SIT BACK AND UNWIND
As a tumultuous quarter came to a close last week, it appears many investors were in unwind mode – selling equities and shifting into sectors and regions perceived to be more defensive. As denoted in previous market outlooks, the global cycle is certainly ageing, which should prompt more volatility. However, taking in to consideration President Trump’s harsh trade and foreign policy rhetoric, without it, underlying conditions would likely still be resilient enough to support markets. The POTUS has certainly therefore made his mark. Last week this continued as the Trump administration’s efforts to stop all nations from importing Iranian oil contributed to a sharp appreciation in the commodity’s price (a large draw in US inventories also signalling a tightening market).
Elsewhere, global M&A volumes hit an all-time high during the first half of 2018 – amounting to USD 2.5trn compared to the previous high in 2007 of USD 2.3trn. After wild returns for fixed income managers in May, the best quarterly performance for the USD since 2016 and US corporate bonds posting 2 consecutive quarters of negative returns for the first time since the crisis, this has many investors talking about “echoes” from previous bear markets. Whilst taking a cautious outlook on the long-term prospects for developed markets ever since the crisis, the question remains if this is a foregone conclusion or not. Of course, if the trade war does not de-escalate, the impact of threatened tariffs on all sides would be very material and could plunge the global economy into recession. If instead more balanced agreements can be found over the next few months, markets may have already discounted enough for the time being.
S&P 2,656 +1.99%, 10yr Treasury 2.85% +5.32bps, HY Credit Index 339 -13bps, Vix 17.41 -4.08Vol
US equities finished lower last week (worst day in 3 months for the S&P on Monday) but with large divergences at the sector level. Technology, healthcare (after Amazon bought an online pharmacy company) and small caps underperformed, whilst defensive sectors and energy stocks ended higher. In fixed income, Treasury yields fell, with the curve flatter again at 32bps on the 2/10s.
From a trade perspective, news flow was mixed. On the positive side, the White House stepped back from plans to limit Chinese investment into US technology firms, instead announcing more rigorous reviews by the Committee on Foreign Investment in the United States. More worryingly, Treasury Secretary Steve Mnuchin was forced to deny reports that Trump wanted to leave the World Trade Organisation (calling them “an exaggeration”). Moreover, Trump showed clear dissatisfaction (by tweet and by speech) at an SEC filing that revealed Harley-Davidson was planning to move some of its motorcycle production abroad, in order to avoid EU tariffs. To quote an Al Jazeera article from last week, Trump’s polices are fast morphing from “America First” to “America Alone”.
Economic data was mixed; Q1 GDP was downgraded to 2% from 2.2% and the Commerce Department’s price index for personal-consumption expenditures, excluding food and energy costs, hit 2% in May (the Fed’s target) for the first time in 6 years. Next week sees a more significant data dump with minutes to the last FED meeting and the June employment report.
Eurostoxx 3,451 +1.71%, German Bund 0.54% +1.40bps, Xover Credit Index 276 -10bps, USDEUR .811-0.41%
Core European equity markets followed global peers lower, with bond yields unchanged to slightly lower.
At Friday’s EU summit, Angela Merkel won a victory in concluding bilateral agreements with Greece and Spain on migrants (Germany will be allowed to send back refugees previously registered in those countries) in return for financial aid. Meanwhile, Reuters reported that the ECB may take a page out of the FED’s playbook by enacting their version of “operation twist”; rotating bond holdings into longer dated bonds to offer continued support to the economy beyond the end of QE in December.
In terms of data, headline inflation rose to 2% following surging oil prices. However, given that the core measure remained at a lowly 1%, this is likely to make little difference to ECB policy.
The Czech central bank (CNB) raised the policy rate by 25bp to 1% in June, as expected. According to the Board of the CNB, raising the policy rate was the appropriate response to the build-up of inflationary pressures and a weakening koruna.
In Turkey, manufacturing confidence shrank to 104.6 in June for the third consecutive month. The index remains above the 100-threshold that indicates optimism of the survey participants. Details reveal that firms became less optimistic about their growth prospects and foresee inflation in the double-digit territory over the next 12 months’ time.
Incumbent President Erdogan gained more than 50% of the votes in the elections, while his party (AKP) and his coalition party (MHP) won an absolute majority in the parliament in presidential and parliamentary elections held on June 24.
Even though political stability should prevail thanks to the outcome, markets may not be calmed as long as the stance of monetary and fiscal policy arms remain uncertain. If the fiscal stance remains expansive or the independence of the central bank is curbed even further, the TRY is likely to remain volatile and the weakening pressure on it may intensify.
The proposed pension reform by the Russian government plans to increase the pension age for both men and women to 65 and 63, respectively, over the course of the next two decades. Should the Duma pass the proposal, the available labour force and number of eligible workers may be boosted, while fiscal policy may benefit from the reform by facing lower future pension liabilities.
The Hungarian authorities took a step in the Turkish direction last week, when government officials commented on recent FX market developments and openly blamed ‘market speculators’ for the depreciation of the Hungarian forint versus major currencies, notably the Euro. In disagreement with the government spokesperson, the central bank released a short statement citing that the central bank shall not comment on short-term FX market developments.
The exchange rate of the Hungarian currency hit new historical highs against the euro last week, as the cross touched 330. The central bank has seemingly no intention to tighten monetary conditions anytime soon.
HSCEI 11,965 +2.43%, Nikkei 21,835.53 + 0.71%, 10yr JGB 0.05% 0bps, USDJPY 107.260 +0.40%
Asian markets faced another negative week to round off a tough quarter, though Friday provided some respite on account of a stronger print for the Yuan and some softening from Beijing on FDI restrictions.
The Chinese RMB has lost 5% of its value against the dollar since early April, reverting back to levels last seen in December 2017. Around half of that depreciation has come in June, coinciding with the escalation in trade tensions with the US. This has created market speculation the Chinese government will now progress any trade war in to a currency war. These concerns were further heightened when the People’s Bank of China announced a cut to the reserve requirement ratio, freeing up $100bn of liquidity for the commercial banking system.
Last week also saw domestic Chinese stocks enter a bear market, delivering their worst run of form since the crash of January 2016 which saw the government’s ‘National Team’ step in and buy equities in spades to absorb selling pressure.
Rubbing further salt in the wounds of Chinese equity investors last week were overhyped reports of new restrictive policies on shanty town redevelopment projects, which the market misconstrued as a hammer blow for the broader Chinese property sector. With many of the largest developers’ share prices falling 5%-10% on the announcement, on closer inspection these moves appear largely unjustified, with the government leaving its goal of relocating 5.8 million residents unchanged. The reports themselves were also fairly vague in nature, stating only that the China Development Bank has begun to “strictly scrutinize” the use of low cost PBoC loans for redevelopment projects, and has taken a more centralised approach to loan authorisation.
Bank Indonesia delivered a surprise 50bps rate hike, the third time rates have been raised over the last two months, making for a cumulative 100bps of tightening. The central bank acted in response to renewed pressure on the rupiah, which fell another 3% against the dollar in June, taking it to a 5% depreciation year to date.
Economic activity in Vietnam remains strong. GDP in the first half of the year expanded 7.08% YOY, while exports and imports grew 16% and 11% respectively.
MSCI Lat Am 3,027 -0.08%
Andres Manuel Lopes Obrador (“AMLO”) will be Mexico’s President for the next 6 years. He succeeds Pena Neto and takes office in December 2018. AMLO’s third attempt at the presidency brought him success winning with 53.2% of the votes last Sunday. He will be supported by both the Senate and Congress as his MORENA party won respectively 29 out of 96 (65 reported) and 217 out of 300 (100% reported) seats.
AMOL was elected on the promises of:
- Clamping down on corruption and violence. Violence fuelled by organised crime, has left more than 100,000 people murdered over 6 years and more than 100 candidates during the campaign. AMLO is seen as an outsider and promised to uproot “the mafia of power” and end corruption, especially by the PRI (Institutional Revolutionary Party) that dominated political life for 77 out of the past 89 years.
- Reducing poverty. He promised higher pensions for the elderly, guaranteed food prices for small farmers and subsidised gasoline prices.
Most of the specifics and details remain vague, and experts question the risk of a weaker fiscal positioning.
During the campaign, AMLO showed little interest or understanding of economics. The only things known are:
- Fiscal budget: He targets a balanced budget in 3 years, i.e. by 2021. Many economists are sceptical of his ambitions, with Mexico’s current budget deficit at approximately 2.5% of GDP. AMLO’s fiscal reduction plan consists of increasing spending to reduce poverty, funding a series of grand infrastructure projects, such as building oil refineries and railroads, which will be compensated by scrapping inefficient social programmes, and halving civil servants pay with more efficient central procurement.
- Monetary policy: AMLO committed to respect the independence of the central bank and maintain the free-floating MXN.
- Energy sector: AMLO is likely to slow down the opening of the country’s energy sector and review all concession contracts and privatization of energy assets signed in the past 6 years. This could be a concern in which it could put his policies and USD 200bn of investments at risk.
- NAFTA renegotiation: He is likely to take a tougher stance on this topic compared to his predecessor; his advisers have stated “No NAFTA is better than bad NAFTA”, moreover AMLO sternly defends the rights of Mexicans and Latinos in the US and is at odds with US immigration policies. Mexico receives USD 25bn in remittances from the US and AMLO wants to ensure such flow of funds is maintained, hence is opposed to Trump’s immigration policies.
- Other populist measures could include a cap on banks’ interest rates and prosecution of influential economic groups, which he deems gained from a privileged relationship with the PRI.
On the data front, Mexico’s economy weakened in April, growing 1.3% YOY (calendar adjusted). The service sector was somewhat resilient, while the industrial and primary sectors slowed down sharply.
It looks like the robust performance posted in Q1 2018 was temporarily due to reconstruction works (after the September 2017 earthquake) and this boost already seems to be waning.
Brazil’s set of macro data for May was positive:
- Brazil’s central government posted a BRL 11bn primary deficit in May, which implies that it will probably meet its primary-deficit target for the year (2.2% of GDP or BRL 161bn). The Brazilian government thus far limited the impact of diesel subsidies and lower excise tax promises made to the truck drivers to end their strike in May.
- In the 12 months to May, the current account deficit widened to USD 13bn or 0.65% of GDP. Largely covered by direct investment in the country of USD 62bn (3.1% of GDP).
However, foreign net outflows from Brazil’s equity market in H1 2018 reached BRL 10bn, the worst level for the first 6 months of any given year in history. By comparison, in 2008 outflows for the whole year were BRL 24.6bn. Investors are fearing the impact of the FED tightening cycle (despite Brazil being a very domestically driven economy), Brazil’s presidential elections in October and the economy growing much slower than anticipated this year.
In contrast to Brazil, Argentina’s macro data shows a strong negative impact from the crisis:
- Argentina’s economic activity contracted 0.9% YOY in April.
- Argentina’s current account deficit grew deeper in Q1 2018, to USD 9.6bn from a USD 7.2bn deficit posted in the same quarter of 2017. As a result, in the 12 months to March, the current account deficit hit 5.3% of GDP, up from 4.8% registered in 2017. This poor performance shows no signs of stopping as the trade deficit widened by USD 1.3bn in the month of May. The poor performance of exports was caused not only by a lower harvest but also due to FX instability.
MSCI Africa 966 -0.21%
Egypt’s central bank kept its key interest rates unchanged; deposit and lending rates were held at 16.8% and 17.8% respectively.
The MPC’s decision was expected. The government needs to contain the inflationary impact of the new austerity measures required under the IMF backed reform programme. In a move to reduce circa USD 2.4bn in budget cost, the government announced plans to raise fuel prices by up to 50%, electricity prices by an average of 26% and nearly double the price of piped drinking water, starting from this month.
The impact of the reforms is being borne out in economic data, which has strengthened since the programme began in late 2016. In Q3 of the 2017/18 fiscal year, current account deficit narrowed to USD 1.9bn from USD 3.1bn a year earlier as tourism revenues rose to USD 2.3bn in the quarter, from USD 1.3bn in the same quarter a year ago. In addition, expatriate remittances increased to USD 6.5bn from USD 5.8bn, Suez Canal revenues edged up to USD 1.4bn from USD 1.2bn and the overall balance of payments improved to a surplus of USD 5.4bn vs. USD 4.0bn.
Kenya’s economy grew at the fastest pace since 2016 in Q1 2018, driven by improved weather conditions and business confidence from the much-reported political détente. GDP grew 5.7% in Q1 compared with a revised 5.3% in the previous quarter and 4.8% in the same period of last year. The agriculture sector, which employs more than 40% of the population, expanded by 5.2%, compared to 1% in the same period last year, and contributed 30% to the output. Elsewhere, Kenya’s YOY inflation rose to 4.3% in June from 4.0% the previous month.
In South Africa, negotiation between troubled state power utility Eskom and unions continued. Eskom raised its wage increase offer for 2018 to 6.2% from 4.7% previously. This compares to a 9% increase in 2018, and 8.6 and 8.5% hikes for 2019 and 2020 demanded by the unions.
The state-owned utility did however get some respite from German state-owned bank KfW, who agreed to loan Eskom USD 100mn to significantly improve security of supply and reduce transmission losses in part though the integration of renewable energy sources.
Elsewhere in Africa:
- The World Bank approved a total of USD 2.1bn in concessionary loans to fund projects in Nigeria aimed at improving access to electricity and promoting governance.
- The World Bank approved a new USD 500mn loan to support economic reforms in Tunisia. The loan is aimed at promoting private investment and creating opportunities for small businesses, while protecting vulnerable households and increasing energy security.
This week’s global market outlook is powered by Alquity www.alquity.com