Good morning.. I wanted to get this out early as Bond markets are getting smashed. The world’s governments are embracing MMT and massive stimulus packages are being unveiled. I guess they are trying to bridge the economy while we get through this ...
Good Morning.. A solid start in Asian equity markets as we head into US earnings season even with the dangerous and continuing rise in virus cases in the US over the weekend. Maybe investors are tiring of this news but it remains a drag on the global economy. Many are looking for solid beats in this weeks Chinese GDP data and after emerging from a locked down economy, I would be amazed if it didn’t show marked improvements. But GDP is rather backward looking and in some respects, so are earnings: I would be more interested in hearing management forecasts and predictions in the earnings reports. I am sticking with my bullish EUR outlook and still feel the EU may outperform in coming months and it may get a boost if the frugal nations within the EU can agree to some form of the joint bond this Friday. But compromise is likely and the structure may be watered down somewhat. GBP still seems to be supported with talk of spending and UK bonds show no lack of appetite to support such actions. No data of note today so it may be a quiet one. Is TINA dead now as there are growing alternative returns than just equities? Gold remains bid and so too bonds and cross assets seem to be less euphoric about the thought of a rapid recovery!! Retail or speculative equity investors are still partying on the deck even after the Titanic hit the iceberg. No worries, it’s unsinkable; right?
Keep the Faith..
Stocks rally as we march into earnings season:
After another 1% gain on Wall St Friday, Asia stocks have started the week with gains, led by Shanghai and the Nikkei with the latter up 2%. No fear there of the upcoming earnings season in the US and S&P futures, at the time of writing are up another 17 points. The thing with earnings, is that it is not often about how good or bad they are in real terms but how they come in against forecasts and those forecasts for this quarter have been set pretty low and so the chances of some better looking numbers are probably quite high. It will be interesting how the bank numbers fare with zero rates and a relatively flat curve but we have to balance that with the fact that the Fed has been active and open about its future activities so the banks trading desks have probably made significant gains from front-running the Fed, which apparently is totally legal. This is as close as it gets to free money. But some companies are certainly struggling and a few shocks may yet be seen and I would focus more on management guidance, which is forward looking, rather than some of these earnings headlines but equity investors seem unafraid of what these earnings may throw up. (JPMorgan, Bank of America, Wells Fargo, Goldman Sachs, BNY Mellon and Citigroup start the U.S. earnings season). Interestingly though, we saw the broader market outperform the NASDAQ in the US on Friday for the first time in a while.
Broader U.S. stock market outperforms Nasdaq for first time in almost two weeks
Global equities trade at the highs seen back in February as we head into earnings and it’s been an impressive rally.
But I think we need to be looking forward and considering the future for the global economy and on that note the threats to growth still look rather concerning with secondary outbreaks bringing lockdowns fears again in many countries and we are still some way from discovering a vaccine, let alone being able to distribute it. Again we may be seeing V-shaped data but that does not guarantee a V-shaped recovery and a lot of data is going to start settling back to suggesting a longer drag back to full recovery as unemployment weighs heavily on many economies and businesses rush to cut costs. There is still a great deal of reluctance by many to venture out into restaurants and bars and few still seem to want to get on a plane or public transport unless they have to. Hospitality and transport firms have a long hard battle ahead still. Virus cases in the US keep rising steeply with Florida on Sunday posting the biggest one-day rise in cases since the coronavirus pandemic began, reporting 15,300 new infections. South Carolina and Texas set new marks a day earlier but it seems equity investors are tiring of reacting to this news.
I think Asia equity investors are pricing in some better Chinese GDP data due this week as Q2 is seen as propelling GDP higher on Wednesday, after falling -6.8% and there is a belief that the Chinese economy is recovering faster than that of the US and some other developed world economies but it is also boosted by calls from the administration to buy stocks. Maybe we are seeing some foreign capital being allocated to China again. However, the data is rather backward looking but stocks seem to react to any good news they can get as virus news is not good in HK or Australia. But Chinese data may also help EU equity markets and again I see some outperformance here, even against the mighty US in coming weeks and the EUR may be a beneficiary and I am sticking doggedly to my bullish EUR recommendation, even after a rather poor week for the EUR towards the end of last week. It is still a little weak against a resurgent GBP but I think both could do well against the USD again this week and I think the USD is still headed for a trend lower. The problem now is that the USD is tightly inversely correlated to risk moves and so it is a choppy ride. Restrictions across Europe are being lifted and consumers are back out; but demand is not strong and data suggests exporters are still struggling.
European retail sales volumes expanded by 18 per cent month on month in May as outlets reopened and consumers proved willing to put to work some of the savings they had accumulated during lockdown. The rebound in sales was larger than expected and brought spending back to near last year’s levels.
Line chart of Volume index, rebased showing European retail sales rebound
Clearly, this data reflects the unlocking and opening of the retail space but the savings built up may now be being spent. I think Europe and the UK have dealt better than the US with keeping workers connected to their jobs and this could see a stronger consumer confidence than we see in the US. I think the psychological impact may be far greater in the US from job losses and job insecurity. Also this week, it will be interesting to hear what the ECB have to say about the economy as it seems to me they are running at two speeds again with Germany and other northern countries closer to pre-virus levels of economic activity than France, Italy and Spain across all available data measures.
Line chart of Real GDP, rebased showing The pandemic is set to widen countries’ differences
German retail sales spending exceeded last year’s levels in May, while high-frequency data indicators, which are more timely than official statistics although their reliability is variable, suggest that attendance is reaching normal levels at retail and entertainment hubs and Germany is not so reliant on tourism and hospitality as others. The overall recovery looks based on more of a concrete foundation than that of the US right now in my view.
But we still need to get this joint bond sorted out but the more frugal nations like the Netherlands are not in agreement at all on how it should be structured as they still oppose grants. This Friday’s meeting is the last meeting on the subject before the summer break and still looks in danger of failing to meet a compromise as the Netherlands are now suggesting they want a veto on any of the €750 bailouts. Maybe there is come compromise available but Rutte is playing hardball for his less than enthusiastic voters back home who seem dead against grants to the likes of Italy and other southern nations. Diplomats told the FT that fiscally conservative capitals are demanding cuts to the European Commission’s €750bn fund called “Next Generation EU” and want to further reduce the bloc’s upcoming €1.07tn budget as their price for doing a deal at the summit. Some tough negotiating left there but all nations are aware of the fact that this bond is needed for the future of the EU itself and so some compromise will be found but when?
Global equities are up almost 40% since late March, causing a healthy amount of scepticism that “markets have run ahead of the fundamentals”. This may well be the case as the recovery is not going to be quick and the central banks have probably done all they need to do for now unless we see another rout. The dangers or risks are still prevalent and cases in the US are still rising. The vaccine is not going to arrive before the winter, where further spikes are expected and more lockdowns could be seen and yet equity markets are supposed to be forward looking. There is a lot of chatter about US consumers holding large savings now but there is data suggesting this is being used to pay down debt. No one knows how deep and long lasting the scars from this virus will be and yet the euphoria in stocks is incredibly high due to massive monetary and fiscal stimuli. If we look at markets in general and not just equity markets, the picture and story seem rather different and seems to reflect a greater understanding of the struggles facing the US and global economy ahead.
Bond markets seem to be pricing a lot of caution and cross-asset valuations suggest that the market is deeply suspicious of growth returning to normal, worries about ongoing market volatility and expects deep scarring in the US and global economy for years to come. There are many ways to describe such a scenario, but ‘V’ isn’t among them. Does this matter if the Fed is determined it seems to keep markets driving higher? But this is becoming a real disconnect with reality and it is the length of the recovery, when realised, that could disappoint investors but what else is there I hear you scream? What is the alternative? To be honest there are a few now as gold has outperformed equities and so too bond returns. TINA is dead and I am not sure that this euphoric rise can last. Stocks may well advance from here but I am not sure for how long as markets digest what is really going to be coming down the pipe; a long hard slog back to normality which may take years.
As MS suggested, greater optimism on the recovery should boost demand for smaller, more cyclical businesses, which have more gearing to economic activity. That’s not exactly happening. Relative valuations for global small caps versus large caps are well below average, and low-quality stocks have almost never been cheaper to high-quality ones. The basis between BBB and A rated credit, and B and BB rated credit, remains elevated and developed market yields are still within a whisker of all-time lows, despite the improvement in stock markets and economic indicators. So, equity markets are clearly acting on animal spirits in my view and I am not sure we have ever seen such a large retail presence buying stocks, particularly in the US. This is starting to look dangerously like a speculative bubble. Volatility markets also suggest scepticism about a return to normal, as Implied equity and credit vol sit in the top 15% of all observations of the last 20 years (the very opposite of ‘normal’), while skew, a measure of how much extra investors are willing to pay for disaster protection, has rarely been higher. Neither suggest a market that’s pricing a return to normal any time soon. The disconnect between equity markets and reality seems to be dangerously wide.
Are investors now rearranging the deckchairs on the Titanic and partying on the belief that it is unsinkable? The global economy took a powerful hit below the waterline akin to the Titanic hitting that iceberg and it is not clear at all that it has been plugged. Right now the Feds pumps are keeping the water from dragging the whole economy down but can they last and will the fiscal stimulus be enough if unemployment remains high? We have a growing amount of companies closing and becoming bankrupt and the Fed cannot save them all or stop firms cost cutting and laying off staff. Right now it is 5 or 6 tech stocks that seem to be holding everything up but even they may struggle if trade wars continue to spread with Trump threatening the EU if they pursue a digital tax on US tech giants. This, plus an escalation in the US/China trade war (phase2), is likely to remain a drag on global trade and growth for some time.
The basics suggest that attempting to fine-tune monetary policy is easy as they say that if real growth is capped at 4%, the ideal policy is one in which money supply grows at 4%, velocity is constant and the price level is constant. This produces maximum real growth and zero inflation. It’s all fairly simple as long as the velocity of money is constant. It turns out that money velocity is not constant. Velocity is the factor the Fed cannot control; Velocity is psychological: It depends on how an individual feels about their economic prospects. It cannot be controlled by the Fed’s printing press. It measures how much money gets spent from people to businesses and how it flows through the system. While money supply is indeed much higher, the velocity of that money has been falling for a couple of decades. From its peak of 2.2 in 1997 (each dollar supported $2.20 of nominal GDP), it fell to 2.0 in 2006 just before the global financial crisis and then crashed to 1.7 in mid-2009 as the crisis hit bottom. Even before the new pandemic-related crash, it fell to 1.37 in early 2020. It can be expected to fall even further as the new depression drags on. Why is this important; well, as velocity approaches zero, the economy approaches zero. Money printing is then impotent; after all, $7 trillion times zero = zero. There is no economy without velocity of money.
Quite simply (and is something that seems to be lost on some investors), the factors the Fed can control, such as base money, are not growing fast enough to revive the economy and decrease unemployment. Again, I am sorry, but I come back to how long we will have to live with high unemployment amidst weak growth. The equity investors maybe overstating the Fed’s importance, as spending is driven by the psychology of lenders and consumers, essentially a behavioural phenomenon. The Fed has forgotten (if it ever knew) the art of changing expectations about inflation, which is the key to changing consumer behaviour and driving growth. It has nothing to do with money supply alone. Productivity remains shockingly low in many developed nations and monetary policy is deflationary and not inflationary. The bottom line is, monetary policy can do very little to stimulate the economy unless the velocity of money increases and the prospects of that happening aren’t great right now.
Long EUR @ 1.1210.. Stop at 1.1150
Long EURAUD @ 1.6250 stop at 1.6080
Brought to you by Maurice Pomery, Strategic Alpha Limited.
Strategic Alpha Report Disclaimer
Doo Prime endeavor to ensure the reality, adequacy, reliability and accuracy of all the information provided, but do not guarantee its accuracy and reliability. All the information, analyses, comments, statements, and/or data provided in this report is for information purposes only. Client’s use of any contents of the report as the basis for the transaction, the client shall fully aware of the risks and agreed to bear all the risks. Client shall cautiously judge the accuracy of the information. Doo Prime has no liability for any loss caused by any inaccuracy or omissions of the contents and subjective reasons of Client.
This information is powered by Strategic Alpha. Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice.