Euro Area
Dear Clients, In addition to this Weekly Report, you will also be getting a Special Report authored by some of our top strategists on global growth. The manufacturing recession that began in early 2018 has lasted longer than most expected. The risk is that this is an additional end-of-cycle indicator, with important ramifications for the U.S. dollar. The dollar tends to stage meaningful rallies in recessions. In this week’s publication, we highlight some of the key indicators we are watching for justification on maintaining a pro-cyclical stance, but the internal debate from the Special Report highlights how delicate the balance of forces for this stance are. A fortnight ago we suggested a few portfolio hedges, and recommend maintaining tight stops on all positions until September. Next week, we will be sending you a Special Report on gold, from our colleagues in the Commodity & Energy Strategy team. In the interim, I will be learning from our clients in Latin America about some of the forces currently shaping global FX markets. I will report back with my findings in a few weeks. Kind Regards, Chester Ntonifor Foreign Exchange Strategist Highlights There is very scant evidence that global growth is bottoming. That said, it is usually darkest before dawn. A few key indicators are beginning to flash amber, which we will continue to closely monitor. The deceleration phase this cycle has been as prolonged as others, warning that the rebound could also be V-shaped. The AUD/JPY cross will be a very useful barometer. Stay long a basket of petrocurrencies versus the euro and short USD/JPY. Feature One of the most cyclical developed-market indices is the Japanese Nikkei (Table I-1).1 Almost 60% of all sectors are concentrated in just three: consumer discretionary, information technology and industrials. Boasting a wide spectrum of global robotic, automotive and construction machinery giants, Japanese companies sit at the epicenter of the global manufacturing supply chain. As such, it is very telling when Japanese share prices – which track global bond yields very closely – appear to be making a tentative bottom (Chart I-1). On the currency front, a lower greenback has also tended to be a very useful confirmation signal that we are entering a reflationary window. A slowing global economy on the back of deteriorating trade is positive for the greenback. As a reserve and counter-cyclical currency, the dollar has tended to rise during times of capital flight. On the other hand, a dovish Federal Reserve knocks down U.S. interest rate expectations relative to the rest of the world. This has historically been bearish for the dollar, and positive for global growth (Chart I-2). More importantly, even if the Fed does not proceed to cut rates as much as the market expects, it will be because global growth has bottomed, which will also favor non-U.S. rates. Chart I-1Japanese Share Prices Usually Bottom Before Bond Yields Chart I-2A Dovish Fed Will Be Dollar Bearish The commodity and export channel also helps explain why rising global growth is negative for the dollar. In theory, rising commodity prices (or rising terms of trade) allow for increased government spending in export-driven economies, making room for the resident central bank to tighten monetary policy. This is usually bullish for the currency. Rising terms of trade also further increases the fair value of the exchange rate. Balance-of-payments dynamics also tend to improve when exports are booming. Altogether, these forces combine to be powerful undercurrents for pro-cyclical currencies. Both political and domestic pressure for central banks to ease policy is the highest it has ever been. Chart I-3Both Economic And Political Pressure For Central Banks To Alter Policy Both political and domestic pressure for central banks to ease policy is the highest it has ever been.2 This suggests that either they have already done so or the conditions warranting stimulus have hit climactic pressure. Going forward, such a synchronized move by global central banks is usually accompanied by a synchronized recovery, for the simple reason that central banks are usually behind the curve (Chart I-3). Finally, the starting point for long dollar positions is one of an overcrowded trade, along with U.S. Treasury bonds. The latest downdraft in global manufacturing has nudged U.S. net speculative long positions to a point where they typically experience exhaustion (Chart I-4). This suggests there may be a scarcity in fresh dollar bulls. 2018 was particularly favorable for the dollar, as a liquidity crunch (the Fed’s balance sheet runoff) underpinned a sizeable rally. The big surge in cryptocurrencies this year (and gold) could suggest that the liquidity environment is once again becoming favorable. Chart I-4Dollar Positioning Is Stretched Chart I-5Carry Trades Are Usually Consistent With Higher Yields An improving liquidity environment will be especially favorable for carry trades. High-beta currencies such as the RUB/USD, ZAR/USD and BRL/USD have stopped falling and are off their lows of the year. These currencies are usually good at sniffing out a change in the investment landscape. The message so far is that the drop in U.S. bond yields may have been sufficient to make these currencies attractive again (Chart I-5). Bottom Line: There is very scant evidence that global growth is bottoming. That said, it is usually darkest before dawn. A few key indicators are beginning to flash amber, which we will continue to monitor closely. A Few Growth Barometers A key difference from last year is that U.S. growth leadership is set to give way to the rest of the world. The U.S. ISM manufacturing Purchasing Manager’s Index (PMI) peaked last August and has been steadily rolling over relative to its trading partners. Historically, the relative growth differential between the U.S. and elsewhere has had a pretty good track record of dictating trends in the dollar. The message is that the manufacturing PMI should pick up from 47.6 currently to the 50 boom/bust level in the coming months. Meanwhile, there is some evidence that there are tentative signs of a bottom in global growth: Chart I-6Euro Area Might Be Close To A Bottom Europe: The Swedish new orders to inventory ratio has a long and pretty accurate track record of calling bottoms in European growth, and the message is that the manufacturing PMI should pick up from 47.6 currently to the 50 boom/bust level in the coming months. Importantly, the recoveries have tended to be V-shaped pretty much throughout the past two decades. Any further decline in the PMI will pin it at levels consistent with the last European debt crisis (Chart I-6). Japan: Japan is closely impacted by the industrial cycle, especially demand from China. And while overall machinery orders remain weak, machine tool orders from China have bottomed. China: The Chinese credit impulse has bottomed. This suggests the contraction in imports, along with Korean and Taiwanese exports, is near its nadir (Chart I-7). The domestic bond market in China is becoming pretty good at signaling reflationary conditions for domestic demand (Chart I-8). Singapore exports this week were deeply negative, but this could be the bottom if all credit-injection so far in China starts flowing. Shipping indices are already recovering very strongly, and global machinery stocks are re-rating. Chart I-7A Modest Recovery For Exports Chart I-8Chinese Imports Should Bounce A pickup in Chinese growth should begin to benefit commodity currencies, especially the Australian dollar. A lot of the bad news already appears to be priced into the Aussie, which is down 14% from its 2018 peak and 37% from its 2011 peak. This suggests outright short AUD bets are susceptible to either upside surprises in global growth or simply forces of mean reversion. Importantly, the AUD/JPY cross is sitting at an important technical level. Ever since the financial crisis, the 72-74 cent zone has proven to be formidable resistance, with the cross failing to break below both during the euro area debt crisis in 2011-2012 and the China slowdown of 2015-2016. Speculators are now massively short the cross, suggesting that any upward move could be powerful and significant (Chart I-9). A rally in the Swedish krona will be another confirmation that global growth may have bottomed. A rally in the Swedish krona will be another confirmation that global growth may have bottomed. On a relative basis, the Swedish economy appears to have troughed relative to that of the U.S., making the USD/SEK an attractive way to play USD downside. From a technical perspective, USD/SEK failed to break decisively above 9.60, and is now trading below a major resistance at 9.40 (Chart I-10). Aggressive investors can slowly begin accumulating short positions, while being cognizant of the negative carry. Chart I-9AUD/JPY Near A Critical Zone Chart I-10The Swedish Krona Is Attractive Bottom Line: We are already long the SEK versus NZD, and the thesis remains intact from our June 7th recommendation. The AUD/JPY cross is very close to a bottom. Hold EUR/CAD For A Trade Chart I-11EUR/CAD Technicals: Limited Downside The EUR/CAD has reached an important technical level, and what will follow is either a major breakdown or a powerful bounce (Chart I-11). With Canadian data firing on all cylinders and the euro area in the depths of a manufacturing recession, the cross has rightly responded to growth divergences. On the downside, the EUR/CAD is at the bottom of the upward trending channel that has existed since 2012, in the vicinity of 1.45-1.46. A bounce here will not meet initial upside resistance until the triple top, a nudge above 1.6. The biggest catalyst for this cross going forward will likely be interest rate differentials, since any improvement in euro area data will continue to reduce the scope by which the European Central Bank stays dovish relative to the Bank of Canada. European rates are further below equilibrium, and the ECB’s dovish shift will help lift the growth potential of the euro area. Meanwhile, the Canadian neutral rate will be heavily weighed down by the large stock of debt in the Canadian private sector, exacerbated by overvaluation in the housing market. Valuations and balance-of-payment dynamics also favor the euro versus the CAD on a long-term basis. Bottom Line: Hold the EUR/CAD for a trade with a stop at 1.45. Chart I-12Gold/Silver Ratio Near Speculative Extreme Trade Idea: Buy Silver, Sell Gold The gold/silver ratio is reaching a speculative extreme. Usually, reflationary cycles benefit silver more than gold, with 100 usually the upper bound of the gold/silver ratio. We are very close to such a tipping point. Stay tuned (Chart I-12). Chester Ntonifor, Foreign Exchange Strategist chestern@bcaresearch.com Currencies U.S. Dollar Chart II-1USD Technicals 1 Chart II-2USD Technicals 2 Recent data in the U.S. have continued to soften: Headline PPI fell to 1.7% year-on-year in June. Core PPI was unchanged at 2.3% year-on-year in June. NY Empire State manufacturing index increased to 4.3 in July. Retail sales increased by 0.4% month-on-month in June. Import and export prices contracted by 0.9% and 2% year-on-year respectively in June. Building permits contracted by 6.1% month-on-month in June. Housing starts softened by 0.9% month-on-month. Philadelphia Fed manufacturing index rose to 21.8 in July from 0.3 in June. Continuing jobless claims fell to 1.686 million this week, while initial jobless claims increased to 216 thousand. DXY increased by 0.4% this week. On Tuesday, Fed Chair Powell gave a short speech in Paris, regarding the current developments in the U.S. economy, and some post-crisis structural shifts. While U.S. economy has been on the 11th consecutive year of expansion, Powell highlighted concerns towards softer growth this year, in the manufacturing sector in particular, weighed down by weaker consumer spending, sluggish business investment, and trade war uncertainties. Report Links: On Gold, Oil And Cryptocurrencies - June 28, 2019 Battle Of The Central Banks - June 21, 2019 EUR/USD And The Neutral Rate Of Interest - June 14, 2019 The Euro Chart II-3EUR Technicals 1 Chart II-4EUR Technicals 2 Recent data in the euro area have been weak: Industrial production contracted by 0.5% year-on-year in May. Trade balance widened to €20.2 billion in May. Headline and core inflation increased by 1.3% and 1.1% year-on-year respectively in June. EUR/USD fell by 0.36% this week. ZEW data continue to soften in July: The sentiment index in the euro area fell to -20.3, and the sentiment in Germany decreased to -24.5. Moreover, the European Commission’s summer forecast released last week cut the 2020 euro area GDP projection from 1.5% (spring forecast) to 1.4%, and lowered inflation to 1.3% for both this year and next year. Report Links: Battle Of The Central Banks - June 21, 2019 EUR/USD And The Neutral Rate Of Interest - June 14, 2019 Take Out Some Insurance - May 3, 2019 The Yen Chart II-5JPY Technicals 1 Chart II-6JPY Technicals 2 Recent data in Japan have been negative: Industrial production contracted by 2.1% year-on-year in May. Capacity utilization increased by 1.7% in May. Exports contracted by 6.7% year-on-year in June. Imports also fell by 5.2% year-on-year. Total trade balance increased to ¥589.5 billion. USD/JPY fell by 0.2% this week. The weak Q2 data worldwide, driven by a significant slowdown in the manufacturing sector have raised concerns for a possible near-term recession. This has been exacerbated by a trade war, U.S.-Iranian tensions and Brexit uncertainties. We continue to favor the yen as a safe-haven currency. Hold to the short USD/JPY and short XAU/JPY positions. Report Links: Portfolio Tweaks Into Thin Summer Trading - July 5, 2019 Battle Of The Central Banks - June 21, 2019 Short USD/JPY: Heads I Win, Tails I Don’t Lose Too Much - May 31, 2019 British Pound Chart II-7GBP Technicals 1 Chart II-8GBP Technicals 2 Recent data in the U.K. have been mixed: Rightmove house price index contracted by 0.2% year-on-year in July. On the labor market front, ILO unemployment rate was unchanged at 3.8% in May. Average earnings including bonus increased by 3.4% in May. Headline inflation was unchanged at 2% year-on-year in June. Core inflation increased to 1.8% year-on-year. Retail sales increased by 3.8% year-on-year in June. GBP/USD fell by 0.5% this week, now trading around 1.2486. The Brexit uncertainties still loom over the U.K. Boris Johnson and Jeremy Hunt are fighting to take over from Theresa May as the leader of the Conservative Party and the UK’s next Prime Minister. In addition, the Q2 credit conditions survey released this Thursday indicates that default rates on loans to corporates increased for small and large businesses in Q2. Meanwhile, these are expected to increase for businesses of all sizes in Q3. Report Links: Battle Of The Central Banks - June 21, 2019 A Contrarian View On The Australian Dollar - May 24, 2019 Take Out Some Insurance - May 3, 2019 Australian Dollar Chart II-9AUD Technicals 1 Chart II-10AUD Technicals 2 Recent data in Australia have been mixed: Westpac leading index fell by 0.08% month-on-month in June. On the labor market front, unemployment rate was unchanged at 5.2% in June. Participation rate was steady at 66%. 500 new jobs were created in June, including 21.1 thousand new full-time positions, and a loss of 20.6 thousand part-time positions. AUD/USD increased by 0.3% this week. The RBA minutes released this week reiterated that the central bank is ready to adjust interest rates if required, in order to support sustainable growth and achieve the inflation target overtime. The easing financial conditions and rising terms of trade all underpin the Aussie dollar in the long term. Report Links: A Contrarian View On The Australian Dollar - May 24, 2019 Beware Of Diminishing Marginal Returns- April 19, 2019 Not Out Of The Woods Yet - April 5, 2019 New Zealand Dollar Chart II-11NZD Technicals 1 Chart II-12NZD Technicals 2 Recent data in New Zealand have been mostly positive: House sales keep contracting by 3.8% year-on-year in June. Business manufacturing PMI increased to 51.3 in June. Headline inflation increased to 1.7% year-on-year in Q2. NZD/USD rose by 0.6% this week. Solid incoming data have lifted the New Zealand dollar for the past few weeks. However, the kiwi might lag the Aussie given the RBNZ is behind the RBA. The market is currently pricing in an 84% probability of a rate cut at the beginning of next month, but more cuts could be needed down the road. Hold to our long AUD/NZD and SEK/NZD positions. Report Links: Where To Next For The U.S. Dollar? - June 7, 2019 Not Out Of The Woods Yet - April 5, 2019 Balance Of Payments Across The G10 - February 15, 2019 Canadian Dollar Chart II-13CAD Technicals 1 Chart II-14CAD Technicals 2 Recent data in Canada have been mostly positive: Headline and core inflation both fell to 2% year-on-year in June. ADP employment shows an increase of 30.4 thousand new jobs in June. USD/CAD increased by 0.3% this week. Just last week, the BoC kept its interest rate on hold. With a more dovish Fed, this might narrow the interest rate differentials between the Fed and the BoC. We favor the loonie in the near-term based on the interest rate differentials, crude oil prices, and relatively more positive data incoming from Canada. Report Links: Portfolio Tweaks Into Thin Summer Trading - July 5, 2019 On Gold, Oil And Cryptocurrencies - June 28, 2019 Currency Complacency Amid A Global Dovish Shift - April 26, 2019 Swiss Franc Chart II-15CHF Technicals 1 Chart II-16CHF Technicals 2 Recent data in Switzerland have been mixed: Producer and import prices contracted by 1.4% year-on-year in June. Exports increased to CHF 20,328 million, while imports fell to CHF 17,131 million in June. This lifted the trade balance up to 3,251 million. USD/CHF increased by 0.35% this week. We continue to favor the Swiss franc in the long term. The rising market volatility has increased the appetite for the Swiss franc. Moreover, the Swiss franc is still cheap compared to its fair value. Report Links: What To Do About The Swiss Franc? - May 17, 2019 Beware Of Diminishing Marginal Returns - April 19, 2019 Balance Of Payments Across The G10 - February 15, 2019 Norwegian Krone Chart II-17NOK Technicals 1 Chart II-18NOK Technicals 2 Recent data in Norway have been negative: Trade balance narrowed to NOK 5.2 billion in June. USD/NOK increased by 0.8% this week. The recent energy price volatility, mostly due to the uncertainties of oil demand has knocked down the Norwegian krone. In the long term, we continue to believe that the OPEC 2.0’s production strategy of reducing global oil inventories, and U.S. – Iran tension will drive oil prices higher, thus bullish for petrocurrencies including the Norwegian krone. Report Links: Portfolio Tweaks Into Thin Summer Trading - July 5, 2019 On Gold, Oil And Cryptocurrencies - June 28, 2019 Currency Complacency Amid A Global Dovish Shift - April 26, 2019 Swedish Krona Chart II-19SEK Technicals 1 Chart II-20SEK Technicals 2 Recent data in Sweden have been positive. Industrial orders increased by 3.2% year-on-year in May. Budget balance came in at SEK -24.8 billion in June. USD/SEK fell by 0.28% this week. Recent data shows that the Swedish government debt is sliding below 35% of GDP. This is triggering political pressure on the government to expand fiscal support. More fiscal expenditure will allow for a more hawkish Risksbank, supporting the Swedish Krona. Report Links: Where To Next For The U.S. Dollar? - June 7, 2019 Balance Of Payments Across The G10 - February 15, 2019 A Simple Attractiveness Ranking For Currencies - February 8, 2019 Footnotes 1 The Global Industry Classification Standard (GICS) classification does not really apply for euro zone companies, so we used the Industry Classification Benchmark (ICB) for the euro area, the U.S., and Japan. The difference between GICS and ICB is that the new GICS standard (which took effect last year) splits Telecom into an additional Communication Services sector. ICB may also apply this later this year. 2 Carola Binder, “Political Pressure on Central Banks,” SSRN, December 16, 2018. Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades
The model results for the euro are the mirror image of the dollar, with no evidence of mispricing. What is interesting about the euro, however, is that the biggest buy signal was generated in 2015, and since then the fair value has exhibited a series of…
Highlights The onset of a down-oscillation in growth strongly suggests a rotation out of the growth-sensitive Industrials and Materials into the relatively defensive Healthcare sector. But if the sharpest move in bond yields has already happened, it also suggests that Banks might hold up versus other cyclical sectors. New recommendation 1: Overweight Banks versus Industrials. New recommendation 2: Overweight Eurostoxx50 versus Nikkei225. Remain overweight Eurostoxx50 versus Shanghai Composite and neutral versus the S&P500. Feature Chart of the WeekEuro Stoxx 50 Vs. Nikkei 225 = Global Banks In Euros Vs. Global Industrials In Yen Several decades ago, English football’s top division was a showcase for the top English and British footballers. But not anymore. This year, the top six footballers in the English Premier League hail from Argentina, the Netherlands, Belgium, Senegal, Portugal, plus a token Englishman. Nowadays, if you want to see English or British footballers you have to go to the lower divisions.1 The English Premier League provides a powerful analogy for the FTSE100. Many of the top companies in this blue-chip index have their origins and main businesses outside the U.K. The names say it all: Royal Dutch, Hong Kong and Shanghai Banking Corporation, British American Tobacco, and so on. Just like in football, if you want stock market exposure to the U.K, you now have to go to the lower divisions: the FTSE250 or the FTSE Small Cap. A view on an economy does not necessarily translate into the same view on its mainstream stock market. The leading companies in the FTSE100 are multinationals, whose sales and profits have a minimal exposure to the economic fortunes of the U.K. This leads to a result which causes investors a great deal of cognitive dissonance: a view on an economy does not necessarily translate into the same view on its mainstream stock market. Picking Stock Markets The Right Way Royal Dutch is neither a Dutch company nor a U.K. company, it is a global company. And the same is true for the vast majority of companies in the FTSE100 and all other major indexes such as the Eurostoxx50, Nikkei225, and S&P500. However, Royal Dutch is most definitely an oil and gas company which moves in lockstep with the global energy sector. Hence, by far the most important performance differentiator for any mainstream equity index is the sector fingerprint that distinguishes the equity index from its peers. Each major stock market has a distinguishing ‘long’ sector in which it contains up to a quarter of its total market capitalisation, as well as a distinguishing ‘short’ sector in which it has a significant under-representation. The combination of this long sector and short sector gives each equity index its distinguishing fingerprint (Table 1): FTSE100 = long energy, short technology. Eurostoxx50 = long banks, short technology. Nikkei225 = long industrials, short banks and energy. S&P500 = long technology, short materials. MSCI Emerging Markets = long technology, short healthcare. Another important factor is the currency. Royal Dutch receives its revenues and incurs its costs in multiple major currencies, such as euros and dollars. In other words, Royal Dutch’s global business is currency neutral. But the Royal Dutch stock price is quoted in London in pounds. Hence, if the pound strengthens, the company’s multi-currency profits will decline in pound terms, weighing on the stock price. Conversely, if the pound weakens, it will lift the Royal Dutch stock price. This means that the domestic economy can impact its stock market through the currency channel. Albeit it is a counterintuitive relationship: a strong economy via a strong currency hinders the stock market; a weak economy via a weak currency helps the stock market. Be Careful With Valuation Comparisons Chart of the Week to Chart I-7 should prove beyond doubt that the sector plus currency effect is all that you need to get right to allocate between these four major regions. The charts show all the permutations of relative performances taken from the S&P500, Eurostoxx50, Nikkei225 and FTSE100 over the last decade. Chart I-2FTSE 100 Vs. S&P 500 = Global Energy In Pounds Vs. Global Technology In Dollars Chart I-3FTSE 100 Vs. Nikkei 225 = Global Energy In Pounds Vs. Global Industrials In Yen Chart I-4FTSE 100 Vs. Euro Stoxx 50 = Global Energy In Pounds Vs. Global Banks In Euros Chart I-5Euro Stoxx 50 Vs. S&P 500 = Global Banks In Euros Vs. Global Technology In Dollars Chart I-6Euro Stoxx 600 Vs. MSCI Emerging Markets = Global Healthcare In Euros Vs. Global Technology In Dollars Chart I-7S&P500 Vs. Nikkei225 = Global Tech In Dollars Vs. Global Industrials ##br##In Yen One important implication of sectors and currencies driving stock market allocation is that the head-to-head comparison of stock market valuations is meaningless. Two sectors with vastly different structural growth prospects – say, energy and technology – must necessarily trade on vastly different valuations. So the sector with the lower valuation is not necessarily the better-valued sector. By extension, the stock market with the lower valuation because of its sector fingerprint is not necessarily the better-valued stock market. Likewise, if investors anticipate the pound to ultimately strengthen – because they see that the pound is structurally cheap today – they might downgrade Royal Dutch’s multi-currency profit growth expectations in pound terms and trade the stock at an apparent discount. But allowing for the anticipated decline in other currencies versus the pound there is no discount. It follows that any multinational listed in Europe will give a false impression of cheapness if investors see European currencies as structurally undervalued. Another implication is that simple ‘value’ indexes may not actually offer value. In reality, they comprise a collection of sectors on the lowest head-to-head valuations which, to repeat, does not necessarily make them better-valued. The sector plus currency effect is all that you need to allocate between equity markets. Some people suggest comparing a valuation with its own history, and assessing how many ‘standard deviations’ it is above or below its norm. Unfortunately, the concept of a standard deviation is meaningful only if the underlying series is ‘stationary’ – meaning, it has no step changes through time. But sector valuations are ‘non-stationary’: they do undergo major step changes when they enter a vastly different economic climate. For example, the structural outlook for bank profits undergoes a step change when a credit boom ends. Therefore, comparing a bank valuation after a credit boom with the valuation during the credit boom is like comparing an apple with an orange! The Current Message Last week, we pointed out that current activity indicators are losing momentum, or outright rolling over. The reason being that “both the interest rate impulse and short-term credit impulses are now on the cusp of down-oscillations, which will bear on economies and financial markets in the second half of the year.” This week’s profit warning from BASF supports this analysis. To be clear, this is not a binary issue about recession or no recession. This is just a common or garden down-oscillation in European (and global) growth which tends to happen every 18 months or so with remarkable regularity. Nevertheless, the down-oscillation has a major bearing on sector allocation (Chart I-8) and, therefore, a major bearing on regional equity allocation. Chart I-8Switch Out Of Growth-Sensitives Into Healthcare Based on the major equity index ‘sector fingerprints’ we need to rank the attractiveness of six major global sectors: Materials, Energy, Industrials, Banks, Healthcare, and Technology. In the first half of the year, Industrials outperformed while Banks underperformed. Why? Because Industrials were following the up-oscillation in growth whereas Banks were tracking the bond yield down, as the flattening (or inverting) yield curve ate into their margins. Now, the onset of a down-oscillation in growth strongly suggests a rotation out of the growth-sensitive Industrials and Materials into the relatively defensive Healthcare sector (Chart I-8). But if the sharpest move in bond yields has already happened, it also suggests that Banks might hold up versus other cyclical sectors (Chart I-9 and Chart I-10). Meanwhile, for Energy and Technology we do not hold a high-conviction view. Hence, our ranking of the sectors is as follows: Chart I-9Banks Have Tracked The Bond Yield ##br##Down... Chart I-10...But If The Sharpest Move In Yields Is Over, Banks Can Outperform Other Cyclicals Healthcare Banks Energy and Technology Industrials and Materials On the basis of this ranking, and the major equity index sector fingerprints we are making two new recommendations. Overweight Banks versus Industrials. Overweight Eurostoxx50 versus Nikkei225. For completeness, remain overweight Eurostoxx50 versus Shanghai Composite and neutral versus the S&P500. A New Look To Our Recommendations Finally, from this week onwards we are changing the way we show our investment recommendations. Trades will refer to an investment horizon of 3 months or less, and these will mostly fall within the Fractal Trading System. Cyclical Recommendations will refer to an investment horizon usually between 3 months and a year, and will be sub-divided into asset allocation, equities, and bonds, rates and currencies. Structural Recommendations will refer to an investment horizon longer than a year, and will also be sub-divided into asset allocation, equities, and bonds, rates and currencies. We are changing the way we show our investment recommendations. We have also taken the opportunity to close long-standing stale positions. We hope you find the new look more user-friendly. Next week we will be publishing a jointly written round table discussion in which we debate and explore the interesting view differences within BCA. Absent a major development in the markets, this will replace the normal weekly report. Fractal Trading System* This week we note that the strong rally in the Australian stock market has reached a 65-day fractal dimension which has signalled previous countertrend reversals especially in relative terms. Accordingly, this week’s recommended trade is short ASX 200 vs. FTSE100. The profit target is 2% with a symmetrical stop-loss. In other trades, we are pleased to report that short euro area industrials vs. market achieved its profit target and is now closed. This leaves five open positions. For any investment, excessive trend following and groupthink can reach a natural point of instability, at which point the established trend is highly likely to break down with or without an external catalyst. An early warning sign is the investment’s fractal dimension approaching its natural lower bound. Encouragingly, this trigger has consistently identified countertrend moves of various magnitudes across all asset classes. Chart I-11 The post-June 9, 2016 fractal trading model rules are: When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. Use the position size multiple to control risk. The position size will be smaller for more risky positions. * For more details please see the European Investment Strategy Special Report “Fractals, Liquidity & A Trading Model,” dated December 11, 2014, available at eis.bcaresearch.com. Dhaval Joshi, Chief European Investment Strategist dhaval@bcaresearch.com Footnotes 1 The top six players are based on the six nominations for the 2019 PFA Footballer of the Year: Sergio Aguero (Argentina), Virgil Van Dijk (Netherlands), Eden Hazard (Belgium), Sadio Mane (Senegal), Bernardo Silva (Portugal), and Raheem Sterling (England). Virgil Van Dijk was the winner. Fractal Trading System Cyclical Recommendations Structural Recommendations Closed Fractal Trades Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields Interest Rate Chart II-5Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations
The European and U.S. labor markets are not as different as a quick glance suggests. Unemployment rates are well below the OECD’s estimates of the full employment NAIRU level. Wages are starting to gain some upward momentum in Europe, even as U.S. Average…
Because the yield move in the U.S. was larger, the UST-Bund spread has narrowed from a 2019 peak of 253bps to the current level of 233bps. Breaking down nominal 10-year yields into their real and inflation expectations components illustrates how the wideness…
Highlights Current activity indicators are now losing momentum, or outright rolling over. This confirms that European (and global) growth is now entering a down-oscillation. Why? It is the rate of decline in the bond yield that has driven the current up-oscillation in growth and it is mathematically impossible for the rate of decline in the bond yield to keep increasing, or even stay where it is. Equity investors should rotate from pro-cyclical to pro-defensive sectors. But the support to risk-asset valuations from low bond yields will keep the aggregate European equity market in a sideways channel. Feature Chart of the WeekThe Interest Rate Impulse And Credit Impulse Are Both Entering ##br##Down-Oscillations If the level of interest rates drove economic growth then, let’s face it, the economies of Japan and Switzerland would have reached the moon by now! In both Japan and Switzerland, the policy rate and long bond yield have been at ultra-low levels for decades (Chart I-2). This is true for both the nominal level and the real level of the interest rate and bond yield. But we all know that the level of interest rates does not drive economic growth. Chart I-2Japan And Switzerland Have Had Ultra-Low Bond Yields For Decades If Interest Rates Decline At A Reduced Pace, Growth Slows Most people understand that it is the change in interest rates that can drive economic growth. The main transmission mechanism is by adding to or subtracting from credit creation. For example if, in a given period, a -0.5 percent decline in the interest rate added €50 billion to credit creation, then the extra €50 billion would constitute additional economic demand. Many people struggle to understand the subtle and counterintuitive follow-on point. If interest rates decline, but at a reduced pace, it can slow economic growth. To understand why, let’s continue the example. If, in the following period, a further -0.5 percent decline in the interest rate added another €50 billion of credit-sourced demand, it would constitute the same rate of growth as in the first period. But a further -0.25 percent decline in the interest rate which added €25 billion to demand would result in the growth rate halving. The counterintuitive thing is that the interest rate has continued to decline, yet it has caused growth to slow! If interest rates decline, but at a reduced pace, it can slow economic growth. This counterintuitive dynamic is about to unfold in the European and global economy during the second half of this year. The pace of change in the interest rate (inverted) drives the credit impulse, and thereby drives short-term growth oscillations (Chart I-3). Of course, other influences on credit creation can sometimes swamp the interest rate impact. But not in the latest cycle. From the fourth quarter of 2018, both the pace of decline in the interest rate – or more precisely, the bond yield – and the credit impulse were in a synchronised and closely connected up-oscillation. Chart I-3The Pace Of Change In the Bond Yield (Inverted) Drives The Credit Impulse Unfortunately, it is mathematically impossible for the pace of decline in the bond yield to keep increasing, or indeed stay where it is. Hence, both the interest rate and credit impulses are now on the cusp of down-oscillations, which will bear on economies and financial markets in the second half of the year (Chart of the Week). Growth Rebounded, But Will Now Fade From the fourth quarter of 2018, European and global growth very clearly entered an up-oscillation. Let’s list all the evidence: First and foremost, quarter-on-quarter GDP growth rates picked up: by 2.5 percent in Germany; by 1 percent in the euro area; and by 1 percent in the developed economies (Chart I-4).1 The stark evidence that growth rebounded, but is now rolling over. The best current activity indicators rebounded: specifically the ZEW economic sentiment indicators for both Germany and the euro area (Chart I-5 and Chart I-6); the euro area composite PMI picked up too, albeit very modestly. Chart I-4Global Growth Rebounded... But Is Now Likely To Roll Over Chart I-5Current Activity Indicators ##br##Rebounded... Chart I-6...But Are Now Rolling Over The aforementioned interest rate impulses (inverted) and 6-month credit impulses picked up, and sharply in China (Chart I-7). Chart I-7Short-Term Impulses Rebounded... But Are Now Rolling Over The equity sector that is most exposed to growth – the industrials – strongly outperformed the broader market, especially in the euro area (Chart I-8). Chart I-8Industrials Outperformed Strongly... But Are Now Rolling Over In fact, just the first item on our list, the pick-up in GDP growth, should suffice to demonstrate the up-oscillation in growth, and that should be that. After all, GDP – after revisions – is the broadest measure of economic activity. Nevertheless, for the sceptics, the corroboration of four independent pieces of evidence should, once and for all, confirm that growth rebounded late last year and early this year. Now though, all of these indicators are losing momentum, or outright rolling over. This confirms that growth is now entering a down-oscillation. Why? To repeat, it is the rate of decline in the bond yield that has driven the current up-oscillation in growth and it is mathematically impossible for the rate of decline in the bond yield to keep increasing, or even stay where it is. The ultimate test of a good theory is its predictive power. In the case of investment strategy this means calling the markets right. Our bond yield and credit impulse oscillation framework passes this test with flying colours, especially at the last two turning-points. On February 1, 2018 at the onset of the last down-oscillation we correctly recommended: “Downgrade banks to underweight versus healthcare” Then on August 30 2018 at the onset of the last up-oscillation we correctly recommended: “Take profits in the 35 percent outperformance of European healthcare versus banks” Now, at the onset of a new down-oscillation, we recommended last week that equity investors should as a first step go underweight European industrials and switch once again to the less economically-sensitive and less price-sensitive healthcare sector. Sector rotation has huge implications for equity market regional and country allocation. Nowadays, regional and country relative performance just comes from the dominant stock and sector fingerprints of each stock market. Next week, we will advise on what the onset of a new down-oscillation means for Europe as a region relative to the world as well as for equity market allocation within Europe. Enhancing The ‘Rule Of 4’ And The ‘Rule Of 3’ The level of interest rates does not drive economic growth, but the level of interest rates – or more precisely, bond yields – does drive the valuations of equities and other risk-assets. Moreover, it does so in a viciously non-linear way. Essentially, at a tipping point, higher bond yields can suddenly undermine the valuation support of equities, triggering a plunge in the stock market and other risk-assets which threatens a disinflationary impulse on the economy. How can we sense this tipping point? Previously we defined it as when the sum of the 10-year yields on the T-bond, German bund, and JGB is at 4 percent, the ‘rule of 4’. Conversely, when the sum is below 3 percent, the ‘rule of 3’, the seemingly rich valuation of equities and other risk-assets is well underpinned.2 Higher bond yields can suddenly undermine the valuation support of equities. Did this framework work? Yes, perfectly. On September 13 2018 when the global bond yield was approaching danger level, our framework was spot-on in forecasting that: “Using the 10-year T-bond yield as a roadmap, a short trip to the uplands of 3.5 percent would precede a longer journey down to 2 percent” Nevertheless, today we are enhancing the rule. The global bond yield must include China and it must include the aggregate euro area rather than just Germany. Hence, our enhanced metric is the simple average of the 10-year yields of the U.S., the euro area, and China. But to simplify matters, we can proxy the 10-year yield of the aggregate euro area with the 10-year yield of France. So calculate the simple average of the 10-year yields of the U.S., France, and China (Chart I-9). Chart I-9The Rules Of 4 And 3 Become The Rules Of 2.5 And 2 A value approaching 2.5 equates to danger for equities and risk-assets. A value below 2.0 equates to an underpinning for equities and risk-assets. Today, the value stands at 1.8. So to sum up, European (and global) growth will experience a down-oscillation in the second half of 2019, but the support to risk-asset valuations will keep the aggregate European equity market in a sideways channel. For equity investors, the big game in town will be sector rotation, as well as regional and country rotation. Of which, more next week. Stay tuned. Fractal Trading System* This week we note that the spectacular rally in the Greek stock market this year is now ripe for a countertrend move. We prefer to play this on a hedged basis, so this week’s recommended trade is short Athex versus the Eurostoxx 600. Set the profit target at 7 percent with a symmetrical stop-loss. Chart I-10 The Fractal Trading System now has five open positions. For any investment, excessive trend following and groupthink can reach a natural point of instability, at which point the established trend is highly likely to break down with or without an external catalyst. An early warning sign is the investment’s fractal dimension approaching its natural lower bound. Encouragingly, this trigger has consistently identified countertrend moves of various magnitudes across all asset classes. The post-June 9, 2016 fractal trading model rules are: When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. Use the position size multiple to control risk. The position size will be smaller for more risky positions. * For more details please see the European Investment Strategy Special Report “Fractals, Liquidity & A Trading Model,” dated December 11, 2014, available at eis.bcaresearch.com. Dhaval Joshi, Chief European Investment Strategist dhaval@bcaresearch.com Footnotes 1 Based on a GDP weighted average of the U.S., euro area, and Japan. 2 Please see the European Investment Strategy Weekly Report ‘The Rule Of 4 Becomes The Rule Of 3’ dated March 21, 2019 available at eis.bcaresearch.com. Fractal Trading System Recommendations Asset Allocation Equity Regional and Country Allocation Equity Sector Allocation Bond and Interest Rate Allocation Currency and Other Allocation Closed Fractal Trades Trades Closed Trades Asset Performance Currency & Bond Equity Sector Country Equity Indicators Bond Yields Chart II-1Indicators To Watch - Bond Yields Chart II-2Indicators To Watch - Bond Yields Chart II-3Indicators To Watch - Bond Yields Chart II-4Indicators To Watch - Bond Yields Interest Rate Chart II-5Indicators To Watch - Interest Rate Expectations Chart II-6Indicators To Watch - Interest Rate Expectations Chart II-7Indicators To Watch - Interest Rate Expectations Chart II-8Indicators To Watch - Interest Rate Expectations
Highlights Relative Growth & Inflation: Underlying U.S. and European economic growth momentum remains surprisingly similar, with weakness concentrated in manufacturing industries most exposed to trade uncertainty. Realized inflation readings are also fairly close, although there is less spare capacity in the U.S. where wages are growing at a much faster rate. UST-Bund Spread: The yield gap between 10-year U.S. Treasuries and German Bunds is now fairly valued after the larger decline in U.S. yields seen in 2019. The Fed is more likely to deliver less easing relative to market expectations than the ECB, leaving the UST-Bund spread susceptible to a rebound over the 6-12 months. Hedged Vs Unhedged: We continue to recommend overweighting German Bunds vs U.S. Treasuries in global currency-hedged bond portfolios, given the substantial yield pickup gained by hedging into U.S. dollars out of euros. Feature “We should have Draghi instead of our Fed person.” – U.S. President Donald Trump Chart of the WeekIt’s Tough To Get A Weaker USD, Mr. President In his own inimitable way, President Trump in the above quote has called out the glaring difference between the ECB, which seems very willing to deliver more policy stimulus to a struggling euro area economy, and the Fed, which is reluctantly being pulled towards a rate cut. Yet while the current ECB President will be looking for a new job in a few months after his term expires, the reality is that President Trump will have to live with the current Fed leadership for the foreseeable future. Our Central Bank Monitors do indicate a need for easier monetary policy on both sides of the Atlantic (Chart of the Week). The signal from our ECB Monitor is stronger than that of our Fed Monitor, but U.S. Treasury and German bund yields have both fallen sharply with markets pricing in lower inflation expectations and new policy stimulus. The result is a relatively modest narrowing of U.S.-European expected interest rate differentials that has had little impact in weakening the U.S. dollar (USD) versus the euro. With both the Fed and ECB now in play for rate cuts, this is a good time to review the drivers of the spread between U.S. Treasury (UST) yields and German government bond yields – specifically, the widely-followed 10-year Treasury-Bund spread. A Quick Trans-Atlantic Comparison Of Growth, Inflation & Interest Rates The global bond rally seen this year has driven the 10-year UST yield fall back to the 2% level last seen in 2016. The 10-year Bund yield, on the other hand, has plummeted to a new all-time low of -0.3%. The yield move in the U.S. was larger, thus the UST-Bund spread has narrowed from a 2019 peak of 253bps to the current level of 233bps. Breaking down the nominal 10-year yields into the real yield and inflation expectations components illustrates how the current wide UST-Bund spread is almost purely a “real” phenomenon (Chart 2). 10-year CPI rates are 1.9% and 1.4% in the U.S. and euro area, respectively, accounting for 50bps of the overall 233bps UST-Bund spread. Adjusting the nominal yields by those CPI swap rates leaves a real 10-year Treasury yield of +0.1%, compared to -1.7% in Europe (using the 10-year German yield versus 10-year euro CPI swap). Thus, the market-implied real yield differential is 180bps, accounting for the bulk of the nominal UST-Bund spread. Our proxy for the market’s expectation of the real neutral interest rate – the 5-year Overnight Index Swap (OIS) rate, 5-years forward minus the 5-year CPI swap rate, 5-years forward – is indicating that investors now think the neutral real fed funds rate is 0% and the neutral real ECB rate is around -1% (Chart 3). Chart 2Real Yields Dictating UST-Bund Spread Chart 3Global Yields Discounting Fresh ECB QE? Those market-implied measures typically follow the path of our estimate of the term premium for the 10-year Treasury and Bund. For both markets, however, the term premium is now at a much more negative level than suggested by the past relationship with our real neutral rate proxy. The gap between the 10-year UST term premium (-60bps) and the 10-year German Bund term premium (-124bps) now contributes about 64bps to the nominal UST-Bund spread. When looking at the relative cyclical state of the U.S. and European economies at present, there are surprisingly few differences that show up in the data. Term premia are heavily influenced by investor risk aversion and the demand for safe assets during periods of uncertainty. Given the numerous headline risks that investors are faced with at the moment (U.S.-China trade, slowing global growth, U.S.-Iran military tensions, the start of the 2020 U.S. Presidential election cycle), it is understandable that money has flooded into the safety of developed market government debt. Yet when looking at the relative cyclical state of the U.S. and European economies at present, there are surprisingly few differences that show up in the data (Chart 4). The euro area manufacturing PMI is now at 47.8, below the 50 line that indicates an expanding industrial sector, but may be starting to stabilize. The U.S. ISM manufacturing index, at the same time, now sits at 52.1 and is closing in on the levels seen in Europe. Meanwhile, consumer confidence measures remain elevated both in the U.S. and Europe, even after the recent small dips. Business confidence measures like the NFIB U.S. small business survey and the European Commission’s business climate indicator remain firm relative to the post-crisis history, although both are off their cyclical peaks. That relative dearth of spare capacity in the U.S. compared to Europe is the most fundamental reason for the higher level of U.S. interest rates relative to the euro area. Turning to the state of labor markets on both sides of the Atlantic, the stories are also similar (Chart 5). Unemployment rates are well below the OECD’s estimates of the full employment NAIRU level. Wages are starting to gain some upward momentum in Europe, but U.S. Average Hourly Earnings are growing about one percentage point faster than equivalent measures in the euro area. Chart 4Not A Huge U.S.-Europe Cyclical Growth Gap Chart 5Not A Huge U.S.-Europe Structural Growth Gap The implication here is that there is less slack in the U.S. labor market than in Europe, as exemplified by the fast rate of wage growth in the U.S. Chart 6A Bit More Wage Inflation In The U.S. That relative dearth of spare capacity in the U.S. compared to Europe is the most fundamental reason for the higher level of U.S. interest rates relative to the euro area (Chart 6). U.S. potential GDP growth is only marginally faster than it is in Europe, with virtually the same rate of long-term labor productivity growth (about 0.5% per year, according to the OECD). Yet according to the New York Fed’s most recent estimates of the natural real interest rate (“r-star”), the level of the inflation-adjusted policy rate that would be considered neither stimulative nor restrictive given current estimates of spare capacity, is 0.7% in the U.S. and -0.4% in Europe.1 Looking ahead, both the Fed and ECB are likely to deliver some monetary easing in the coming months, perhaps as soon as the next set of policy meetings in late July. The market expects much more from the Fed, though, with 92bps of cuts discounted over the next twelve months. 16bps of cuts are also expected from the ECB, but that is more likely to be delivered than the market expectation for the Fed. There is even a chance that the ECB could restart their Asset Purchase Program, although likely not after delivering a small rate cut first. In any case, there is likely to be more disappointment from the Fed compared to the ECB over the next 6-12 months, with the result being some upward pressure placed on the UST-Bund spread. Bottom Line: Underlying U.S. and European economic growth momentum remains surprisingly similar, with weakness concentrated in manufacturing industries most exposed to trade uncertainty. Realized inflation readings are also fairly close, although there is less spare capacity in the U.S. where wages are growing at a much faster rate. There is likely to be more disappointment from the Fed compared to the ECB over the next 6-12 months, with the result being some upward pressure placed on the UST-Bund spread. Valuation & Currency Risk In The UST-Bund Spread Our valuation model for the 10-year Treasury-Bund spread indicates that the current spread level of 233bps is very close to fair value of 223bps (Chart 7). Chart 7UST-Bund Spread Fairly Valued The main variables in the model are the spread between the fed funds rate and the ECB 1-week refinancing rate, the ratio of the unemployment rates of the U.S. and euro area, and the differential between the headline inflation rates of the U.S. and euro area. The model also includes the balance sheets of the Fed and ECB as variables, to capture any effects on the Treasury-Bund spread from quantitative easing programs. Historically, the UST-Bund spread has been driven mostly by the gap between Fed and ECB policy rates and, to a lesser extent, the relative state of unemployment. Inflation differentials have become less of a driver of the spread during the years since the 2008 financial crisis (Chart 8), although this is part of the broader issue of wage growth diverging from price inflation in the developed economies. The reaction function of the central banks, and of bond yields, is still rooted in the amount of perceived spare economic capacity – and future inflation potential – implied by unemployment rates. Looking ahead, if the Fed and ECB were both to deliver the full amount of easing over the next year discounted in the USD and EUR OIS curves, then the fair value of the spread would narrow to 208bps. The one-year-ahead forward rates for both the 10-year UST and German Bund imply a spread tightening to 229bps, which means that it would likely require the Fed delivering the full 92bps of easing discounted over the next twelve months – not our base case view – to make betting on additional UST-Bund spread tightening a profitable trade that would beat the forwards. So while the case for betting on additional UST-Bund spread narrowing is a poor one at current levels, the case for favoring Bunds over Treasuries on a currency-hedged basis in U.S. dollar terms is strong. Going long German government bonds vs U.S. Treasuries, while hedging the euro currency exposure into U.S. dollars, actually generates a pickup in yield, despite the fact that the entire German yield curve has negative yields out to 15-year maturities. Chart 9 shows the U.S.-German bond yield spreads for the 2-year, 5-year, 10-year and 30-year maturities. The solid line in all panels represents the yield spread in currency-unhedged terms, while the dotted line in all panels shows the spread after hedging the Bund yields into U.S. dollar equivalents (using 3-month currency forwards). Across all four maturities shown, the wide unhedged U.S.-German spreads turn into negative spreads after currency hedging. This is due to the considerably higher short-term interest rates in the U.S. that are gained when selling euros forward for dollars. Chart 8UST-Bund Spread Driven By Fed/ECB Gap Chart 9UST-Bund Spreads Look VERY Different After Hedging FX Risk Thus, going long German government bonds vs U.S. Treasuries, while hedging the euro currency exposure into U.S. dollars, actually generates a pickup in yield, despite the fact that the entire German yield curve has negative yields out to 15-year maturities. When looking at the relative performance of German bonds relative to not only U.S. Treasuries, but the overall Bloomberg Barclays Global Treasury index, Germany has basically matched the index over the past year in currency-hedged terms (Chart 10, middle panel). On an unhedged basis, the relative performance of German debt is obviously far more volatile given the swings in the euro. Yet even in unhedged terms, the relative performance of Germany versus the U.S. appears to be turning around, despite the recent additional narrowing of the UST-Bund spread (bottom panel). Chart 10Favor Bunds Over USTs In USD-Hedged Bond Portfolios Chart 11UST-Bund Spread Tightening Looks Stretched This highlights the risk of solely looking at the spread between yields denominated in different currencies. FX movements can dominate relative yield changes, as has been the case of late with the EUR/USD exchange rate rising off the 2019 lows on the back of falling UST yields. We continue to prefer viewing cross-country spread trades in currency-hedged terms when we make our recommendations. On that basis, we like hedged Bunds over U.S. Treasuries – especially with the current UST-Bund spread now discounting a lot of relatively bad news in the U.S. versus Europe (Chart 11). Bottom Line: The Fed is more likely to deliver less easing relative to market expectations than the ECB, leaving the UST-Bund spread susceptible to a rebound over the next 6-12 months. We continue to recommend overweighting German Bunds vs U.S. Treasuries in global currency-hedged bond portfolios, given the substantial yield pickup gained by hedging into U.S. dollars out of euros. Robert Robis, CFA, Chief Fixed Income Strategist rrobis@bcaresearch.com 1 The New York Fed’s r-star estimates can be found here: https://www.newyorkfed.org/research/policy/rstar Recommendations The GFIS Recommended Portfolio Vs. The Custom Benchmark Index Duration Regional Allocation Spread Product Tactical Trades Yields & Returns Global Bond Yields Historical Returns
Highlights Central banks globally have turned dovish, with the Fed virtually promising to cut rates in July. But this will be an “insurance” cut, like 1995 and 1998, not the beginning of a pre-recessionary easing cycle. The global expansion remains intact, with the fundamental drivers of U.S. consumption robust and China likely to ramp up its credit stimulus over the coming months. The Fed will cut once or twice, but not four times over the next 10 months as the futures markets imply. Underlying U.S. inflation – properly measured – is trending higher to above 2%. U.S. GDP growth this year will be around 2.5%. Inflation expectations will move higher as the crude oil price rises. Unemployment is at a 50-year low and the U.S. stock market at an historical peak. These factors suggest bond yields are more likely to rise than fall from current levels. The upside for U.S. equities is limited, but earnings growth should be better than the 3% the bottom-up consensus expects. The key for allocation will be when to shift in the second half into higher-beta China-related plays, such as Europe and Emerging Markets. For now, we remain overweight the lower-beta U.S. equity market, neutral on credit, and underweight government bonds. To hedge against the positive impact of China stimulus, we raise Australia to neutral, and re-emphasize our overweights on the Industrials and Energy sectors. Feature Overview Precautionary Dovishness – Or Looming Recession? Recommendations Central banks everywhere have taken a decidedly dovish turn in recent weeks. June’s FOMC statement confirmed that “uncertainties about the outlook have increased….[We] will act as appropriate to sustain the expansion,” hinting broadly at a rate cut in July. The Bank of Japan’s Kuroda said he would “take additional easing action without hesitation,” and hinted at a Modern Monetary Theory-style combination of fiscal and monetary policy. European Central Bank President Draghi mentioned the possibility of restarting asset purchases. There are two possible explanations. Either the global economy is heading into recession, and central banks are preparing for a full-blown easing cycle. Or these are “insurance” cuts aimed at prolonging the expansion, as happened in 1995 and 1998, or similar to when the Fed went on hold for 12 months in 2016 (Chart 1). Our view is that it is most likely the latter. The reason for this is that the main drivers of the global economy, U.S. consumption ($14 trillion) and the Chinese economy ($13 trillion) are likely to be strong over the next 12 months. U.S. wage growth continues to accelerate, consumer sentiment is close to a 50-year high, and the savings rate is elevated (Chart 2); as a result core U.S. retail sales have begun to pick up momentum in recent months (Chart 3). Unless something exogenous severely damages consumer optimism, it is hard to see how the U.S. can go into recession in the near future, considering that consumption is 70% of GDP. Moreover, despite weaknesses in the manufacturing sector – infected by the China-led slowdown in the rest of the world – U.S. service sector growth and the labor market remain solid. This resembles 1998 and 2016, but is different from the pre-recessionary environments of 2000 and 2007 (Chart 4). There is also no sign on the horizon of the two factors that have historically triggered recessions: a sharp rise in private-sector debt, or accelerating inflation (Chart 5). Chart 1Insurance Cuts, Or Full Easing Cycle? Chart 2Consumption Fundamentals Are Strong... Chart 3...Leading To Rebound In Retail Sales Chart 4Manufacturing Weak, But Services Holding Up Chart 5No Signs Of Usual Recession Triggers China’s efforts to reflate via credit creation have been somewhat half-hearted since the start of the year. Investment by state-owned companies has picked up, but the private sector has been spooked by the risk of a trade war and has slowed capex (Chart 6). China may have hesitated from full-blown stimulus because the authorities in April were confident of a successful outcome to trade talks with the U.S., and a bit concerned that the liquidity was going into speculation rather than the real economy. But we see little reason why they will not open the taps fully if growth remains sluggish and trade tensions heighten.1 Chinese credit creation clearly has a major impact on many components of global growth – in particular European exports, Emerging Markets earnings, and commodity prices – but the impact often takes 6-12 months to come through (Chart 7). A key question is when investors should position for this to happen. We think this decision is a little premature now, but will be a key call for the second half of the year. Chart 6China's Half-Hearted Reflation Chart 7China Credit Growth Affects The World Chart 8Fed Won't Cut As Much As Market Wants... The Fed has so clearly signaled rate cuts that we see it cutting by perhaps 50 basis points over the next few months (maybe all in one go in July if it wants to “shock and awe” the market). But the futures market is pricing in four 25 bps cuts by April next year. With GDP growth likely to be around 2.5% this year, unemployment at a 50-year low, trend inflation above 2%,2 and the stock market at an historical high, we find this improbable. Two cuts would be similar to what happened in 1995, 1998 and (to a degree) 2016 (Chart 8). In this environment, we think it likely that equities will outperform bonds over the next 12 months. When the Fed cuts by less than the market is expecting, long-term rates tend to rise (Chart 9). BCA’s U.S. bond strategists have shown that after mid-cycle rate cuts, yields typically rise: by 59 bps in 1995-6, 58 bps in 1998, and 19 bps in 2002.3 A combination of rising inflation, stronger growth ex-U.S., a less dovish Fed that the market expects, and a rising oil price (which will push up inflation expectations) makes it unlikely – absent an outright recession – that global risk-free yields will fall much below current levels. Moreover, June’s BOA Merrill Lynch survey cited long government bonds as the most crowded trade at the moment, and surveys of investor positioning suggest duration among active investors is as long as at any time since the Global Financial Crisis (Chart 10). Chart 9...So Bond Yields Are Likely To Rise Chart 10Investors Betting On Further Rate Decline The outlook for U.S. equities is not that exciting. Valuations are not cheap (with forward PE of 16.5x), but earnings should be revised up from the currently very cautious level: the bottom-up consensus forecasts S&P 500 EPS growth at only 3% in 2019 (and -3% YoY in Q2). We have sympathy for the view that there are three put options that will prop up stock prices in the event of external shocks: the Fed put, the Xi put, and the Trump put. Relating to the last of these, it is notable that President Trump tends to turn more aggressive in trade talks with China whenever the U.S. stock market is strong, but more conciliatory when it falls (Chart 11). For now, therefore, we remain overweight U.S. equities, as a lower beta way to play an environment that continues to be positive – but uncertain – for stocks. But we continue to watch for the timing to move into higher-beta China-related markets as the effects of China’s stimulus start to come through. Chart 11Trump Turns Softer When Market Falls Garry Evans Chief Global Asset Allocation Strategist garry@bcaresearch.com What Our Clients Are Asking Chart 12Temporary Forces Drove Inflation Downturn Why Is Inflation So Low? After reaching 2% in July 2018, U.S. core PCE currently stands at 1.6%, close to 18 month lows. This plunge in inflation, along with increased worries about the trade war and continued economic weakness, has led the market to believe that the Fed Funds Rate is currently above the neutral rate, and that several rate cuts are warranted in order to move policy away from restrictive territory. We believe that the recent bout of low inflation is temporary. The main contributor to the fall in core PCE has been financial services prices, which shaved off up to 40 basis points from core PCE (Chart 12, panel 1). However, assets under management are a big determinant of financial services prices, making this measure very sensitive to the stock market (panel 2). Therefore, we expect this component of core PCE to stabilize as equity prices continue to rise. The effect of higher equity prices, and the stabilization of other goods that were affected by the slowdown of global growth in late 2018 and early 2019, may already have started to push inflation higher. Month-on-month core PCE grew at an annualized rate of 3% in April, the highest pace since the end of 2017. Meanwhile, trimmed mean PCE, a measure that has historically been a more stable and reliable gauge of inflationary pressures, is at a near seven-year high (panel 3). The above implies that the market might be overestimating how much the Fed is going to ease. We believe that the Fed will likely cut once this year to soothe the pain caused by the trade war on financial markets. However, with unemployment at 50-year lows, and inflation set to rise again, the Fed is unlikely to deliver the 92 basis points of cuts currently priced by the OIS curve for the next 12 months. This implies that investors should continue to underweight bonds. Chart 13Turning On The Taps Will China Really Ramp Up Its Stimulus? The direction of markets over the next 12 months (a bottoming of euro area and Emerging Markets growth, commodity prices, the direction of the USD) are highly dependent on whether China further increases monetary stimulus in the event of a breakdown in trade negotiations with the U.S. But we hear much skepticism from clients: aren’t the Chinese authorities, rather, focused on reducing debt and clamping down on shadow banking? Aren’t they worried that liquidity will simply flow into speculation and have little impact on the real economy? Now the government has someone to blame for a slowdown (President Trump), won’t they use that as an excuse – and, to that end, are preparing the population for a period of pain by quoting as analogies the Long March in the 1930s and the Korea War (when China ground down U.S. willingness to prolong the conflict)? We think it unlikely that the Chinese government would be prepared to allow growth to slump. Every time in the past 10 years that growth has slowed (with, for example, the manufacturing PMI falling significantly below 50) they have always accelerated credit growth – on the basis of the worst-case scenario (Chart 13, panel 1). Why would they react differently this time, particularly since 2019 is a politically sensitive year, with the 70th anniversary of the founding of the People’s Republic in October and several other important anniversaries? Moreover, the government is slipping behind in its target to double per capita income in the 10 years to end-2020 (panel 2). GDP growth needs to be 6.5-7% over the next 18 months to achieve the target. The government’s biggest worry is employment, where prospects are slipping rapidly (panel 3). This also makes it difficult for the authorities to retaliate against U.S. companies that have large operations, such as Apple or General Motors, since such measures would hurt their Chinese employees. Besides a significant revaluation of the RMB (which we think likely), China has few cards to play in the event of a full-blown trade war other than fully turning on the liquidity tap again. Aren’t There Signs Of Bubbliness In Equity Markets? Clients have asked whether the current market environment has been showing any classic signs of euphoria. These usually appear with lots of initial public offerings (IPO), irrational M&A activity, and excess investor optimism. The IPO market has some similarities to the years leading up to the dot-com bubble, but it is important to look below the surface. The percentage of IPOs with negative earnings in 2018 was similar to the previous peak in 1999. However, the average first-day return of IPOs in 2019, while still above the historical average, has been much lower than that during the dot-com bubble period (Chart 14, panel 1). There is also a difference in the composition of firms going public. There are now many IPOs for biotech firms that have heavily invested in R&D, and so have relatively low sales currently but await a breakthrough in their products; by their nature, these are loss-making (panel 2). Cross-sector, unrelated M&A activity has also often been a sign of bubble peaks. It is a consequence of firms stretching to find inorganic growth late in the cycle. Such deals are characterized by high deal premiums, and are usually conducted through stock purchases rather than in cash. The current average deal premium is below its historical average (panel 3). Additionally, 2018 and 2019-to-date M&A deals conducted using cash represented 60% and 90% of the total respectively, compared to only 17% between 1996 and 2000. Investor sentiment is also moderately pessimistic despite the rally in the S&P 500 since the beginning of the year (panel 4). This caution suggests that investors are fearful of the risk of recession rather than overly positive about market prospects, despite the U.S. market being at an historical high. Given the above, we do not see any signals of the sort of euphoria and bubbliness that typically accompanies stock market tops. Will Japan Benefit From Chinese Reflation? Japan has been one of the worst-performing developed equity markets since March 2009, when global equities hit their post-crisis bottom in both USD (Chart 15) and local currency terms. Now with increasing market confidence in China’s reflationary policies, clients are asking if Japan is a good China play given its close ties with the Chinese economy. Our answer is No. Chart 16Downgrade Japan To Underweight It’s true that Japanese equities did respond to past Chinese reflationary efforts, but the outperformances were muted and short-lived (Chart 16, panel 1). Even though Japanese exports to China will benefit from Chinese reflationary policy (panel 5), MSCI Japan index earnings growth does not have strong correlation with Japanese exports to China, as shown in panel 4. This is not surprising given that exports to China account for only about 3% of nominal GDP in Japan (compared to almost 6% for Australia, for example). The MSCI Japan index is dominated by Industrials (21%) and Consumer Discretionary (18%). Financials, Info Tech, Communication Services and Healthcare each accounts for about 8-10%. Other than the Communication Services sector, all other major sectors in Japan have underperformed their global peers since the Global Financial Crisis (panels 2 and 3). The key culprit for such poor performance is Japan’s structural deflationary environment. Wage growth has been poor despite a tight labor market. This October’s consumption tax increase will put further downward pressure on domestic consumers. There is no sign of the two factors that have historically triggered recessions: a sharp rise in private-sector debt, or accelerating inflation. As such, we are downgrading Japan to a slight underweight in order to close our underweight in Australia (see page 16). This also aligns our recommendation with the output from our DM Country Allocation Quant Model, which has structurally underweighted Japan since its inception in January 2016. Global Economy Chart 17Is Consumption Enough To Prop Up U.S. Growth? Overview: The tight monetary policy of last year (with the Fed raising rates and China slowing credit growth) has caused a slowdown in the global manufacturing sector, which is now threatening to damage worldwide consumption and the relatively closed U.S. economy too. The key to a rebound will be whether China ramps up the monetary stimulus it began in January but which has so far been rather half-hearted. Meanwhile, central banks everywhere are moving to cut rates as an “insurance” against further slowdown. U.S.: Growth data has been mixed in recent months. The manufacturing sector has been affected by the slowdown in EM and Europe, with the manufacturing ISM falling to 52.1 in May and threatening to dip below 50 (Chart 17, panel 2). However, consumption remains resilient, with no signs of stress in the labor market, average hourly earnings growing at 3.1% year-on-year, and consumer confidence at a high level. As a result, retail sales surprised to the upside in May, growing 3.2% YoY. The trade war may be having some negative impact on business sentiment, however, with capex intentions and durable goods orders weakening in recent months. Euro Area: Current conditions in manufacturing continue to look dire. The manufacturing PMI is below 50 and continues to decline (Chart 18, panel 1). In export-focused markets like Germany, the situation looks even worse: Germany’s manufacturing PMI is at 45.4, and expectations as measured by the ZEW survey have deteriorated again recently. Solid wage growth and some positive fiscal thrust (in Italy, France, and even Germany) have kept consumption stable, but the recent tick-up in German unemployment raises the question of how sustainable this is. Recovery will be dependent on Chinese stimulus triggering a rebound in global trade. Chart 18Few Signs Of Recovery In Global Ex-U.S. Growth Japan: The slowdown in China continues to depress industrial production and leading indicators (panel 2). But maybe the first “green shoots” are appearing thanks to China’s stimulus: in April, manufacturing orders rose by 16.3% month-on-month, compared to -11.4% in March. Nonetheless, consumption looks vulnerable, with wage growth negative YoY each month so far this year, and the consumption tax rise in October likely to hit consumption further. The Bank of Japan’s six-year campaign of maximum monetary easing is having little effect, with core core inflation stuck at 0.5% YoY, despite a small pickup in recent months – no doubt because the easy monetary policy has been offset by a steady tightening of fiscal policy. Emerging Markets: China’s growth has slipped since the pickup in February and March caused by a sharp increase in credit creation. Seemingly, the authorities became more confident about a trade agreement with the U.S., and worried about how much of the extra credit was going into speculation, rather than the real economy. The manufacturing PMI, having jumped to almost 51 in March, has slipped back to 50.2. A breakdown of trade talks would undoubtedly force the government to inject more liquidity. Elsewhere in EM, growth has generally been weak, because of the softness in Chinese demand. In Q1, GDP growth was -3.2% QoQ annualized in South Africa, -1.7% in Korea, and -0.8% in both Brazil and Mexico. Only less China-sensitive markets such as Russia (3.3%) and India (6.5%) held up. Interest rates: U.S. inflation has softened on the surface, with the core PCE measure slipping to 1.6% in April. However, some of the softness was driven by transitory factors, notably the decline in financial advisor fees (which tend to move in line with the stock market) which deducted 0.5 points from core PCE inflation. A less volatile measure, the trimmed mean PCE deflator, however, continues to trend up and is above the Fed’s 2% target. Partly because of the weaker historical inflation data, inflation expectations have also fallen (panel 4). As a result, central banks everywhere have become more dovish, with the Australian and New Zealand reserve banks cutting rates and the Fed and ECB raising the possibility they may ease too. The consequence has been a big fall in 10-year government bonds yields: in the U.S. to only 2% from 3.1% as recently as last September. Global Equities Chart 19Worrisome Earnings Prospects Remain Cautiously Optimistic, Adding Another China Hedge: Global equities managed to eke out a small gain of 3.3% in Q2 despite a sharp loss of 5.9% in May. Within equities, our defensive country allocation worked well as DM equities outperformed EM by 2.9% in Q2. Our cyclical tilt in global sector positioning, however, did not pan out, largely due to the 2% underperformance in global Energy as the oil price dropped by 2% in Q2. Going forward, BCA’s House View remains that global economic growth will pick up sometime in the second half thanks to accommodative monetary policies globally and the increasing likelihood of a large stimulus from China to counter the negative effect from trade tensions. This implies that equities are likely to rally again after a period of congestion within a trading range, supporting a cautiously optimistic portfolio allocation for the next 9-12 months. The “optimistic” side of our allocation is reflected in two aspects: 1) overweight equities vs. bonds at the asset class level; and 2) overweight cyclicals vs. defensives at the global sector level. However, corporate profit margins are rolling over and earnings growth revisions have been negative (Chart 19). Therefore, the “cautious” side of our allocation remains a defensive country allocation, reflected by overweighting DM vs. EM. Our macro view hinges largely on what happens to China. There is an increasing likelihood that China may be on a reflationary path to stimulate economic growth. We upgraded global Industrials in March to hedge against China’s re-acceleration. Now we upgrade Australia to neutral from a long-term underweight, by downgrading Japan to a slight underweight from neutral, because Australia will benefit more from China’s reflationary policies (see next page). Chart 20Australian Equities: Close The Underweight Upgrade Australian Equities To Neutral The relative performance of MSCI Australian equities to global equities has been closely correlated with the CRB metal price most of the time. Since the end of 2015, however, the CRB metals index has increased by more than 40%, yet Australian equities did not outperform (Chart 20, panel 1). Why? The MSCI Australian index is concentrated in Financials (mostly banks) and Materials (mostly mining), as shown in panel 2. Aussie Materials have outperformed their global peers, but the banks have not (panel 3). The banks are a major source of financing for the mining companies (hence the positive correlation with metal prices). They are also the source of financing for the Aussie housing markets, which have weighed down on the banks’ performance over the past few years due to concerns about stretched valuations. We have been structurally underweight Australian equities because of our unfavorable view on industrial commodities, and also our concerns on the Australian housing market and the problems of the banks. This has served us well, as Australian equities have done poorly relative to the global aggregate since late 2012. Now interest rates in Australia have come down significantly. Lower mortgage rates should help stabilize house prices, which suffered in Q1 their worst year-on-year decline, 7.7%, in over three decades. Australian equity earnings growth is still slowing relative to the global earnings, but the speed of slowing down has decreased significantly. With 6% of GDP coming from exports to China, Aussie profit growth should benefit from reflationary policies from China (panel 4). Relative valuation, however, is not cheap (panel 5). All considered, we are closing our underweight in Australian equities as another hedge against a Chinese-led re-acceleration in economic growth. This is financed by downgrading Japan to a slight underweight (for more on Japan, see What Our Clients Are Asking, on page 11). Government Bonds Chart 21Limited Downside In Yields Maintain Slight Underweight On Duration: After the Fed signaled at its June meeting that rates cuts were likely on the way, the U.S. 10-year Treasury yield dropped to 1.97% overnight on June 20, the lowest since November 2016. Overall, the 10-year yield dropped by 40 bps in Q2 to end the quarter at 2%. BCA’s Fed Monitor is now indicating that easier monetary policy is required. But that is already more than discounted in the 92 bps of rate cuts over the next 12 months priced in at the front end of the yield curve, and by the current low level of Treasury yields. (Chart 21). We see the likelihood of one or two “insurance” cuts by the Fed, but the current environment (with a record-high stock market, tight corporate spreads, 50-year low unemployment rate, and 2019 GDP on track to reach 2.5%) is not compatible with a full-out cutting campaign. In addition, the latest Merrill Lynch survey indicated that long duration is the most crowded global trade. Given BCA’s House View that the U.S. economy is not heading into a recession but rather experiencing a manufacturing slowdown mainly due to external shocks, the path of least resistance for Treasury yields is higher rather than lower. Investors should maintain a slight underweight on duration over the next 9-12 months. Chart 22Favor Linkers Over Nominal Bonds Favor Linkers Vs. Nominal Bonds: Global inflation expectations have dropped anew in the second quarter, with the 10-year CPI swap rate now sitting at 1.55%, 41 bps lower than its 2018 high of 1.96%. However, historically, the change in the crude oil price tends to have a good correlation with inflation expectations. BCA’s Commodity & Energy Strategy service revised down its 2019 Brent crude forecast to an average of US$73 per barrel from US$75, but this implies an average of US$79 in H2. (Chart 22). This would cause a significant rise in inflation expectations in the second half, supporting our preference for inflation-linked over nominal bonds. We also favor linkers in Japan and Australia over their respective nominal bonds. Corporate Bonds Chart 23Profit Growth Should Still Outpace Debt Growth We turned cyclically overweight on credit within a fixed-income portfolio in February. Since then, corporate bonds have produced 120 basis points of excess return over duration-matched Treasuries. We believe this bullish stance on credit will continue to pay dividends. The global leading economic indicators have started to stabilize while multiple credit impulses have started to perk up all over the world. Historically, improving global growth has been positive for corporate bonds (Chart 23, panel 1). A valid concern is the deceleration in profit growth in the U.S., as the yearly growth of pre-tax profits has fallen from 15% in 2018 Q4 to 7% in the first quarter of this year. In general, corporate bonds suffer when profit growth lags debt growth, as defaults tends to rise in this environment. Is this scenario likely over the coming year? We do not believe so. While weak global growth at the end of 2018 and beginning of 2019 is likely to weigh on revenues, the current contraction in unit labor costs should bolster profit margins and keep profit growth robust (panel 2). Additionally, the Fed’s Senior Loan Officer Survey shows that C&I loan demand has decreased significantly this year, suggesting that the pace of U.S. corporate debt growth is set to slow (panel 3). How long will we remain overweight? We expect that the Federal Reserve will do little to no tightening over the next 12 months. This will open a window for credit to outperform Treasuries in a fixed-income portfolio. We have also reduced our double underweight in EM debt, since an acceleration of Chinese monetary stimulus would be positive for this asset class. Commodities Chart 24Watch Oil And Be Wary Of Gold Energy (Overweight): Supply/demand fundamentals continue to be the main driver of crude oil prices. However, it seems as though the market is discounting something else. President Trump’s tweets, OPEC+ coalition statements, and concerns about future demand growth are contributing to price swings (Chart 24, panel 1). According to the Oxford Institute for Energy Studies, weak demand has reduced oil prices by $2/barrel this year. That should be offset, however, by a much larger contribution from supply cuts, speculative demand, and a deteriorating geopolitical environment. We see crude prices tilted to the upside, as OPEC’s ability to offset any supply disruptions (besides Iran and Venezuela) is limited (panel 2). We expect Brent to average $73 in 2019 and $75 in 2020. Industrial Metals (Neutral): A stronger USD accompanied by weakening global growth since 2018 has put downward pressure on industrial metal prices, which are down about 20% since January 2018. However, we now have renewed belief that the Chinese authorities will counter with a reflationary response though credit and fiscal stimulus. That should push industrial metal prices higher over the coming 12 months (panel 3). Precious Metals (Neutral): Allocators to gold are benefiting from the current environment of rising geopolitical risk, dovish central banks, a weaker USD, and the market’s flight to safety. Escalated trade tensions, falling global yields, and lower growth prospects are some of the factors that have supported the bullion’s 18% return since its September 2018 low. Until evidence of a bottom in global growth emerges, we expect the copper-to-gold ratio – another barometer for global growth – to continue falling (panel 4). The months ahead could see a correction, as investors take profits with gold in overbought territory. Nevertheless, we continue to recommend gold as both an inflation hedge as well as against any uncertain escalated political tensions. Currencies Chart 25Stronger Global Growth Will Weigh On The Dollar U.S. dollar: The trade-weighted dollar has been flat since we lowered our recommendation from positive to neutral in April. We expect that the Fed will cut rates at least once this year, easing financial conditions, and boosting economic activity. This will eventually prove negative for the dollar. However as long as the global economy is weak the greenback should hold up. Stay neutral for now. Euro: Since we turned bullish on the euro in April, EUR/USD has appreciated by 1.5%. Overall, we continue to be bullish on EUR/USD on a cyclical timeframe. Forward rate expectations continue to be near 2014 lows, suggesting that there is little room for U.S. monetary policy to tighten further vis-à-vis euro area monetary policy, creating a floor under the euro (Chart 25, panel 1). EM Currencies: We continue to be negative on emerging market currencies. However, some indicators suggest that Chinese weakness, the main engine behind the EM currency bear market might be reaching its end. Chinese marginal propensity to spend (proxied by M1 growth relative to M2 growth), has bottomed and seems to have stabilized (panel 2). The bond market has taken note of this development, as Chinese yields are now rising relative to U.S. ones (panel 3). Historically, both of these developments have resulted in a rally for emerging market currencies. Thus, while we expect the bear market to continue for the time being, the pace of decline is likely to ease, making EM currencies an attractive buy by the end of the year. Accordingly, we are reducing our underweight in EM currencies from double underweight to a smaller underweight position. Alternatives Return Enhancers: Hedge funds historically display a negative correlation with global growth momentum. Despite growth slowing over the past year, hedge funds underperformed the overall GAA Alternatives Index as well as private equity. Hedge funds usually outperform other risky alternatives during recessions or periods of high credit market stress. Credit spreads have been slow to rise in response to the slowing economy and worsening political environment. A pickup in spreads should support hedge fund outperformance (Chart 26, panel 2). Inflation Hedges: As we approach the end of the cycle, we continue to recommend investors reduce their real estate exposure and increase allocations towards commodity futures. Our May 2019 Special Report4 analyzed how different asset classes perform in periods of rising inflation. Our expectation is that inflation will pick up by the end of the year. An allocation to commodity futures, particularly energy, historically achieved excess returns of nearly 40% during periods of mild inflation (panel 3). Volatility Dampeners: Realized volatility in the catastrophe bond market is generally low. In fact, absent any catastrophe losses, catastrophe bonds provide stable returns, with volatility that is comparable to global bonds (panel 4). In a December 2017 Special Report,5 we tested for how the inclusion of catastrophe bonds in a traditional 60/40 equity-bond portfolio would have impacted portfolio risk-return characteristics. Replacing global equities with catastrophe bonds reduced annualized volatility by more than 1.5%. Risks To Our View Chart 27What Risk Of Recession? Our main scenario is sanguine on global growth, which means we argue that bond yields will not fall much below current levels. The risks to this view are mostly to the downside. There could be a full-blown recession. Most likely this would be caused either by China failing to do stimulus, or by U.S. rates being more restrictive than the Fed believes. Both of these explanations seem implausible. As we argue elsewhere, we think it unlikely that China would simply allow growth to slow without reacting with monetary and fiscal stimulus. If current Fed policy is too tight for the economy to withstand, it would imply that the neutral rate of interest is zero or below, something that seems improbable given how strong U.S. growth has been despite rising rates. Formal models of recession do not indicate an elevated risk currently (Chart 27). We continue to watch for the timing to move into higher-beta China-related markets as the effects of China’s stimulus start to come through. Even if growth is as strong as we forecast, is there a possibility that bond yields fall further. This could come about – for a while, at least – if the Fed is aggressively dovish, oil prices fall (perhaps because of a positive supply shock), inflation softens further, and global growth remains sluggish. Absent a recession, we find those outcomes unlikely. The copper-to-gold ratio has been a good indicator of U.S. bond yields (Chart 28). It suggests that, at 2%, the 10-year Treasury yield has slightly overshot. In fact, in June copper prices started to rebound, as the market began to price in growing Chinese demand. Chart 28Can Bond Yields Fall Any Further? Chart 29Are Analysts Right To Be So Gloomy? For U.S. equities to rise much further, multiple expansion will not be enough; the earnings outlook needs to improve. Analysts are still cautious with their bottom-up forecasts, expecting only 3% EPS growth for the S&P500 this year (Chart 29). This seems easy to beat. But a combination of further dollar strength, worsening trade war, further slowdown in Europe and Emerging Markets, and higher U.S. wages would put it at risk. Footnotes 1 Please see What Our Clients Are Asking on page 9 of this Quarterly for further discussion on why we are confident China will ramp up stimulus if necessary. 2 Trimmed Mean PCE inflation, a better indicator of underlying inflation than the Core PCE deflator, is above 2%. Please see What Our Clients Are Asking on page 8 of this Quarterly for details. 3 Please see U.S. Bond Strategy Weekly Report, “Track Records,” dated June 18, available at usb.bcaresearch.com. 4 Please see Global Asset Allocation Special Report “Investors’ Guide To Inflation Hedging: How To Invest When Inflation Rises,” dated May 22, 2019 available at gaa.bcaresearch.com 5 Please see Global Asset Allocation Special Report “A Primer On Catastrophe Bonds,” dated December 12, 2017 available at gaa.bcaresearch.com GAA Asset Allocation
Highlights So What? Economic stimulus will encourage key nations to pursue their self-interest – keeping geopolitical risk high. Why? The U.S. is still experiencing extraordinary strategic tensions with China and Iran … simultaneously. The Trump-Xi summit at the G20 is unlikely to change the fact that the United States is threatening China with total tariffs and a technology embargo. The U.S. conflict with Iran will be hard to keep under wraps. Expect more fireworks and oil volatility, with a large risk of hostilities as long as the U.S. maintains stringent oil sanctions. All of our GeoRisk indicators are falling except for those of Germany, Turkey and Brazil. This suggests the market is too complacent. Maintain tactical safe-haven positioning. Feature “That’s some catch, that Catch-22,” he observed. “It’s the best there is,” Doc Daneeka agreed. -Joseph Heller, Catch-22 (1961) One would have to be crazy to go to war. Yet a nation has no interest in filling its military’s ranks with lunatics. This is the original “Catch-22,” a conundrum in which the only way to do what is individually rational (avoid war) is to insist on what is collectively irrational (abandon your country). Or the only way to defend your country is to sacrifice yourself. This is the paradox that U.S. President Donald Trump faces having doubled down on his aggressive foreign policy this year: if he backs away from trade war to remove an economic headwind that could hurt his reelection chances, he sacrifices the immense leverage he has built up on behalf of the United States in its strategic rivalry with China. “Surrender” would be a cogent criticism of him on the campaign trail: a weak deal will cast him as a pluto-populist, rather than a real populist – one who pandered to China to give a sop to Wall Street and the farm lobby just like previous presidents, yet left America vulnerable for the long run. Similarly, if President Trump stops enforcing sanctions against Iranian oil exports to reduce the threat of a conflict-induced oil price shock that disrupts his economy, then he reduces the United States’s ability to contain Iran’s nuclear and strategic advances in the wake of the 2015 nuclear deal that he canceled. The low appetite for American involvement in the region will be on full display for the world to see. Iran will have stared down the Great Satan – and won. In both cases, Trump can back down. Or he can try to change the subject. But with weak polling and yet a strong economy, the point is to direct voters’ attention to foreign policy. He could lose touch with his political base at the very moment that the Democrats reconnect with their own. This is not a good recipe for reelection. More important – for investors – why would he admit defeat just as the Federal Reserve is shifting to countenance the interest rate cuts that he insists are necessary to increase his economic ability to drive a hard bargain with China? Why would he throw in the towel as the stock market soars? And if Trump concludes a China deal, and the market rises higher, will he not be emboldened to put more economic pressure on Mexico over border security … or even on Europe over trade? The paradox facing investors is that the shift toward more accommodative monetary policy (and in some cases fiscal policy) extends the business cycle and encourages political leaders to pursue their interests more intently. China is less likely to cave to Trump’s demands as it stimulates. The EU does not need to fear a U.K. crash Brexit if its economy rebounds. This increases rather than decreases the odds of geopolitical risks materializing as negative catalysts for the market. Similarly, if geopolitical risk falls then the need for stimulus falls and the market will be disappointed. The result is still more volatility – at least in the near term. The G20 And 2020 As we go to press the Democratic Party’s primary election debates are underway. The progressive wave on display highlights the overarching takeaway of the debates: the U.S. election is now an active political (and geopolitical) risk to the equity market. A truly positive surprise at the G20 would be a joint statement by Trump and Xi plus some tariff rollback. Whenever Trump’s odds of losing rise, the U.S. domestic economy faces higher odds of extreme policy discontinuity and uncertainty come 2021, with the potential for a populist-progressive agenda – a negative for financials, energy, and probably health care and tech. Yet whenever Trump’s odds of winning rise, the world faces higher odds of an unconstrained Trump second term focusing on foreign and trade policy – a potentially extreme increase in global policy uncertainty – without the fiscal and deregulatory positives of his first term. We still view Trump as the favored candidate in this race (at 55% chance of reelection), given that U.S. underlying domestic demand is holding up and the labor market has not been confirmed to be crumbling beneath the consumer’s feet. Still Chart 1 highlights that Trump’s shift to more aggressive foreign and trade policy this spring has not won him any additional support – his approval rating has been flat since then. And his polling is weak enough in general that we do not assign him as high of odds of reelection as would normally be afforded to a sitting president on the back of a resilient economy. This raises the question of whether the G20 will mark a turning point. Will Trump attempt to deescalate his foreign conflicts? Yes, and this is a tactical opportunity. But we see no final resolution at hand. With China, Trump’s only reason to sign a weak deal would be to stem a stock market collapse. With Iran, Trump is no longer in the driver’s seat but could be forced to react to Iranian provocations. Bottom Line: Trump’s polling has not improved – highlighting the election risk – but weak polling amid a growing economy and monetary easing is not a recipe for capitulating to foreign powers. The Trump-Xi Summit On China the consensus on the G20 has shifted toward expecting an extension of talks and another temporary tariff truce. If a new timetable is agreed, it may be a short-term boon for equities. But we will view it as unconvincing unless it is accompanied with a substantial softening on Huawei or a Trump-Xi joint statement outlining an agreement in principle along with some commitment of U.S. tariff rollback. Otherwise the structural dynamic is the same: Trump is coercing China with economic warfare amid a secular increase in U.S.-China animosity that is a headwind for trade and investment. Table 1 shows that throughout the modern history of U.S.-China presidential-level summits, the Great Recession marked a turning point: since then, bilateral relations have almost always deteriorated in the months after a summit, even if the optics around the summit were positive. Table 1U.S.-China Leaders Summits: A Chronology The last summit in Buenos Aires was no exception, given that the positive aura was ultimately followed by a tariff hike and technology-company blacklistings. Of course, the market rallied for five months in between. Why should this time be the same? First, the structural factors undermining Sino-American trust are worse, not better, with Trump’s latest threats to tech companies. Second, Trump will ultimately resent any decision to extend the negotiations. China’s economy is rebounding, which in the coming months will deprive Trump of much of the leverage he had in H2 2018 and H1 2019. He will be in a weaker position if they convene in three months to try to finalize a deal. Tariff rollback will be more difficult in that context given that China will be in better shape and that tariffs serve as the guarantee that any structural concessions will be implemented. Bottom Line: Our broader view regarding the “end game” of the talks – on the 2020 election horizon – remains that China has no reason to implement structural changes speedily for the United States until Trump can prove his resilience through reelection. Yet President Trump will suffer on the campaign trail if he accepts a deal that lacks structural concessions. Hence we expect further escalation from where we are today, knowing full well that the G20 could produce a temporary period of improvement just as occurred on December 1, 2018. The Iran Showdown Is Far From Over Disapproval of Trump’s handling of China and Iran is lower than his disapproval rating on trade policy and foreign policy overall, suggesting that despite the lack of a benefit to his polling, he does still have leeway to pursue his aggressive policies to a point. A breakdown of these opinions according to key voting blocs – a proxy for Trump’s ability to generate support in Midwestern swing states – illustrates that his political base is approving on the whole (Chart 2). Yet the conflict with Iran threatens Trump with a hard constraint – an oil price shock – that is fundamentally a threat to his reelection. Hence his decision, as we expected, to back away from the brink of war last week (he supposedly canceled air strikes on radar and missile installations at the last minute on June 21). He appears to be trying to control the damage that his policy has already done to the 2015 U.S.-Iran equilibrium. Trump has insisted he does not want war, has ruled out large deployments of boots on the ground, and has suggested twice this week that his only focus in trying to get Iran back into negotiations is nuclear weapons. This implies a watering down of negotiation demands to downplay Iran’s militant proxies in the region – it is a retreat from Secretary of State Mike Pompeo’s more sweeping 12 demands on Iran and a sign of Trump’s unwillingness to get embroiled in a regional conflict with a highly likely adverse economic blowback. The Iran confrontation is not over yet – policy-induced oil price volatility will continue. This retreat lacks substance if Trump does not at least secretly relax enforcement of the oil sanctions. Trump’s latest sanctions and reported cyberattacks are a sideshow in the context of an attempted oil embargo that could destabilize Iran’s entire economy (Charts 3 and 4). Similarly, Iran’s downing of a U.S. drone pales in comparison to the tanker attacks in Hormuz that threatened global oil shipments. What matters to investors is the oil: whether Iran is given breathing space or whether it is forced to escalate the conflict to try to win that breathing space. Chart 4Iran’s Rial Depreciated Sharply The latest data suggest that Iran’s exports have fallen to 300,000 barrels per day, a roughly 90% drop from 2018, when Trump walked away from the Iran deal. If this remains the case in the wake of the brinkmanship last week then it is clear that Iran is backed into a corner and could continue to snarl and snap at the U.S. and its regional allies, though it may pause after the tanker attacks. Chart 5More Oil Volatility To Come Tehran also has an incentive to dial up its nuclear program and activate its regional militant proxies in order to build up leverage for any future negotiation. It can continue to refuse entering into negotiations with Trump in order to embarrass him – and it can wait until Trump’s approach is validated by reelection before changing this stance. After all, judging by the first Democratic primary debate, biding time is the best strategy – the Democratic candidates want to restore the 2015 deal and a new Democratic administration would have to plead with Iran, even to get terms less demanding than those in 2015. Other players can also trigger an escalation even if Presidents Trump and Rouhani decide to take a breather in their conflict (which they have not clearly decided to do). The Houthi rebels based in Yemen have launched another missile at Abha airport in Saudi Arabia since Trump’s near-attack on Iran, an action that is provocative, easily replicable, and not necessarily directly under Tehran’s control. Meanwhile OPEC is still dragging its feet on oil production to compensate for the Iranian losses, implying that the cartel will react to price rises rather than preempt them. The Saudis could use production or other means to stoke conflict. Bottom Line: Given our view on the trade war, which dampens global oil demand, we expect still more policy-induced volatility (Chart 5). We do not see oil as a one-way bet … at least not until China’s shift to greater stimulus becomes unmistakable. North Korea: The Hiccup Is Over Chart 6China Ostensibly Enforces North Korean Sanctions The single clearest reason to expect progress between the U.S. and China at the G20 is the fact that North Korea is getting back onto the diplomatic track. North Korea has consistently been shown to be part of the Trump-Xi negotiations, unlike Taiwan, the South China Sea, Xinjiang, and other points of disagreement. General Secretary Xi Jinping took his first trip to the North on June 20 – the first for a Chinese leader since 2005 – and emphasized the need for historic change, denuclearization, and economic development. Xi is pushing Kim to open up and reform the economy in exchange for a lasting peace process – an approach that is consistent with China’s past policy but also potentially complementary with Trump’s offer of industrialization in exchange for denuclearization. President Trump and Kim Jong Un have exchanged “beautiful” letters this month and re-entered into backchannel discussions. Trump’s visit to South Korea after the G20 will enable him and President Moon Jae-In to coordinate for a possible third summit between Trump and Kim. Progress on North Korea fits our view that the failed summit in Hanoi was merely a setback and that the diplomatic track is robust. Trump’s display of a credible military threat along with Chinese sanctions enforcement (Chart 6) has set in motion a significant process on the peninsula that we largely expect to succeed and go farther than the consensus expects. It is a long-term positive for the Korean peninsula’s economy. It is also a positive factor in the U.S.-China engagement based on China’s interest in ultimately avoiding war and removing U.S. troops from the peninsula. From an investment point of view, an end to a brief hiatus in U.S.-North Korean diplomacy is a very poor substitute for concrete signs of U.S.-China progress on the tech front or opening market access. There has been nothing substantial on these key issues since Trump hiked the tariff rate in May. As a result, it is perfectly possible for the G20 to be a “success” on North Korea but, like the Buenos Aires summit on December 1, for markets to sell the news (Chart 7). Chart 7The Last Trade Truce Didn't Stop The Selloff Chart 8China Needs A Final Deal To Solve This Problem Bottom Line: North Korea is not a basis in itself for tariff rollback, but only as part of a much more extensive U.S.-China agreement. And a final agreement is needed to improve China’s key trade indicators on a lasting basis, such as new export orders and manufacturing employment, which are suffering amid the trade war. We expect economic policy uncertainty to remain elevated given our pessimistic view of U.S.-China trade relations (Chart 8). What About Japan, The G20 Host? Japan faces underrated domestic political risk as Prime Minister Abe Shinzo approaches a critical period in his long premiership, after which he will almost certainly be rendered a “lame duck,” likely by the time of the 2020 Tokyo Olympics. The question is when will this process begin and what will the market impact be? If Abe loses his supermajority in the July House of Councillors election, then it could begin as early as next month. This is a real risk – because a two-thirds majority is always a tall order – but it is not extreme. Abe’s polling is historically remarkable (Chart 9). The Liberal Democratic Party and its coalition partner Komeito are also holding strong and remain miles away from competing parties (Chart 10). The economy is also holding up relatively well – real wages and incomes have improved under Abe’s watch (Chart 11). However, the recent global manufacturing slowdown and this year’s impending hike to the consumption tax in October from 8% to 10% are killing consumer confidence. Chart 10Japan's Ruling Coalition Is Strong The collapse in consumer confidence is a contrary indicator to the political opinion polling. The mixed picture suggests that after the election Abe could still backtrack on the tax hike, although it would require driving through surprise legislation. He can pull this off in light of global trade tensions and his main objective of passing a popular referendum to revise the constitution and remilitarize the country. Chart 11Japanese Wages Up, But Consumer Confidence Diving We would not be surprised if Japan secured a trade deal with the U.S. prior to China. Because Abe and the United States need to enhance their alliance, we continue to downplay the risk of a U.S.-Japan trade war. Bloomberg recently reported that President Trump was threatening to downgrade the U.S.-Japan alliance, with a particular grievance over the ever-controversial issue of the relocation of troops on Okinawa. We view this as a transparent Trumpian negotiating tactic that has no applicability – indeed, American military and diplomatic officials quickly rejected the report. We do see a non-trivial risk that Trump’s rhetoric or actions will hurt Japanese equities at some point this year, either as Trump approaches his desired August deadline for a Japan trade deal or if negotiations drag on until closer to his decision about Section 232 tariffs on auto imports on November 14. But our base case is that there will be either no punitive measures or only a short time span before Abe succeeds in negotiating them away. We would not be surprised if the Japanese secured a deal prior to any China deal as a way for the Trump administration to try to pressure China and prove that it can get deals done. This can be done because it could be a thinly modified bilateral renegotiation of the Trans-Pacific Partnership, which had the U.S. and Japan at its center. Bottom Line: Given the combination of the upper house election, the tax hike and its possible consequences, a looming constitutional referendum which poses risks to Abe, and the ongoing external threat of trade war and China tensions, we continue to see risk-off sentiment driving Japanese and global investors to hold then yen. We maintain our long JPY/USD recommendation. The risk to this view is that Bank of Japan chief Haruhiko Kuroda follows other central banks and makes a surprisingly dovish move, but this is not warranted at the moment and is not the base case of our Foreign Exchange Strategy. GeoRisk Indicators Update: June 28, 2019 Our GeoRisk indicators are sending a highly complacent message given the above views on China and Iran. All of our risk measures, other than our German, Turkish, and Brazilian indicators, are signaling a decrease geopolitical tensions. Investors should nonetheless remain cautious: Our German indicator, which has proven to be a good measure of U.S.-EU trade tensions, has increased over the first half of June (Chart 12). We expect Germany to continue to be subject to risk because of Trump’s desire to pivot to European trade negotiations in the wake of any China deal. The auto tariff decision was pushed off until November. We assign a 45% subjective probability to auto tariffs on the EU if Trump seals a final China deal. The reason it is not our base case is because of a lack of congressional, corporate, or public support for a trade war with Europe as opposed to China or Mexico, which touch on larger issues of national interest (security, immigration). There is perhaps a 10% probability that Trump could impose car tariffs prior to securing a China deal. Chart 12U.S.-EU Trade Tensions Hit Germany Chart 13German Greens Overtaking Christian Democrats! Germany is also an outlier because it is experiencing an increase in domestic political uncertainty. Social Democrat leader Andrea Nahles’ resignation on June 2 opened the door to a leadership contest among the SPD’s membership. This will begin next week and conclude on October 26, or possibly in December. The result will have consequences for the survivability of Merkel’s Grand Coalition – in case the SPD drops out of it entirely. Both Merkel and her party have been losing support in recent months – for the first time in history the Greens have gained the leading position in the polls (Chart 13). If the coalition falls apart and Merkel cannot put another one together with the Greens and Free Democrats, she may be forced to resign ahead of her scheduled 2021 exit date. The implication of the events with Trump and Merkel is that Germany faces higher political risk this year, particularly in Q4 if tariff threats and coalition strains coincide. Meanwhile, Brazilian pension reform has been delayed due to an inevitable breakdown in the ability to pass major legislation without providing adequate pork barrel spending. As for the rest of Europe, since European Central Bank President Mario Draghi’s dovish signal on June 18, all of our European risk indicators have dropped off. Markets rallied on the news of the ECB’s preparedness to launch another round of bond-buying monetary stimulus if needed, easing tensions in the region. Italian bond spreads plummeted, for instance. The Korean and Taiwanese GeoRisk indicators, our proxies for the U.S.-China trade war, are indicating a decrease in risk as the two sides moved to contain the spike in tensions in May. While Treasury Secretary Steve Mnuchin notes that the deal was 90% complete in May before the breakdown, there is little evidence yet that any of the sticking points have been removed over the past two weeks. These indicators can continue to improve on the back of any short-term trade truce at the G20. The Russian risk indicator has been hovering in the same range for the past two months. We expect this to break out on the back of increasing mutual threats between the U.S. and Russia. The U.S. has recently agreed to send an additional 1000 rotating troops to Poland, a move that Russia obviously deems aggressive. The Russian upper chamber has also unanimously supported President Putin’s decree to suspend the Intermediate Nuclear Forces treaty, in the wake of the U.S. decision to do so. This would open the door to developing and deploying 500-5500 km range land-based and ballistic missiles. According to the deputy foreign minister, any U.S. missile deployment in Europe will lead to a crisis on the level of the Cuban Missile Crisis. Russia has also sided with Iran in the latest U.S.-Iran tension escalation, denouncing U.S. plans to send an additional 1000 troops to the Middle East and claiming that the shot-down U.S. drone was indeed in Iranian airspace. We anticipate the Russian risk indicator to go up as we expect Russia to retaliate in some way to Poland and to take actions to encourage the U.S. to get entangled deeper into the Iranian imbroglio, which is ultimately a drain on the U.S. and a useful distraction that Russia can exploit. In Turkey, both domestic and foreign tensions are rising. First, the re-run of the Istanbul mayoral election delivered a big defeat for Turkey’s President Erdogan on his home turf. Opposition representative Ekrem Imamoglu defeated former Prime Minister Binali Yildirim for a second time this year on June 23 – increasing his margin of victory to 9.2% from 0.2% in March. This was a stinging rebuke to Erdogan and his entire political system. It also reinforces the fact that Erdogan’s Justice and Development Party (AKP) is not as popular as Erdogan himself, frequently falling short of the 50% line in the popular vote for elections not associated directly with Erdogan (Chart 14). This trend combined with his personal rebuke in the power base of Istanbul will leave him even more insecure and unpredictable. Second, the G20 summit is the last occasion for Erdogan and Trump to meet personally before the July 31 deadline on Erdogan’s planned purchase of S-400 missile defenses from Russia. Erdogan has a chance to delay the purchase as he contemplates cabinet and policy changes in the wake of this major domestic defeat. Yet if Erdogan does not back down or delay, the U.S. will remove Turkey from the F-35 Joint Strike Fighter program, and may also impose sanctions over this purchase and possibly also Iranian trade. The result will hit the lira and add to Turkey’s economic woes. Geopolitically, it will create a wedge within NATO that Russia could exploit, creating more opportunities for market-negative surprises in this area. Finally, we expect our U.K. risk indicator to perk up, as the odds of a no-deal Brexit are rising. Boris Johnson will likely assume Conservative Party leadership and the party is moving closer to attempting a no-deal exit. We assign a 21% probability to this kind of Brexit, up from our previous estimate of 14%. It is more likely that Johnson will get a deal similar to Theresa May’s deal passed or that he will be forced to extend negotiations beyond October. Matt Gertken, Vice President Geopolitical Strategist mattg@bcaresearch.com Ekaterina Shtrevensky, Research Analyst ekaterinas@bcaresearch.com France: GeoRisk Indicator U.K.: GeoRisk Indicator Germany: GeoRisk Indicator Italy: GeoRisk Indicator Spain: GeoRisk Indicator Russia: GeoRisk Indicator Korea: GeoRisk Indicator Taiwan: GeoRisk Indicator Turkey: GeoRisk Indicator Brazil: GeoRisk Indicator What's On The Geopolitical Radar? Section III: Geopolitical Calendar