Bedrock’s Newsletter for Friday 19th of October, 2018
19 October 2018


 Friday, 19th of October 2018

We are closing-out a nasty week… Another one, where fears of rising interest rates, brewing political conflict between the USA and Saudi Arabia and further commercial ‘misunderstandings between the USA and China are spreading jitters with the global investors that we are. China’s GDP figures for Q3 2018 showed that its economic growth slowed to 6.5% year-over-year to Q3 ‘18, amid concerns surrounding the ongoing trade war between Washington and Beijing. Should we be concerned? Well, applying 65% growth to the current GDP of about $12.24Bn we calculate that China is adding some $800 billion of GDP power per annum. The US must grow at over 4.20% in order to maintain its lead in GDP size vs. China. We thought it appropriate to show this chart of relative economic weights, where you can see that the Chinese growth is equivalent to adding a Switzerland or two Belgium’s each year… Also, it can give some perspective as to the economic importance of the brewing Saudi conflict- At $0.68T of GDP, the Saudi economy represents some 9 months of Chinese growth… But as we all heard elsewhere, size isn’t everything…


Gross Domestic Product (GDP) by Country 2017



Saudi Arabia in effect controls the oil matrix. They have the power to utterly disrupt the energy market via relatively small production variations. And, they help the West in containing Iran. Possibly these elements could be weighted to counterbalance the GDP size?


What else might be driving those rather violent moves? Goldman Sachs CEO David Solomon said on Thursday that he believes part of October’s steep stock sell-off was the result of programmatic trading. “There’s no question when you look at last week, some of the selling is the result of programmatic selling because as volatility goes up, some of these algorithms force people to sell,” said Solomon. “Market structure can, at times, contribute to volatility and one of the things that we’re spending a bunch of time thinking about at the firm is how changes in market structure over the course of the last 10 years will affect market activity.” The Goldman chief highlighted the rise of a number of relatively new market assets — such as passive index or exchange-traded funds — as examples of the new types of technology that are still being perfected. Clearly, there is a change in the decision-processes that are moving markets. There is also a cross-market contamination effect- Now that China is the second economy of the world, movements in its stock exchanges actually send ripples through the whole world (we thought it normal that the world followed the US…). The Shanghai Composite Index plunged 2.9% Tuesday, sending negative ripples through world markets. China stocks are now down 12% in October and 26% over the last 12 months. But U.S. investors feel insulated from China’s losses. Why wouldn’t they, with the S&P up 4.5% this year while Shanghai is down 25%? A study by CNBC using analytics tool Kensho found that U.S. stocks are more often weaker when the declines in Chinese stocks are large. Over the past 10 years, when Shanghai stocks fell 10% or more in a 30-day period, the U.S. stock market was up only about 30% of the time, and the U.S. indexes all averaged significant declines. For instance, the S&P 500 on average fell 4.8% when China was down 10% or more, and the Nasdaq was even worse with a loss of 5.3%. As Shanghai stocks went down, so did basic commodities, like copper, off 8.3%, and oil, off 8.5% on average in the 30-day periods. Crude oil was down nearly 70% of the time when Chinese shares toppled, and copper was down 78% of the time. Safe havens, however, averaged gains and gold rose by 0.6% while the dollar index was up 1.5%. Both were higher more than half the time. We wanted an integrated world? Here we are…The largest U.S.-listed exchange-traded fund tracking Saudi Arabian stocks sank Thursday as U.S. Treasury Secretary Steve Mnuchin said he was skipping an investor conference in Riyadh amid rising pressure to hold the kingdom’s leadership accountable for the disappearance of a Saudi journalist. The $219 million iShares MSCI Saudi Arabia ETF, ticker KSA, was down 1.6% in afternoon trading. Still up some 7.5% YTD…


For market professionals, the most significant thing that happened in early October was a flip in investor psychology. The correlation between stock prices and interest rates, as measured over the prior 52 weeks, turned from positive to negative—so higher rates implied lower stock prices. That’s happened only four times since 1989. Some strategists are confident the bull market will endure even if rates continue to rise. They reason that the Fed under Chairman Jerome Powell won’t make the mistake of raising rates too fast and snuffing out the expansion. The chief investment strategist at BMO Capital Markets said this week “periods of higher or rising rates have coincided with double-digit annual returns for the S&P 500, on average.” That may be. But if Oct. 10-11 taught us anything, it’s that bad weather can escape the radar’s notice, and hibernating bears can suddenly emerge from their caves. Well… We are watching very encouraging Q3 earnings, mostly beating expectations on both top-line revenues and on bottom line profits… you were worried about high P/E ratios? Well, as the “P” of the Prices is coming down and the “E” as in Earnings is rising, the ratio is falling doubly fast. Looking cheap yet? The other factor for establishing “cheapness” is the cost of capital, or simply, interest rates. Yes, these have risen some, and as per the Fed minutes released this week they are likely to rise some more. But the benchmark 10-year Treasury note yields 3.17% as we write, not significantly higher. But then, China US Treasury holdings are at their lowest in 14 months. China trimmed its holdings of U.S. Treasuries in August by about $6 billion, to the lowest level since June 2017. If they stop buying… couple this with The U.S. budget deficit which grew to $779 billion in Trump’s first full fiscal year as president, the highest since 2012 amid tax cuts and spending increases. The budget gap for the 12 months through September was 17% wider than the same 12-month period a year earlier. The deficit as a share of total economic output was 3.9% in fiscal 2018, up 0.4% point from the year prior. Clearly, the US would not qualify for EU membership… Smiles aside, the US Treasury will have to borrow this deficit just as China is buying less and the Fed will be selling more… Supply up, demand down… Prices of US$ bonds are likely to fall… That means yield will rise!


That said, let’s not forget that even when all else is lost, the future still remains.



Market Weekly Highlights

Currencies & Commodities

  • The greenback, which has lost value for almost one month on the back of US-China continued trade dispute matters with the Dollar Index DXY moving from the 97 highs to 93.90 has recovered its strength since the last FOMC decision to raise rates. The USD continued to rally across major currencies mainly driven by the Federal Reserve’s expected rate hike guidance for 2019 as well as the investors’ flight-to-quality reaction to the latest correction in the equity markets; the DXY is currently trading at 96.03. As a general remark, global trade disputes, US sanctions, the Turkey and Italy contagion fears on Europe, Fed interest rate anticipations and US mid-term elections will remain present and continue to add volatility to currency markets.
  • The EURUSD pair is trading lower for the week around 1.1450 on the back of the recent concerns expressed by the European Union over the Italian government’s spending plans and fiscal deficit, raising overall conflicts within the common currency zone and therefore limited the EUR recent rally to 1.1800.
  • The CHF is the currency that also lost this week, with the USDCHF pair jumping from 0.9840 to 0.9960, while the EURCHF trades at 1.1405 this morning.
  • The Pound edged lower this week, reaching 1.3050, still higher from the 1.2660 reached in the middle of August but well below the 1.4375 top seen early this year in April.
  • The JPY seems to have marked a pause to the latest two-week rally against the USD with the pair trading from 114.50, the lowest levels seen this year, to 111.63 at the beginning of this week; currently it stands at 112.44.
  • In EM, both the Russian Ruble and Turkish Lira are suffering amid US sanctions for the former and economic crisis and political turmoil for the latter. However, since mid-September the Russian Ruble has strengthened against the USD trading from 70 to 65.70, as has the Turkish Lira which reached 7.23 in early August and now is at 5.63.
  • The Brazilian Real is flat for the week, now at 3.72 against the USD, however it experienced a post-election rally of 13% but has not fully recovered from the 20% losses since the start of the year amid lower appetite for emerging market currencies sparked by trade-war fears and rising US interest rates.
  • Bitcoin hit nearly 8’500 jumping 20% from the latest support found at just above 6’200, only to come back to almost 6380 now; still a big drop since the beginning of March.
  • Crude oil WTI is down this week to $69 per barrel, amid US dollar strengthening, Trade War escalation and mounting pressures from US sanctions on Iranian Oil; Brent is trading at about $79.86.

Fixed Income

  • 10Y U.S. Treasuries yields, which had traded in a range during the last quarter of 2017 from 2.30% to 2.40%, have crossed 3.20% this month amid inflationary pressures and FED rate hikes.
  • The Japanese 10-year JGB yield has traded in a range from 0.020% to 0.060% for the past 6 months, after dropping from the 0.10% seen in early February; to then jump to 0.15% as BOJ tapers.
  • In Europe, the German Bund yield nearly doubled at one point this year, jumping from 0.40% to 0.80%, but then came back down as low as 0.20% on the back of Italian crisis fears. Now at 0.40%, almost where it closed 2017. Same for the French 10Y Yield which had crossed the 1% during February dropping as much as 0.60% during the summer to trade back higher at almost 0.81% currently.
  • In Peripheral Europe Italian 10Y yields are now trading above the 3.50%, levels seen in May when their internal political turmoil kicked-off. Currently, they show 3.74% well above the 1.70% low April levels. The Spanish 10Y yields trade some 195 bps lower than Italy at 1.80% higher from where it started the year at 1.61%.


  • Markets in the US are down since last Friday but remain positive for 2018 with NASDAQ being the strongest performer and posting 8.43% positive yearly return, despite the 8% drop since the highest levels reached this year. SP500 and DJIA are up, respectively by +3.56% and +2.67% YTD. The SP500 is currently at just above 2’768, the DJIA just a couple of points below 25’380, while Nasdaq is trading some points above 7’480.
  • In Europe, markets are down for the week on the back of Italian sell-off pressures and showing negative returns for the year so far. The Eurostoxx50, DAX, Spanish IBEX 35, Italian FTS MIB and Swiss SMI are all down by -8.74%, -10.72%, -12.27%, -14.00% and -6.13% YTD. The CAC 40 is the least negative performer showing 4.37%.
  • In Asia, the Nikkei has turned negative once again for the year so far at -1.02% YTD, while Hang Seng is down by 14.57%. BOVESPA turned positive for the year again showing a strong +9.74% helped by the lower BRL having jumped as much as 23% from the lows in June.


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