Money Matters February 28, 2017

The overall interpretation of post-election trading dynamics for US equities is as follows:

  • Investors are reticent to reduce exposure because economic data is resilient, supported by a broader global rebound.
  • Investors are afraid to materially increase risk because political uncertainty is heightened and valuations are challenging.

The result has been a consistent rally on record-breaking low volatility. We wonder, however, whether warning signs are now flashing:

  • Bond yields have faded the “reflation” trade. The US 10-year yield has slipped some 30bps from its December peak.
  • The Trump government is getting side-tracked from its growth agenda. Time and political capital has focused on immigration, staffing, and Obamacare repeal, rather than investment and tax reform.
  • The FED is getting closer to a 3rd rate hike. After the release of the February FOMC minutes, markets now price over a 60% probability of a May move.
  • Technical indicators are suggesting caution. Insiders sold USD 7.8bn of stock in February (most in 6 years) whilst the 14-day RSI for the S&P 500 has breached 70.

On Tuesday the President has a chance to keep the show on the road with the State of the Union address to Congress. Markets will be looking for more detail.
shutterstock_255640093 UNITED STATES
S&P 2,367 +0.69%, 10yr Treasury 2.33% -10.30bps, HY Credit Index 319 -5bps, Vix 11.47 -0.02Vol
Last week saw yet another 5 days without the S&P 500 logging a +/- 1% day, whilst the Dow Jones Industrial Average made it 11 record closing highs in a row. 

From a data perspective, existing home sales reached their highest level in almost a decade. However, Michigan consumer sentiment dropped from its recent peak. Reviewing sentiment surveys over the past fortnight more generally, there is some evidence of the Trump confidence effect waning.

 The minutes to the last FED meeting were interpreted as marginally hawkish with many participants judging a rate hike would be warranted “fairly soon”. This saw a small increase in the probability of a hike in March, albeit the market still favours a May move.
Eurostoxx 3,316 -0.57%, German Bund 0.20% -11.60bps, Xover Credit Index 292 -2bps, EURUSD 1.058 +0.49%
Despite impending elections and weaker than expected industrial production released last week, European survey data continues to go from strength to strength. Both the German IFO (business sentiment at the highest level since March 2014) and Eurozone PMIs (six-year high) signaled very strong momentum. Meanwhile, the general Government in Germany achieved a record surplus of 0.8% of GDP for 2016, the best since reunification.
In bond markets, the Schatz (German 2-year bond) marked an astonishing record, touching the lowest yield in history at -0.95% or a 2.1% discount to its US equivalent. Although this has been attributed to risk aversion, it is much more likely due to market dysfunction created by ECB bond buying and financial regulation.
On the political front, in France centrist candidate Fillon was handed a reprieve from investigations into employing family members as parliamentary aides. State prosecutors handed over the investigation to judges, Which is expected to mean there will be no conclusion until after elections. Elsewhere, another of the centrist candidates, Macron, saw his candidacy boosted after François Bayrou offered him an alliance. The markets appeared to take this positively, with the French 10-year rallying 11bps (albeit this was less than the German Bund’s 12bps gains). Greek bonds also traded better after EU President Dijsselbloem stated that there would be more emphasis on deep reforms, rather than austerity and the Head of the IMF Lagarde commented that a “debt haircut isn’t required for Greece”. Hmm…
Over the last 6 months, we have been supporters of a “tactical” allocation towards European equites on the basis of improving economic data and a global under-weight towards the region. For now, the economy continues to do “OK” and, the balance of probability is that the French elections will be navigated without an anti-establishment (Le Pen) victory. However, fund flows are now more normalised (5 consecutive weeks of positive allocations) and we shouldn’t forget the long-term, unequivocally negative, outlook.
The second release of Q4 GDP for the UK saw an upward revision (from 0.6 to 0.7%). This was again on the basis of a resilient consumer.
HSCEI 1,033 +0.57%, Nikkei 1,910.00 +0.82%, 10yr JGB 0.05% 0bps, USDJPY 112.330 -0.60%
Authorities in China continue to provide increasing clarity on the likely trajectory of monetary policy. 

Since Q3 2016, a series of subtle tweaks to both interest rates and regulation of the financial services sector have slowly painted a picture of how the People’s Bank of China is thinking. Since the turn of the year, however, the PBOC’s objectives have become far clearer, through both explicit action taken and more detailed communication from policymakers.

This week senior PBOC economist Ma Jun added further clarity, reaffirming that the central bank will adopt a prudent and neutral policy stance, attempt to prevent an increase in debt levels across the economy to unsustainable levels and to prevent the formation of potentially systemically destructive asset price bubbles.
After a few quiet months, President Rodrigo Duterte of the Philippines returned to high-profile and contentious actions, with a senator who was a prominent critic of his war on drugs (which has led to hundreds of killings of accused dealers) jailed on allegedly baseless charges. Duterte remains a double-edged sword for the Philippines. On one edge, he promises to improve law and order and to provide crucial infrastructure investment. On the other, his fanatical and unorthodox approach threatens to unease foreign investors and undermine business confidence. With the Philippines currently among the fastest growing economies in the world (with +6% YoY GDP growth expected for 2016), foreign investors appear to be willing to tolerate the risks posed by Duterte. However, at the first sign of disruption to the functioning of domestic markets (which, in fairness, there has been none so far) this situation would likely change. Any disturbance of the Business Process Outsourcing sector, which provides hundreds of thousands of well-paid jobs to the country every year, would heavily tip the scales against the President.
The Bank of Korea Monetary Policy Committee held interest rates on hold at 1.25% as expected, with a unanimous decision.

 Whilst the BOK governor stressed that the central bank’s policy stance has not changed since last month’s meeting, the accompanying MPC statement was less dovish, in light of better export growth and higher commodity prices.
Thailand’s economy grew 3.0% in Q4 2016, down from 3.2% in Q3, in line with expectations. A slowdown in private consumption expenditure contributed to Thailand’s growth rate falling to its lowest level since Q4 2015. Government spending and fixed capital formation strengthened quarter on quarter.
shutterstock_255640093LATIN AMERICA
MSCI Lat Am 2,618 -0.25%
Brazil’s central bank cut rates by 75bps to 12.25%. In addition, the monetary policy committee issued a very dovish communiqué hinting to a continuation of the easing cycle and opening the door for its acceleration. The central bank made clear that the pace of this easing cycle depends on “neutral real interest rates”.

Given that inflation is falling quickly and inflation expectations are also lowering, we wouldn’t be surprised if the central bank brings the SELIC rate to 10% or below by the end of the year. In addition, the strength of the currency is another argument in favour of cutting rates more aggressively. The strong BRL may start to hurt exporters and creates incentives for consumption and imports over investments (as cost of funds remain high).
Colombia’s trade deficit contracted to USD 4.1Bn in 2016 from USD 11.8Bn a year prior as imports fell for the 33rd month in a row last December. Prices of oil, coal and coffee, the country’s main exports, the collapse of the currency (making imported goods more expensive) and deceleration of consumption (GDP growth reached 2% in 2016 vs. 3.1% in 2015) were responsible for the lower trade deficit.
Mexican GDP slowed down moderately in 2016 to 2.3% (vs. 2.6% in 2015). 

This figure doesn’t include any consequences of the Trump election last November. As we are seeing with Brexit, the lag effect appears much later in the figures. It is likely that FDIs and other investments will be put on hold given this new uncertainty. Consumer confidence plunging to its lowest level on record last January doesn’t bode well either.
MSCI Africa 818 +0.62%
We have more clarity on candidates running for the ANC leadership election in South Africa next December. Currently, it looks like a 2-horse race between Deputy President Cyril Ramaphosa and Nkosazana Dlamini-Zuma, a former cabinet minister and the president’s ex-wife (who just ended her term as chairperson of the AU Commission). Last week, the chief parliamentary whip of SA’s ruling ANC, Jackson Mthembu threw his support behind Cyril Ramaphosa as the party’s next leader. The ANC had its worst-ever electoral performance in the municipal election of last August, which saw the party cede control in the metros of Johannesburg, Nelson Mandela Bay and Tshwane (Pretoria) and losing once again in Cape Town. Its share of the national vote fell 7.7pp to 54.5%. The next ANC leader will, nonetheless, likely be elected president in 2019. 

South Africa’s budget was announced last week. In a very perilous exercise, Finance minister Gordhan announced very few changes but enough to avoid a rating downgrade next June. The Treasury stuck to raising R28bn in taxes (as promised in October), and the expenditure ceilings have been cut yet again. In particular, he announced:

  • An increase in the marginal tax rate for individual’s earnings more than R1.5m pa from 41% to 45%
  • A dividend tax rate increase from 15% to 20%
  • Levy taxes on sugar and fuel

Thus, the budget deficit forecast stands at 3.1% of GDP for current fiscal year falling to 2.6% of GDP in FY2019/20.
The Central Bank of Egypt kept its overnight deposit rate at 14.75% and its overnight lending rate at 15.75%, for the third consecutive meeting.

We argue that this decision to leave real interest rates at -14% (based on January’s 29% inflation rate) doesn’t bode well for the currency and inflation. This may explain why the currency stopped appreciating last week, following the CBE announcement, after a 17% rally (vs. USD) since the beginning of the month. Monetary policy in Egypt has been quite poor up to now, although the floating of the EGP was a relief. Tourism is showing signs of recovery in Egypt. China’s top public travel agency reported a 58% increase in tourists flying to Egypt in 4Q16 compared with 2015. Japan’s HIS travel agency said the number of tourists heading to Egypt increased 5-fold in the same period. Data from the government’s statistics agency shows 551,600 tourists visited Egypt in December 2016, compared with 440,000 the year before. However, this recovery comes from a very depressed base as visitor numbers plunged from 14.7 million in 2010 and 9.3 million in 2015 to 5.3 million in 2016. China will invest USD 20Bn in Egypt over the next 10 years, as part of a broader USD 35Bn investment in Africa. These investments will mainly be directed to infrastructure projects.
The Nigerian central bank is trying to close the gap between the official and street FX rates. Last week the central bank sold USD 370Mn to commercial banks at a 375 USD/NGN (vs. official rate of 305 and black market of 520 last Monday). It seems that this cleared some of the retail backlog as the black market rates fell to 450 USD/NGN by Friday.

The CBN may also be underestimating the size of overall FX demand. Opening up the FX market by freely floating the naira would be a better alternative for the CBN in bridging this gap. Acting President Yemi Osinbajo is seeking the National Assembly’s approval to issue additional USD 500Mn in Eurobonds to plug the shortfall in the government’s record budget of NGN6.9tn (USD22.5bn). Nigeria is also seeking at least a USD 1Bn from the World Bank and USD 1.3Bn from China.

The fact that Nigeria suns such a big budget deficit and struggles to raise debt while its Net Debt/GDP ratio stands at 13% tells a lot about the challenges of the government: inability to raise taxes (4% of GDP), dependence on one single commodity price, dependence on external flows… Fiscal and monetary policies are totally delusional in Nigeria. Institutions are weak and the government has been very inefficient, plunging the country into recession and in the current dire situation. The free floating of the currency would be a first step in the right direction.

Source: Alquity Global Market Update


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