Bedrock’s Newsletter for Friday 11th of May, 2018
11 May 2018


 Friday, 11th of May 2018

Another « breath-taking week » has passed, or nearly,… Donald Trump has pulled the USA out of the Iranian Nuclear agreement. This act was clearly not aligned with the other signatories to this deal. Disarray among the powers of the world doesn’t appear to be good, especially as it induced Israel and Iran to feel themselves free to enter direct hostilities. The only visible and explicable outcome (so far) has been the rise in oil prices, which can be explained by the expected removal of Iranian supply from the market as the old sanctions are reinstated. Less supply; same demand: prices up… WTI is trading comfortably over $70 per barrel and Brent over $77. Unusually, the US$ in which Oil is priced has continued its ascent as oil was rising. The Dollar index [DXY] is now strong, at 92.55 Making oil even more expensive for non-US$ based economies…

And we got lovely images of the two Koreas playing nice with each other, under the fatherly smiles of the Donald. Yes, the previously wicked North Korean who kidnapped three Americans is now an honourable partner that released these Americans… Hmmm… is it another Chamberlain moment (with Trump taking on the role) or a true Kodak Moment? Time will tell. What is clear is that the change in how America conducts its Foreign Policy has shaken the trouble-trees…

The Treasury yield curve from 5 to 30 years flattened on Thursday to the lowest level since August 2007, as a combination of weaker-than-expected U.S. inflation and solid demand for a record bond auction bolstered investor confidence in owning long-dated securities. The spread narrowed by more than 4 basis points, the most since February, dropping through a previous intraday low from April to 27.7 basis points. The gap between 2- and 10-year Treasuries also shrank in a bull flattening move. U.S. inflation took a breather in April from its acceleration in recent months, with the core consumer price index up by a weaker-than-anticipated 0.1% from March and just 2.1% on an annual basis. Perhaps in part because of the data, the Treasury saw good demand for its $17 billion auction of 30-year bonds, the largest-ever sale of the maturity. “Bull flattening of the yield curve signals that inflation is not a problem,” Scott Minerd, chief investment officer at Guggenheim Partners, said Thursday on Twitter. “But that won’t stop the Fed from staying on course for three more rate hikes this year.” Investors and Federal Reserve officials alike have been on guard for the curve flattening toward inversion, which has historically preceded recessions. Yet bond traders are still pricing in more than two additional quarter-point rate hikes by year-end, betting policy makers will stick to their tightening path. Thirty-year yields fell about 5 basis points on Thursday, a steeper drop than any other maturity, to about 3.11 percent. But look at the stock markets… they clearly are not pricing an economic slow down nor a geopolitical melt-down!?

Back to the oil story – Oil prices have risen 14 percent this year – half of this increase reflects stronger global demand, a Bloomberg Economics model suggests. The rest is probably due to heightened tensions with Iran and other supply shocks. The return of U.S. sanctions could crimp Iranian oil exports, but the global supply shock might be mitigated by increased pumping elsewhere, according to the analysis. And in spite of the oil price rise, for whatever real reason, the inflation figures are just not reacting as one would expect – holding at or below where everyone who counts want them to go… So bonds are not collapsing in price, yields are steady and equities continue to melt upwards… Goldilocks is clearly alive and well, even with all those bears around her… It has become shockingly common this earnings season for companies to report better-than-expected profits only to see their share prices fall. There are many explanations but none make much sense, nor do they acknowledge the bright outlook for equities. First-quarter earnings on average were forecast to rise by an exceptionally high 17%, so it might seem reasonable for investors to be disappointed with anything short of perfection. However, earnings are coming in close to a gain of 22%, so that theory doesn’t hold water. One might then reasonably infer from the share price declines that future earnings projections are being revised lower. Although Caterpillar Inc. did suggest the first quarter might be the peak for its margins, results were sufficiently strong that analysts revised up their estimates for the balance of 2018 and even 2019. There goes another theory out the window.

To explain the market’s behaviour, some analysts are suggesting the problem is that so much of the rise in earnings is due to the decline in tax rates, which is nonrecurring, so it should be discounted somehow. This explanation is both wrong and incompetent. Unlike other periods when a company might see a temporary reduction in tax rates that artificially boosts results in one quarter that might be entirely reversed the very next quarter, this time the reduced tax rate is recurring. Moreover, every stock analyst understands this and has built a lower tax rate into their earnings forecasts for 2018, 2019 and beyond. In fact, that’s precisely why earnings were expected to rise about 20% this year, an extremely large gain at this late stage of the business cycle. Yet an incremental gain of 10% is already expected for next year. Another explanation suggests that stocks declined because the growth rate of profits will decelerate in 2019, which is another incompetent view. The 2018 tax reform resets the tax rate lower and resets the profit level higher. Another 20 percent gain on top of this year’s 20% increase was never in any analyst’s projections. Instead, it is impressive that analysts expect an incremental 10% rise in corporate profits in 2019 this late in the business cycle on top of the 20% jump gain projected for 2018. Another widely expressed view is that stocks are historically expensive, so any retreat just represents more reasonable valuations. It has been repeated so often that it must be true, right? The data show the exact opposite. The S&P 500 Index closed at about 2,663 last Friday. According to FactSet, projected earnings are $158.78 for 2018 and $174.89 in 2019. These numbers may be revised higher rather than lower after analysts recalibrate following the better-than-expected first-quarter earnings season in which 79% of firms so far beat estimates. The estimates indicate the market is trading at 16.8 times projected 2018 earnings and 15.2 times projected 2019 earnings. Those compare with the market’s average multiple of 16.7 over the past 50 years. That average multiple was calculated over periods of both low inflation and low interest rates and high inflation and high interest rates. Since prevailing interest rates remain exceptionally low historically, a better comparison would be those periods when inflation was comparable to today’s rate of about 2%. In those periods, the P/E multiple for the market averaged around 19.5 times. On this basis alone, one should infer stocks are actually cheap by about 14% and even cheaper based on 2019 earnings estimates. But much of this is just noise to the economics of business. The economy is healthy and growing, profits are rising nicely, and stock valuations are actually fair or below appropriate levels. Interest rates are rising, so some stock volatility should be expected and, of course, stocks have never been known to be stable. So the best explanation might be that’s it mostly noise. Market psychology can greatly affect stocks in the short run. Nonetheless, the values are there, and it’s reasonable to expect another leg up for the bull market.

Just for the record, after nearly a decade of underperformance, hedge funds are actually faring better than the stock market in 2018. Thanks to higher volatility, the rally in energy prices and some well-placed bets in fixed income, managers in the $3.2 trillion hedge fund industry posted a 0.38% gain in April that brings the total return for the year to 0.39%, according to industry tracker HFR. The HFRI Fund Weighted Composite Index finished April narrowly ahead of the S&P 500, which posted a loss, including dividends, of 0.38% through the first four months.

We stay long equities into the Summer, and glad (so far) we didn’t sell in May… And a quip about all the “Me Too” and other womens’ lib movements we quote Timothy Leary “Women who seek to be equal with men lack ambition.”



Market Weekly Highlights

Currencies & Commodities

  • The greenback stalled after a rally that took it to a four-month high, easing somewhat the concerns of outflows from emerging markets from a stronger US currency and amid further signs of an easing of the trade tensions and a potential “Era of Peace” for the two Koreas.
  • The Dollar Index DXY is flat for the week at 92.64.
  • The USD is also unchanged against the Euro at around 1.1924 as a slowdown in Euro Area growth momentum was confirmed by the latest PMI data.
  • The CHF found a support at parity against the USD and resistance around 1.20 against the EUR! (a level not seen since the de-pegging of the EURCHF Exchange rate in January 2015).
  • The Pound is trading flat for the week at 1.3530 after reaching 1.4375 last month as is the Japanese Yen at 109.28 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. However it has now retraced some of the losses and stands at 61.73.
  • 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 nearly 3.55, amid lower apetite for emerging market currencies sparked by trade-war bombast, goepolitcal 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 8’700 to the USD.
  • Crude oil WTI trades higher for the week at $71.44 per barrel amid the tensions fuelled by the Syrian events, lower US inventories and potential Iranian Sanctions; while Brent is trading at about $77.41.

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% on Wednesday this week, standing now at 2.95%.
  • In Europe, the German Bund yield nearly doubled at one stage earlier this year, jumping from 0.40% to 0.80%, but then came back down at around 0.49%. It currently trade at 0.54%, 8 bps higher than where it closed 2017. Same for the French 10Y Yield which had crossed the 1% mark during February and is now back to 0.78%.
  • In Peripheral Europe Italian 10Y yields are now just below 1.90% trading higher for the week amid internal political turmoil, whilst the Spanish 10Y yields trades some 65 bps lower than Italy at 1.25% down from where it started the year at 1.61%.
  • The Japanese 10 year JGB yield opened the year 2018 at 0.053% and reached 0.10% in early February. It now stands at 0.047%, continuing to offer a POSITIVE yield.


  • Equity markets in the US have turned positive again for the Year 2018 with NASDAQ which is higher by 7.27%; DJIA is up a mere 0.08% and SP500 +1.85%. The DJIA is just below 24’740, the SP500 at around 2’720 while Nasdaq is trading some points above 7’400 (as of Thursday close).
  • In Europe markets are also showing positive returns for the year with the exeption of the Swiss Market SMI still down -4.36%. Eurostoxx50, CAC 40 and Italian FTSE MIB are strongly up respectively by 1.60%, 4.00% and 9.70% while DAX and FTSE 100 are up only +0.50% and 0.16%.
  • In Asia, the Nikkei trades nearly flat for the year so far marking -0.03% while Hang Seng and Bovespa are trading up at a strong + 4.02% and +12.38% respectively.


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