INTERVIEW WITH A VAMPIRE
For US markets, a standout feature of the last few years has been the concentration of returns and profitability across a very small number of firms. Indeed, the overall number of listed companies in the US has fallen from 7,300 in the late 90’s to only 3,599 today. Moreover, the share of total profits generated by the top 100 firms has shifted from around 50% in the 70/80/90s to approximately 85%. This dynamic owes much to the technology sector and its “disruption” of traditional business models. As such, the contribution of tech stocks to equity returns has been extremely significant; the NASDAQ has outperformed the S&P 500 every year since 2012, whilst the MSCI AC Asia IT index has delivered almost 2.25x the return of its (already tech heavy) MSCI AC Asia parent over 5 years.
Of course, the tech rally is certainly not without foundation. However, there is a case that a combination of excess liquidity, few other bright spots across developed markets and strong momentum has caused investors to forget potential cyclicality. Moreover, the global success of US tech firms has perhaps masked the overall picture in US equities.
Elsewhere, the oil price continued its struggle, with another week of losses as the Energy Information Agency projected that US domestic oil output will top 10 million barrels a day in 2018.
This week sees a FED meeting, at which a rate rise is expected, as well as Bank of England, Bank of Japan and Swiss National Bank gatherings at which policy is likely to be left on hold. There is also a Eurogroup meeting, which will focus on the Greek bailout review.
S&P 2,432 -0.30%, 10yr Treasury 2.21% +4.14bps, HY Credit Index 327 +3bps, Vix 11.20 +0.95Vol
Markets escaped relatively unharmed from Former FBI Director James Comey’s testimony to Senate regarding the investigation into Russia’s interference in the presidential election and Donald Trump’s demands that the Bureau end its investigation into his national security advisor Michael Flynn. When asked if the President had tried to obstruct justice, he commented “That’s a conclusion that I’m sure the special counsel will work towards to try and understand what the intention was there and whether that’s an offence.”
With “Super Thursday” (UK elections, the testimony and an ECB meeting) out of the way, the VIX dropped to its lowest level since 1993 at 9.37%.
Economic data was somewhat weaker – ISM non-manufacturing for May coming in lower, alongside negative revisions for factory orders (declining for the first time in 5 months) and durable goods. However, the JOLTS report recorded the highest level of job openings on record, with the number of hires falling thus suggesting employers are finding it difficult to find qualified workers.
Eurostoxx 3,572 -0.80%, German Bund 0.26% -1.00bps, Xover Credit Index 241 -8bps, EURUSD 1.121 +0.78%
At the June ECB meeting, Mario Draghi delivered an improved growth forecast and a tightening in forward guidance – specifically the committee dropped their reference to “lower” interest rates (the deposit rate is currently at -0.40%) and upgraded the outlook to “broadly balanced” from “tilted to the downside”. However, the overall tone was dovish. The inflation outlook was revised lower and there was an ongoing commitment that the “ECB will be in the market for a long time”, i.e. that QE will continue until at least the end of the year. Bond yields therefore declined and the Euro lost ground against the USD. In terms of economic data, German factory orders fell more than expected in April (albeit this is a volatile series).
Even though the financial crisis was almost 10 years ago, Europe has still not completed a clean-up of its banks. This week the “Single Resolution Board” (part of the ECB) judged that Banco Popular of Spain was “failing or likely to fail”. This prompted a rescue by Santander at a price of 1 Euro, with all shareholders and junior bondholders wiped out. This outcome may prompt a similar “resolution” for Veneto Banca and Popolare di Vicenza in Italy.
Elsewhere in southern Europe, the potential for a change in electoral system in Italy (towards German style proportional representation) unravelled after the ruling PD party lost a parliamentary vote. This reduces the probability of snap elections as President Matarella made electoral change a pre-condition for an early vote.
Meanwhile, the president of the Spanish region of Catalonia announced an independence referendum for the 1st October. The referendum is opposed by the central government and all main political parties. It is therefore unlikely to go ahead, as the central government can stop it on constitutional grounds.
Last, in the first round of the French legislative elections yesterday early results suggest new President Emmanuel Macron has claimed a dominant victory, albeit on an extremely low turnout. The second round is held next weekend.
After one of the worst campaigns in memory, Theresa May’s early election gamble came back to bite her in the face. The Tories won 318 seats (versus 326 required for a majority and 331 in 2015), a result which leaves the Government with no clear mandate for Brexit negotiations. Indeed, the Prime Minister has been forced to engage with the “DUP” in Northern Ireland (who won 10 votes) to keep her minority government in power. What the DUP might demand in return is as yet unclear. GBPUSD weakened around 1.5%, prompting a rally in the FTSE led by USD earners.
Economic data has suggested a gradual underlying weakening of the UK economy (for example, last week industrial and manufacturing output and consumer spending data from visa – suggesting a YOY fall in real spending by 0.8%). The lack of strong leadership is unlikely to help escape this trend, although it may result in a “softer” Brexit, which could help investor confidence in the short run.
HSCEI 1,050 -0.78%, Nikkei 1,990.00 -0.83%, 10yr JGB 0.06% +0bps, USDJPY 110.220 +0.00%
China’s economic data continues to suggest that the economy is stabilising around the current growth trajectory.
Following recent months of expansionary PMI data, in May, trade data rebounded, while foreign reserves increased for the fourth consecutive month. Inflationary pressures remained largely benign.
China’s FX reserves increased $24bn over the course of the month, a greater increase than the $20bn witnessed in April. Given the weakness of USD versus other major global currencies during May, much of this increase is attributed to positive revaluation effects.
Export growth increased from 8.0% YOY last month to 8.7% YOY, imports accelerated from 11.9% YOY to 14.8%, and the trade balance increased slightly from $38.0bn USD of surplus in April to $40.8bn in May. High exports came from new order growth, while the import strength is indicative of healthy domestic demand conditions.
China’s CPI inflation rate increased slightly, in line with expectations, from 1.2% in April to 1.5% in May, while PPI fell from 6.4% to 5.5%. The month on month changes in both CPI and PPI can both be largely attributed to unfavourable and favourable respective base effects. PPI is likely to continue to moderate through the second half of 2017 on this basis.
In line with consensus expectations, the Reserve Bank of India left interest rates on hold at last week’s monetary policy committee meeting.
The repo rate was left unchanged, however the Statutory Liquidity Ratio was cut by 50bps.
Over the last two years or so, the direction of Indian interest rates became largely a one-way bet. Inflation appeared to be structurally declining from the double-digit rates seen over the preceding few years down to sub-5% territory. It also appeared that, under former Governor Raghuram Rajan, the RBI had completed much of the heavy lifting in implementing a credible inflation targeting policy for arguably the first time.
As India now enters a world of sub-3% inflation, though, this certainty over the medium-term rate outlook may begin to fade. For example, following the April central bank meeting, when the RBI officially changed its stance from accommodative to neutral, the bond market sold off on the back of expectations for potential rate hikes and an end to the current easing cycle. However, after this was included in the June policy statement –
“The abrupt and significant retreat of inflation in April from the firming trajectory that was developing in February and March has raised several issues that have to be factored into the inflation projections”.
– it now appears that the central bank is signalling a more dovish position..
CPI inflation in the Philippines fell from 3.4% YOY in April to 3.1% in May, reducing pressure on the incoming central bank governor Espenilla (who takes office in July following his appointment by President Duterte) to raise interest rates. Bangko Sentral Pilipinas operates with a 2%-4% inflation target, which is now comfortably satisfied.
MSCI Lat Am 2,536 -0.39%
The MXN performed well last week (+2.4%) on the back of the PRI winning the election in the State of Mexico and three other states being split between the PAN and the PRI. This election was a good indication of the electoral strength of Mexico’s main parties given that roughly 25% of the country’s voters went to the polls, 1 year before general elections. The fact that the leftist Morena party, led by Andres Manuel Lopez Obrador, didn’t do well, was appreciated by markets.
Mexico’s consumer confidence came in at 86.8 in May, above market expectations and 2.2 pts above April’s print. However, it stands 4.5 pts below the level recorded in the same month in 2016. This improvement can be attributed to the strength of formal employment (+4% YOY) and the better outlook for US-Mexico relationships.
Nonetheless, high inflation (from 4.7% YOY in January to 6.2% YOY in the first half of May), rising domestic interest rates, and softer labour market conditions should keep consumer confidence at low levels.
Brazil’s industrial production grew 0.6% MOM in April and March’s IP was revised upward to -1.3% from -1.8% MOM. Despite the MOM gain, the YOY growth rate is still negative (-4.5% YOY). May was also the 7th consecutive month of production growth for both cars and trucks, which improved 33.5% and 42.1% YOY, respectively.
The data confirms that industrial production is recovering slowly, which is consistent with the surveys that show a recovery in business confidence, aided by the decline in interest rates. Brazil’s industrial cycle is recovering ahead of the consumer cycle.
MSCI Africa 854 -2.07%
Egypt’s net reserves rose 9% in May to $31.1bn, the highest since February 2011, up $7bn so far this year and more than doubling since August 2016. As a result, import coverage rose to 5.6 months from 5.2 in April.
Egypt’s inflation eased to 29.7% YOY in May after peaking at 31.5% in April. This is the first decline in CPI over the past 6 months (since the floating of the EGP).
S&P left South Africa’s rating unchanged (as did Fitch). However, it maintained the negative watch.
South Africa fell into technical recession in 1Q17 with GDP contracting 0.7% QOQ (still +1.0% YOY) following a 0.3% QOQ contraction in 4Q16. GDP/capita hasn’t grown for 4 years and 2Q17 didn’t start very well as manufacturing production contracted 4.1% YOY in April.
Source: Alquity Global Market Update www.alquity.com