Summer SolStice

[Pages:14]MONTHLY STRATEGY REPORT JULY 2018

Summer Solstice

MONTHLY STRATEGY REPORT. JULY 2018

Summer Solstice

A few days ago, we crossed the summer solstice, the time of year when the sun is at its highest. In the Southern Hemisphere more than 500 years ago, the Incas celebrated the Wawa Inti Raymi, a ritual in honour of the sun, this time of year. This celebration was started by Inca Pachacutec to legitimise the control the empire had over its subjects. This ceremony symbolised the re-birth of the Sun god, starting a new annual cycle, "the Inca circular time." For the Incas, the notion of time was different from ours. It wasn't linear with a start and finish, but rather a "spiral" process whose phases were repeated in large, recurring cycles. This idea was linked to the agricultural cycle (preparing the land, seeding, and harvesting). For them, the past was not separated from the future or the present; instead, it was part of the same cycle that allowed continuous regeneration.

While the sun shines highest in the Northern Hemisphere, and the global economy recovers, the central banks have recently announced they will continue their stimulus withdrawal. The Federal Reserve has sped up, raising interest rates 0.25%, and it hopes to raise rates two more times by the end of the year to around 2.25-2.50. For its part, the ECB has chosen to reduce its bond buying programme by half (15 Billion Eur/month) starting in September. Most importantly, it has stated that it will end the bond buying programme in December. This decision implies that by the next winter solstice in the Norther Hemisphere, the main central banks will have stopped being net contributors of net cash flow into the system.

Central Banks Balance Sheet Evolution and Predictions (FED, BOJ & ECB, In M$*)

Source: Bloomberg and Banca March

FED BANK OF JAPAN ECB

TOTAL

800,000

700,000 600,000

FORECAST

500,000

400,000

300,000

200,000

100,000

0

-100,000

-200,000 MAR.14 SEP.14

MAR.15 SEP.15

MAR.16 SEP.16 MAR.17 SEP.17

MAR.18 SEP.18 MAR.19

* Assuming: BoJ extends the frequency of its balance sheet increase and the FED increases its pace of balance sheet reduction to $50 billion.

After 11 years of unprecedented monetary stimulus, having quadrupled its balance sheets such that organisations like the ECB have pumped in around 2.5 trillion Euros, we are going to face a significant change. Without a doubt, the current economic cycle is not only a spiral, and one that has very little to do with the Inca concept of time cycles, but the monetary medicine that got us out of the 2008 crisis has no comparison in history, especially regarding the magnitude of cash flow that the central banks have put into the system.

These organisms, who understand the situation and the side effects perfectly, have, for a long time, been telegraphing and postponing the withdrawal. The monetary "doping" and extremely low interest rates have favoured economic recovery in the US for over nine years, and with growth above 2%, we are in the second longest economic cycle in history.

Summer Solstice

2

MONTHLY STRATEGY REPORT. JULY 2018

US economic cycle length

Source: Bloomberg and Banca March

MAR. 1991 JUN. 2009

FEB. 1961

NOV. 1982

NOV. 2001

MAR. 1975

OCT. 1949

AVERAGE (SINCE 1950)

MAY. 1954

NOV. 1970

APR. 1958

JUL. 1980

0

2

4

6

8

10

With such a mature cycle in the US, the main destabilizing factor to keep an eye on, outside of Trump's threats of trade war, or the Italian political crisis, will be the steps toward monetary normalisation and the maturation of the US cycle.

The good news is that, although some indicators have started to deteriorate, there are many factors that still make us optimistic.

On the negative side is the trend of Consumer confidence expectations and the deterioration of the credit spreads over the last six months. On the bright side, the Business confidence trend clearly stands out, particularly in the US, where it is near February levels, when it was the highest it has ever been during this cycle. Additionally, the trend of the different yield curves, even though they are flattening, still offer a safety margin, and their inversion would not necessarily mean a recession will start within the next 12 months.

EVOLUTION RECESSION RISK

Source: Banca March

INDICATOR Worsening of credit differentials Pending curve evolution

Stock market evolution

Business confidence Consumer confidence Worsening of consumer confidence Fall from high levels of plants' used capacity Slowdown of employment rate growth Negative real interest rates Pending Australian curve Performance of Chinese economy

DESCRIPTION

Loss of performance levels from 6 months ago Manufacturing ISM > 50 Fall < 12-month average Expectations vs present situation

VALUE

0.33 0.937 75.63 60.2

-57.90

77.86

10 years vs 2 years

0.82 -0.46 0.599

51.5

This is why models like the one the FED uses still point toward a reduced likelihood of recession.

Summer Solstice

3

MONTHLY STRATEGY REPORT. JULY 2018

Probability of Recession. Federal Reserve

Source: Bloomberg, FED and Banca March

100% 90% 80% 70% 60% 50% 40% 30% 20% 10%

0% 59 61 63 65 67 69 71 73 75 77 79 81 83 85 87 89 91 93 95 97 99 01 03 05 07 09 11 13 15 17

NBER RECESSION

PROBABILITY OF RECESSION IN 1 YEAR (FED MODEL, BASED ON PENDING CURVE)

THRESHOLD

However, what we are convinced of is that, even if the central banks put all their effort into ensuring the stimulus is withdrawn very soon, it will be very difficult to replicate the low volatility environment we have enjoyed in the past. From now on, it will be much more painful to obtain the extra returns that risk assets like equities provide. While the cycle stretches on and our indicators still show that the current expansion should last at least another 12 to 18 months, inflation rates are already starting to reflect the increased price of oil. Just like the Incas, I would like to think that this cycle will be a spiral and that it is time to harvest the fruits. The problem is that after 11 years of intervention, the ammunition used by the central banks is starting to be pulled back and this time the idea of a cycle is more linear than ever.

In this last part of the cycle, the stock markets should continue to do well. The secret is getting out six months before the party ends. For now, put up with the volatility.

Joan Bonet Maj?

Service Director, Market Strategies

Summer Solstice

4

MONTHLY STRATEGY REPORT JULY 2018

RISKS ARE INCREASING BUT EQUITIES ARE STILL THE BEST OPTION

MONTHLY STRATEGY REPORT. JULY 2018

RISKS ARE INCREASING BUT EQUITIES ARE STILL THE BEST OPTION

In June, all attention was focused on: the increasing trade war, the clear messages given by the FED and the ECB, as well as the OPEC summit.

The trade war intensified with a two-front attack. President Donald Trump confirmed imposing 25% tariffs on $50 billion worth of Chinese imports, $34 billion of which will take effect on July 6, and the rest will be delayed pending evaluation. Also, the US threatens to introduce tariffs on another $200 billion worth of products and imposing restrictions on Chinese investment in US tech and industrial companies that have "sensitive" technology. China has responded by announcing it will adopt measures with the same impact. The US also announced the end of the tariff exemptions for European steel and aluminium and is looking into imposing a 20% tariff on European car imports. The E.U., in response, imposed 2.8 billion worth of tariffs on US products and awaits possible new measures to adjust its response.

Trade tensions are intensifying

Source: Bloomberg and Banca March

Tariffs on solar panels (30%) and washing machines (50%). JAN.18

Tariffs on steel (25%) and aluminium (10%). To be applied on China and the rest of exempt countries (temporarily).

FEB.18

Copyright laws: China is threatened with new tariffs on imports (totalling $50,000M).

MAR.18

A study on new tariffs against China regarding products valued at $100,000M is announced.

APR.18

Several rounds of talks have been held without reaching an agreement (China, EU and NAFTA). The USA have

threatened with tariffs of 25% on the automotive sector.

MAY.18

End of exemption of tariffs on steel and aluminium imports for the EU, Canada and Mexico.

1

Imposition of tariffs of 25% on products imported from China (valued at $50,000M): On 6th July new

2 tariffs on 818 products will be introduced ($34,000M imports) and the rest is postponed pending further consultations (they would affect 284 products valued

at $16,000M).

3 New additional tariffs are expected totalling $200,000M.

JUN.18

FEB.18

China responds with equivalent tariffs (totalling $3,000M) and lodges a complaint with the WTO.

MAR.18

China announces similar tariffs on US imports ($50,000M concerning products such as cars, soya, planes).

APR.18

China responds: a study on the possibility of devaluating the yuan will be conducted and new tariffs on US products ($2400M) are announced.

1

China responds by announcing that measures with the same impact will be adopted.

JUN.18

The EU responds with tariffs totalling 2,800M on a

2 list of US products (motorcycles, whiskey, etc.) as a result of aluminium and steel tariffs.

3 Mexico and Canada: no advances have been made in the NAFTA talks held.

NOV.18 "MID-TERM ELECTIONS"

Throughout the month, the developed central banks have continued stimulus withdrawal. The FED took a more aggressive approach, speeding up the interest rate hikes and indicating it will do two more hikes by year's end, up to 2.25-2.5%. The European Central Bank announced that the government and corporate bond buying programme will end in December. The Central Bank of China announced the third reduction in the cash flow which would mean pumping 100 billion into the system. The purpose of this measure is to counteract the tariffs announced by the US.

RISKS ARE INCREASING BUT EQUITIES ARE STILL THE BEST OPTION

6

MONTHLY STRATEGY REPORT. JULY 2018

The OPEC agreed to increase oil production after a year and half of cuts, with a true increase that could be around 600,000-800,000 barrels per day. The price of Brent, close to recent highs, shows that the agreement is not enough to compensate for growing demand and production losses in countries like Venezuela and Iran.

At the macroeconomic level, there are growing inflation concerns as a result of increased energy costs. The preliminary June European Consumer Price Index grew 2% year-to-year. In the US, the general CPI was 2.8%, and the underlying personal consumption deflator reached 2%, meeting the FED target. On the positive side, we can point out the positive readings, around the world, regarding business confidence and growth in US and Chinese retail sales.

Emerging equities lead the declines in June. The increase in US interest rates and the worsening of the trade war, particularly in China, impacted emerging stock markets (MSCI Emerging -4.5% and MSCI China -5.6%). In Brazil, electoral uncertainty and the transportation strike caused an 8.4% decline in the MSCI index in June, -18.6% for the year. In Europe, moderate losses were seen in the export stock markets (EuroStoxx50 -0.7%, -3% for the year), while the IBEX closed in June with a 1.6% increase, after -5.2% in May and -4.1% for the year. In the US, stock markets closed in June with moderate gains (S&P +0.4%; Nasdaq +0.9%), reaching 1.7% and 8.8% gains this year, respectively.

Positive month for the government fixed income market. The formation of new governments in Italy and Spain encouraged the purchase of peripheral debt. In this context, the IRR on 10-year Spanish bonds fell 18 BP to 1.32%. The Italian bonds, meanwhile, fell 10 BP to 2.7% and -40 BP against the highs reached during the month. The German Bund closed at 0.3%.

In the US, the announcement of the increased frequency of interest rate hikes was reflected on the short part of the curve (+10 BP for 2-year, 2.53%), while the 10-year bonds closed unchanged in June at 2.86%.

Very little movement in currency markets. The US interest rate increase compensated for peripheral political tensions - government changes in Italy and Spain - and the Euro/dollar exchange rate closed at 1.168 EUR/USD in June, almost unchanged. The same stability was found in the EUR/GBP exchange rate, awaiting progress in Brexit negotiations, at 0.88 GBP/EUR.

For the commodities market, OPEC's decision to increase crude production did not get in the way of the price of Brent rising 2.4% in June, to $79.4/barrel, +30% in four months and near highs reached four years ago. The large trade tensions were not reflected in the price of gold: -3.5% in June to $1,253.2/ounce.

RISKS ARE INCREASING BUT EQUITIES ARE STILL THE BEST OPTION

7

How to position ourselves in the current environment

Risks are going up, but equities are the best choice

MONTHLY STRATEGY REPORT. JULY 2018

STRATEGIC POSITION

TYPE OF ASSET

-2

LiquidITY

BONDS

EQUITIES

AlteRnativE ASSETS

BONDS

-2

SOVEREIGN DEBT

High Quality (AAA)

Peripherical assets

CORPORATE BONDS

Investment Grade

High Yield

EMERGING DEBT

CONVERTIBLE BONDS

EQUITIES

-2

EuropE

UNITED STATES

EMERGING MARKETS

JapAn

-1

Neutral

+1

+2

-1

Neutral

+1

+2

-1

Neutral

+1

+2

Increased risk

During the last month, risks have intensified. In particular, there are two external factors that could cause a quicker deterioration of the current economic cycle that we believe is still growing: protectionism and increased energy costs.

Trade tensions will continue to rise...

Starting with the first, trade tensions between the US and the other economic powers, far from going down, have continued to get stronger and we have witnessed it worsen with greater trade restrictions.

...even though, at the moment, the measures applied have little direct economic effect...

Starting with the first, trade tensions between the US and the other economic powers, far from going down, have continued to get stronger and we have witnessed it worsen with greater trade restrictions.

Since January, we have witnessed threats from the US President, but little by little these threats are starting to turn into concrete measures that also bring about a response from other economies. For the moment, the direct effect these measures have on economic growth is still small; as an example, the increase in the already applied tariffs represent only 5% of total US imports.

Measures announced on total imports (US)

Source: Bloomberg, FED and Banca March

% Total

100%

Imports

TOTAL IMPORTS USA

75%

AUTOMOTIVE SECTOR

77%

ADDITIONAL TO CHINA APPLIED

50%

25%

9%

0%

9%

5%

RISKS ARE INCREASING BUT EQUITIES ARE STILL THE BEST OPTION

8

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download