Bedrock’s Newsletter for Friday 22nd of June, 2018

Posted by Carlota Vandekoppel on 22nd June 2018

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Friday, 22nd of June 2018

As June is winding down, we sense a slowing in the rate of rattles to the system. This week afforded us only two “Trump Specials” : more of the same with tariffs against China and then ‘out of left field’, as Americans like to say, a horrific decree on migrants on the southern border of the USA, thankfully reversed after public outcry. The ugliness spilled over to Europe as well, as governments of Malta, Italy, and France refused or ignored need of asylum for a boatload of refugees. Thankfully, Spain showed compassion. Why do we write about this in an investments-orientated letter? We are not trying to appear altruistic but rather direct your attention to what is clearly the single greatest risk to our comforts, way of life, and ultimately, our investment strategies for the future. Clearly, a rethink of capital allocation is required on a global basis.

Once upon a time, not so long ago, great leaders in Europe decided to create the European Union to fend-off the risk of future conflict. They succeeded, even if the application isn’t perfect (yet). But we all know that all the wars of past times were driven by economics, albeit often dressed in other costumes. The global refugee issues are all at their core driven by economics and are the single greatest risk for our future. Income and wealth gaps are the greatest ever and they had been the root cause for revolutions – French and Russian being the most dramatic, neither of which was on anybody’s radar when they erupted. Yes, that is the right word – we are sitting on a volcano…

Bringing our thoughts back to the trivia of finance, the bull market is entering a new phase but PNC Financial’s Jeffrey Mills believes that’s no reason to get negative on stocks. The firm’s co-chief investment strategist acknowledged it will be hard to replicate last year’s record gains. He referred to 2018 as a “reset year” as stocks retrace. “The market is catching its breath…There’s going to be a continued push and pull between strong fundamentals. So, we have solid growth [and] really good earnings, but then multiples that have come down” Mills said Thursday. Despite his prediction of a near-term market pause, Mills doesn’t think investors should get overly defensive. He listed energy as a top play in this environment. We like his thinking, but others aren’t as sanguine.

Nobody wants to use the ‘B’ word, but a bubble is upon us, a growing number of market watchers are warning – and it could pop sooner than many expect, Centricus Asset Management Fund Manager Ralph Jainz said Monday, joining a long list of financial players casting doubt on the strength of the market’s current bull run. “Nobody wants to talk about this being a bubble. It’s the greatest asset inflation bubble we have seen in 20 years” Jainz said during an appearance on CNBC’s Squawk Box Europe. There is wide disagreement over whether markets have further to climb or whether we’ll see a spectacular market correction. Investing titan Mark Mobius recently predicted an impending correction of up to 30%, while others see no cause for concern.

Some advisors are pointing out that today’s stock market is the most overvalued on record — more so than in 1929, 2000, and 2007. Maybe. We remind you that “Overvalued” and “Undervalued” are subjective terms. The actual “Value” is objective, being the Dollar-weighted consensus on “Value”. That said, many remain conversely optimistic about the markets. Credit Suisse said in a note last week that there are “clear signs that economic growth is set to accelerate across major regions in the second half of 2018, creating a favourable climate for equities and certain commodities.”

We did get one substantial surprise this week: on Tuesday, China’s central bank lent 200 billion yuan ($31 billion) to financial institutions via its medium-term lending facility (MLF), highlighting concerns over liquidity and potential economic drag from a trade war with the United States.

The surprise injection of funds came just hours after U.S. President Donald Trump escalated the tit-for-tat trade scrap with Beijing by threatening to impose a 10% tariff on $200 billion of Chinese goods. The move also comes after the central bank’s unexpected decision last week to leave borrowing costs for inter-bank loans unchanged after the U.S. Federal Reserve raised its policy rate. Greater China markets recorded heavy losses on the back of that news. On the mainland, the Shanghai composite fell 3.82% to close below the 3,000 mark at 2,906.43. The smaller Shenzhen composite sank 5.77% and closed at 1,594.05 while Hong Kong’s Hang Seng Index fell 3.08%.

The malaise over trade wars has spread wide across just about all stock markets, driving capital back into the bond markets. As this happens, we ask ourselves if those best of the best bonds, the US Treasuries, are truly a good or even reasonable hiding place? After all, the protagonist (China) is the biggest holder of these instruments. In a way, these holdings are like a nuclear threat hanging over us all… The lurch toward protectionism rattled commodities and commodity-linked currencies, which retreated across the board. Oil fell as traders weighed OPEC’s discussions on a compromise over increasing output ahead of a meeting in Vienna this week. The CBOE Volatility Index [VIX] rose to the highest since May, while government bonds in Europe rallied alongside U.S. notes. Developing-nation stocks dropped the most since March. Nonetheless, it still is in the very low range at just under 14! Furthermore, through all the hollers and bouncing, the NASDAQ posted yet another all-time high this week…

Some investors have been tempted to move away from human based portfolio management towards the A.I. world, feeling that the machines will have less, if any, emotions in the way of wise decisions. Oaktree Capital Management’s Howard Marks has a new client memo out titled “Investing Without People,” which is a pretty standard take on passive investing, quants, artificial intelligence, etc. We would put forth to you that there is a logical fallacy in trying to exclude emotions from the investing process: after all, it is sentiment that drives markets! Without sentiments, they go nowhere… How can you reason that a machine which has neither Greed nor Fear programmed into its wires could possibly get it right?

The Swiss National Bank (SNB) has said it is prepared to intervene in currency markets if it deems that the Swiss franc has gained too much strength. The central bank kept its main borrowing rate in negative territory Thursday as it acknowledged the risks of global trade friction and political change in Italy. Will a robot ever understand Thomas Jordan’s thinking on Italian politics? In April, the Swiss franc briefly weakened past 1.20 per euro for the first time since the SNB abruptly removed its cap on the currency in 2015. The Swissie has quickly strengthened since mid–April and now stands at about 1.15 to each euro.

Last week central banks spoke. The US confirmed its tightening mode as Europe went softer. The US interest rate curve continued its flattening with the two and ten year Treasury yield falling to 35bps, the lowest since 2007. If it were to go below zero, i.e., an inverted yield curve, it is considered by many to be the harbinger of recession – and then what will happen? Will the ECB be able to raise rates with the USA in recession? We wouldn’t bet on it… The ECB might find itself in the Bank of Japan (BOJ) conundrum of the 1990’s and early 2000’s!

In light of the aforementioned why, oh why isn’t the Dollar doing what it is supposed to do and rise? The Dollar Index [DXY] is down at 94.15, back down from last week’s visit of the 95 level and yet, Gold is sinking now down to $1’270 or so, off some $90 from its high in January. Oil at $66.25 now is also down from $72 just one month ago. We wonder if it is a general malaise emanating from our opening topic?

Yesterday is not ours to recover, but tomorrow is ours to win or lose – Lyndon B. Johnson

Market Weekly Highlights

Currencies & Commodities

The greenback recorded new highs for the year this Thursday, continuing the rally it started last month. The Dollar Index DXY is finally flat for the week after crossing 95.50 yesterday.
The USD tested 1.15 lows yesterday against the Euro to only trade back lower at 16.70 on the back of today’s latest PMI data, which suggests a recovery in growth in the Eurozone.
The CHF followed the same path and is flat this week with the EURCHF marking 1.1550 this morning, while CHFUSD is moving lower from parity.
The Pound trades higher this week, crossing 1.33 after trading at 1.31 yesterday, still lower from the 1.4375 top last month. The JPY also stabilised this week around 110.20, remaining stronger for the year against the USD.
In EM, the Russian Ruble steadied at around 63.50, while the Turkish Lira, which went on a free fall and reached 4.92 against the US$ at its low point, recovered a bit to 4.46 to only trade back lower at actually 4.70.
The Brazilian Real, is flat for the week, now at nearly 3.77, amid lower appetite for emerging market currencies sparked by trade-war fears, geopolitical risks and rising US interest rates.
Bitcoin is now back down at 6’380, a big drop since the beginning of May.
Crude oil WTI trades higher for the week at $66.45 per barrel, stronger for the year amid the tensions fuelled by the Syrian/Iran events, lower US inventories, and Iranian Sanctions; while Brent is trading at about $74.40.

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%, crossed 3.10% last month amid inflationary pressures, and now trades below 2.92%.
The Japanese 10 year JGB yield opened the year 2018 at 0.053% and reached 0.10% in early February. It now stands at 0.035%, continuing to offer a POSITIVE yield.
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 to actually mark 0.35%, lower than where it closed 2017. Same for the French 10Y Yield which had crossed the 1% during February and is now back to 0.70%.
In Peripheral Europe Italian 10Y yields are now again just below 2.70%, having jumped 150bps higher during May amid internal political turmoil. The Spanish 10Y yields trades some 135bps lower than Italy at 1.34% down from where it started the year at 1.61%.

Equities

Markets in the US are again mixed for the Year 2018 with NASDAQ and SP500 being positive and trading higher by respectively 11.73%, 2.85% while DJIA is trading lower, -1.04%. The SP500 is at around 2’750 the DJIA is just above 24’460, while Nasdaq is trading some points above 7’710.
In Europe markets are showing negative returns for the year so far with the exception of the French CAC 40 and Italian FTSE MIB, which are still up by respectively +0.79% and +0.14%. The Eurostoxx50, DAX , Spanish IBEX 35, and Swiss SMI are all down respectively by 2.24%, 2.92%, 2.72% and 9.04%.
In Asia, the Nikkei trades again lower for the year so far marking -1.09% as are also Hang Seng and BOVESPA which are down by 1.94% and 8.28% for the latter.

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