Bedrock’s Newsletter for Friday 27th of April, 2018
27 April 2018

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 Friday, 27th of April 2018

 Spring is well entrenched all around us. And, it is true, Spring is a time of renewal and growth. If you had a doubt, see the two Korean leaders planting a tree together, peek at the US Dollar which has taken off (at last!), with the DXY index shooting up to 91.56, oil at $68 for ETI and $74.70 for Brent. Then, there are the earnings for Q1 which have been coming in fast and furious – amazing how a monster such as Amazon [AMZN] can show results that beat expectations by almost 2X… Data on Thursday showed the economy remains on a strong footing. The number of Americans filing unemployment benefits dropped to the lowest level in more than 48 years last week and the goods trade deficit tumbled in March on strong export growth. According to a Reuters survey of economists, GDP growth likely slowed to a 2.0% annualized rate in the first three months of the year. The economy grew at a 2.9% pace in the fourth quarter. The government will publish its advance estimate of first-quarter GDP on Friday. The anticipated slowdown in economic growth is likely to be temporary against the backdrop of a robust labour market that is expected to underpin consumer spending. The economy is also expected to get a boost from the Trump Administration’s $1.5 trillion income tax cut package as well as increased government spending. Looking good, Spring 2018!

Corporate America is well on its way to what could be a record-breaking profit season, and investors don’t really care. First-quarter reports so far are turning one of the market’s most time-honoured truths on its head: that profits drive prices. Despite earnings growth of more than 18% and an 80% beat rate, the market is little changed since the season has accelerated. That was true again Tuesday, when a slew of high-profile beats couldn’t push the overall market much higher as traders hammered even some companies that beat expectations. In fact, as trading progressed, major averages turned decidedly negative, even as nearly three-quarters of the 23 companies that reported topped Wall Street estimates. “It is pretty amazing when you look at it, an earnings season that’s having an equal and opposite reaction to results,” said Art Hogan, chief market strategist at B. Riley FBR. “It’s a very difficult market to please right now.”

Companies that have topped earnings estimates have seen share price gains of just 0.1% in the two days after reporting, well below the typical average increase of 1.1% as tracked over the past five years, according to FactSet. Earnings misses have resulted in two-day declines of 0.9%, which is well below the typical 2.4% decline. Indeed, investors have been fickle, perhaps because they have more on their minds than just bottom-line profits. Among the concerns are: the looming possibility of a U.S. trade war with China, rising bond yields (the benchmark 10-year Treasury note yield briefly passed 3 percent on Tuesday), and a potentially more aggressive Federal Reserve that could raise rates as many as four times in total before the year ends. And there’s more: earnings reports are a look in the rear-view mirror, which is showing companies getting a lift from tax cuts that will level off over time. The big boost in quarterly earnings likely to continue through 2018 will be tough to top in 2019. That means investors are looking through the earnings reports and envisioning a potential deceleration ahead. Caterpillar, for instance, saw a sharp drop after its CFO said the company’s outlook assumed that the first quarter was the “high water mark” for the year. You just can’t please everyone all the time… but we retain the fundamental strength in the economic data and the results are just confirmation. Will this euphoria last forever? Probably not, but our best guess is that it has quite long legs still. Stay with equities: even the pessimists are starting to see the light- The VIX measure for risk is down… now at 16.25 and then U.S. Conference Board’s consumer sentiment index rose higher in April; in contrast to the moderation expectated. The sentiment index rose to 128.7 in the month, as compared with consensus expectations of falling to 126. The rebound in sentiment was spread evenly between the present situation and expectations indices. Consumer sentiment has continued to be resilient even in the face of the recent uncertainty stoked by anti-trade rhetoric and stock market volatility, and consumers’ perception of future economic conditions continue to be favourable. These augur well for consumption spending and GDP growth, stated Barclays.

The European Central Bank (ECB) held interest rates steady on Thursday, amid signs the Euro Area’s growth outlook may have softened. The ECB’s interest rate on its main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at zero, 0.25 and -0.40% respectively. Speaking from Frankfurt, ECB President Mario Draghi said “underlying strength” in the euro zone’s economy continued to underpin the bank’s confidence despite signs of “moderation” in recent weeks. He added an “ample degree of monetary stimulus” remained necessary over the coming months. “The Governing Council expects the key ECB interest rates to remain at their present levels for an extended period of time, and well past the horizon of net asset purchases,” the ECB said in a statement, repeating its long-standing guidance on interest rates. “The euro-zone economy remained stuck in a lower gear in April,” said Chris Williamson, chief business economist at IHS Markit. “Growth has downshifted markedly since the peak at the start of the year, but importantly still remains robust.”

All these Spring-time musings are all well and pleasing, but the “elephant in the room” this time is the yield on the US ten-year Treasury Notes which crossed 3%and are trading in a narrow band at this level. The government’s benchmark debt instrument saw its yield pass 3% on Tuesday, a four-year high that ostensibly helped to trigger a violent stock market reversal that saw the Dow close lower by about 425 points. The calculus behind fear of the 3% yield seems obvious: With the S&P 500 dividend yield at 1.9%, a risk-free investment like U.S. Treasuries yielding 3% makes more sense in a volatile environment. But that reasoning is weak. The play assumes holding the bond to duration and clipping coupons, and the stock market has never shown inflation-adjusted returns that low over a 10-year period. Absent a major crash and a deep recession, it likely won’t over the next decade as well. While everyone on Wall Street is pounding the table over the rising 10-year yield, the 2-year note rose above 2.5% Wednesday, a level it last closed at August 2008, just a month before the financial crisis imploded with the collapse of Lehman Brothers. A risk-free investment with a 2.5% yield over two years? That seems a little more reasonable.

Overall, we remain favourable to equities and shy of bonds. We are pleased the currency traders have found the green light again… And as we have all gotten used to Donald Trump, we are reminded of Napoleon Bonaparte’s quip “In politics, stupidity is not a handicap…”

 

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Market Weekly Highlights

Currencies & Commodities

  • The greenback trades stronger this week amid further signs of the trade tensions easing and a potential “Era of Peace” for the two Koreas. The Dollar Index DXY is now higher at 91.80.
  • The USD strengthened against the Euro since the beginning of the week at around 1.2070 as Euro Area growth momentum slows.
  • The CHF lost ground, both against the USD and the EUR, respectively at 0.99 and 1.1970! (a level not seen since the de pegging of the EURCHF Exchange rate in January 2015).
  • The Pound is trading lower this week at 1.3789 after reaching 1.4375 on last week as is the Japanese Yen at 109.34 but still stronger for the year against the USD.
  • After the recent comments and several Russian sanctions, the Ruble tumbled reaching 65 against the USD last week. However it has now retraced some of the losses and stands at 62.73.
  • The Brazilian Real, which opened the year at 3.3080, and had reached almost 3.12 in January against the USD, has moved lower since, now at 3.4753, amid lower appetite for emerging market currencies sparked by trade-war bombast, geopolitical risks and inflation global comeback.
  • The Crypto Currencies, which went through an important correction during January dropping by about 60%, are seeing some kind of a rebound, with Bitcoin moving from 6’000 back to almost 9’200 to the USD.
  • Crude oil WTI trades unchanged for the week at $67.92 per barrel amid the tensions fuelled by the Syrian events, lower US inventories and potential Iranian Sanctions; while Brent is trading at about $74.45 .

Fixed Income

  • 10Y U.S. Treasuries which had traded in a range during the last quarter of 2017 at yields from 2.30% to 2.40% have seen yields crossing 3% this week and actually marking 2.97%.
  • The Japanese 10 year JGB yield opened the year 2018 at 0.053% and reached 0.10% in early February. It now stands at 0.055%, 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 at around 0.49%. It currently trade at 0.57%, 12 bps higher than where it closed 2017. Same for the French 10Y Yield which had crossed the 1% during February and is now back to 0.79%.
  • In Peripheral Europe, Italian 10Y yields are now just above 1.737% trading some 15 bps lower than where it started the year so far, whilst the Spanish 10Y yields trades some 54 bps lower than Italy at 1.24% down from where it started the year at 1.61%.

Equities

  • Markets in the US have turned negative again for the Year 2018 with the exception of NASDAQ which is still positive at +3.12%; DJIA is down at 1.61% and SP500 at -0.25%. The DJIA is at 24’320, the SP500 at around 2’666 while NASDAQ is trading some points above 7’110 (as of Thursday).
  • In Europe markets are showing mixed returns for the year so far with Eurostoxx50, CAC 40 and Italian FTSE MIB up respectively by 0.15%, 2.73% and 9.32% while DAX is down at –2.59% , FTSE 100 at -2.97% and Swiss Market SMI at -5.85%.
  • In Asia, the Nikkei trades lower by -1.30% for the year while Hang Seng is up +2.64% together with Bovespa which is trading at a strong +13.06%.

 

Highlighted items are interesting data points for the week. Source: Bloomberg (26/04/2018)

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