Bedrock’s Newsletter for Friday 26th of October, 2018

Posted by Carlota Vandekoppel on 26th October 2018

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Friday, 26th of October 2018

It is the last Friday of October, a month notorious for humbling investors and markets. This October has only added to this notoriety… As Q3 earnings parade keeps rolling-in, we feel vindicated that as we had expected, results are both better than had been expected by the street and generally good in absolute terms. But then, the market is responding with a general worldwide decline.

As late as the month of September, the street was pointing its fingers at rising interest rates as the major risk to the financial world. President Trump wailed about the Fed and its misunderstanding of the economy. Somehow though, today the benchmark US ten-year Treasury is yielding 3.09%, down some 15 basis points since September. This reduction in the discounting rate ought to have boosted equity prices… Then, the improving economy should have boosted them further. Then, Q3 earnings would have an investor believe that the market still has long legs under it. All this being true and rational, the markets have fallen. So much so, that the DJIA and S&P 500 turned negative for the year during Wednesday’s big falls. The NASDAQ remained in positive grounds, but it looks as though the falls will resume today after Google and Amazon disappointed the markets after the close last night.

This year’s sell-off may not be fully justified yet by facts on the ground, but the risks are becoming clearer. Corporate profits may have peaked as costs are starting to rise from labour and raw materials’ prices. Is the US about to confront an immigration wave from central America, like the European’s problems with middle eastern and African flows? What is really going-on with China? The trade war is doing what? and to whom exactly? And, could this trade conflict spill-over into an armed one? Around trade routes in the contested South China seas? And now we are feeling the malaise of the Saudi Arabian horror story in Turkey. One man was murdered, terrible as it may be, it is an immaterial event in the greater scheme of things, like the murder of Empress Elisabeth of Austria (Sissy) some 120 years ago, right here, in Geneva? Arguably, the latter triggered the events leading to World War (I)… As we observe the carnage across equities everywhere, in all sectors, we see that the VIX, the famous “fear index” is now at 26, way up from the 10 to 12 range we had seen for some time now, but way below the spike to 34 in early February. Gold? At $1’237 it is up somewhat from its August lows of $1’170, but a long way below the $1’350 spike in late January. Oil? Well, despite the Saudi scandal, it has been drifting down, rather than up as one might expect- $66.75, down some $10 since the start of October. The Dollar, an old and faithful escape lane from risk has risen! The trade weighted DXY index is at 96.40 up some 10% since February. This one has been long in coming… The Swiss Franc is now at parity with the US Dollar, the Pound Sterling paying for the disarray in Parliament, now at $1.28 looking quite soft. Here, we can understand it. Theresa May said this week that 95% of the Brexit issues were resolved. Wonderful… but let’s not forget that 95% of the Titanic’s journey was wonderful…

We also have some European issues going on here… Italy is being naughty with its budget deficit but escaped a Moody’s downgrade to junk status- Italian bonds rallied after the nation said it will ensure its deficit does not break a 2.4 percent target next year and Moody’s Investors Service kept it at investment grade. But there are worrisome signs there and some eyes are looking at France as well. In the case of France, it is a very difficult budget to accept by the European Commission because France has not had a balanced budget since 1974 and has missed its own deficit targets more than eleven times… The Euro is drifting down, now at $1.137 or so… Read the markets, predict the news. Not the inverse, i.e., read the news to predict the markets- Amidst the general euphoria and Goldilocks data we forgot our own mantra…

The markets are telling us that something is lurking below the surface, something not so nice… IS it global warming? Is it the departure from QE around the globe? Is it the aftershocks from a realization that the 30 year-long bond markets rally is over? Are our thoughts re-adjusting valuations to a new world?

Time will tell. There is the often ignored “Hemline Index”, to which we had alluded a couple of weeks ago- it is lengthening… as you may recall, this index measures the length or shortness of lady’s skirts… As it moves so does the S&P 500. Statistically, the best predictor of the direction of equity markets. To our chagrin, they appear to be getting longer. The markets might be falling…

Donald Trump just ahead of the US mid-term elections announced a 10% tax cut for middle income Americans. Even this didn’t stabilize the markets.

Central banks are set to increase their purchases of gold in 2018 for the first time in five years as eastern European and Asian countries seek to diversify their reserves. Net purchases of gold by central banks are forecast to rise to 450 metric tons this year, up from 375 tons in 2017, according to consultancy Metals Focus Ltd. That will be the first increase since 2013, when banks boosted their holdings by 646 tons, the most for several decades. Do they know something that we don’t??

European Central Bank (ECB) President Mario Draghi said on Thursday that he expected inflation to pick up towards the end of the year. Earlier, the ECB had kept its main rates unchanged and had promised to stick to its stimulus exit timetable. Draghi added that upward inflation pressure would not be short-lived as wage increases were not temporary.

The good news that emanates from the falls in equity prices is that valuations are normalizing. Actually, ahead of what looks like another down day today, the S&P 500 forward looking P/E ratio is just under 16X. The lowest in years, well below historic averages… The drop in the ratio came from both ends of the computation- The “P” or Price of the equities is down, then, the “E” of the Earnings is up. Are we close to a bottom for this re-pricing shake-up?

Investors should take advantage of the worst monthly equity selloff in this bull market to position for a year-end rally as fears over Federal Reserve hawkishness are likely overdone, says Tom Lee, head of research at Fundstrat Global Advisors. Tom Lee believes that the Fed ‘has the market’s back, i.e., there is a floor below these prices… The old “Fed Put” …

Back for an instant to China- China’s Yuan rebounds after nearing its weakest level in a decade. Now at 6.95 to the US Dollar, the depreciation has taken away some of the sting of US Tariffs… 9% decline in the past 6 months…

Let’s hold tight into the rest of the month and hope that we get a better base for the next leg up!

He didn’t mean this in the context of investments, but we believe this fits our optimism on equities- “The absence of alternatives clears the mind marvellously.”- Henry Kissinger

Market Weekly Highlights

Currencies & Commodities

The greenback, which lost value for almost one month on the back of US-China continued trade disputes matters with the Dollar Index DXY moving from the 97 highs down to 93.90 has come back 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 flight-to-quality reaction by investors to the latest correction in the equity markets; the DXY is currently trading at 96.60 ahead of Q3 US GDP data. As a general remark, global trade disputes, US sanctions, Turkey and Italian contagion fears on Europe, Fed interest rate anticipations and US mid-term elections will remain present and add volatility to currency markets.
The EURUSD pair continues to trade lower this week around 1.1370 on the back of concerns expressed recently by the European Union over the expansionary fiscal plans of the Italian government, raising overall conflicts within the common currency zone and stopping the latest EUR latest rally at 1.1800.
The CHF has also lost value this week with the USDCHF pair trading above parity, while the EURCHF trades at 1.1373 this morning.
The Pound edged lower this week, reaching 1.28, still higher than 1.2660 seen 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 rally of the last two weeks against the USD with the pair trading from 114.50, the lowest levels seen this year, to 111.63 the beginning of this week; currently standing at 111.90.
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 up from 70 to 65.70, unchanged this week, 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 3.70 against the USD, however it lived a 13% post-election rally 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 6,420 now; still a big drop since the beginning of March.
Crude oil WTI is down this week to $66.34 per barrel, amid US dollar strengthening, Trade War escalation and mounting pressures from US sanctions on Iranian Oil; Brent is trading at about $76.24.

Fixed Income

10Y U.S. Treasury yield, which had traded in a range during the last quarter of 2017 from 2.30% to 2.40%, crossed the 3.25% this month amid inflationary pressures and FED rate hikes to show 3.08% currently.
The Japanese 10-year JGB yield has traded in a range from 0.020% to 0.060% for the first 6 months and then hit 0.16% as BOJ tapers to only drop back to 0.11% currently, levels last seen in early February.
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% in May on the back of Italian crisis fears. Now at 0.38%, slightly lower 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 back higher at almost 0.90%, currently showing 0.74%.
In Peripheral Europe, Italian 10Y yield is now trading above the 3.50%, levels seen in May when the country’s internal political turmoil kicked-off, well above the 1.70% low of April. The Spanish 10Y yield trades some 190 bps lower than Italy at 1.59% almost where it started the year at 1.61%.

Equities

As of Thursday’s, close, the markets in the US are all down since last Friday but remain just positive for the year 2018, with NASDAQ being the strongest performer and posting 9.6% positive yearly return, despite the 12% drop since the highest levels reached this year. SP500 and DJ also remain up, respectively by +1.2% and +1.07% yearly returns. The SP500 is currently at just above 2’705, the DJIA just a few points below 24’990, while Nasdaq is trading closed Thursday at 7’016.
In Europe, markets are down for the week and showing important negative returns for the year so far. The Eurostoxx50, DAX, Spanish IBEX 35, Italian FTS MIB and Swiss SMI are all down by -11.30%, -13.84%, -13.65%, -15.28% and -7.96%.
In Asia, the Nikkei has turned negative for the year so far marking -6.9% YTD, while Hang Seng is down by 17.39%. BOVESPA turned positive for the year again showing a strong 10.05% helped by the lower BRL having jumped as much as 23% from the lows in June

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