarity in frameworks, it may be impossible to use the same digital currency in different jurisdictions, therefore further fragmenting the international financial system. (This angle shows a more economic case for digital currencies to endure). BIS Annual Economic Report 2019 (BIS, Report) The BIS has a bearish tone in their annual report. They argue that monetary policy cannot be the engine of higher sustainable growth. Central banks’ role is now exhausted, and monetary stimulus alone adds little economic value; worse, it could do harm. Tax systems need to be reformed because they currently favour debt over equities. Bank profits are low in some advanced economies with price-to-book ratio hovering around 0.5x for the Euro Area. This suggests that many banks have yet to manage a full repair of their balance sheets. Corporate debt markets are overheating. High yield, low rated debt is on the rise with the leveraged loan market reaching $3tn. China is aiming to deleverage the corporate sector in a transition to a service-based economy but it’s hurting SMEs and local government and is depressing investment and economic activity. China Focus: China Opens More Sectors to Foreign Investment with New Negative Lists (Xinhuanet, 4 min read) China’s ‘negative lists’ indicate its sectors and industries that are prohibited for investment. In an unusual move this June, it has revised the lists rolled out in 2018 to allow for more foreign controlling majorities and even full ownership in an increasing number of industries.
The changes will be fully implemented by the end of 2019, one year ahead of schedule, and will predominantly reduce scrutiny across the services sector (call centres, printing, store-and-forward). Also affected, however, are agriculture and mining, meaning that the exploration and development of petroleum, natural gas, and other chemicals will be open to foreign investors.
Domestic firms will benefit too with state control loosening on shipping, electricity, and brokerage. The revisions are part of China’s overall strategy of a more open economy and have succeeded in stabilizing international corporate confidence and foreign capital inflows – FDI was a record high of $140bn last year.FBI Urges Universities to Monitor Some Chinese Students and Scholars in the U.S. (National Public Radio, 5 min read) Chinese academic researchers in STEM fields at US universities are being increasingly monitored amid fears of intellectual property theft – there are some 340,000 Chinese students in the US as of last year. The FBI and a number of counter-intelligence officials are warning of the emergence of non-traditional spies who steal technology to help China get ahead. The officials have been visiting college heads to educate them on the risks and on how to identify potential threats on campus.
The universities, however, see these briefings not just as too vague, but also as damaging to their ongoing research. There emerges a trade-off, then, between national security risks and the maintenance of engagement with the global research community. The only formally blacklisted company by numerous Universities has been Huawei – the rest are approached on a case by case basis. The article also reveals how warnings are not limited to education – now American tech companies, think-tanks, and investors are alerted of cyber espionage threats and discouraged of collaborating.
If we place the piece within the wider political landscape, President Trump and the top officials at the FBI have long advocated that China is using every tool at its disposal to steal information, but these types of policies are likely to endure beyond his tenure and could negatively impact the US education sector in terms of revenues and research advances. Further, it entrenches the tech cold war that is emerging between the US and China.China’s Bizarre May Intervention Numbers (Follow the Money, 5 min read) In May, investors were closely following Trump’s next steps amid fears of more trade tensions with China. The yuan was depreciating, and this would usually mean that the PBOC would sell dollars to maintain currency stability and vice versa. The amounts purchased or sold by the central bank are monitored by intervention indexes, often the PBOC FX reserves or FX Settlements. And even though equilibrium levels of overall intervention have significantly dropped in China since 2014, Brad Setser observes a positive correlation between yuan movements and the need to intervene in the past 10 years. When the CNY Spot is high, the PBOC Balance Sheet falls, indicating direct purchases of currency by the bank. Given this analysis, he was expecting a dollar sell-off by Chinese state banks, but puzzlingly, settlement data showed that they were buying instead.
Setser has two explanations: either China enforced limits and rations to importers’ and locals’ ability to buy foreign currency in an anticipation of the outflows or the bond index inclusion, or trade surplus and reserve diversification caused hot money to ramp up FX inflows. A key point to take away from this article is that China has tools beyond its FX reserves to manage its currency and attempting to play for sharp CNY moves could be a fool’s errand.Why China No Longer Needs Hong Kong (The New York Times, 6 min read) Recent protests in Hong Kong have highlighted the creeping shift in political and economic power. At one time Hong Kong’s economy was one-fifth the size of China’s; it is now barely one-thirtieth. China leveraged Hong Kong’s international presence in the period after 1997 to accomplish much. Firstly, given that China had not yet been allowed to join the WTO, it was able to push half of its trade through Hong Kong employing is as an entrepôt. Hong Kong was also recognised as an international financial centre, which benefited kickstarting Mainland China’s economy, and allowed the Renminbi to gain traction in the financial markets.
The article suggest, however, that through three decades of high economic growth and financial clout, China has now positioned itself to detach from its previous heavy dependence on Hong Kong. Further, it is actually infiltrating its vision of rule into Hong Kong’s currently shaken democracy. This quick read makes an important addition to the wider case that China can isolate HK issues from the mainland. China also has ambitions to accelerate the rise of Shanghai as a financial centre and also boost Singapore as the region’s favoured offshore centre.Demographics May Decide the U.S-China Rivalry (Axios, 3 min read) This piece reveals how with an aging and shrinking population, both the US and China may experience adverse long-term economic consequences, with the more severe implications in China as a consequence of their closed immigration position and earlier ‘one child’ policy. Despite the change in the latter policy to allow families in China to have up to two children and in rural regions even more, Chinese fertility still averaged just 1.18 between 2010 and 2018.
Further data has also indicated that the working-age population in China has been shrinking since 2014, and an estimated one-third of China’s population will be 60 years old by 2050. To cater for this, the Chinese Government will have to spend a large proportion of their fiscal budget on social welfare, pensions, and health care, instead of investments that may stimulate economic growth. As a solution, the China has already begun investing into industrial robots. Further policy changes, such as increasing the retirement age and relaxing border controls on migration could reduce the impact of the issue. This article is a particularly quick read, and is important for showing that China is not immune to the fiscal pressures that many developed countries are facing in terms of spiralling health costs.
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