Oct 1, 2014 - 2. 4. 45. 50. 55. 60. Growth (Markit Manufactuing PMI). A cce le ra tio n. (6 m th. C h g ...... v c. In f
Chartbook October 2014
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Chart of the month Total assets held by the Fed, ECB, BoJ and BoE combined have been rising at an average pace of about $850bn per year over the past five years, exceeding $10tn as of this month.
G4 central banks’ combined balance sheet to keep expanding ECB
BoJ
Fed
BoE
14
12
(*) Assuming the following balance sheet changes: - ECB: expanding by €1tn over 3 years; - BoJ: expanding by JPY70tn a year; - Fed: shrinking by $200bn a year; - BoE: unchanged.
The trend of the aggregate CB balance sheet is not going to change meaningfully over the next three years, as the BoJ and ECB will more than fill the gap left by the Fed ending QE.
Projection*
While EUR and JPY liquidity may not be as “powerful” as USD liquidity, global asset markets are nonetheless going to continue benefiting from accommodative global monetary conditions. We explore this theme in the Multi Asset section.
10
8
6
Elsewhere in this month’s Chartbook:
4
2
0 2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Fixed Income. UST 10y spread to Bunds can widen well beyond 155bp. Currencies. USD “mega uptrend” still in its early stages. Equities. Pick EMs carefully – and expect underperformance relative to DMs. Commodities. A series of lower highs confirms the downtrend that started in 2008. [Andrea Cicione]
Contact and disclaimers
$tn
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
1 October 2014
In this month's Chartbook
............................................................................................................................ Summary and key points ............................................................................................................................ Macro drivers
Multi-Asset
Fixed Income
US growth acceleration, slowdown elsewhere 55
G4 central banks: a balance-sheet act
13
US short end remains a puzzle
21
Global inflationary pressures remain subdued 66
CB assets and asset markets
14
Bear-flattening is only recent
22
Growth can push up funding costs
77
Short-dollar, long-rates trades?
15
Spread to bunds could go a long way
23
…pressuring parts of EMs
88
EM equities getting ahead of themselves?
16
Especially as Treasuries aren’t cheap
24
And a China slowdown doesn’t help
99
EMs’ US vulnerabilities
17
The problem with BoE hikes pricing
25
But Fed tightening likely to be gentle
10
China weighing down on EMs too
18
US High Yield lagging IG credit
26
…the ECB has much further to go
11
EM equities-commodities recoupling
19
US HY fundamentals remain solid
27
…and the BoJ can’t stop now
12
Slowing rotation out of bonds
20
Differentiation key for EM debt
28
............................................................................................................................ Equities
Commodities
USD mega uptrend in early stages
29
A bad breadth problem
37 37
Commodity de-correlation to continue
45 45
Valuations supportive of USD strength
30
There is no alternative
38 38
A less commodity-intensive growth cycle
46 46
FX carry vulnerable to USD strength
31
Can ECB QE push valuations higher?
39 39
Declines in all sub-categories
47 47
Draghi driving the euro lower
32
EM to underperform DM
40 40
Performance patterns change
48 48
GBP: policy divergence and C/A to weigh
33
DM/EM rotation in reverse?
41 41
Crude upheaval
49 49
Reasons to be bearish CHF
34
EM macro: choosy does it
42 42
Deteriorating demand outlook
50 50
AUD to underperform CAD
35
EM: Lagging earnings, flagging inflows
43 43
Cattle bulls
51 51
EM Macro RV interesting to us
36
Mind the EM value traps
44 44
Rates taking the lustre off gold
52 52
Contact and disclaimers
Currencies
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Summary - key points
............................................................................................................................ US and US-leveraged economies continue to outperform the Eurozone, China and most of EM. While US rates may rise, pressuring parts of EM, any policy tightening will likely be gentle. Further supportive of our “Goldlilocks” outlook is further stimulus by the ECB and BoJ in the wake of sputtering growth. ____________________________________________________________________________________________________________________________
Macro drivers
G4 central banks’ combined balance sheets will keep expanding at roughly the same pace as the past five years. While not as “powerful” as USD liquidity, BoJ’s and ECB’s balance sheets expansion will continue to support asset prices. EMs are more vulnerable to falling USD liquidity than DMs. EM stocks look particularly exposed after their good run this year. ____________________________________________________________________________________________________________________________
Multi-Asset
US short-end rates path remains a puzzle. Evidence of bear-flattening has emerged, which we think will crystallise into 2015. Treasury spreads to Bunds can widen by a lot more if the experience of JGBs is any guide; our model also supports this view. US HY underperformance relative to IG debt looks stretched; we expect a convergence. ____________________________________________________________________________________________________________________________
Fixed Income
The long-term dollar upswing is in its early stages. Historical parallels and valuations suggest significant further upside. While the euro has weakened quite a bit, we see plenty of further weakness on Fed-ECB balance sheet divergence. In commodity and EM FX, we like macro RV themes based on terms of trade and monetary policy divergence (e.g. PLN/HUF). ____________________________________________________________________________________________________________________________
Currencies
Commodities remain in a weakening trend, as broad indices continue to form a pattern of lower highs. The recent uptick in EM leading indicators is unlikely to signal the beginning of a cyclical upswing. China softness and excess oil supply suggest that Energy and Industrial Metals will remain under pressure. ____________________________________________________________________________________________________________________________
Commodities
Contact and disclaimers
A US correction may be looming with QE3 about to end, rates going up soon, valuations full, small caps underperforming, and market breadth measures worsening. But the US remains investors’ best bet over the medium term. EMs have had a good run since March this year but that’s running out of steam: it’ll pay off to be selective. ____________________________________________________________________________________________________________________________
Equities
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Macro Drivers US growth acceleration, slowdown elsewhere US & linked economies have accelerating growth expectations…
0
Russia
US
Korea India
Indonesia
-2 Italy
Greece
Turkey Germany
-4
50
Spain Mexico Global
0 Czech
Eurozone
France
Japan
Taiwan
EM
Brazil
China
100
Canada
China
Eurozone
Japan
-50
UK
-100
-6 Poland Growth (Markit Manufactuing PMI)
-150 Jan-14
-8 45
50
55
60
For the US and US-leveraged economic blocks (including Canada and Taiwan), survey growth-expectations data show evidence of not only faster growth, but also growth acceleration in recent months. On the other hand, Eurozone and related economies (especially Poland, but also the UK) have noticeably lost growth momentum.
Feb-14 Mar-14
Apr-14
May-14
Jun-14
Jul-14
Aug-14
Sep-14
Oct-14
Evidence based on hard data is consistent, as US data surprises have been regularly on the topside in recent weeks. Most other major blocks, especially China, Japan and the Eurozone have had negative data surprises.
5
Contact and disclaimers
2
US
Acceleration (6mth Chg in PMI)
4
…and the most positive hard-data surprises
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Macro Drivers Global inflationary pressures remain subdued
5
Commodities (CRB; rhs)
6
Inflation (2014 OECD forecasts)
OECD CPI YoY
…while large output gaps imply low demand-driven inflation
500 4
5
450 3
4 400 3
Turkey (-5.1%, 8%) Mexico
Chile
UK
2
All OECD
350
US
2 1
300
Italy Ireland
0
250
Spain
Eurozone Czech
200 2006
2008
2010
2012
New Zealand
Hungary
Sweden Switzerland
Greece (-12.8%, -1.1%) -1 2004
Norway Canada Germany Poland
France
1
0
Japan
Australia
Output gap (2014 OECD forecasts)
-1
2014
-9
From a supply perspective, softness in commodity prices has meant lower rawmaterial prices and lower cost-push inflation. Commodity prices have a lead on gauges of global inflation and appear to be heading lower again against the backdrop of soft investment and production data out of China recently.
-6
-3
0
3
Aggregate demand pressures on inflation are also very subdued, given large output gaps and generally below-target inflation rates in major economies. Most inflation rates in the chart above are way below the 2% level targeted by major central bankers globally.
6
Contact and disclaimers
Softer commodities mean low cost-push inflation…
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Macro Drivers Growth can push up funding costs Policy rules suggest higher equilibrium short-end rates… Actual Fed funds rate
…and rising growth expectations imply higher long-end rates
Taylor-rule implied
Global PMI
6
US 5y/5y swap (rhs)
56
5
4.3
55
4 54 3
Widening policy gap
3.8 53
2 1
3.3
52
0 51 -1 50
-2 -3 2005
2006
2007
2008
2009
2010
2011
2012
2013
49 Oct-11
2014
Acceleration in US growth means that the same policy rules that earlier called for “negative policy rates” (or unconventional policy measures such as QE) are now calling for positive and rising policy rates. The Fed funds rate will have to rise in the coming months, raising short-term costs of funding.
2.3 Apr-12
Oct-12
Apr-13
Oct-13
Apr-14
Long-end rates also respond to measures of growth expectations, especially insofar as they generate inflation risk premiums. Further acceleration in such measures can cause higher long-end rates too, though, for the most part, our central scenario is for short-end rates to rise by more and the curve to bear flatten.
7
Contact and disclaimers
2.8
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Macro Drivers …pressuring parts of EMs Sections of EM still fragile with worsening C/A balances…
1
India
4
Romania
3
Poland
Hungary Israel
Czech
Ukraine Turkey
-1
1
Chile Philippines
-1
Philippines
South Africa Mexico Taiwan Colombia Brazil Korea Indonesia Peru Hong Kong
EMs with high and rising inflation rates vulnerable
Thailand
Czech Poland
Singapore
China
India
Russia Brazil
-4
The vulnerable lot with deteriorating C/As
Romania Hungary
-5
C/A to GDP -2 -10
Russia
China Israel
-3
South Africa
Turkey
Malaysia
-2
Malaysia
Indonesia
Colombia
Peru
0
Singapore
Hong Kong
Mexico
0
2
Taiwan
Korea
Chile
Current inflation rates -6
-5
0
5
10
15
20
-1
Higher global funding costs in the wake of rising US rates will be problematic for sections of the EM universe, especially for those countries which have seen a further deterioration in the external balances since last year’s “taper tantrum” sell-off.
0
1
2
3
4
5
6
7
8
9
And those EM countries with high and rising inflation rates may need to tighten policy in tandem with the Fed in order to stem capital outflows. Countries falling in both trouble zones (i.e. wider C/A deficits and higher inflation) are likely to face significant short-term challenges. Notable in this group are Brazil, South Africa and Turkey.
8
10
Contact and disclaimers
2
Change in C/A to GDP since Q1 2013
3
5
Thailand
Change in inflation since Q1 2013
4
…and higher inflation rates than in Q1 2013
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Macro Drivers And a China slowdown doesn’t help China’s economic slowdown is broad-based… Fixed asset investment yoy
…which hurts commodities and many EMs’ terms of trade
Retail sales yoy
Brazil
South Africa
Chile
Indonesia
Industrial production yoy 45
30
35
25
25 20 15 15 5 10 -5
-15 0 2010
2011
2012
2013
-25 2009
2014
An additional challenge for many EMs is the broad and sustained slowdown in China, which is the destination of a large chunk of global commodity exports
2010
2011
2012
2013
2014
And, as a consequence, the terms of trade of major EM commodities exporters have been on a deteriorating course recently.
9
Contact and disclaimers
5
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Macro Drivers But Fed tightening likely to be gentle Declining participation rate implies slack Jobless claims
… which shows up in subdued wage growth Average hourly earnings yoy
Participation rate (rhs)
Core PCE deflator
ISM manufacturing (rhs) 700
68
3.75
60
67
3.25
55
66
2.75
50
65
2.25
45
1.75
40
1.25
35
650 600 550 500 450
350 300
64
63
250 0.75 2008
200 62 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
However, we note that higher global funding costs are unlikely to come in a violent way. Yes, jobless claims are close to levels of previous booms, but the sharp decline in the participation rate qualifies that observation heavily. There is still spare capacity in the economy…
30 2009
2010
2011
2012
2013
2014
…which is also evident in the fact that core-inflationary and wage-growth pressures are subdued despite the strong evidence of an accelerating cyclical recovery.
10
Contact and disclaimers
400
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Macro Drivers …the ECB has much further to go With growth slowing, inflation pressures remain absent… CPI
5y/5y inflation swap
…and credit market fragmentation remains large
Composite PMI (rhs)
3.3
Italy 56
Spain
300 250
54 2.8
Spread to Germany in bp on loans to non-financial corporations
200
52
150
2.3 50
100 1.8
48 50 46 44
-50
42
-100
40
-150 2004
0.8
0.3 Sep-11
Mar-12
Sep-12
Mar-13
Sep-13
Mar-14
Sep-14
Eurozone inflation and long-term inflation expectations (as measured by President Draghi’s preferred 5y5y inflation swap) have declined and an incipient recovery has stalled with country-level and Eurozone-level PMIs dropping, raising further the spectre of deflation.
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
And the fact that credit market fragmentation still persists, the case for the ECB to act further strongly and decisively remains. The balance sheet expansion that President Draghi envisages will unlikely be achieved by the measures announced so far and the governing council will probably have to agree new measures.
11
Contact and disclaimers
0
1.3
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Macro Drivers …and the BoJ can’t stop now The BoJ knows inflation will fall once the tax effect rolls out… CPI yoy
…and has already begun moving quietly Increase in BoJ holdings of gov't paper, % of GDP
CPI yoy (without tax hike)
USD/JPY (rhs)
4
30% 105
3
20%
2 1
95
10%
0
85
0%
-1 -2 Jan-13
Apr-13
Jul-13
Oct-13
Jan-14
Apr-14
-10% 2011
Jul-14
75 2012
2013
2014
US and associated economies continue to outperform other major blocks including Eurozone and China.
Stronger US growth will mean higher rates and tighter global funding conditions…
…generating pressure points in sections of the global economy, particularly in C/A deficit EMs.
But Fed tightening is likely to be gentle given that spare capacity persists.
Future ECB and BoJ easing will further mitigate the stresses coming from tighter US policy.
12
Contact and disclaimers
Investment conclusions
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Multi-Asset
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
G4 central banks: a balance-sheet act
G4 central banks’ combined balance sheet to keep expanding ECB
BoJ
Fed
Over the past five years, total assets held by the Fed, ECB, BoJ and BoE combined have been rising at an average pace of about $850bn per year, reaching more than $10tn as of the start of this month.
BoE
14
12
(*) Assuming the following balance sheet changes: - ECB: expanding by €1tn over 3 years; - BoJ: expanding by JPY70tn a year; - Fed: shrinking by $200bn a year; - BoE: unchanged.
Projection*
While the jury is still out with regard to the long-term economic benefits of all this money being pumped into the financial system (at least as far as Europe and Japan are concerned), there is little doubt by now that liquidity has had very positive repercussions on asset prices.
10
8
This trend is unlikely to change anytime soon, as we expect the growth rate of cumulative G4 central bank assets to remain largely unchanged over the next three years.
6
4
While EUR and JPY liquidity may not be as “powerful” as USD liquidity, global asset markets are nonetheless going to benefit from accommodative global monetary conditions.
2
0 2007
2008
2009
2010
2011
2012
2013
2014
2015
13
2016
2017
Contact and disclaimers
$tn
Lombard Street Research
Multi-Asset
Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
CB assets and asset markets
CB assets’ 85% correlation with DM stocks since March 2009… Total G4 CB assets
…and 93% correlation with G4 bonds
MSCI World (rhs)
Total G4 CB assets
14
2400 $tn
14
Projection
Avg G4 10y yield (inv, rhs)
$tn
0.0
Projection
2200 12
0.5 12
2000 1800
10
1.0 1.5
10
1600 8
2.0
1400
8
2.5
1200 6
3.0 6
1000 800
4
3.5 4.0
4
600 2 2007
4.5
400 2009
2011
2013
2015
2 2007
2017
DM equities have benefited from G4 central banks’ balance sheet expansion…
5.0 2009
2011
…as have done G4 government bonds.
14
2013
2015
2017
Contact and disclaimers
Chart of the month
Chartbook October 2014
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Multi-Asset
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Short-dollar, long-rates trades?
Are US stocks and HY short-dollar trades? HY spread to Libor (bp)
S&P 500
And are they long-rates trades? Dollar Index (rhs)
2200
HY spread to Libor (bp) 130
S&P 500
UST 2y yield (rhs)
2200
%
8 7
120
1800
1800 6
110 1400
5
1400 100
4
1000
1000
3
90 2 600
80
1 200 2000
70 2002
2004
2006
2008
2010
2012
200 2000
2014
With the dollar getting stronger as the market continues to re-price Fed policy, investors are concerned that HY and S&P 500 are looking increasingly vulnerable. US corporate profits may suffer from a stronger currency to a degree, but the strength in the domestic economy will probably outweigh the negative FX impact.
0 2002
2004
2006
2008
2010
2012
2014
Besides, while dollar down / stocks up was the norm in the pre-Global Financial Crisis period, we believe that going forward strong dollar will be associated with rising equities – just as in the second half of the 1990s. There is also little historical evidence that a rising rates environment is unfavourable for corporate bonds and equities, at least early in the tightening cycle.
15
Contact and disclaimers
600
Lombard Street Research
Multi-Asset
Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
MSCI EM
EM ccy avg vs. USD*
120 EM debt "craze"
115
EM LC bonds (rhs) All measures rebased (1-May-2013 = 100)
105
EM equity "craze"?
110
105
100
95
100
90
95 85 90 80 85 75
80 * Simple average of Poland, Brazil, South Africa, Malaysia, Indonesia, Mexico, Russia, Thailand, Hungary, Colombia
70 Feb-11
Equities
Commodities
EM equities getting ahead of themselves?
EM equities a possible casualty of tighter US monetary policy
75 Aug-10
Currencies
Aug-11
Feb-12
Aug-12
Feb-13
Aug-13
16
Feb-14
Aug-14
Loose US monetary policy has caused EM bubbles to develop in the past. The last one was in 2012-2013, when EM debt – local currency particularly – benefited spectacularly from falling US yields, prompting investors to seek higher returns in developing economies’ debt. Before the “taper tantrum” hit, EM debt had diverged significantly from the equity and currency markets. May 2013 put an end to the EM debt “craze” and EM LC yields rose sharply, reconciling the differences between bond prices, equity prices and FX rates. EM bonds never fully regained their pretantrum valuations, but EM equities darted ahead, surpassing their early-2013 highs. This has been on the back of slightly improved fundamentals, in some cases, but expensive equity valuations in DMs and still ample dollar liquidity played a major role too. As the first Fed hike gets closer, EM equities are likely to suffer. But, with the BoJ and ECB stepping on the liquidity pedal, and investors’ positioning less extreme than last year, we don’t expect a repeat of the taper-tantrum experience.
Contact and disclaimers
Chart of the month
Chartbook October 2014
Lombard Street Research Contents
Multi-Asset
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
EMs’ US vulnerabilities
A rising dollar favours DM equities over EM… MSCI DM / EM
…and so do rising real yields MSCI DM / EM
US$ Index (rhs)
UST 10y real rate (TIPS) (rhs)
4.0
130
4.0
5
3.5
120
3.5
4
3.0
110
3.0
3
2.5
100
2.5
2
2.0
90
2.0
1
1.5
80
1.5
0
70
1.0 2000
1.0 2000
2002
2004
2006
2008
2010
2012
2014
If a secular bull market is about to start for the USD, as we suspect to be the case, DM equities’ outperformance of EMs will likely continue.
-1 2002
2004
2006
2008
2010
2012
Rising real yields in the US will also hinder EM stocks’ performance.
17
2014
Contact and disclaimers
Chart of the month
Chartbook October 2014
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Multi-Asset
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
China weighing down on EMs too
Weak China driving EM currencies down… China Manuf. PMI
JPM EM Ccy index (rhs)
65
130
China Manuf. PMI
ZAR/USD* (rhs)
TRY/USD* (rhs)
65
BRL/USD* (rhs) 150
1-May-2010 = 100
140
120
60
China HSBC PMI
60
130
110 55
120
55
110
100 50
50
100
90
90
45
45
80
80 40
70
40
70
60 35 2005
60 2006
2007
2008
2009
2010
2011
2012
2013
35 2005
2014
Given the exposure of many emerging market economies to the commodity supercycle, a further Chinese slowdown will continue to weigh on EM currencies.
50 2006
2007
2008
2009
2010
2011
2012
2013
2014
Current account-deficit currencies will continue to be hit the hardest.
18
Contact and disclaimers
China HSBC PMI
…particularly the “usual suspects”
Lombard Street Research Chart of the month
Multi-Asset
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
EM equities-commodities recoupling
Jump in real UST yields driving commodities lower Real 10y UST yield
Energy
Industrial Metals
Precious Metals
EM equities-commodities: re-coupling EM equities
3.5
DM equities
200
3000
3.0
CRB Index
Industrial Metals
Jan-2010 = 100
180
2.5
2500
160 2.0 1.5
140
2000
1.0
120
0.5
1500
100
0.0
80 1000
60
-1.0 -1.5 2005
500 2006
2007
2008
2009
2010
2011
2012
2013
40 2005
2014
Rising USD real yields are also a factor in driving commodity prices down, above all precious metals.
2006
2007
2008
2009
2010
2011
2012
2013
2014
EM equities started moving sharply higher in April, shortly followed by industrial metals. The recent weakness is helping EM stocks re-couple with the broader commodities complex, which has been rolling over since June.
19
Contact and disclaimers
-0.5
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Multi-Asset
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Slowing rotation out of bonds
Early signs of rotation back into US Treasuries? S&P500 / UST total return (7.5y z-score)
Stocks still investors’ favourite compared to HY in the US
y/y (7.5y z-score)
S&P500 / US HY total return (7.5y z-score)
5
y/y (7.5y z-score)
6
4 3
4
2
2
1 0
0
-1
-2
-2 -3 1992 1994 1996
1998 2000 2002 2004 2006 2008
-4 1992 1994 1996
2010 2012 2014
1998 2000 2002 2004 2006 2008
2010 2012 2014
Despite the end of Fed QE and the first rate hike looming closer, G4 central banks’ combined balance sheets will keep expanding at roughly the same pace as the past five years for the foreseeable future.
While not as “powerful” as USD liquidity, BoJ’s and ECB’s balance sheets expansion will continue to be supportive of asset prices.
EMs are more vulnerable to falling USD liquidity than DMs. Investors’ recent enthusiasm with EM stocks makes them vulnerable to a stronger USD. EM bonds, still “unloved” after last year’s “taper tantrums”, could be more resilient in the near term.
Commodities, industrial metals above all, will continue to track EM equities’ performance.
20
Contact and disclaimers
Investment conclusions
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Fixed Income US short end remains a puzzle Forward pricing has shifted lower despite tapering and higher inflation UST 2y
Forward implied after Jan Fed meeting
Forward implied after September Fed meeting
Core PCE y/y
1.6
1.4
1
0.8
0.6
0.4
Mar-14
May-14
Jul-14
Sep-14
Nov-14
Jan-15
21
Mar-15
We continue to see the likely re-pricing of the short-end and the attendant bear-flattening of the Treasury curve as the most significant risk in the US and global fixed-income markets. Judging by the price action in recent days, in the wake of strong PMI and housingmarket data, we believe we may already be in the bear-flattening phase. The risk is that flattening turns sharper and more rapid.
Contact and disclaimers
However, the path for the 2-year Treasury as yield priced in the forward curve after the September FOMC is significantly below the path after the January FOMC. What’s more puzzling is that this shift lower in the forward path has occurred over a period that the FOMC members’ own forecasts of the Fed funds rate have staggered higher (in the FOMC “dots”).
1.2
0.2 Jan-14
The behaviour of the short-end of the US Treasuries curve is a bit of a conundrum to us. The Fed started tapering its asset purchases at the end of last year, since which time macroeconomic indicators have gone from strength to strength. Core inflation is also higher than at the start of the year.
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Fixed Income Bear-flattening is only recent The short-end has underperformed the long end US 2/10y (rhs)
1.01 1
US 2/10y 270
220
0.6
260
215
0.58
250
210
0.99
0.52
195
220
0.5 190
210
0.96
0.54
200
230
0.97
0.56
205
240 0.98
US 2y (rhs)
0.48
185 200
0.46
180
0.95 190
0.93 Jan-14
0.44
175
0.94
180 170 Mar-14
May-14
Jul-14
0.42
170 165 Jul-14
Sep-14
In fact, for much of the year, the long end of the curve has outperformed the short end defying most consensus expectations of a bear-steepening of the Treasury curve along with Fed’s tapering of asset purchases.
Aug-14
Sep-14
0.4 Oct-14
In the last few sessions, however, we have seen more evidence of the sort of flattening we typically associate with tightening cycles, i.e. bear flattening. We think this trend is likely to crystallise as we head into next year.
22
Contact and disclaimers
Short/Long end total return
But bear-flattening is just beginning
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Fixed Income Spread to bunds could go a long way Scenario stress-testing suggests scope for a lot more widening Fitted* 100
…. as indeed happened with JGBs in the 90s
Bund 10y - UST 10y
Generic 10y JGB/UST ratio
bp
10y JGB-UST yield differential (rhs)
1.25
-100
1.20
-150
1.15
-200
1.10
-250
50 0 -50 -100
-200
1.05
Scenario A: factors 1 stdev from mean
-250 -300 -350 -400
* Based on relative inflation expectations (5/5y inflation swaps), growth expectations (PMI new orders and IFO expectations), REER, equity volatility and consumer confidence
-450 1996
1998
2000
2002
2004
2006
Scenario B: min/max in factors
2008
2010
2012
Japan falls into deflation
1.00
-350
0.95
-400
0.90 1991
2014
-300
-450 1992
1993
1994
1995
1996
1997
1998
1999
…as indeed happened for the case of the Treasuries spread to JGBs in the 1990s after the Japanese crash in 1989. The Treasury-JGB spread went from about 150bps at the start of the 1990s to a whopping 400bps+ by the time Japan actually fell into deflation in 1998.
While the spread of 10-year Treasuries to Bunds has been on a sustained widening trend, our model-based scenario analysis suggests that it could ultimately go much wider than current levels, …
23
Contact and disclaimers
-150
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Fixed Income Especially as Treasuries aren’t cheap Fair value estimates are moving gently higher with inflation Model-implied
Core PCE y/y (rhs)
6.0
US 10y 3.0
Fed balance bheet ($trn, rhs, inverted)
4.5
0.0
5.5 5.0 4.5
0.5 4.0
2.5
1.0 3.5
4.0 3.5
2.0
2.0
3.0 1.5
2.5 2.5
3.0 2.5
1.5
2.0
3.0
1.0
3.5
2.0
4.0
0.5
1.5
1.5 1.0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
4.5 0.0
1.0 2008
Most of the further spread-widening relative to Bunds is likely to come from Treasuries moving higher. Modelling Treasury yields using monetary-policy, inflation and growth fundamentals, we find that Treasuries are expensive even at the current subdued levels of core inflation. Our estimate of fair value is now trending gently up with core inflation.
5.0 2009
2010
2011
2012
2013
2014
Moreover, Fed balance-sheet expansion is now coming to an end, which will take away an important policy driver of the downtrend in Treasury yields.
24
Contact and disclaimers
US 10y
And balance-sheet expansion is coming to an end
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Fixed Income The problem with BoE hikes pricing Markets have steadily priced in BoE rate hikes Latest
6mths back
… but much of the case for rate hikes lacks an inflation basis 12mths back
1y/1y swap
55
CPI
Unemployment (rhs, inverted)
3.0
6.0 6.2
45
2.5
6.4 6.6
35 Cumulative rate hikes priced in money-market curves (bp).
2.0
6.8
25
7.0 1.5
7.2
15 7.4 7.6 7.8 -5 1m
2m
3m
4m
5m
6m
7m
8m
9m
10m
11m
0.5 Jan13
12m
Base rate hikes by the Bank of England have been getting priced in sterling money-market curve throughout the previous 12 months, with the BoE governor seeming to confirm market’s expectations.
8.0 Jul13
Jan14
Jul14
While we agree that the BoE will probably hike, we also note that the case for rate hikes is mostly built on the strong performance of the job market. Inflation has been trending lower and has so far shown no tendency to rise. The shortend of the sterling curve appears to be taking notice of this lack of inflation.
25
Contact and disclaimers
1.0
5
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Fixed Income US High Yield lagging IG credit US HY underperformance of IG getting stretched
Mixed evidence of US HY being short-dollar trade
650
CDX HY
2-year history
600
HY spread to Libor
R2 = 0.96 2200
550
Dollar Index (rhs) 130
bp
120
1800
500
110 1400
450 100 400
1000 90
29-Sep-14 600
80
300 CDX IG 250 50
60
70
80
90
100
200 2000
110
The underperformance of US High Yield relative to Investment Grade credit presents an opportunity for a convergence trade (see Portfolio Tactics, 24-Sep2014). HY outflows, which have been large in recent weeks and have been a major driver of the divergence between HY and IG, have slowed down significantly.
70 2002
2004
2006
2008
2010
2012
2014
A possible further repricing of Fed policy expectations, driving the US$ higher, is a risk for HY. But while there’s been positive correlation in the past between dollar and HY spreads, there have been periods when the two have diverged markedly – most notably since 2011 until very recently.
26
Contact and disclaimers
350
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Fixed Income US HY fundamentals remain solid Risk-adjusted HY/IG relative performance
A 2-standard deviation dislocation
5 x CDX IG - CDX HY 100
5 x CDX IG - CDX HY (3-month z-score) 3
bp
2
50
1
0
0 -50
-1
-100
2012
2013
-3 2010
2014
CDX HY fundamentals remain solid Net debt to ebitda
2012
2013
2014
An undemanding refinancing profile Gross margins (rhs)
7.5
Bonds %
7.0 6.5
35
100
34
80
Loans CDX HY (100 constituents)
$bn
33
6.0 5.5
60
32
27
2030+
2029
2028
2027
2026
2025
2024
2023
0
2022
29 Q1 2014
2021
Q1 2013
2020
Q1 2012
2019
Q1 2011
2018
Q1 2010
20
2014
Q1 2009
30
2017
40
31
2016
5.0 4.5 4.0 3.5 Q1 2008
2011
Contact and disclaimers
2011
2015
-150 2010
-2
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Fixed Income Differentiation key for EM debt Outside of taper tantrum, EM does well with rising US yields EMBI 1000 900 800 700 600 500 400 300 200 100 2004 2005
…but a few like Turkey could still feel the heat
US 10y (rhs)
Turkey 5y CDS 5.5 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0
2006 2007 2008 2009
2010 2011 2012 2013
Short-term external debt/total external debt (rhs)
450
36
Steady ramp-up of short-term debt since US QE
400 350
32
300
28
250
24
200
20
150 100 2005
2014
16 2006
2007
2008
2009
2010
2011
2012
2013
2014
We think US short-end rates are too low relative to the macroeconomic dynamics.
And while long-end rates seem destined to rise too, we look for bear-flattening to intensify into next year.
Our scenario analysis and the example of JGBs show that the UST-Bund spread can widen further significantly.
Without a pick-up in CPI inflation, UK short-end rates could correct lower.
The underperformance of US HY relative to IG looks stretched; we look for convergence.
EM sovereign credit performance likely to be less uniform with rising US yields.
28
Contact and disclaimers
Investment conclusions
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Currencies
Summary
Macro Drivers
Multi Asset
Fixed Income
130
Overvaluation after the Volcker rate hikes
29%
Overvaluation after the tech boom
21%
Historical average 90
80
1978
1982
1986
1990
1994
It has long been our central FX view that the dollar is in a multi-year upswing, as US monetary policy is likely to diverge on the tighter side relative to most other major global currencies. Indeed, the dollar has made significant headway relative to a broad basket of currencies since 2011. Given such sustained outperformance, worries about dollar overvaluation can surface in investor discourse. We argue, however, that any such worries are way too premature, especially when compared to previous multi-year dollar upswings during the regime of floating exchange rates in operation since the early 1970s.
100
1974
Commodities
1998
2002
29
2006
2010
2014
The dollar real effective exchange rate is 21% below the peak reached in the early 2000s at the end of the tech boom and 29% below the peak in the early 1980s, when the Volcker rate hikes pushed the dollar higher against its global counterparts. On both occasions, the dollar had become the highest-yielding major currency globally, a title we expect it to reclaim during the current cycle.
Contact and disclaimers
110
70 1970
Equities
USD mega uptrend in early stages
Long way to go before dollar valuation becomes extreme
120
Currencies
Lombard Street Research Chart of the month
Currencies
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Valuations supportive of USD strength
USD expensive only against a handful of currencies
… some of which can stay cheap or cheapen further
40%
0%
30% -5% 20% -10%
10%
0%
-10% -20% -20%
BoJ QE
Weak domestic demand; heavy dependence of oil and exports to US
C/A deficit; Deflation inflation risks high; CBRT tending to ease
TRY
SEK
INR
CAD
TWD
JPY
Comparing the dollar real effective exchange rate ratios to a range of currencies over a 20-year horizon, we see that the dollar is still cheap against a majority of major G10 and EM currencies.
ZAR
-25%
JPY ZAR TWD CAD INR SEK TRY GBP HUF EUR CLP KRW COP PLN CHF MXN RUB CZK ILS CNY NOK MYR AUD IDR NZD BRL
-30%
Low growth; C/A deficit; negative real rates; SARB credibility; labour unrest
And the currencies which look cheap on this metric are likely to stay cheap for some time owing to strong specific structural and policy drivers, which are likely to operate for the foreseeable future.
30
Contact and disclaimers
-15%
Lombard Street Research
Chartbook October 2014
Chart of the month
Contents
Summary
Macro Drivers
Multi Asset
Currencies
FX carry vulnerable to USD strength
USD strength associated with negative carry-trade returns Deutsche Bank FX carry index
Fixed Income
Currencies
Equities
Commodities
Pick-up in short-term FX volatility accompanies carry sell-offs
Nominal effective USD (rhs)
AUDUSD 1m2y Vol Curve
150
115
140
110
FX carry (rhs)
6
130
5 125
4 130
105
120
100
110
95
3 120
2 1
115 0
90
90
85
80
80
-1
110
-2 -3
105
-4 70 2000
75 2002
2004
2006
2008
2010
2012
-5 2009
2014
Sustained dollar strength has been bad historically for the FX carry trade. Over the previous 10 years, this was largely because USD was among the lower yielding major currencies globally. In future, we expect USD rates to overtake those of high yielders and ultimately USD will become a recipient of carry inflows.
100 2010
2011
2012
2013
2014
FX options-market signals, specifically a rise in short-dated implied volatility compared to long-dated implied volatility for high-yielding currencies, are indicating that this carry sell-off has begun. Historical experience suggests that there is plenty of further carry sell-off still ahead of us.
31
Contact and disclaimers
100
Lombard Street Research Chart of the month
Currencies
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Draghi driving the euro lower
The yield advantage of EUR will erode further with ECB QE EURUSD 1y1y differential
… and excess liquidity will put further pressure on EUR
Fed to ECB balance sheet
200
EUR/USD Xccy Basis
EUR/USD spot (rhs)
0
2500
1.50
-20
150
1.45
2000 -40
100
1.40 1500
-60
50
1.35 -80
1000 0
1.30 -100 500 1.25
-120 -100 2009
0 2010
2011
2012
2013
-140 Jan-10
2014
While nominal interest-rates differentials have been in a EUR-negative trend since last year, ECB balance sheet contraction during 2013 relative to the Fed has been a major support for the EUR. With the ECB committed to expanding its balance sheet significantly, the relative balance-sheet dynamics are likely to turn strongly EUR-negative, especially as Fed QE ends.
1.20 Jan-11
Jan-12
Jan-13
Jan-14
As a consequence of ECB measures, relative liquidity dynamics will generate an excess supply of euros relative to dollars (as seen in measures such as the 3month cross-currency basis), which will likely get more scarce with the end of Fed QE and will increasingly become expensive to short against the euro with Fed rate rises next year.
32
Contact and disclaimers
-50
Lombard Street Research Chart of the month
Currencies
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
GBP: policy divergence and C/A to weigh
GBP vulnerable to policy re-pricing on both sides … GBP rate hikes (MPC swaps)
… and the impact of unfavourable BoP dynamics
USD rate hikes (Fed funds futures)
UK C/A % GDP
80
US C/A % GDP
0
0
70
-1 -1
60
-2
50
-3
-2
40
-4 -3
30
-5
20
-6 -4
0 Oct-14
-7
Jan-15
Apr-15
Jul-15
-5 2000
Oct-15
While the forthcoming Bank of England rate hikes are well telegraphed and more than adequately priced in, we see a risk of sterling suffering relative to the dollar on account of possible policy re-pricing for both the BoE and the Fed. Inflation dynamics are diverging in the two economies, …
2002
2004
2006
2008
2010
2012
-8 2014
…and the relative balance-of-payments dynamics have turned much more dollar positive over the recent years. The current-account cycles in the two economies were quite synchronised in the pre-crisis years, but the sustained US C/A adjustment is in sharp contrast to the UK’s C/A deterioration over the last couple of years.
33
Contact and disclaimers
10
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Currencies
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Reasons to be bearish CHF
C/A and haven flows have persistently supported the franc CHF NEER
SNB will be keen to ward off any challenges to the floor
Swiss C/A, % GDP (rhs)
EUR/CHF
150
18
145
16
140
25d risk reversal (rhs)
1.26
4
1.25
3
14 1.24
135
12
130
2
Markets challenged the SNB floor in early 2012
1
1.23
10 125
-1 8
1.22
120
-2 6 1.21
1.20
2
105 100 2001
-3
4
110
0 2003
2005
2007
2009
2011
1.19 Jan12
2013
In a world beset with financial, sovereign and geopolitical crises, safe haven demand for the Swiss franc has been more than ample and quite sustained, contributing to deflation in the Swiss economy, despite the EUR/CHF floor imposed by the SNB at the height of the Eurozone periphery crisis.
-4 -5 May12
Sep12
Jan13
May13
Sep13
Jan14
May14
Sep14
Markets may be looking again to test the resolve of the SNB to defend the floor as EUR/CHF risk reversals have turned negative for the first time since Q4 2012. We believe this will press the SNB into taking CHF-weakening measures, given the deflationary pressures in the Eurozone and the weakening of the euro. Our preference, however, will be to sell CHF against USD.
34
Contact and disclaimers
115
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Currencies
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
AUD to underperform CAD
AUD terms of trade and C/A underperforming those of CAD AUD/CAD Terms of trade ratio
Domestic and external FX drivers have turned CAD positive
AUD-CAD C/A % GDP (rhs)
1.1
AUD-CAD CPI 2
US-China leading indicator (rhs)
3.0
25 23
2.5 1.0
0
21 2.0
0.9
19
-2 1.5
0.8
-4
17
1.0
15 13
0.5 0.7
-6
11 0.0 9
-8 -0.5
0.5 2000
-10 2002
2004
2006
2008
2010
2012
-1.0 2010
2014
Within the commodity-FX complex, we are much more positive on the Canadian dollar than the Australian dollar. Relative terms of trade and currentaccount dynamics have turned AUD-negative in recent months, with industrial metals significantly underperforming oil, …
7 5 2011
2012
2013
2014
…and China, the key target of Australian exports, underperforming the US, the main destination of most Canadian exports. The cyclical divergence between China and the US is also reflected in the cyclical divergence between Australia and Canada, which we believe will generate significant monetary policy divergence between the two and push AUD/CAD lower.
35
Contact and disclaimers
0.6
Lombard Street Research Chart of the month
Currencies
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
EM Macro RV interesting to us
We like cyclical divergence stories such as PLN/HUF
… and terms-of-trade based themes such as TRY/RUB
IP Growth Differential (Poland-Hungary)
TRY/RUB
CPI y/y differential (Poland-Hungary, rhs) 15
23
1
60
22
10
70
21
0
5
Brent (rhs, inverted)
80
20
0
-1
-5 -10
19
-2
-15 -20 Jan-12
-3 Jul-12
Jan-13
Jul-13
Jan-14
90
18 17
100
16
110
15 2008
Jul-14
2009
2011
2012
2013
2014
We believe the long-term dollar upswing is in early stages; fundamental valuations seem to support our view.
A resurgent dollar will be problematic for the global FX carry trade hitting higher-yielding G10 and EM FX hard.
Cyclical and monetary-policy divergence will likely take the euro much lower relative to the dollar.
GBP/USD is vulnerable to a relative policy re-pricing too, with UK CPI and C/A dynamics suggesting weakness.
AUD is set to underperform CAD over the coming years as economic cycles and terms-of-trade dynamics diverge.
In EM, we like cyclical and terms-of-trade divergence stories such as short PLN/HUF.
36
Contact and disclaimers
Investment conclusions
Lombard Street Research
Equities
Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Equities
Commodities
A bad breadth problem
Waiting for the “big one” NYSE Composite Index
% NYSE stocks above 200d MA, rhs
11500
100
11000
90
10500
80
10000 70
9500
60
9000 8500
50
8000
40
7500
30
7000 20
6500
10
6000 5500 May-09
Currencies
0 May-10
May-11
May-12
May-13
37
May-14
The last correction (i.e. a more than 10%, but less than 20% decline) in the US stock market happened in 2012, coinciding with the end of QE2. The previous one, in 2010, corresponded to the end of QE1. It is therefore not surprising that US equity investors have been waiting for the end of QE3, likely to happen in the next couple of months, with some trepidation. In addition, expectations of the first Fed rate hike have been brought forward – adding to the general sense of anxiety – as data has been surprising to the upside. But there are other signs suggesting that a possible US equity market correction may be looming. The small-cap Russell 2000 index has failed to make new highs in August, unlike the S&P 500. And market breadth indicators, such as the number of stocks in the NYSE trading above their 200d moving average, have been noticeably weaker. This suggests that the extraordinarily consistent trend that the S&P 500 has been in since May 2012 may be finally about to break.
Contact and disclaimers
Chart of the month
Chartbook October 2014
Lombard Street Research Chart of the month
Equities
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
There is no alternative
EA earnings? What earnings? EPS (fwd)
Expensive DM valuations
p/e (fwd)
2.8
Stoxx 600 (rhs)
17
400
p/b
2.6
US Switzerland
2.4
15 350
2.2
11
DM
2.0
300
250
1.6
7
Spain
200
3 2006
2007
2008
2009
2010
2011
2012
2013
5
Despite the concerns about the US stock market, probably overdue for a correction, the hard truth for equity investors is that, to quote former UK prime minister Margaret Thatcher in a different context, “there is no alternative”. Euro Area profits, despite rather promising leading indicators in the past 12 months, have been noticeable for the absence.
RoE
Italy
1.0
2014
France
Japan
1.2 150
Germany
Euro Area
1.4
5
Australia
UK
1.8 9
Canada
7
9
11
13
15
Besides, DM equities valuations are generally quite expensive in p/e terms – though on a p/b vs. RoE basis things are more nuanced. And while EM valuations are generally cheaper, there are pretty good reasons for it – be it the end of cheap dollar funding, a strong dollar, China’s slowdown, or their weak fundamentals.
38
Contact and disclaimers
13
Lombard Street Research Chart of the month
Equities
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Can ECB QE push valuations higher?
A very selective earnings growth picture…
…but a very broad-based repricing p/e (12m fwd)
EPS (12m fwd) change since May-2012
Change since May-2012
25 20
Msci Emu
15
Inf Tech
10
Industrl
5
Hlth Care
MSCI Euro Area sector weights
Material
25
Utility
20
Energy
15
Tel Svc
10
Inf Tech
Cons Dis
Industrl
Con Stpl
5
30
The upside for Euro Area stocks looks limited, despite expectations of ECB QE. Sectors that had potential for earnings recovery have already done so. Others, with a more domestic focus, will be unlikely to benefit from liquidity and a weaker EUR.
39
Inf Tech
Finance
0
Tel Svc
20
Material
10
Energy
0
Hlth Care
-10
Utility
-20
Con Stpl
-30
Industrl
-40
Cons Dis
-50
Contact and disclaimers
Finance
Material
Hlth Care
Utility
Finance
Cons Dis
Energy
Con Stpl
Tel Svc
Msci Emu
0
Lombard Street Research Chart of the month
Equities
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
EM to underperform DM
Unsustainable divergences
Higher $ rates not an obstacle to DM outperformance
DM / EM equities
Dollar index (rhs)
DM / EM equities
4.5
Fed funds rate (rhs)
4.5
130
%
1997-98 EM crisis
4.0
8
4.0
120
9
7
3.5
3.5 6
110 3.0 3.0
2.5
5
100 2.5
4
Dot-com bubble
2.0
Global Financial Crisis
90 2.0
1.5
1.5
1.0
1.0 1990
70 1994
1998
2002
2006
2010
2014
1 0 1994
1998
2002
2006
2010
2014
High or rising Fed fund rates do not seem to have prevented DMs from outperforming EMs historically. Emerging markets’ stronger showing during the 2003-2007s period had more to do with EMs’ 5x index gain than with US rising rates.
DM / EMs relative performance tends to correlate with the USD. We expect the dollar to continue to get stronger, and as a consequence EMs’ outperformance of DMs year-to-date to be reversed (something that has already started occurring in the past couple of weeks).
40
Contact and disclaimers
2
80
0.5 1990
3
Lombard Street Research Chart of the month
Equities
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Equities
Commodities
3
DM / EM equity TR (y/y)
Jan-2010 = 100
%
MSCI EM (removing)
80
170
70
160
60
150
50
140
40
130
30
120
20
110
10
100
0
2
1
0
90
-1
-2
-10 -3
-20 2011
2012
2013
MSCI World (adding)
MSCI EM (adding) -3
2014
With the DM / EM total returns rate of change shortly going negative a few weeks ago, it looked like investors had had enough of DMs’ expensive valuations and had started piling in into EM stocks.
DM / EM equity TR (7.5y z-score) -2
-1
0
1
MSCI World (removing) 2
3
Those early signs have not been confirmed, and a sharply rising dollar has sent DM / EM relative performance into reverse gear – at least for the time being.
41
Contact and disclaimers
EM Equity TR
Investors have not given up on DMs just yet
DM / EM equity TR (y/y) (7.5y z-score)
DM Equity TR
80 2010
Currencies
DM/EM rotation in reverse?
Early signs of rotation into EMs not finding confirmation
180
Fixed Income
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Equities
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
EM macro: choosy does it
Positive and rising real rates not enough for Brazil, Russia Sep-14
Apr-13
5
EM FX much more stable after the fall caused by the “taper tantrums”
Change
Since May-2013 10
Real short-term interest rates (%)
4
Currency % change vs USD
5
3
0
2
-5
1
-10
0
-15
-1
-20
-2
Since Feb-2014
-25 Russia
India
S. Africa
China
Mexico
Korea
Taiwan
Russia
Current account deficits still a problem for South Africa and Brazil… Current 15
Brazil
India
Mexico
Taiwan
China
Korea
…And that’s not the only one they have
1 year ago
GDP growth (% of Q1 00 - Q2 08 average) 100
Current account balance (% GDP)
10
S. Africa
80 60
5
40
0
20 0
-5
-20
-10
-40 S. Africa
Brazil
India
Mexico
China
Russia
Korea
Taiwan
Taiwan
42
China
India
Korea
Mexico
Russia
S. Africa
Brazil
Contact and disclaimers
Brazil
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Equities
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
EM: Lagging earnings, flagging inflows
More of a EM re-rating than a recovery MSCI EM 100
Inflows showing signs of fatigue already Non-financials
EEM (MSCI EM ETF)
12m trailing EPS
60
1600
50
1400
40
1200
30
1000
20
800
10
600
0
400 2010
VWO (FTSE EM ETF)
90 80 70 60 50
30 20 10 0 2000
2002
2004
2006
2008
2010
2012
2014
Earnings have been soft in EMs ever since 2011, making the recent rise in emerging equities more of an exercise in re-rating than one in recovery. NonFinancials have been faring particularly poorly in terms of profitability.
2011
2012
2013
2014
The tentative signs that flows into EM equities were recovering have already started to fade.
43
Contact and disclaimers
40
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Equities
Summary
Macro Drivers
Multi Asset
35 30
Currencies
Equities
Commodities
Mind the EM value traps
Valuations generally cheaper than DMs… 40
Fixed Income
(0.7) 0.3 (1.3) Number of stdev from 7.5y mean
(0.3)
0.5
2.0
25
…but mind the value traps (1.0)
1.9
Key
Last
+/- 1 stdev
Avg
3.0
0.1
p/b
Mexico
2.5
7.5y range
India Taiwan (tr.)
2.0
South Africa
20 1.5
15 10
EM
China
Korea (tr.)
1.0
5
Brazil
Russia
0
RoE
0.5 CN
IN
KR
TW
BR
MX
RU
ZA
EM
5
10
15
20
25
A US correction may be in the making, with (1) QE3 about to end, (2) rates going up soon, (3) valuations full, (4) small caps underperforming large caps, and (5) market breadth measures sending warning signals.
However, there are few markets, if any, where equity investors can reasonably expect better returns than the US.
Europe, with virtually no earnings growth, has already re-rated and ECB QE and a weaker euro will be of little help.
EMs have had a good run since March this year but that’s already running out of steam: being selective will pay off.
Russia, Brazil and South Africa remain value traps. India still looks appealing in the long-term but may suffer from a higher dollar and tighter USD liquidity. China may outperform other EMs as it is less dollar-dependent.
44
Contact and disclaimers
Investment conclusions
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Commodities Commodity de-correlation to continue
UBS Bloomberg CMCI Composite TR Index
MSCI AC World TR (rhs)
1800
200
1700 180 1600 1500
160
1400 140
1300 1200
120
1100 100
1000 900
80 800 700 2007
60 2008
2009
2010
2011
2012
2013
45
2014
As we have often pointed out, the paths of commodities and global equities have been divergent over the last couple of years. We continue to believe that a re-coupling is unlikely. The relative demand-supply outlook has deteriorated for long commodity positions, while the improving earnings outlook (especially in the US, but also in Japan) and the still ample global liquidity are likely to keep equities well supported. Secondly, the China slowdown is real and even the Chinese authorities seem to suggest that they would not lean heavily against the slowdown insofar as it aids economic rebalancing. Lastly, low and falling real interest rates are likely to become a thing of the past, especially as the Fed begins contemplating policy rate hikes along with other central banks like the Bank of England. So while a deteriorating demand-supply outlook and adverse discount rate effects will persistently keep commodities under pressure, equities are likely to ride higher with solid earnings growth.
Contact and disclaimers
Commodities’ persistently divergent path relative to equities
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Commodities A less commodity-intensive growth cycle More growth doesn’t necessarily mean higher commodities JP Morgan Global PMI
Not the beginning of a cyclical upswing EM leading indicator (based on OECD series), 6m%
CRB index (rhs)
DJ-UBS Commodity TR index, (rhs) 54
330
53
320
2.5
520
2.0
470
1.5 52
420
1.0
310
370
0.5 51
320
300
0.0 270 -0.5
290
220
-1.0 49
170
-1.5
280
120
-2.0 48 Sep-11
Mar-12
Sep-12
Mar-13
Sep-13
Mar-14
270 Sep-14
-2.5 1994
The global growth cycle has turned significantly less commodity-intensive over the last 18 months or so, with a China slowdown being accompanied by a US growth acceleration and increased global commodity supply relative to demand.
70 1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
We don’t expect the uptick in EM leading indicators to signal the beginning of a cyclical upswing for commodities. China’s slowdown, rising real rates and generally improved supply-demand dynamics will likely keep prices in check for now.
46
Contact and disclaimers
50
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Commodities Declines in all sub-categories Weakness all around… Energy 120
…particularly in Grains
Industrial Metals
Agriculture
Agriculture
Precious Metals
Soybean
Corn
Wheat
Total returns, Jan-2014 = 100
Total returns, Jan-2014 = 100
120 115
110
110
105
100
100
90 95
85 Jul-13
Oct-13
Jan-14
Apr-14
Jul-14
70 Jul-13
Oct-14
Since late summer, we have seen broad declines across all major sub-categories including energy, industrial metals, agriculture and precious metals, with the declines in agricultural commodities being particularly pronounced.
Oct-13
Jan-14
Apr-14
Jul-14
Oct-14
A significant portion of the decline in agricultural commodities is down to the bumper corn crop in the US. Also adding to the downtrend is the lack of any meaningful disruptions from a feared El Niño event.
47
Contact and disclaimers
80
90
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Commodities Performance patterns change Arabica’s robust performance
Commodity carry staring an unwind in the face
35
30
JP Morgan commodity carry index
Circle size reflects returns per unit of volatility: the bigger the circle, the higher the Sharpe ratio
Oats Palladium
6
350
5
300
4
250
3
200
2
150
1
Lean Hogs
20 Zinc
Coffee Robusta Cocoa
15 Aluminium 10
Live Cattle Annualized ytd return (%)
5 -10
400
Coffee Arabica
Nickel
25
USD 1y1y (rhs)
0
10
20
30
40
50
60
100 2007
70
0 2008
2009
2010
2011
2012
2013
2014
The commodity carry trade (earning positive roll on backwardated term structures) has been one of the success stories of the crisis years, contributed to by the robust growth in China and the decline in global funding costs. Both drivers are weakening.
In a year that has seen global growth accelerate, commodities most reliant on global growth (such as aluminium) are among the worst performers. Investment opportunities are likely to surface on the back of idiosyncratic stories, e.g., in the coffee market, the outperformance of Arabica (tracking the New York market) relative to Robusta (tracking the London market).
48
Contact and disclaimers
40
Annaulzed 30d volatility (%)
45
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Commodities Crude upheaval Goodbye backwardation
A long way to go
WTI (4th-16th ctr.)
CFTC net non-comm.positions 2.0
Difference (USD)
500
$
1.9
8
400
120
1.7
0
110
1.6
-4
140 130
1.8
4
300
100
1.5
-8
90
1.4
-12 -16
Ratio
200 80
1.3
-20
1.2
-24
1.1
-28
1.0
-32
0.9
-36 1992
WTI (rhs)
60
1998
2001
2004
2007
2010
50
0
40
0.8 1995
70
100
-100 2007
2013
Rising inventory levels have eroded the premium on near-term WTI contracts, bringing down the extent of backwardation, during a period when crude oil prices have declined globally.
30 2008
2009
2010
2011
2012
2013
2014
Despite the recent decline, speculative positions are still net long. The decline could have a long way to go.
49
Contact and disclaimers
12
WTI (4th/16th ctr., rhs)
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Commodities Deteriorating demand outlook Demand-supply balance suggests a bearish outlook for crude Brent yoy
China softness implies downward pressure on industrial metals HSBC China Manuf. PMI
Demand/Production 1y change (rhs)
China Manuf. PMI
BBG Industrial Metals (rhs) 200%
20
65
300
15
150%
260
60 10
220
100%
55 5
180
50%
50 0
140
0%
45
-5
-100% 1995
-10
40
-15 1998
2001
2004
2008
2011
35 2005
2014
The most recent Oil Market Report of the International Energy Agency suggests that the global demand-supply balance has tilted towards excess supply. There has been a pronounced decline in demand growth in Q2 2014, with a weaker outlook for Europe and China underpinning the downward revisions.
60
20 2006
2007
2008
2009
2010
2011
2012
2013
2014
A down-drift in Chinese activity indicators bodes especially ill for industrial metals, as China is by some distance the most significant marginal importer of industrial commodities such as iron ore and copper.
50
Contact and disclaimers
-50%
100
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Commodities Cattle bulls Forming a base
A consistent trend
DJ-UBS Live Cattle TR index
5-year MA
Live Cattle, generic 1st contract ($/lb)
220
170
200
150 130
180
110 160
90
140
70 Jul-06
Jul-08
Jul-10
Jul-12
50 Mar-02
Jul-14
Falling headcount
Mar-04
Mar-06
130
Million heads
Mar-10
Mar-12
Mar-14
Cattle placement on feed still slow in attempt to rebuild the herd Cattle, beginning stocks
140
Mar-08
Cattle on feed for 7 states, y-y% 8
source: USDA
6 4
120
2
110
0 -2
100
-4
90
-6
80
-8 2007
60 63 66 69 72 75 78 81 84 87 90 93 96 99 02 05 08 11 14
51
2008
2009
2010
2011
2012
2013
2014
Contact and disclaimers
120 Jul-04
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Commodities Rates taking the lustre off gold Volcker rate hikes finished off the 1970s gold bull market Gold
History just seems to be repeating itself
US 2y real rate (rhs)
Gold
US 2y real rate (rhs)
1900
780 9
680 480 380
5
1500
3
1300
1 -2
180
-4
900
-6
700 2009
1977
1978
1979
1980
1981
1982
1983
2 1 0 -1
1100
280 80 1976
3
1700
7
580
4
1984
-2 -3 -4 2010
2011
2012
2013
2014
Commodities remain in a weakening trend, as broad indices continue to form a pattern of declining highs.
We doubt that the recent uptick in EM leading indicators signals the beginning of a cyclical upswing, as the global growth cycle has turned significantly less commodity-intensive.
China softness and excess oil supply suggest that Energy and Industrial Metals will remain under pressure, while rising real rates will weigh on Precious Metals just as they did in the early 1980s.
We continue to like Cattle due to strong fundamentals and supportive technicals.
52
Contact and disclaimers
Investment conclusions
Lombard Street Research Chart of the month
Chartbook October 2014 Contents
Summary
Macro Drivers
Multi Asset
Fixed Income
Currencies
Equities
Commodities
Disclaimer This report has been issued by Lombard Street Research Financial Services Limited. It should not be considered as an offer or solicitation of an offer to sell, buy, subscribe to or underwrite any securities or any derivative instrument or any other rights pertaining thereto (“financial instruments”) or as constituting advice as to the merits of selling, buying, subscribing for, underwriting or otherwise investing in any financial instruments. This report is intended to be viewed by clients of Lombard Street Research Financial Services Limited only. The contents of this report, either in whole or in part, shall not be reproduced, stored in a data retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise without written permission of Lombard Street Research Financial Services Limited. The information and opinions expressed in this report have been compiled from publicly available sources believed to be reliable, but are not intended to be treated as advice or relied upon as fact. Neither Lombard Street Research Financial Services Limited, nor any of its directors, employees or agents accepts liability for and, to the maximum extent permitted by applicable law, shall not be responsible for any loss or damage arising from the use of this report including as a result of decisions made or actions taken in reliance upon or in connection with the information contained in this report. Lombard Street Research Financial Services Limited does not warrant or represent that this report is accurate, complete or reliable and does not provide any assurance whatsoever in relation to the information contained in this report. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this report based on the information available. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Past performance should not be taken as an indication or guarantee of future performance, and no representation or warranty, express or implied is made regarding future performance. This information is subject to change without notice, its accuracy is not guaranteed, it may be incomplete or condensed and it may not contain all material information concerning the company and its subsidiaries.
Lombard Street Research Financial Services Limited may have issued other reports that are inconsistent with, and reach different conclusions from, the information presented in this report. Lombard Street Research Financial Services Limited is Authorised and Regulated by the UK Financial Services Authority. FSA Firm Reference Number: 502674. Registered Office: 9 cloak Lane, London EC4R 2RU Registered in England No. 6862824 Registered in England No. 6862824
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Contact and disclaimers
The value of any securities or financial instruments or types of securities or financial instruments mentioned in this report can fall as well as rise. Foreign currency denominated securities and financial instruments are subject to fluctuations in exchange rates that may have a positive or adverse effect on the value, price or income of such securities or financial instruments. Certain transactions, including those involving futures, options and other derivative instruments, can give rise to substantial risk and are not suitable for all investors. This report does not have regard to the specific instrument objectives, financial situation and the particular needs of a client. Clients should seek financial advice regarding the appropriateness of investing in any of the types of financial instrument or investment strategies discussed in this report.
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