Bedrock’s Newsletter for Friday 21st of September, 2018
21 September 2018


 Friday, 21st of September 2018

Can you believe it? We are a week away from ending Q3. We barely finished smiling at Q2 results… Groundhog Day, keeps repeating… We dare venture that, as has become customary, the analysts will yet again underestimate the results that we will read in early October. Another impetus for further rises in the markets… We remind you that the markets are a discounting mechanism- they take the future earnings and discount them to the present. When reality becomes known, the same calculations are made with the new data; If the earnings “beat”, then the new present value is higher than before. Markets rise. So simple… There are caveats though- the same equation that results in higher value from higher earnings, calculates a lower value if the discounting factor is increased. For this particular exercise, it is customary to use the yield on the US 10 year Treasury. This year, every quarter-end we saw the said yield decline, if slightly. This time though, it appears that it might be rising… Now at a 3.10%…

The selloff in Treasuries that has taken the 10-year yield above 3 percent isn’t getting enough attention. Although DoubleLine CEO Jeffrey Gundlach has noticed. He’s right — at least on the first part. References to “Treasury yields” in news articles are dramatically below where they were in April, when the 10-year yield traded above 3 percent for the first time since 2014. There’s a simple reason no one’s talking about the selloff in the $15 trillion Treasury market: It’s tough to find the negative ramifications across other asset classes. U.S. stocks have been moving in near-tandem with bond yields since the 10-year crossed the 3 percent threshold.

The traditional master-slave relationship in global markets — soaring U.S. yields undercutting emerging markets — isn’t on display this week. BlackRock is touting the asset class, and inflows are staging a tentative return. Case in point: The largest exchange-trade fund tracking emerging-market local currency bonds reeled in $169 million on Tuesday, the most since June 2017, after losing about a quarter of total assets since early April. And that’s in part because King Dollar is eating humble pie this week despite the push higher in yields. The Bloomberg Dollar Spot Index is trading at its lowest level in three weeks. Longer-term inflation-protected Treasury yields are up but haven’t broken out to fresh year-to-date highs, and have been mired in a relatively tight range for five years. Some more global context: the selloff in Treasury bonds has come during a reduction in the perceived risk of turmoil between Italy and the European Union over its budget — which had previously pushed investors to seek safer options in fixed income. As Italian bond yields have fallen, core rates have risen. But as Treasury yields have risen, their implied volatility — as judged by Bank of America’s MOVE Index — has remained subdued. “Where we are today, is in a period of relative calm as U.S. bond yields probe their highs, and we become accustomed to trade rhetoric and perhaps, blasé about the economic damage it will cause,” writes Societe Generale SA’s global strategist Kit Juckes.

What’s next? The “Great Bull” market that came after the financial crisis is dead due to slowing economic growth, rising interest rates and too much debt, according to a Bank of America Merrill Lynch analysis. In its place will be one that features lower returns, the bulk of which will be concentrated in assets that suffered during the recovery, Michael Hartnett, BofAML’s chief investment strategist, said in a wide-ranging note looking at markets 10 years after the collapse of Lehman Brothers. “The Great Bull Dead: end of excess liquidity = end of excess returns,” Hartnett said. The liquidity reference is to central banks that have pumped in $12 trillion worth in various easing programs that have seen 713 interest rate cuts around the world, according to Merrill Lynch. Leading the way has been the U.S. Federal Reserve, which kept its benchmark interest rate anchored near zero for seven years and pumped up its own balance sheet to more than $4.5 trillion at one point. All that stimulus has led to a 335 percent surge in the S&P 500 since the crisis lows. But as the Fed and others end asset purchases and gradually raise rates, investors will have to brace for significant changes, Hartnett wrote. In that climate, he advised investors to focus on “inequality, innovation and immortality,” that would benefit pharma companies and technology disruptors, along with inflation plays in commodities, value stocks, and markets outside the U.S. and Canada. The latest leg of the bull market has been fuelled by last year’s tax cuts that also contributed to soaring corporate earnings along with a fresh round of share buybacks that is expected to eclipse $1 trillion this year. Buybacks have totalled $4.7 trillion since the crisis.

Relax… Th VIX trades Thursday to 11.40 which is down and actually a very low absolute level. Low to no fear! The DXY US Dollar index is drifting down at 93.50 and no market scares elsewhere… Smile, if Q3 earnings will fit our thoughts, another leg up can be expected.

Our concerns remain around the US/China “trade wars”. We read US officials saying that the Chinese are out of ammunition here- maybe $20BN worth of US exports remain un-tariffed, whilst the USA has many billions of Chinese imports yet to tax… America is ahead… or is it? Lets no forget the single largest US export to China is not in hard-goods or even services- It is US Treasuries. Arguably, when China buys a T. Note, it is importing a US product- they send US$ to the Fed, receive an American government I.O.U.  Why can’t China pace a tariff on Treasuries? Hmm… not obvious what this might mean or do… If our humble thinking could imagine this scenario, be sure that someone in China did as well… Something might well be brewing in this arena- China’s holdings of U.S. Treasury bills, notes and bonds dropped to a six-month low of $1.171 trillion in July, from $1.178 trillion in June. The data is closely watched, since dumping Treasury securities is viewed as one-way China could retaliate against the U.S. in an ongoing trade dispute, but bond strategists are sceptical China is really trying to send a message this way. China is the biggest holder of U.S. Treasuries, followed by Japan. Japan’s holdings rose to $1.04 trillion from $1.03 trillion in June.

Recession risk is low, even when looking out over the next three years, according to Goldman Sachs. The firm said the chance of a U.S. recession is “muted” in the near term, and at 36 percent over the next three years, below the historical average. “Our model paints a more benign picture in which robust growth—coupled with receding concerns that financial conditions were unsustainably easy—have so far put a lid on US recession risk,” Goldman economists wrote. They said there has been increasing investor interest in the chance of a recession in the U.S. over the next few years. Weakness in emerging markets and China has also created concerns that the U.S. economy could ultimately be impacted. “Historical experience suggests that recessions in the U.S. have gone hand in hand with recessions elsewhere. Looking at the past four decades, the average chance of a recessionary quarter in the next year in another DM economy is just over 20% if the US is not currently in recession but nearly 70% if it is,” noted the Goldman economists. The correlation to other developed markets has decreased with each U.S. recession from 1980 to 2001. However, the financial crisis triggered recession in nearly all developed economies, the economists added.

There’s nothing on the horizon that’s indicating the next financial crisis is going to happen anytime soon, according to Tony James, executive vice chairman at the Blackstone Group. “The last crisis was a terrible crisis, but it was both a financial crisis and an economic downturn. Right now, I don’t see any economic downturn on the horizon, so it will be a little while before I think you have that confluence of factors,” he said.

We are feeling confident as we roll down Q3 and keep an optimistic outlook through the Trump induced fog. If only the US Dollar would listen… You still worried? Remember that” What the caterpillar calls the end of the world the master calls a butterfly”. Richard Bach



Market Weekly Highlights

Currencies & Commodities

  • The greenback has edged lower since mid August on the back of US-China continued trade dispute matters and FED rate move anticipations. The Dollar Index DXY which reached almost 97 back in mid August is now trading lower at around 94.00, down for the week. Global trade disputes, various US sanctions, the latest Turkey contagion fear on Europe as well as Fed interest rate anticipations remain present and add pressure to curreny markets.
  • The EURUSD pair is trading higher for the week around 1.1786, breaking out of its recent range strengthening against the USD from the 1.1311 lows of the year. This, despite fears of contagion on Turkey’s turmoil.
  • The CHF is stronger this week with the CHFUSD pair at 0.9576 and EURCHF at 1.1297 this morning.
  • The Pound edged higher this week reaching 1.3240 up from 1.2660 which was reached in the middle of August. this remains well below the 1.4375 top seen early this year in April .
  • The JPY is lower this week, trading at 112.82 this morning, on the back of Abe’s re-election as party leader.
  • 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. The Russian Ruble is trading at around 66, while the Turkish Lira which reached 7.23 in early August came off to 5.69 but is now back again at around 6.27, despite the presentation of a medium-term economic plan that look well-intentioned but lacking in details.
    The Brazilian Real is slightly higher for the week, now at 4.07, however it has lost about 20% since the beginning of year amid lower apetite for emerging market currencies sparked by trade-war fears and rising US interest rates.
  • Bitcoin is now back at 6’500, still a big drop since the beginning of March.
  • Crude oil WTI is up this week to $70.50 per barrel, amid US dollar weakening, Trade War escalation and mounting preasures from US sanctions on Iranian Oil; Brent is trading at about $79.00.

Fixed Income

  • 10Y U.S. Treasuries yields, are now back above 3.00% this month amid inflationary pressures and FED rate hike expectations.
  • 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 0.14% 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 0.47%, slightly higher than where it closed 2017. Same for the French 10Y Yield which had crossed the 1% during February dropped as much as 0.60% in summer to trade now back higher at almost 0.80%.
  • In Peripheral Europe Italian 10Y yields are now trading in a wide range from 2.50% to 3.50%, actually at 2.88% well above the 1.70% low April levels before the internal political turmoil, but below the 3.50% reached in May. The Spanish 10Y yields trades some 130 bps lower than Italy at 1.50% down from where it started the year at 1.61%.
  • Markets in the US are up since last Friday, at new record highs. NASDAQ being the strongest performer and posting 16.29% positive yearly return. SP500 and DJ are up, respectively by +9.62% and +7.84% yearly returns. The SP500 is actually at just above 2’930, the DJIA just a couple of points below 26’660, while NASDAQ is trading some points below 8’030.
  • In Europe, markets are up for the week but mostly showing negative returns for the year so far with the exeption of the French CAC 40 which is up by +3.21%. The Eurostoxx50, DAX, Spanish IBEX 35 and Swiss SMI are all down by -2.27%, -3.95%, -3.98% and -3.56%.
  • In Asia, the Nikkei trades higher for the year so far marking +4.85%, while Hang Seng is down by 6.61%. BOVESPA turned positive for the year again showing +2.24% helped somehow by the lower BRL .


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