Friday, 4th of May 2018
What can we say? We are well into Q1 earning season and we have seen essentially better than expected figures being reported: revenues are up across the board, bottom lines are fattening, and outlooks shiny. Geopolitics appear to have calmed down too – North Korea is the now the New Buddy on the block, Syria has slipped of our screens, and the “Global Trade Wars” language appears to have attenuated. Oh yeah, and Donald Trump has been nominated for a Nobel Peace Prize. For a moment we thought this must be a typo… did they mean a Nobel Hair Piece?
As the month of May rolls up on us we remember the adage “Sell in May and go away”; watching the action all around it would appear that we are not the only ones to have thought of this… Equity markets have continued to show serious nervousness with huge intra-day swings in indices, mostly for no obvious reasons. We wonder if the culprits are Algorithms gone haywire… Anyway, let’s review what has really happened so far this year. The S&P 500, now at 2’630, had started the year at 2’673. We are fractionally down and this after being pleasantly surprised with general beats. Go figure. Or, should we believe that indeed the markets were priced to perfection, effectively anticipating the “Beat Expectations”? Linguistically, and even logically, this is like an oxymoron. Basically, the US equity indices are flat for the year, having rattled us all with a broad trading band. Some call this phase “Consolidation”, whereby the markets are adapting to new data and agreeing on new valuation matrices. Where will they go from these levels? Well, let’s recharge our faithful crystal ball and take a look into a possible and even probable future…
Firstly, let us stare into the interest-rate corner. We see that the benchmark 10 year yield in the US hovers just below 3%, after the Federal Reserve kept its benchmark interest rate unchanged Wednesday but acknowledged that inflation is beginning to creep higher. In a widely expected move, the central bank’s Federal Open Market Committee held the funds rate at a target of 1.5 to 1.75%. However, there were several tweaks to the post-meeting statement that market participants likely will find instructive. Markets that already were anticipating that the Fed would move to a more aggressive posture this year got more to chew on. Perhaps most significantly, the committee noted that “overall inflation and inflation for items other than food and energy have moved close to 2%.” That was an upgrade from the March meeting in which the FOMC said the indicators “have continued to run below 2%.” The change is key as Fed officials consider 2 percent to be a healthy level of inflation and a key for continuing to push rates higher. Something did happen though: the Federal Reserve’s interest-rate decision sparked a move in the U.S. yield curve that’s been virtually absent of late. The spread between 5- and 30-year yields widened after the announcement to 33.6 basis points, the highest since April 27. Curve steepening is a rare enough occurrence – it’s near the flattest levels in more than a decade amid bets on continued gradual Fed rate hikes. Yet, it’s actually the manner of the steepening that’s striking. The world’s biggest bond market experiences so-called bull steepening when shorter-term Treasuries rally to a greater extent than their longer-dated counterparts. Indeed, five-year yields fell as much as 1.7 basis points and two-year yields dropped 1.2 basis points. In contrast, 10-year yields were flat and those on the long bond rose. Remember the talk of the past few months? A flattening yield-curve feared to be a pre-cursor for an inversion which in itself scares equity investors who consider this to be evidence of an impending recession… Ooof, that was a long-winded phrase… and they were all wrong… The Fed spoke and the curve, bless it, steepened… Yes; once everyone sees this, equities may resume they rise to the skies, resting on the actually, quite extraordinary results we have seen.
Subsequently, let’s take a look at oil. WTI has risen in price from a $60/Bbl level at year-end to $68.50 now. Yes, there are tensions with Iran, but these were much the same exactly a year ago when WTI traded at $42. The “feeling” we get is that there truly is a demand driven price rise. The global economies appear to mostly be chugging along quite well, with a slight slowing of the Euro-zone. This could be attributed to the strength of the Euro until just days ago but, overall, the world’s GDP is growing and as we all know, GDP is an animal that eats energy… We don’t pretend that we can see the future prices of oil barrels, but we observe where they are and conclude that these prices reaffirm to us that the state of the world is economically at least, quite well, thank you.
We feel that there is some clarity as to the state of the world and there is continued support to the equity sector but investors are shovelling money into bonds at a furious pace – despite having virtually every conceivable reason to ditch the sector. In fact, April saw the most money devoted to fixed income since October 2014, coming despite tumult over a multi-year peak in several government bond yields that fuelled worry over a broader turn in market conditions and higher inflation. Fixed income ETFs, which follow bond market indexes, took in just shy of $16 billion in investor cash during the month, dwarfing the $10 billion dedicated to funds that track the stock market, according to FactSet. Mutual funds have shown similar traits this year. Investors pulled nearly $11 billion out of U.S. equity funds in the first quarter and $205.6 billion over the past 12 months, according to Morningstar. Taxable bond mutual funds took in $9 billion in the first three months and $170.1 billion during the past year. What can we say? We haven’t been bullish on fixed income since quite some time now, but we were believers that the bonds will end their 35-year bull-run into a calm zone more or less at these levels. We didn’t fear a crash from Fed tightening and parallel unwinding of Central Bankers’ balance sheets. All in all, the flows during the month, and throughout 2018 so far, show that investors are still not ready to go all-in for a stock market bull that is now 9 years old, the second-longest in history. “The most hated US equity bull market of all time has lost none of its ability to both repulse fresh capital and still live to fight another day,” Nick Colas, co-founder of DataTrek Research, said in his daily market note. Bulls wonder why more people haven’t bought in, but that scepticism has prevented a full-out stocks fervour that typically leads to a bear market.
The trouble for investors this year is that most asset classes have moved little in either direction, though there are opportunities in stock selection and in individual commodities. In that environment, money has moved to cash and its equivalents and away from risk, particularly in U.S. assets. Cash has risen to 16.6% of investor portfolios, the largest share since May 2017, according to the American Association of Individual Investors. From some angles, the US two-year Treasury note looks sexy with a 2.50% yield…
Back to our FX nemesis: our positive outlook on the US Dollar has ben somewhat revendicated with the DXY Dollar index at 92.40 now, the Swiss Franc at about parity to the Dollar. In addition, the head of HSBC’s FX research team has said he has completely altered his outlook to back a dollar bull run in the coming weeks. “We have changed our view. We were very wishy-washy, the dollar’s kind of going sideways. It worked well but we think we are now in breakout time,” David Bloom told CNBC’s “Squawk Box Europe” last Friday. A titbit of data came as Turkey’s credit rating was lowered by S&P Global Ratings, which cited a deteriorating inflation outlook and the long-term depreciation and volatility of the nation’s exchange rate. S&P reduced its foreign-currency rating to BB-/B, on par with Brazil and Vietnam, according to a statement Tuesday. That’s below where it’s rated by Moody’s Investors Service and Fitch Ratings.
As we watch more of the ongoing Washington DC’s sitcom, we are reminded that “The past is really almost as much a work of the imagination as the future” – Jessamyn West.
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