評価
Highlights New structural recommendation: long GBP/USD. The substantial Brexit discount in the pound makes it a long-term buy for investors who can tolerate near-term volatility. The most powerful equity play on a fading Brexit discount would be the U.K. homebuilders. Specifically, Persimmon still has a further 25 percent of upside. Take profits in long Euro Stoxx 50 versus Shanghai Composite. Within Europe, close the overweight to Switzerland and the underweight to the Netherlands. Stay overweight banks versus industrials. Stay overweight the Euro Stoxx 50 versus the Nikkei 225. Fractal trade: long NZD/JPY. Feature Chart of the WeekThe Pound Has Substantial Upside If The Brexit Discount Fades Carnival Says The Pound Is Cheap Carnival, the world’s largest cruise liner company, lists its shares on both the London and New York stock exchanges. But there is an apparent riddle: in London the shares trade on a forward PE of 8.8, while in New York they trade on 9.4. How can Carnival trade at different valuations on the two sides of the Atlantic when the market should instantly arbitrage the difference away? The answer to the riddle is that the London listing is quoted in pounds, the New York listing is quoted in dollars, while Carnival’s sales and profits are denominated in a mix of international currencies. Neither Brexit developments nor a potential Jeremy Corbyn led government will prevent the pound from rallying in the longer term. Carnival is trading on a higher valuation in New York versus London because the market is expecting its mixed currency earnings to appreciate more in dollar terms than in pound terms. Put another way, the valuation differential is expecting the pound to appreciate versus the dollar to a ‘fair value’ of around $1.40 (Chart I-2). Likewise, BHP Billiton shares are trading on a higher valuation in their Sydney listing compared to their London listing. This valuation differential is expecting the pound to appreciate versus the Australian dollar to around A$2.00 (Chart I-3). Chart I-2Carnival Says The Pound Is Cheap Chart I-3BHP Billiton Says The Pound Is Cheap In other words, the market believes that neither Brexit developments nor a potential Jeremy Corbyn led government will prevent the pound from rallying in the longer term. We tend to agree. The Wrong Way To Pick Stock Markets… And The Right Way Before continuing with the pound’s prospects, let’s wander into the wider investment landscape. One important lesson from dual-listed companies like Carnival and BHP Billiton is that a multinational’s valuation will appear attractive in a market where the currency is structurally cheap.1 This lesson has deep ramifications. Today, multinationals dominate all the major stock markets, meaning that the entire stock market will appear cheap if its currency is cheap. The stock market will also appear cheap if it is skewed towards lower-valued sectors. But sectors trade on a low valuation for a reason – poor long-term growth prospects. Through the past decade, Japanese banks seemed a relative bargain, trading on a forward PE of less than half of that on personal products companies (Chart I-4). Yet Japanese banks were not a relative bargain. Quite the contrary. Through the past decade Japanese personal products have outperformed the banks by 500 percent! (Chart I-5) Chart I-4Japanese Banks Seemed A Relative Bargain... Chart I-5...But Japanese Banks Were Not A Relative Bargain Hence, beware of picking stock markets on the basis of observations such as ‘European stocks are cheaper than U.S. stocks’. Given that a stock market valuation is the result of its currency valuation and its sector composition, assessing relative value across major stock markets is extremely difficult, if not impossible. To repeat, Carnival appears to be trading at a valuation discount in London versus New York, but the cheapness is illusory. Here’s the right way to pick major stock markets. Identify your preferred sectors and currencies, and then pick the regional and country stock markets that are skewed to these preferred sectors and currencies. In this regard, large underweight sector skews also matter. For example, China and EM have a near-zero exposure to healthcare equities, so their performances tend to correlate negatively with that of the global healthcare sector – albeit the causality could run in either direction. Identify your preferred sectors and currencies, and then pick the regional and country stock markets that are skewed to these preferred sectors and currencies. In early May, we noticed that the extreme outperformance of technology versus healthcare was at a critical technical point at which there was a high probability of a trend reversal. This high conviction sector view implied overweight Europe versus China, as well as overweight Switzerland and underweight Netherlands within Europe (Chart I-6 and Chart I-7). Chart I-6When Tech Underperforms Healthcare, China Underperforms Switzerland Chart I-7When Tech Underperforms Healthcare, The Netherlands Underperforms Switzerland Given that this sector trend reversal has played out exactly as anticipated, it is time to bank the profits: Close long Euro Stoxx 50 versus Shanghai Composite. And within Europe, close the overweight to Switzerland and the underweight to the Netherlands. Right now, it is appropriate to overweight banks versus industrials. It is the pace of the bond yield’s decline that has weighed on bank performance this year. But if the sharpest decline in bond yields is behind us, as seems likely, then banks should fare better versus other cyclicals (Chart I-8). Chart I-8If The Sharpest Decline In Bond Yields Is Over, Banks Will Outperform Industrials Once again, this sector view carries an equity market implication: stay overweight the Euro Stoxx 50 versus the Nikkei 225 (Chart I-9). Chart I-9Euro Stoxx 50 Vs. Nikkei 225 = Global Banks In Euros Vs. Global Industrials In Yen The Pound Is A Long-Term Buy Back to the pound. The message from the dual listings of Carnival and BHP Billiton is that the pound is cheap, and this is neatly corroborated by the relationship between relative interest rates and the pound versus the euro and dollar. Based on the pre-Brexit relationship between relative real interest rates and the pound’s exchange rate, we can quantify the ‘Brexit discount’. Absent this discount, the pound would now be trading close to €1.30 and well north of $1.40 (Chart of the Week and Chart I-10). Chart I-10The Pound Has Substantial Upside If The Brexit Discount Fades In the Brexit psychodrama, we do not claim to know exactly how the next few days or weeks will play out. In the short term, Brexit is a classic non-linear system, and non-linear systems are inherently unpredictable. However, in the longer term we expect the Brexit discount to fade in any sort of transitioned resolution that allows the U.K. to adapt to a new trading relationship with the world, or alternatively to stay in a relationship broadly similar to the current one. Whatever the eventual endpoint is, the key requirement to remove the Brexit discount is to avoid a cliff-edge. We expect the Brexit discount to fade in any sort of transitioned resolution. The stumbling block to a resolution is that the three key actors – the EU, the U.K. government, and the U.K. parliament – have conflicting red lines, so the Brexit ‘Venn diagram’ has had no overlap. The EU will not countenance a customs border that divides Ireland; the current U.K. government wants a Free Trade Agreement, which implies casting away Northern Ireland into the EU customs union; and the current U.K. parliament – unless its intentions suddenly change – wants the whole of the U.K., including Northern Ireland, to remain in the EU customs union. Given that the EU will not budge its red line, the only way to a lasting resolution is for the government and parliament red lines to realign, This could happen via parliament being willing to sacrifice Northern Ireland, via a second referendum, or via a general election in which the government’s intentions and/or the composition of parliament changed. Given a long enough investment horizon – 2 years or more – it is likely that the government and parliament will realign their red lines to a Free Trade Agreement or to a customs union, one way or another. On this basis, the substantial Brexit discount in the pound makes it a long-term buy for investors who can tolerate near-term volatility. Accordingly, today we are initiating a new structural recommendation: long GBP/USD. For equity investors, the most powerful play on a fading Brexit discount would be the U.K. homebuilders (Chart I-11). Specifically, if the pound reached $1.40, Persimmon still has a further 25 percent of upside. Chart I-11U.K. Homebuilders Have Substantial Upside If The Brexit Discount Fades Fractal Trading System* Based on its collapsed fractal structure, we anticipate a countertrend rally in NZD/JPY within the next 130 days. Accordingly, go long NZD/JPY setting a profit target of 3 percent and a symmetrical stop-loss. Chart I-12 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 There are also several companies with dual listings in the U.K. and the euro area. Unfortunately, these valuation differentials have been temporarily distorted by the risk of a no-deal Brexit, in which EU27 investors may have been forbidden from trading in the U.K. listed shares. Fractal Trading System Cyclical Recommendations Structural Recommendations Fractal 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
Analysis on Turkey is available below. Highlights A dovish Fed or robust U.S. growth does not constitute sufficient conditions for a bull market in EM. China’s business and credit cycles are much more important factors for EM than those of the U.S. A recovery in the Chinese economy and global manufacturing is not imminent. The common signal reverberating from various financial markets is that the risks to the global business cycle are still skewed to the downside. Feature Current investor perceptions of emerging markets are mixed. Some expect EM to benefit greatly from low U.S. interest rates. These investors view even a partial trade deal between the U.S. and China as sufficient for EM to embark on a bull market. BCA’s Emerging Markets Strategy team disagrees with this narrative. We deliberated the significance of the U.S.-China confrontation to EM in our September 19 report; therefore, we will not go over this subject here. Rather, in this report we discuss some of the more common misconceptions surrounding EM currently, and infer what these mean for investment strategies. Perception 1: The share of resource sectors (materials and energy) in the EM equity benchmark has declined substantially. This along with the expanded role of consumers and consumer stocks (Alibaba, Tencent and Baidu) in EM economies and equity markets has made their share prices less exposed to the global trade cycle and commodities prices. Reality: It is true that in many EM bourses, the weight of consumer stocks has been growing. Nevertheless, their financial markets in general, and equity markets in particular, remain very sensitive to the global trade cycle and commodities prices. Chart I-1 illustrates that the aggregate EM equity index has historically been and continues to be strongly correlated with the global basic materials stock index. The latter includes mining, steel and chemical companies. Global materials stocks also exhibit a very strong correlation with Chinese banks’ share prices. Moreover, global materials stocks also exhibit a very strong correlation with Chinese banks’ share prices (Chart I-2). The rationale for the high correlation is that both mainland banks’ profits and global demand for basic materials are driven by a common factor: China’s business cycle. Chart I-1EM And Global Materials Stocks Move Together Chart I-2Chinese Bank And Global Materials Share Prices Are Highly Correlated For example, construction in China is contracting (Chart I-3), which entails both higher NPLs for Chinese banks and lower demand for basic materials. China accounts for about 50% of global consumption of industrial metals, cement and many other basic materials. Finally, EM ex-China bank stocks also correlate strongly with global basic materials share prices. The basis is as follows: Many emerging economies export raw materials, and commodities price fluctuations impact their business cycle, exports and exchange rates. Chart I-3China: Construction Activity Is Contracting Chart I-4High-Yielding EM: Currencies And Local Bond Yields Historically, in high-yielding EM markets, currency depreciation has led to higher interest rates and lower bank share prices, and vice versa (Chart I-4). Lately, EM bond yields have not risen in response to EM currency depreciation. However, we believe this correlation will soon be re-established if EM currencies continue drifting lower. In short, China’s money/credit cycles drive not only the mainland’s business cycle, banking profits and NPLs, but also global trade and commodities prices. The latter two - via their impact on exchange rates and in turn interest rates - have historically explained credit and domestic demand cycles in high-yielding EM. Perception 2: EM stocks are a high-beta play on the S&P 500, i.e., EM equities outperform when the S&P 500 rallies, and vice versa. Reality: Since 2012, the beta for EM equity versus the S&P 500 has often been below one (Chart I-5). Furthermore, since 2012, EM share prices often failed to outpace their DM peers during global equity rallies. Indeed, EM relative equity performance versus DM, as well as the EM ex-China currency total return index, have been closely tracking the relative performance of global cyclicals versus global defensive stocks (Chart I-6). Chart I-5EM Equities Beta To The S&P 500 Chart I-6Global Cyclicals-To-Defensives Equity Ratio And EM In short, EM equities and currencies have been, and will remain, sensitive to the global business cycle rather than the S&P 500. Since 2012, the latter has - on several occasions - decoupled from the global manufacturing and trade cycles. Perception 3: EM stocks, currencies and fixed-income markets are very sensitive to U.S. interest rates. Hence, a dovish Fed will lead to EM currency appreciation. Reality: Chart I-7 reveals that EM currencies, total returns on EM local currency bonds in U.S. dollar terms and EM sovereign credit spreads do not exhibit a strong relationship with U.S. Treasury yields. U.S. interest rate expectations have a much smaller impact on EM financial markets than commonly perceived by the investment community. Overall, U.S. interest rate expectations have a much smaller impact on EM financial markets than commonly perceived by the investment community. Chart I-7EM And U.S. Bond Yields: No Stable Correlation Chart I-8China Cycle And EM Stocks Led U.S. Bond Yields On the contrary, the declines in U.S. bond yields in both 2015/16 and in 2018/19 were due to the growth slowdown that emanated from China/EM. The top panel of Chart I-8 illustrates that Chinese import growth rolled over in December 2017, yet U.S. bond yields rolled over in October 2018. What is more, EM share prices have been leading U.S. bond yields in recent years, not the other way around (Chart I-8, bottom panel). Perception 4: If the U.S. avoids a recession, EM risk assets will recover. Chart I-9EM Profits Are Driven By Chinese Not U.S. Business Cycle Reality: EM per-share earnings contracted in 2012-2014 and in 2019, despite reasonably robust growth in U.S. final demand (Chart I-9, top panel). This suggests that even if the U.S. economy avoids a recession, that will not be a sufficient condition to be bullish on EM. EM corporate profits are highly driven by China’s business cycle. The bottom panel of Chart I-9 illustrates that mainland domestic industrial orders have been the key driver of EM corporate profit cycles since 2008. Perception 5: EM equities, fixed-income markets and currencies are cheap. Reality: EM stocks are not cheap. They are fairly valued. Equity sectors with very poor fundamentals have very low multiples. Hence, they are “cheap” for a reason. These include Chinese banks, state-owned enterprises in various countries and resource companies. Equity segments with robust fundamentals are overpriced. Given that Chinese banks, state-owned enterprises in various countries, resource companies, and cyclical businesses have very large market caps, EM market-cap based equity valuation ratios are low – i.e., they appear cheap. To remove the impact of these large market cap segments, we constructed and have been publishing the following valuation ratios: median, 20% trimmed mean and equal-sub-sector weighted (Chart I-10). Each of these is calculated based on the average of trailing and forward P/E ratios, price-to-book value, price-to-cash earnings and price-to-dividend ratios. EM equities relative to DM are not cheap either. Chart I-11 demonstrates the same ratios – median, 20% trimmed-mean and equal-sub-sector weighted values for EM versus DM. Chart I-10EM Equities Are Not Cheap Chart I-11Relative To DM EM Stocks Are Not Cheap Further, when valuations are not at extremes as in the case of EM equities at the moment, the profit cycle holds the key to share price performance over a 6 to 12-month horizon. EM earnings are presently contracting in absolute terms, and underperforming DM EPS. Two currencies that offer value are the Mexican peso and Russian ruble. Chart I-12EM Local Yields Are Low In Absolute Terms And Relative To U.S. In the fixed-income space, EM local bond yields are very low in absolute terms and relative to U.S. Treasury yields (Chart I-12). EM sovereign and corporate spreads are not wide either. As to exchange rates, the cheapest currencies are those with the worst fundamentals, such as the Argentine peso, Turkish lira and South African rand. The majority of other EM currencies are not very cheap. Two currencies that offer value are the Mexican peso and Russian ruble. Yet foreign investors are very long these currencies, and a combination of lower oil prices and portfolio outflows from broader EM will weigh on these exchange rates as well. Takeaways And Investment Strategy Chart I-13EM Currencies And Industrial Metals Prices EM risk assets and currencies exhibit the strongest correlation with global trade and commodities prices. Chart I-13 indicates that the EM ex-China currency total return index closely tracks commodities prices. This corroborates the messages from Chart I-1 on page 1 and Chart I-6 on page 4. China’s business and credit cycles are much more important for EM than those of the U.S. A dovish Fed or strong U.S. growth are not sufficient reasons to bet on an EM bull market. A recovery in the Chinese economy and global manufacturing is not imminent. Individual EM countries’ domestic fundamentals such as return on capital, inflation, banking system health, competitiveness and politics drive individual EM performance. On these accounts, the outlook varies among EM. Readers can find analyses on specific EM economies in our Countries In-Depth page. Asset allocators should continue underweighting EM stocks, credit and currencies versus their DM counterparts. Absolute-return investors should outright avoid EM, or trade them on the short side. Within the EM equity space, our overweights are Mexico, Russia, Central Europe, Korea ex-tech, Thailand and the UAE. Our underweights are South Africa, Indonesia, Philippines, Hong Kong, Turkey and Colombia. The path of least resistance for the U.S. dollar is up. Continue shorting the following basket of EM currencies versus the dollar: ZAR, CLP, COP, IDR, MYR, PHP and KRW. We are also short the CNY versus the greenback. As always, the list of our country allocations for local currency bonds and sovereign credit markets is available at the end of our reports – please refer to page 16. Take Cues From These Markets We suggest investors take cues from the following financial market signals. They are unequivocally sending a downbeat message for global growth and risk assets: The ratio between Sweden and Swiss non-financial stocks in common currency terms is heading south (Chart I-14). Swedish non-financials include many companies leveraged to the global industrial cycle, while Swiss non-financials are dominated by defensive stocks. Hence, the persistent decline in this ratio presages a continued deterioration in the global industrial sector. Where is the next defense line for this ratio? To reach its 2002 and 2008 nadirs, it will need to drop by another 10%. In the interim, investors should maintain a defensive posture. Chart I-14A Message From Swedish And Swiss Equities Chart I-15A Breakdown In The Making? U.S. FAANG stocks appear to be cracking below their 200-day moving average. The relative performance of global cyclical versus global defensive stocks is relapsing below the three-year moving average that served as a support last December (Chart I-15). U.S. FAANG stocks appear to be cracking below their 200-day moving average (Chart I-16). If this support gives, the next one will be about 17% below current levels. Finally, U.S. high-beta share prices are on the verge of a breakdown (Chart I-17). The next technical support is 10% below current levels. Chart I-16FAANG Are On The Support Line Chart I-17U.S. High-Beta Stocks Are On The Edge Bottom Line: The common message reverberating from these financial markets corroborates our fundamental analysis that a global business cycle recovery is not imminent, and that global risk assets in general, and EM financial markets in particular, are at risk of selling off further. Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Turkey: Is The Mean-Reversion Rally Over? Turkish financial markets have rebounded to their respective falling trend lines (Chart II-1). Are they set to break out or is a setback looming? Chart II-1Back To Falling Trend Chart II-2TRY Is Cheap Pros The economy has undergone a considerable real adjustment and many excesses have been purged: The current account balance has turned positive as imports have collapsed. Going forward, lower oil prices are likely to help the nation’s current account dynamics. The lira has become cheap (Chart II-2). According to the real effective exchange rate based on unit labor costs, the currency is one standard deviation below its fair value. Core and headline inflation have fallen, allowing the central bank to cut interest rates aggressively. However, the exchange rate still holds the key: if the currency depreciates anew, local bonds yields will rise and the ability of the central bank to reduce borrowing costs further will diminish. Finally, private credit and broad money growth have decelerated substantially and are contracting in inflation-adjusted terms (Chart II-3). Chart II-3Money & Credit Have Bottomed Chart II-4Banks Have Been Aggressively Buying Government Bonds The recent gap between broad money and private credit growth has been due to commercial banks buying government bonds (Chart II-4). When a commercial bank purchases a security from non-banks, a new deposit/new unit of money supply is created. Banks’ purchases of government bonds en masse have capped domestic bond yields. However, if pursued aggressively, such monetary expansion could weigh on the currency’s value. Cons Presently, potential sources of macro vulnerability in Turkey are: Foreign debt obligations (FDOs) – which are calculated as the sum of short-term claims, interest payments and amortization over the next 12 months – are at $168 billion, which is sizable. The annual current account surplus has reached only $4 billion and is sufficient to cover only 2.5% of FDOs, assuming the capital and financial account balance will be zero. Clearly, Turkey needs to both roll over most of its foreign debt coming due and attract foreign capital to finance a potential expansion in its imports if its domestic demand is to recover. Critically, $20 billion of net FX reserves, excluding gold, swap lines with foreign central banks and net of domestic banking and non-banking corporations’ foreign exchange deposits, are not adequate either to cover foreign debt obligations. Even though headline and core inflation measures have fallen, wage inflation remains rampant (Chart II-5). If wage inflation does not drop substantially very soon, rapidly rising unit labor costs will feed into inflation leading to negative ramifications for the exchange rate. This is especially crucial in Turkey given President Erdogan has undermined the central bank’s credibility and is resorting to populist measures to revive his popularity. Finally, Turkish banks remain under-provisioned. Currently, the banking regulator is requiring banks to boost their non-performing loans (NPL) ratio to 6.3% of total loans.This a far cry from the 2001 episode when the NPL ratio shot up to 25% (Chart II-6). Even though interest rates rose much more in 2001 than last year, the private credit penetration in the economy was very low in the early 2000s. A higher credit penetration usually implies weaker borrowers have borrowed money and heralds a higher NPL ratio. Typically, following a credit boom and bust, it is natural for the NPL ratio to exceed 10%. We do not think Turkish banks stocks, having rallied a lot from their lows, are pricing in such a scenario. Chart II-5Surging Wages Are A Risk Chart II-6NPL Ratio Is Unrealistic Investment Recommendation We recommend both absolute-return investors and asset allocators not to chase Turkish financial markets higher. Renewed market volatility lies ahead. Given we expect foreign capital outflows from EM, Turkish companies and banks will encounter difficulties in rolling over their external debt and attracting foreign capital into domestic markets. This will produce a new downleg in the exchange rate. In turn, currency depreciation will weigh on performance of local bonds as well as sovereign and corporate credit. Stay underweight. Andrija Vesic, Research Analyst andrijav@bcaresearch.com Footnotes Equities Recommendations Currencies, Credit And Fixed-Income Recommendations
Highlights Q3/2019 Performance Breakdown: Our recommended model bond portfolio underperformed the custom benchmark by -30bps during the third quarter of the year. Winners & Losers: The biggest underperformance came from underweight positions in U.S. Treasuries (-28bps) and Italian government bonds (-18bps) as yields plunged, dwarfing gains from overweights in corporate bonds in the U.S. (+11bps) and euro area (+4bps). Scenario Analysis For The Next Six Months: We are maintaining our current positioning, staying below-benchmark on duration while overweighting U.S. and euro area corporates vs. government debt. In our base case scenario, global growth will begin to stabilize but the Fed will deliver one more “insurance” rate cut by year-end, leading to corporate bond outperformance. Feature Global bond markets have enjoyed a powerful bull run throughout 2019, as yields have plummeted alongside weakening global growth and growing political uncertainty. Those two forces came to a head in the third quarter of the year, with U.S.-China trade tensions ratcheting up another notch after the imposition of higher U.S. tariffs in early August and global manufacturing PMI data moving into contraction territory – especially in the U.S. The result was a significant fall in government bond yields as markets discounted both lower inflation expectations and more aggressive monetary easing from global central banks, led by the Fed and ECB. The benchmark 10-year U.S. Treasury yield and 10-year German Bund yield plunged -40bps and -25bps, respectively, during the July-September period. Yet at the same time, global credit markets remained surprisingly stable, as the option-adjusted spread on the Bloomberg Barclays Global Corporates index was unchanged over the same three months. In this report, we review the performance of the BCA Global Fixed Income Strategy (GFIS) model bond portfolio during the eventful third quarter of 2019. We also present our updated scenario analysis, and total return projections, for the portfolio over the next six months. As a reminder to existing readers (and to new clients), the model portfolio is a part of our service that complements the usual macro analysis of global fixed income markets. The portfolio is how we communicate our opinion on the relative attractiveness between government bond and spread product sectors. This is done by applying actual percentage weightings to each of our recommendations within a fully invested hypothetical bond portfolio. Q3/2019 Model Portfolio Performance Breakdown: Good News On Credit Trumped By Bad News On Duration Chart of the WeekDuration Losses Dwarf Credit Gains In Q3/19 The total return for the GFIS model portfolio (hedged into U.S. dollars) in the third quarter was 2.0%, lagging the custom benchmark index by -30 bps (Chart of the Week).1 This brings the cumulative year-to-date total return of the portfolio to +7.8%, which has underperformed the benchmark by a disappointing –67bps. The Q3 drag on relative returns came entirely from the government bond side of the portfolio; specifically, the underweight allocation to U.S. Treasuries and Italian government bonds (Table 1). Those allocations reflected our views on overall portfolio duration (below benchmark) and a relative value consideration within European spread product (preferring corporates to Italy). Both those recommendations went against us as global bond yields dropped during Q3, with Italian yields collapsing (the benchmark 10-year yield was down –126bps) as investors chased any positive yield denominated in euros after the ECB signaled a new round of policy easing. The total return for the GFIS model portfolio (hedged into U.S. dollars) in the third quarter was 2.0%, lagging the custom benchmark index by -30 bps Table 1GFIS Model Bond Portfolio Q3/2019 Overall Return Attribution Providing some partial offset to the U.S. and Italy allocations were gains from overweight positions in government bonds in the U.K., Australia and Japan. More importantly, our overweights in corporate debt in the U.S. and euro area made a strong positive contribution to the performance of the portfolio. The bar charts showing the total and relative returns for each individual government bond market and spread product sector are presented in Charts 2 and 3. The most significant movers were: Chart 2GFIS Model Bond Portfolio Q3/2019 Government Bond Performance Attribution Chart 3GFIS Model Bond Portfolio Q3/2019 Spread Product Performance Attribution By Sector Biggest outperformers Overweight U.S. high-yield Ba-rated (+4bps) Overweight U.S. high-yield B-rated (+3bps) Overweight U.S. investment grade industrials (+3bps) Overweight Japanese government bonds with maturity of 5-7 years (+2bps) Overweight euro area corporates, both investment grade (+2bps) and high-yield (+2bps) Biggest underperformers Underweight U.S. government bonds with maturity beyond 10+ years (-15bps) Underweight Italy government bonds with maturity beyond 10+ years (-10bps) Underweight U.S. government bonds with maturity of 7-10 years (-5bps) Underweight Japanese government bonds with maturity beyond 10+ years (-4bps) Underweight U.S. government bonds with maturity of 3-5 years (-4bps) Chart 4 presents the ranked benchmark index returns of the individual countries and spread product sectors in the GFIS model bond portfolio for Q3/2019. The returns are hedged into U.S. dollars (we do not take active currency risk in this portfolio) and are adjusted to reflect duration differences between each country/sector and the overall custom benchmark index for the model portfolio. We have also color-coded the bars in each chart to reflect our recommended investment stance for each market during Q3/2019 (red for underweight, blue for overweight, gray for neutral).2 Ideally, we would look to see more blue bars on the left side of the chart where market returns are highest, and more red bars on the right side of the chart were returns are lowest. Chart 4Ranking The Winners & Losers From The Model Bond Portfolio In Q3/2019 One thing that stands out from Chart 4 is that every fixed income sector generated a positive return, except for EM USD-denominated corporates. This is a fascinating outcome given the sharp falls in risk-free government bond yields which typically would correlate to a selloff in risk assets and widening of credit spreads. The soothing balm of looser global monetary policy seems to have offset the impact of elevated uncertainty on trade and future economic growth, allowing both bond yields and credit spreads to stay low. The soothing balm of looser global monetary policy seems to have offset the impact of elevated uncertainty on trade and future economic growth, allowing both bond yields and credit spreads to stay low. We maintained an overweight stance on global spread product throughout Q3, as we felt that the monetary policy effect would continue to overwhelm uncertainty. We did, however, make some tactical adjustments to our duration stance after the U.S. raised tariffs on Chinese imports, upgrading to neutral on August 6th.3 We had felt that higher tariffs were a sign that a potential end to the U.S.-China trade conflict was now even less likely, which raised the odds of a potential risk-off financial market event that would temporarily push bond yields lower. We shifted back to a below-benchmark duration stance on September 17th, given signs of de-escalation in the trade dispute and, more importantly, some improvement evident in global leading economic indicators.4 Bottom Line: Our recommended model bond portfolio underperformed the custom benchmark index during the third quarter of the year, with the drag on performance from an underweight stance on U.S. Treasuries and Italian BTPs overwhelming the gains from corporate credit overweights in the U.S. and euro area. Future Drivers Of Portfolio Returns Looking ahead, the performance of the model bond portfolio will continue to be driven by two main factors: our below-benchmark duration bias and our overweight stance on global corporate debt versus government bonds. Chart 5Overall Portfolio Allocation: Overweight Credit In terms of the specific high-level weightings in the model portfolio, we currently have a moderate overweight, equal to eight percentage points, on spread product versus government debt (Chart 5). This reflects a more constructive view on future global growth. Early leading economic indicators are starting to bottom out and global central bankers are maintaining a dovish policy bias despite low unemployment rates – both factors that will continue to benefit growth-sensitive assets like corporate debt. Early leading economic indicators are starting to bottom out and global central bankers are maintaining a dovish policy bias despite low unemployment rates – both factors that will continue to benefit growth-sensitive assets like corporate debt. We are maintaining our below-benchmark duration tilt at 0.6 years short of the custom benchmark (Chart 6). We recognize, however, that the underperformance from duration in the model portfolio will not begin to be clawed back until there are signs of a bottoming in widely-followed cyclical economic indicators like the U.S. ISM index and the German ZEW. We think that will happen given the uptick in our global leading economic indicator (LEI), but that may take a few more months to develop based on the usual lead time from the LEI to the survey data like the ISM. The hook up in the global LEI does still gives us more confidence that the big decline in global bond yields seen this year is over, especially if a potential truce in the U.S.-China trade war is soon reached, as our political strategists believe to be increasingly likely. Chart 6Overall Portfolio Duration: Moderately Below Benchmark Turning to country allocation, we are sticking with overweights in countries where central banks are likely to be more dovish than the Fed over the next 6-12 months (Germany, France, the U.K., Japan, and Australia). We are staying underweight the U.S. where inflation expectations appear too low and Fed rate cut expectations look too extreme. The Italy underweight has become a trickier call. We have long viewed Italian debt as a growth-sensitive credit instrument rather than the yield-driven rates vehicle it became in Q3 as markets priced in fresh monetary easing measures from the ECB (including restarting government purchases). We will revisit our Italy views in an upcoming report but, until then, we will continue to view Italian BTPs within the context of our European spread product allocation. Thus, we are maintaining an overweight on euro area corporate debt (by 1% each in investment grade and high-yield) while having an equal-sized underweight (-2%) in Italian government bonds. Our combined positioning generates a portfolio that has “positive carry”, with a yield of 3.1% (hedged into U.S. dollars) that is +25bps over that of the custom benchmark index (Chart 7). That same portfolio, however, generates an estimated tracking error (excess volatility of the portfolio versus its benchmark) of 55bps - well below our self-imposed 100bps ceiling and still within the 40-60bps range we have targeted since the start of 2019 (Chart 8). Chart 7Portfolio Yield: Positive Carry From Credit Chart 8Portfolio Risk Budget Usage: Cautious Scenario Analysis & Return Forecasts In April 2018, we introduced a framework for estimating total returns for all government bond markets and spread product sectors, based on common risk factors.5 For credit, returns are estimated as a function of changes in the U.S. dollar, the Fed funds rate, oil prices and market volatility as proxied by the VIX index (Table 2A). For government bonds, non-U.S. yield changes are estimated using historical betas to changes in U.S. Treasury yields (Table 2B). Table 2AFactor Regressions Used To Estimate Spread Product Yield Changes Table 2BEstimated Government Bond Yield Betas To U.S. Treasuries This framework allows us to conduct scenario analysis of projected returns for each asset class in the model bond portfolio by making assumptions on those individual risk factors. In Tables 3A & 3B, we present our three main scenarios for the next six months, defined by changes in the risk factors, and the expected performance of the model bond portfolio in each case. The scenarios, described below, all revolve around our expectation that the most important drivers of future market returns will continue to be the momentum of global growth and the path of U.S. monetary policy. The scenario inputs for the four main risk factors (the fed funds rate, the price of oil, the U.S. dollar and the VIX index) are shown visually in Chart 9. Table 3AScenario Analysis For The GFIS Model Bond Portfolio For The Next Six Months Table 3BU.S. Treasury Yield Assumptions For The 6-Month Forward Scenario Analysis Chart 9Risk Factor Assumptions For The Scenario Analysis Base Case (Global Growth Bottoms): The Fed delivers one more -25bp rate cut by the end of 2019, the U.S. dollar weakens by -3%, oil prices rise by +10%, the VIX hovers around 15, and there is a bear-steepening of the UST curve. This is a scenario where the U.S. economy ends up avoiding recession and grows at roughly a trend-like pace. The Fed, however, still delivers one more “insurance” rate cut to mitigate the risk of low inflation expectations becoming more entrenched. Global growth is expected to bottom out as heralded by the global leading indicators. A truce (but not a full deal) is expected on the U.S.-China trade front, helping to moderately soften the U.S. dollar through reduced risk aversion. The model bond portfolio is expected to beat the benchmark index by +91bps in this case. Global Growth Strongly Rebounds: The Fed stays on hold, the U.S. dollar weakens by -5%, oil prices rise by +20%, the VIX declines to 12, there is a modest bear-steepening of the UST curve. In this tail-risk scenario, global growth starts to reaccelerate in lagged response to the global monetary easing seen this year, combined with some fiscal stimulus in major countries (China, the U.S., perhaps even Germany). The U.S. dollar weakens as global capital flows shift to markets which are more sensitive to global growth. The model bond portfolio is expected to beat the benchmark index by +106bps in this case. U.S. Downturn Intensifies: The Fed cuts rates by -75bps, the U.S. dollar is flat, oil prices fall by -15%, the VIX rises to 30; there is a bull-steepening of the UST curve. Under this tail-risk scenario, the current slowing of U.S. growth momentum gains speed, pushing the economy towards recession. The Fed cuts rates aggressively in response, helping weaken the U.S. dollar, but not before global risk assets sell off sharply to discount a worldwide recession. The model portfolio will underperform the benchmark by -38bps in this scenario. In terms of our conviction level among the main drivers of the model portfolio returns – duration allocation (across yield curves and countries) and asset allocation (credit versus government bonds) – we are most confident that credit returns will exceed those of sovereign debt over the next six months. In terms of our conviction level among the main drivers of the model portfolio returns – duration allocation (across yield curves and countries) and asset allocation (credit versus government bonds) – we are most confident that credit returns will exceed those of sovereign debt over the next six months. The underweight duration position, however, will also eventually begin to pay off if the message from the budding improvement in global leading economic indicators turns out to be correct. A collapse of the U.S.-China trade negotiations is the biggest threat to our base case, which would make the “U.S. Downturn Intensifies” scenario a more likely outcome. Bottom Line: We are maintaining our current positioning, staying below-benchmark on duration while overweighting U.S. and euro area corporates governments. In our base case scenario, global growth will begin to stabilize but the Fed will deliver one more “insurance” rate cut by year-end, leading to spread product outperformance. Robert Robis, CFA, Chief Fixed Income Strategist rrobis@bcaresearch.com Ray Park, CFA, Research Analyst ray@bcaresearch.com Footnotes 1 The GFIS model bond portfolio custom benchmark index is the Bloomberg Barclays Global Aggregate Index, but with allocations to global high-yield corporate debt replacing very high quality spread product (i.e. AA-rated). We believe this to be more indicative of the typical internal benchmark used by global multi-sector fixed income managers. 2 Note that sectors where we made changes to our recommended weightings during Q3/2019 will have multiple colors in the respective bars in Chart 4. 3 Please see BCA Global Fixed Income Strategy Weekly Report, “Trade War Worries: Once More, With Feeling”, dated August 6, 2019, available at gfis.bcaresearch.com. 4 Please see BCA Global Fixed Income Strategy Weekly Report, “The World Is Not Ending: Return To Below-Benchmark Portfolio Duration”, dated September 17, 2019, available at gfis.bcaresearch.com. 5 Please see BCA Global Fixed Income Strategy Weekly Report, “GFIS Model Bond Portfolio Q1/2018 Performance Review: A Rough Start”, dated April 10th 2018, available at gfis.bcareseach.com. 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 Chart 1Contagion? Until last week, global growth weakness had been wholly confined to the manufacturing sector. But the drop to 52.6 in September’s Non-Manufacturing PMI (from 56.4 in August) raises the specter of contagion from manufacturing into the broader U.S. economy. A further drop would be consistent with an economy headed toward recession, and run contrary to the 2015/16 roadmap that has been our base case (Chart 1). We think it is still premature to abandon the 2015/16 episode as an appropriate comparable for the current period. For one thing, the hard economic data paint a rosier picture than the PMI surveys. Industrial production and core durable goods new orders are up 2.5% and 2.3% (annualized), respectively, during the past 3 months. These data have helped drive the economic surprise index above zero, an event that usually coincides with rising yields (bottom panel). The divergence between soft and hard data makes it clear that trade uncertainties are so far having a greater impact on business sentiment than on actual production, but history tells us that these divergences don’t last long. Some positive news on the trade front will be required during the next few months to raise business sentiment and push bond yields higher. Stay tuned. Feature Investment Grade: Overweight Chart 2Investment Grade Market Overview Investment grade corporate bonds outperformed the duration-equivalent Treasury index by 42 basis points in September, before giving back 37 bps in the first week of October. We consider three main factors in our credit cycle analysis: (i) corporate balance sheet health, (ii) monetary conditions, and (iii) valuation. At present, the chief conundrum for investors is that while corporate balance sheet health is weak, the monetary environment is extraordinarily accommodative.1 On balance sheets, our top-down measure of gross leverage is elevated and rising (Chart 2). In contrast, interest coverage ratios remain solid, propped up by the Fed’s accommodative stance. With inflation expectations still very low, the Fed can maintain its “easy money” policy for some time yet. This will ensure that interest coverage stays solid and that bank lending standards continue to ease (bottom panel). This is an environment where corporate bond spreads should tighten. How low can spreads go? Our assessment of reasonable spread targets for the current environment suggests that Aaa, Aa and A-rated spreads are already fully valued, while Baa-rated spreads are 13 bps cheap (panels 2 & 3).2 We recommend focusing investment grade corporate bond exposure on the Baa credit tier, and subbing some Agency MBS into your portfolio in place of corporate bonds rated A or higher. Table 3ACorporate Sector Relative Valuation And Recommended Allocation* Table 3BCorporate Sector Risk Vs. Reward* High-Yield: Overweight Chart 3High-Yield Market Overview High-Yield outperformed the duration-equivalent Treasury index by 66 basis points in September, before giving back 117 bps in the first week of October. The junk index’s option-adjusted spread (OAS) has been fairly stable for most of the year, but the sector has become increasingly attractive from a risk/reward perspective.3 This is because the index’s negatively convex nature has caused its average duration to fall alongside declining Treasury yields. Chart 3 shows that while the index OAS has been rangebound, the 12-month breakeven spread has widened considerably.4 In other words, while junk expected returns have been stable, those expected returns now come with considerably less risk. As a result, the junk index OAS looks increasingly attractive relative to our spread target.5 Specifically, we now view the junk index OAS as 171 bps cheap (panel 3). Falling index duration also explains the divergence between quality spreads and the index OAS. Many have observed that the spread differential between Caa and Ba-rated junk bonds has widened in recent months, while the overall index OAS has been stable (panel 4). However, the divergence evaporates when we look at 12-month breakeven spreads instead of OAS (bottom panel). MBS: Neutral Chart 4MBS Market Overview Mortgage-Backed Securities outperformed the duration-equivalent Treasury index by 24 basis points in September, before giving back 25 bps in the first week of October. MBS have underperformed Treasuries by 31 bps, year-to-date. The conventional 30-year zero volatility spread held flat at 82 bps in September, as a 3 bps increase in expected prepayment losses (option cost) was offset by a 3 bps tightening in the option-adjusted spread (OAS). In last week’s report, we recommended favoring Agency MBS over Aaa, Aa and A-rated corporate bonds.6 We have three main reasons for this recommendation. First, expected compensation is competitive. The conventional 30-year MBS OAS is now 57 bps. This is above the pre-crisis average (Chart 4), and only 4 bps below the spread offered by a Aa-rated corporate bond. Aaa, Aa and A-rated corporate bond spreads also all look expensive relative to our targets. Second, risk-adjusted compensation heavily favors MBS. The 12-month breakeven spread for a conventional 30-year MBS is 21 bps. This compares to 6 bps, 8 bps and 12 bps for Aaa, Aa and A-rated corporates, respectively. Finally, the macro environment for MBS remains supportive. Mortgage lending standards have barely eased since the financial crisis (bottom panel), and most people have already had at least one opportunity to refinance their mortgage. This burnout will keep refi activity low, and MBS spreads tight (panel 2), going forward. Government-Related: Underweight Chart 5Government-Related Market Overview The Government-Related index outperformed the duration-equivalent Treasury index by 10 basis points in September, bringing year-to-date excess returns up to +163 bps. September returns were concentrated in the Foreign Agency sub-sector. These securities outperformed the Treasury benchmark by 55 bps on the month, bringing year-to-date excess returns up to +197 bps. Sovereign bonds underperformed duration-equivalent Treasuries by 6 bps in September, dragging year-to-date excess returns down to +436 bps. Local Authority and Domestic Agency debt underperformed by 1 bp and 2 bps on the month, respectively. Meanwhile, Supranationals bested the Treasury benchmark by a single basis point. Sovereign debt remains very expensive relative to equivalently-rated U.S. corporate credit (Chart 5). While the sector would benefit if the Fed’s dovish pivot eventually results in a weaker dollar, U.S. corporate bonds would also perform well in such an environment. Given the much more attractive starting point for U.S. corporate bond spreads, we find it difficult to recommend sovereign debt as an alternative. While sovereign debt in general looks expensive. USD-denominated Mexican sovereign bonds continue to look attractive relative to U.S. corporates (bottom panel). Investors should favor Mexican sovereigns within an otherwise underweight allocation to the sector as a whole. Municipal Bonds: Overweight Chart 6Municipal Market Overview Municipal bonds underperformed the duration-equivalent Treasury index by 10 basis points in September, dragging year-to-date excess returns down to -57 bps (before adjusting for the tax advantage). We recommended upgrading municipal bonds from neutral to overweight in last week’s report.7 We based the decision on the increasing attractiveness of yield ratios, despite an underlying credit environment that remains supportive for munis. Municipal bond yields failed to keep pace with falling Treasury yields in recent months, and now look quite attractive as a result (Chart 6). The average Aaa-rated Municipal / Treasury (M/T) yield ratio rose 4% in September and is now back above 90%. This is well above the 81% average that prevailed in the late stages of the previous cycle, between mid-2006 and mid-2007. In fact, Aaa M/T yield ratios for every maturity are now above average pre-crisis levels. Though yield ratios still look best at the long-end of the Aaa curve (panel 2), we now recommend owning munis in place of Treasuries across the entire maturity spectrum. Fundamentally, state & local government balance sheets remain solid. We showed in last week’s report that our Municipal Health Monitor is in “improving health” territory, and noted that state & local government interest coverage is positive (bottom panel). Both of those trends are consistent with muni ratings upgrades continuing to outnumber downgrades going forward. Treasury Curve: Maintain A Barbell Curve Positioning Chart 7Treasury Yield Curve Overview The Treasury curve bear-steepened in September, and then bull-steepened sharply last week. All in all, the 2/10 Treasury slope is +12 bps, 12 bps steeper than it was at the end of August. The 5/30 slope is +67 bps, 10 bps steeper than at the end of August. Our fair value models (see Appendix B) continue to show that bullets are expensive relative to barbells across the entire Treasury curve. In particular, 5-year and 7-year maturities look very expensive compared to the short and long ends of the curve. Notice that the 2/5/10 butterfly spread, the spread between the 5-year bullet and a duration-matched 2/10 barbell, remains negative despite the recent 2/10 steepening (Chart 7). We have shown in prior research that the 5-year and 7-year maturities are the most highly correlated with our 12-month Fed Funds Discounter. Our discounter is currently at -74 bps, meaning that the market is priced for nearly three more Fed rate cuts during the next 12 months (top panel). We expect fewer cuts than that, and as such, think the Discounter is more likely to rise. 5-year and 7-year maturities would underperform the rest of the curve in that scenario. We also continue to hold our short position in the February 2020 fed funds futures contract. That contract is currently priced for 2 more rate cuts during the next 3 FOMC meetings. That outcome is possible, but our base case economic outlook is more consistent with 1 further cut, likely occurring this month. TIPS: Overweight Chart 8Inflation Compensation TIPS underperformed the duration-equivalent nominal Treasury index by 38 basis points in September, dragging year-to-date excess returns down to -142 bps. The 10-year TIPS breakeven inflation rate fell 3 bps in September, and then another 2 bps last week. It currently sits at 1.51%, well below levels consistent with the Fed’s target. The divergence between the actual inflation data and inflation expectations is becoming increasingly stark. Trimmed mean PCE inflation has been fluctuating around the Fed’s target for most of the year (Chart 8). However, long-maturity TIPS breakeven inflation rates remain stubbornly low, nowhere near the 2.3% - 2.5% range that is consistent with the Fed’s target. As we have pointed out in prior research, it can take time for expectations to adapt to a changing macro environment.8 That being said, the 10-year TIPS breakeven inflation rate is currently 43 bps too low according to our Adaptive Expectations Model, a model whose primary input is 10-year trailing core inflation (panel 4). It is highly likely that the Fed will have to tolerate some overshoot of its 2% inflation target in order to re-anchor inflation expectations near desired levels. We anticipate that the committee will do so, and we maintain our view that long-dated TIPS breakevens will move above 2.3% before the end of the cycle. ABS: Underweight Chart 9ABS Market Overview Asset-Backed Securities underperformed the duration-equivalent Treasury index by 2 basis points in September, dragging year-to-date excess returns down to +72 bps. The index option-adjusted spread for Aaa-rated ABS widened 2 bps on the month. It currently sits at 36 bps, very close to its minimum pre-crisis level (Chart 9). ABS also appear unattractive on a risk/reward basis, as both Aaa-rated auto loans and credit cards have moved into the “Avoid” quadrant of our Excess Return Bond Map (Appendix C). The Map uses each bond sector’s spread, duration and volatility to calculate the likelihood of earning or losing 100 bps of excess return versus Treasuries on a 12-month horizon. At present, the Map shows that ABS offer poor expected return for their level of risk. In addition to poor valuation, the ABS sector’s credit fundamentals are shifting in a negative direction. Household interest payments continue to trend up, suggesting a higher delinquency rate in the future (panel 3). Meanwhile, senior loan officers continue to tighten lending standards for both credit cards and auto loans. Tighter lending standards usually coincide with rising delinquencies (bottom panel). All in all, the combination of poor value and deteriorating credit quality leads us to recommend an underweight allocation to consumer ABS. Non-Agency CMBS: Neutral Chart 10CMBS Market Overview Non-Agency Commercial Mortgage-Backed Securities outperformed the duration-equivalent Treasury index by 9 basis points in September, bringing year-to-date excess returns up to +227 bps. The index option-adjusted spread for non-agency Aaa-rated CMBS held flat on the month, before widening 4 bps last week. It currently sits at 75 bps, below average pre-crisis levels but above levels seen in 2018 (Chart 10). The macro outlook for commercial real estate is somewhat unfavorable, with lenders tightening loan standards (panel 4) amidst falling demand (bottom panel). Commercial real estate prices have accelerated of late, but are still not keeping pace with CMBS spreads (panel 3). Despite the poor fundamental picture, our Excess Return Bond Map shows that CMBS offer a reasonably attractive risk/reward trade-off compared to other bond sectors (see Appendix C). Agency CMBS: Overweight Agency CMBS outperformed the duration-equivalent Treasury index by 2 basis points in September, bringing year-to-date excess returns up to +90 bps. The index option-adjusted spread held flat on the month, before widening by 5 bps last week. It currently sits at 61 bps. The Excess Return Bond Map in Appendix C shows that Agency CMBS offer high potential return compared to other low-risk spread products. Appendix A - The Golden Rule Of Bond Investing We follow a two-step process to formulate recommendations for bond portfolio duration. First, we determine the change in the federal funds rate that is priced into the yield curve for the next 12 months. Second, we decide – based on our assessments of the economy and Fed policy – whether the change in the fed funds rate will exceed or fall short of what is priced into the curve. Most of the time, a correct answer to this question leads to the appropriate duration call. We call this framework the Golden Rule Of Bond Investing, and we demonstrated its effectiveness in the U.S. Bond Strategy Special Report, “The Golden Rule Of Bond Investing”, dated July 24, 2018, available at usbs.bcaresearch.com. Chart 11 illustrates the Golden Rule’s track record by showing that the Bloomberg Barclays Treasury Master Index tends to outperform cash when rate hikes fall short of 12-month expectations, and vice-versa. Chart 11The Golden Rule's Track Record At present, the market is priced for 74 basis points of cuts during the next 12 months. We anticipate fewer rate cuts over that time horizon, and therefore anticipate that below-benchmark portfolio duration positions will profit. We can also use our Golden Rule framework to make 12-month total return and excess return forecasts for the Bloomberg Barclays Treasury index under different scenarios for the fed funds rate. Excess returns are relative to the Bloomberg Barclays Cash index. To forecast total returns we first calculate the 12-month fed funds rate surprise in each scenario by comparing the assumed change in the fed funds rate to the current value of our 12-month discounter. This rate hike surprise is then mapped to an expected change in the Treasury index yield using a regression based on the historical relationship between those two variables. Finally, we apply the expected change in index yield to the current characteristics (yield, duration and convexity) of the Treasury index to estimate total returns on a 12-month horizon. The below tables present those results, along with 95% confidence intervals. Excess returns are calculated by subtracting assumed cash returns in each scenario from our total return projections. Appendix B - Butterfly Strategy Valuation The following tables present the current read-outs from our butterfly spread models. We use these models to identify opportunities to take duration-neutral positions across the Treasury curve. The following two Special Reports explain the models in more detail: U.S. Bond Strategy Special Report, “Bullets, Barbells And Butterflies”, dated July 25, 2017, available at usbs.bcaresearch.com U.S. Bond Strategy Special Report, “More Bullets, Barbells And Butterflies”, dated May 15, 2018, available at usbs.bcaresearch.com Table 4 shows the raw residuals from each model. A positive value indicates that the bullet is cheap relative to the duration-matched barbell. A negative value indicates that the barbell is cheap relative to the bullet. Table 5 scales the raw residuals in Table 4 by their historical means and standard deviations. This facilitates comparison between the different butterfly spreads. Table 6 flips the models on their heads. It shows the change in the slope between the two barbell maturities that must be realized during the next six months to make returns between the bullet and barbell equal. For example, a reading of +48 bps in the 5 over 2/10 cell means that we would only expect the 5-year to outperform the 2/10 if the 2/10 slope steepens by more than 48 bps during the next six months. Otherwise, we would expect the 2/10 barbell to outperform the 5-year bullet. Table 4Butterfly Strategy Valuation: Raw Residuals In Basis Points (As of October 4, 2019) Table 5Butterfly Strategy Valuation: Standardized Residuals (As of October 4, 2019) Table 6 Appendix C - Excess Return Bond Map The Excess Return Bond Map is used to assess the relative risk/reward trade-off between different sectors of the U.S. fixed income market. The Map employs volatility-adjusted breakeven spread analysis to show how likely it is that a given sector will earn/lose money during the subsequent 12 months. The Map does not incorporate any macroeconomic view. The horizontal axis of the Map shows the number of days of average spread widening required for each sector to lose 100 bps versus a position in duration-matched Treasuries. Sectors plotting further to the left require more days of average spread widening and are therefore less likely to see losses. The vertical axis shows the number of days of average spread tightening required for each sector to earn 100 bps in excess of duration-matched Treasuries. Sectors plotting further toward the top require fewer days of spread tightening and are therefore more likely to earn 100 bps of excess return. Chart 12Excess Return Bond Map (As Of October 4, 2019) Ryan Swift, U.S. Bond Strategist rswift@bcaresearch.com Footnotes 1 Please see U.S. Bond Strategy Weekly Report, “Corporate Bond Investors Should Not Fight The Fed”, dated September 17, 2019, available at usbs.bcaresearch.com 2 For more details on how we arrive at our spread targets please see U.S. Bond Strategy Weekly Report, “The Value In Corporate Bonds”, dated February 19, 2019, available at usbs.bcaresearch.com 3 Please see U.S. Bond Strategy Weekly Report, “Corporate Bond Investors Should Not Fight The Fed”, dated September 17, 2019, available at usbs.bcaresearch.com 4 The 12-month breakeven spread is the spread widening required to break even with a duration-matched position in Treasuries on a 12-month horizon. It can be approximated by OAS divided by duration. 5 For more details on how we arrive at our spread targets please see U.S. Bond Strategy Weekly Report, “The Value In Corporate Bonds”, dated February 19, 2019, available at usbs.bcaresearch.com 6 Please see U.S. Bond Strategy Weekly Report, “Two Themes And Two Trades”, dated October 1, 2019, available at usbs.bcaresearch.com 7 Please see U.S. Bond Strategy Weekly Report, “Two Themes And Two Trades”, dated October 1, 2019, available at usbs.bcaresearch.com 8 Please see U.S. Bond Strategy Weekly Report, “Adaptive Expectations In The TIPS Market”, dated November 20, 2018, available at usbs.bcaresearch.com Fixed Income Sector Performance Recommended Portfolio Specification Corporate Sector Relative Valuation And Recommended Allocation
ハイライト
コーポレート債：高い企業債務残高は次の景気後退期にコーポレート債投資家にとって問題となるが、インフレ圧力が高まり金融政策が引き締めに転じるまではスプレッドはそれに反応しない。米国債に対してコーポレート債をオーバーウェイトで保ちつつ、Baaおよびハイイールドのクレジット層を優先する。
MBS: エージェンシーMBSスプレッドは高格付け（Aaa、Aa、A）のコーポレート債と競合し、リスク調整後ではさらに魅力的に見える。ポートフォリオのAaa、Aa、A格付けのコーポレート債をエージェンシーMBSにスワップすることを推奨する。
ミュニシパル債: ミュニシパル／米国債イールド比の最近の戻りを踏まえ、ミュニシパル債の評価をニュートラルからオーバーウェイトに引き上げるべきである。ミュニシパルの中では、利回りが最も魅力的な長期のAaa格付け債を引き続き優先すべきである。
特集
先週、BCAの年次投資カンファレンスに参加した。イベントは常に専門家パネリストの話を聞き、クライアントが最も関心を寄せている課題を知る良い機会を提供する。何よりも、複数のプレゼンテーションや参加者との会話で2つのテーマが繰り返し浮かび上がった：
大きな企業債務残高
過小評価されたインフレリスク
私たちはこの2つの間に強い関連性を見ている。
企業債務について
パネリストや参加者のコンセンサスは我々の見解と非常に一致していた：高レバレッジのバランスシートは次のデフォルトサイクルでコーポレート債投資家にとって問題になるが、それがいつ起きるかを決定する助けにはならない。
チャート1は、負債対利益比率が持続的に上昇しているにもかかわらず企業倒産は抑制されていることを示している。私たちは最近のレポートでこの乖離の理由を検討し、金融緩和的な金融政策が金利コストを低く抑え、銀行に満期を迎える債務をロールオーバーする自信を与えることでデフォルト率を抑えていると結論付けた。1 本質的には、FRBがより引き締め的な政策姿勢に転じるまでは銀行は企業のバランスシート悪化の兆候を見過ごすだろう。
チャート 1
企業のバランスシートは悪化しているが、デフォルトは低い
Corporate Balance Sheets Are In Bad Shape, But Defaults Are Low
Corporate Balance Sheets Are In Bad Shape, But Defaults Are Low
インフレについて
ここでインフレが重要になる。FRBは長年の低インフレにより投資家がインフレが再来しないと確信しているため、現在も緩和的な金融政策を運営している。その結果、10年物TIPSのブレークイーブン・インフレーション率はわずか1.53%であり、FRBのターゲットと整合する2.3% - 2.5%の範囲を大きく下回っている。
FRBはインフレ期待の再固定化という目標を達成するまで緩和的な政策姿勢を維持しなければならない。そうなって初めて金融政策は引き締めに転じ、企業のデフォルトサイクルのリスクが高まる。我々は以前より、10年物TIPSのブレークイーブン・インフレーション率が2.3%以上になればコーポレートクレジットに対してより慎重になるだろうと考えている。
コアインフレがFRBのターゲット付近で何ヶ月も連続して示されるまで、投資家がそれが永続すると思い始めるには時間がかかるかもしれない。
多くのカンファレンスパネリストはインフレリスクが現在過小評価されていると考えており、我々もフィリップス曲線の死を宣言するには時期尚早だという点では同意するが、インフレ期待が我々の目標レンジ2.3% - 2.5%に到達するまでにはまだ時間を要すると予想している。過去の研究で示したように、インフレ期待は実際のインフレデータの変化に対してゆっくりとしか順応しない。2 現時点で、我々の適応的期待モデルが示す10年物TIPSの公正価値水準はわずか1.94%（チャート 2）である。インフレが現在の水準付近で推移し続ければこの公正価値は上昇するだろうが、そのプロセスには時間がかかる。言い換えれば、コアインフレがFRBのターゲット付近で何ヶ月も出続けるまで、投資家がそれが永続すると信じ始めるには時間がかかるだろう。
チャート 2
適応的期待モデル
Adaptive Expectations Model
Adaptive Expectations Model
チャート 3
インフレは目標からそれほど遠くない
Inflation Not Far From Target
Inflation Not Far From Target
適応プロセスには時間がかかるかもしれないが、インフレはすでにFRBの目標にかなり近いことに注意することが重要である。トレイリング12か月のトリム平均PCEインフレ率は8月時点で1.96%、年率ベースのコアPCEは1.77%であった（チャート 3）。トリム平均インフレは金融危機以降、他のインフレ指標よりも安定しており、コアPCEは時間をかけてトリム平均に近づく傾向がある。
企業債務とインフレについて
我々の見解では、高い企業債務と過小評価されたインフレリスクという2つのテーマは密接に結び付いている。景気回復に非常に長い時間を要したため、インフレは長期にわたり低位にあり、FRBは緩和的な政策姿勢を維持せざるを得なかった。その緩和的姿勢は銀行の貸し出しを促し、企業の債券発行を促進した。最終的にインフレ圧力が高まり、FRBの政策が引き締めに転じると、脆弱な企業バランスシートが露呈する。そうなって初めてコーポレートスプレッドは大幅に拡大するだろう。
それまでは、企業スプレッドがインフレ圧力が予想より早く出現するリスクに対して十分な補償を提供しているかが重要な問題となる。現時点では、リスク／リワードのトレードオフは下位クレジット層でより魅力的であるという但し書き付きで、十分な補償を提供していると考えている。
12か月のハイイールドのブレークイーブン・スプレッドは非常に魅力的で、歴史的中央値を大きく上回っている（チャート 4）。しかし投資適格内では、Baa格付け層のみが十分な補償を提供していると見ている（チャート 4、下段）。Aaa、Aa、A格付けのコーポレート債を保有するよりも良い代替案がある。次節で議論するように。
チャート 4
コーポレート債のバリュエーション
Corporate Bond Valuation
Corporate Bond Valuation
高格付けコーポレートクレジットよりエージェンシーMBSを推奨
チャート 5
MBSは高格付けのコーポレート債より魅力的
MBS More Attractive Than High-Rated Corporate Bonds
MBS More Attractive Than High-Rated Corporate Bonds
前述の通り、A格以上の投資適格コーポレート債は現行のスプレッド水準ではあまり期待される補償を提供していない。実際、我々の以前の調査はそれらのスプレッドがすでに循環的なターゲットを下回っていることを指摘している。3
しかし好材料として、通常の30年エージェンシーMBSの平均オプション調整スプレッド（OAS）はここ数か月で拡大し、高格付けのコーポレートクレジットに対する魅力的な代替となっている。投資家は3つの理由からポートフォリオのAaa、Aa、A格付けコーポレートクレジットをエージェンシーMBSにシフトすることを推奨する。
1) 期待補償は競争力がある
通常の30年エージェンシーMBSの平均OASは現在52ベーシスポイントに達している。これはAa格付けコーポレート債の平均OASよりわずか6ベーシスポイント低く、A格付けよりは37ベーシスポイント低い（チャート 5
2) リスク調整後の補償は優れている
MBSスプレッドはリスクプロファイルを考慮するとさらに魅力的に見える。具体的には、今年MBS指数の平均デュレーションが急低下した一方で、投資適格コーポレート債指数の平均デュレーションは上昇したことを考慮した場合である（チャート 5、パネル2）。実際、MBS指数の平均デュレーションはわずか2.9であるのに対し、A格コーポレート債は7.8である。これは、投資家が損失を被るにはMBSスプレッドが今後12か月で18ベーシスポイント拡大する必要があるのに対し、A格スプレッドはわずか11ベーシスポイント拡大すればよいことを意味する（チャート 5、下段）。
投資家はポートフォリオのAaa、Aa、A格付けコーポレートクレジットをエージェンシーMBSにシフトすることを推奨する。
MBSは負のコンベクシティを示すため、利回りが低下するとデュレーションが下がる。対照的に、ノンコーラブルの投資適格コーポレート債は正のコンベクシティを持ち、デュレーションが上昇している。これは、他の条件が同じであれば、利回りが大幅に低下した後に負のコンベクシティを持つ証券の方がリスク調整後の面で魅力的に見え始めることを意味する。これはまた、負のコンベクシティを持つハイイールドのコーポレート債が現在、投資適格コーポレート債よりもはるかに魅力的に見える主な理由でもある。4
興味深いことに、MBSの指数デュレーションが急低下した直近の2015/16年には、MBSはコーポレート債と比較してそれほど魅力的に見えなかった。それは当時コーポレート債スプレッドも拡大していたからである。今回は、MBS指数デュレーションが急落する間にコーポレート債スプレッドは安定している。米国債利回りにさらなる下値余地があると考えない限り、エージェンシーMBSは良い買いに見える。5
3) マクロリスクは低い
前述のとおり、我々はまだコーポレート債に対するマクロリスクを警鐘を鳴らす段階にはないが、エージェンシーMBSを取り巻くマクロリスクについてはさらに懸念が少ない。モーゲージの借り換え活動はMBSスプレッドの最も重要なマクロドライバーであり、長期にわたり比較的低位にとどまるはずである。現在のような低いモーゲージ金利では、ほとんどの住宅所有者がすでに借り換えの機会を得ているため、借り換えの消耗（refi burnout）は非常に高い。今年はモーゲージ金利が大きく低下したにもかかわらず借り換え活動は小幅のスパイクにとどまったことからも明らかである（チャート 6）。
チャート 6
抑制された借り換え活動は名目スプレッドを低位に保つ
Muted Refi Activity Will Keep Nominal Spreads Low
Muted Refi Activity Will Keep Nominal Spreads Low
チャート 6はまた、名目MBSスプレッドが借り換え活動と高い相関を持ち、現在歴史的なタイト付近にあることを示している。このスプレッドはOAS（MBS投資家の期待リターンの代理）と前払（プレペイメント）活動によって失われると予想されるスプレッド部分の両方を含む。OASが歴史と比べてやや高めである一方で名目スプレッド全体が低位にあるということは、MBSが前払損失に対するバッファをほとんど織り込んでいないことを意味する。マクロの背景を考えると、これは妥当であるように思われる。
借り換えリスクに加えて、未償還モーゲージの信用クオリティが依然として非常に高いことにも注意する。新規モーゲージの中央値FICOスコアは金融危機以降ほとんど低下していない（チャート 7）。さらに、危機後期間の大部分でモーゲージ貸出基準は緩和されてきたが、FRBの7月のシニアローンオフィサー調査では、貸出基準が2005年以降平均より厳しいとする銀行が、基準が緩いとする銀行より多いと報告している。
住宅活動データの改善は一般にモーゲージ金利を押し上げ、それが借り換え活動を制約する。
最後に、住宅活動が大きく弱化する懸念はほとんどない。私たちが追跡する6つの主要な住宅活動データ系列はすべて、今年のモーゲージ金利低下以降で大きく回復している（チャート 8）。住宅活動データの改善は一般にモーゲージ金利を上昇させ、それが借り換え活動を制限する。
チャート 7
モーゲージ貸出基準はタイト
Mortgage Lending Standards Are Tight
Mortgage Lending Standards Are Tight
チャート 8
住宅活動が回復
Housing Activity Hooking Up
Housing Activity Hooking Up
結論: エージェンシーMBSスプレッドは高格付け（Aaa、Aa、A）のコーポレート債と競合し、リスク調整後ではさらに魅力的に見える。ポートフォリオのAaa、Aa、A格付けコーポレート債をエージェンシーMBSにスワップすることを推奨する。
ミュニシパル債の格上げ
7月23日、我々はミュニシパル債のエクスポージャーをオーバーウェイトからニュートラルに引き下げるよう投資家に助言した。6 理由は純粋にバリュエーションによるものである。即時のミュニシパル信用の悪化の兆候は見えなかったが、利回りが代替案に対して単純に低すぎると指摘した。
現在、同様に即時の信用悪化の兆候は見られない。実際、ミュニシパル債の格付けのアップグレードはダウングレードを上回り続け、当社のミュニシパルヘルスモニターは「健康改善」領域にあり、州および地方政府の利払い余力は強い（チャート 9）。7
チャート 9
ミュニシパルの信用クオリティは懸念事項ではない
Muni Credit Quality Is Not A Concern
Muni Credit Quality Is Not A Concern
しかし違いは、イールド比が8月初旬以来劇的に回復し、ミュニシパル債が再び魅力的になったことである（チャート 10）。
チャート 10
ミュニシパル債が再び魅力的に
Munis Attractive Once Again
Munis Attractive Once Again
結論: ミュニシパル／米国債イールド比の最近の戻りを踏まえ、投資家はミュニシパル債をニュートラルからオーバーウェイトに格上げすべきである。ミュニシパルの中では、利回りが最も魅力的な長期のAaa格付け債を引き続き優先するべきである。
Ryan Swift, 米国債ストラテジスト rswift@bcaresearch.com
脚注
1 Please see U.S. Bond Strategy Weekly Report, “Corporate Bond Investors Should Not Fight The Fed”, dated September 17, 2019, available at usbs.bcaresearch.com
2 Please see U.S. Bond Strategy Weekly Report, “Adaptive Expectations In The TIPS Market”, dated November 20, 2018, available at usbs.bcaresearch.com
3 Please see U.S. Bond Strategy Weekly Report, “Corporate Bond Investors Should Not Fight The Fed”, dated September 17, 2019, available at usbs.bcaresearch.com
4 ハイイールド債指数は大半のハイイールドクレジットが組み込まれたコールオプションを有しているため負のコンベクシティを持つ。投資適格コーポレート債はノンコーラブルである傾向がある。
5 Please see U.S. Bond Strategy Weekly Report, “What’s Up In U.S. Money Markets?”, dated September 24, 2019, available at usbs.bcaresearch.com
6 Please see U.S. Bond Strategy Weekly Report, “A Message To The TIPS Market”, dated July 23, 2019, available at usbs.bcaresearch.com
7 For further details on our Municipal Health Monitor please see U.S. Bond Strategy Special Report, “Trading The Municipal Credit Cycle”, dated October 18, 2016, available at usbs.bcaresearch.com
フィクスト・インカム部門のパフォーマンス
推奨ポートフォリオ仕様
Highlights Portfolio Strategy The contracting manufacturing sector that rekindled recession fears, the harsh reality of the Sino-American trade war weighing on profits, downbeat business confidence and mushrooming capex slowdown signals all warn that investors should tread carefully in the historically difficult equity market months of September and October. It no longer pays to be overweight gold mining equities as sentiment is stretched, the restarting of global QE will likely reverse or at least halt the drubbing in global yields and the U.S. dollar inverse correlation should reassert itself and weigh on global gold miners. EM and China ills, deflating global producer pricing power, export blues and souring financial statement metrics underscore that materials stocks have ample downside. Recent Changes Trim the Global Gold Mining index to neutral, today. Downgrade the S&P Materials sector to underweight, today. Table 1 Feature Equities broke out of their trading range last week, but in order for this short-covering rally to become durable, and for volatility to subside, either global growth needs to turn the corner and alleviate recession fears or the trade war needs to de-escalate materially. On the recession front Central Banks (CBs) are doing their utmost to reflate their respective economies, but the early stages of looser monetary policy have been insufficient to change the global growth trajectory. With regard to the trade war, markets cheered the news that talks between the U.S. and China will resume in September and October. The dates for talks are conveniently chosen to follow the September FOMC meeting and the October 1 70th anniversary of the People's Republic of China. The latter date implies that Washington is considering delaying the October 1 tariff hike – and it could imply that Washington does not anticipate any violent suppression of Hong Kong protesters by that time. However, the harsh reality is that the two sides are just “kicking the can down the road”. The longer the Sino-American trade war takes to conclude, the more likely it will serve as a catalyst for a repricing of risk significantly lower (top panel, Chart 1). A technical correction may be necessary to force Trump to reduce the trade pressure significantly. Even if the October 1 tariff hike is postponed it will remain a source of uncertainty ahead of the final tariff tranche slated for December 15. The bond market may offer some clues as to the extent that the escalating trade war will eventually get reflected into stocks (bottom panel, Chart 1). The equity transmission mechanism is through the earnings avenue. Simply put, rising trade uncertainty deals a blow to global trade that boosts the U.S. dollar which in turn makes U.S. exports uncompetitive in global markets, deflates the commodity complex and with a lag weighs on SPX earnings. Chart 1Tracking Trade Uncertainty Speaking of the economically hypersensitive manufacturing sector, last week’s ISM release made for grim reading, further fueling recession fears (the New York Fed now pegs the recession probability just shy of 38% by next August). Not only did the overall survey fall below the boom/bust line (middle panel, Chart 2), but also new orders collapsed. In fact, the drubbing in new orders is worrying and it signals that the economy is going to get worse before it gets better (top panel, Chart 2). Tack on the simultaneous rise in inventories, and the sinking new orders-to-inventories ratio (not shown) warns of additional manufacturing ills in the coming months. Importantly, export orders suffered the steepest losses plunging to 43.3. The last three times that this trade-sensitive survey subcomponent was in such a steep freefall were in 1998, 2001 and 2008, when the SPX suffered peak-to-trough losses of 20%, 49% and 57%, respectively. In fact, since the history of the data, ISM manufacturing export orders have never been lower with the exception of the GFC (Chart 3). Such a retrenchment will either mark the bottom for equities or is a harbinger of a steep equity market correction. We side with the latter as the odds of President Trump striking a real trade deal (including tech) with China any time soon are low. Chart 2Like Night Follows Day Similar to the ISM manufacturing/non-manufacturing divergence (bottom panel, Chart 2), business confidence is trailing consumer conference by a wide mark. Historically this flaring chasm has been synonymous with a sizable loss of momentum in the broad equity market (Chart 4). One plausible explanation is that as business animal spirits suffer a setback, CEOs are quick to prune/postpone capex plans and, at the margin, corporations retrench and short-circuit the capex upcycle. Chart 3Export Carnage Chart 4Mind The Gap Circling back to last week’s capex update, national accounts corroborate the financial statement data deceleration, and in some cases contraction, in capital outlays (Chart 5). As a reminder our thesis is that the EPS-to-capex virtuous upcycle is morphing into a vicious down cycle.1 This week, we downgrade a deep cyclical sector by taking profits in a niche subgroup that has served as a reliable portfolio hedge. Crucially, tech investment, that comprises almost 30% of total investment according to national accounts, is decelerating, R&D and other intellectual property investment have also hooked down, non-residential structures are on the verge of contraction, and industrial, transportation and other equipment –that have the largest weight in U.S. capex – are also quickly losing steam (Chart 6). Chart 5Capex Blues Chart 6All Capex Segments… In more detail, Charts 7 & 8 further break down capital outlays in the respective categories and reveal that worrisomely the investment spending slowdown is broad based. Chart 7…Have Rolled Over… Chart 8…Except For One Adding it all up, the contracting manufacturing sector that rekindled recession fears, the harsh reality of the Sino-American trade war weighing on profits, downbeat business confidence and mushrooming capex slowdown signals all warn that investors should tread carefully in the historically difficult equity market months of September and October. As a reminder, this is U.S. Equity Strategy service’s view and it contrasts with BCA’s sanguine equity market house view. This week, we downgrade a deep cyclical sector by taking profits in a niche subgroup that has served as a reliable portfolio hedge. Downgrade Materials To Underweight… Heightened economic and trade policy uncertainty has claimed the S&P materials sector as one of its victims (Chart 9). Given that our Geopolitical Strategy service’s base case remains that there will be no Sino-American trade deal by the U.S. November 2020 election, there is more downside for materials stocks and we are downgrading this niche deep cyclical sector to a below benchmark allocation.2 Beyond the U.S./China trade war inflicted wounds that materials stocks have to nurse, there are four major headwinds that they will also have to contend with in the coming months. Chart 9Trade Uncertainty Sinking Materials First, the emerging markets (EM) in general and China in particular are in a prolonged soft patch that predates the Sino-American trade war. EM stocks and EM currencies are both deflating at an accelerating pace warning that relative share prices will suffer the same fate (Chart 10). Nothing epitomizes the infrastructure spending/capex cycle more than China’s insatiable appetite for commodities and the news on that front remains dire. The Li Keqiang index continues to emit a distress signal and that is negative for materials top line growth (bottom panel, Chart 10). Second, global inflation is in hibernation and select EM producer price inflation growth series are on the verge of contraction or already outright contracting. Chinese raw materials wholesale prices are in the deflation zone and warn that U.S. materials sector profits will underwhelm (Chart 11). Chart 10Bearish EM… Chart 11…And China Backdrops Base metal prices are a real time indicator of the wellness of the S&P materials sector. Currently, base metals are deflating both on the back of a firming U.S. dollar and contracting global manufacturing. Such a commodity price backdrop is dampening prospects for a profit-led materials sector relative share price recovery (top & middle panels, Chart 12). Third, the materials exports outlook is darkening. Apart from the deflating effect the appreciating U.S. dollar has on commodities it also clips basic materials companies’ exports prospects. How? It renders materials related exports uncompetitive in international markets leading to market share losses. Netting it all out, EM and China ills, deflating global producer pricing power, export blues and souring financial statement metrics underscore that materials stocks have ample downside. Chart 12Weak Pricing Power And Declining Exports In addition, the latest ISM export order subcomponent plunged to multi-year lows reflecting trade war pessimism and falling global end-demand. The implication is that the export relief valve is closed for materials equities (bottom panel, Chart 12). Finally, materials sector financial statement metrics are moving in the wrong direction. Net debt-to-EBITDA is rising anew and interest coverage has likely peaked for the cycle at a time when free cash flow generation has ground to a halt (Chart 13). U.S. Equity Strategy’s S&P materials sector profit growth model encapsulates all these moving parts and warns that a severe profit contraction phase looms (Chart 14). Chart 13Financial Statement Red Flags Chart 14Model Says Sell Netting it all out, EM and China ills, deflating global producer pricing power, export blues and souring financial statement metrics underscore that materials stocks have ample downside. Bottom Line: The time is ripe to downgrade the S&P materials sector to underweight. …Via Trimming Gold Miners To Neutral The way we are executing this downgrade in the materials sector to an underweight stance is by trimming the global gold mining index to a benchmark allocation. Our thesis that gold stocks serve as a sound portfolio hedge remains intact and underpinned when: economic and trade policy uncertainty are on the rise (top panel, Chart 15) global CBs start cutting interest rates and in some cases doubling down on negative interest rates currency wars are overheating Nevertheless, what has changed is the price, and we deem that global gold miners that have gone parabolic are in desperate need of a breather. The top panel of Chart 16 shows that gold stocks have rallied 58% since the May 5, 2019 Trump tweet. This outsized four-month relative return is remarkable and likely almost fully reflects a very dovish Fed and melting real U.S. Treasury yields (TIPS yield shown inverted, bottom panel, Chart 15). A much needed pause for breath is required before the next leg of the relative rally resumes, and we opt to move to the sidelines. Chart 15Positive Backdrop… Chart 16…But Reflected In Prices Moreover, on the eve of the ECB’s September meeting, were President Mario Draghi to re-commence QE in the form of sovereign and corporate bond purchases as markets participants expect, counterintuitively a selloff in the bond markets would confirm that QE and its signaling is working (bottom panel, Chart 16). Ergo, this would likely exert upward pressure on global interest rates including the U.S., especially given the one-sided positioning in the respective global risk free assets. The implication is that the shiny metal and global gold miners would suffer a setback as real yields would rise further. As a reminder, gold bullion yields nothing and gold mining equities next to nothing, thus when competing safe haven assets at the margin start yielding higher, investors flee gold and gold miners and flock to risk free assets. Sentiment toward gold and global gold miners is stretched. Gold ETF holdings are at multi-year highs (second panel, Chart 17) and gold net speculative positions are at a level that has marked previous reversals. In addition, bullish consensus on gold is near 72%, a percentage last reached in 2012 (third & bottom panels, Chart 17). Similarly, relative share price momentum is also warning that global gold mining equities are currently extended (bottom panel, Chart 18). Chart 17Extreme… Chart 18…Sentiment Finally, while the bond market’s view of 100bps in Fed cuts in the next 12 months should have undermined the trade-weighted U.S. dollar, it has actually defied gravity and slingshot to fresh cycle highs. This is a net negative both for gold and gold mining equities as the underlying commodity is priced in U.S. dollars and enjoys an inverse correlation with the greenback. The implication is that the multi-decade inverse correlation will hold and will likely pull down gold and gold mining equities at least in the short-run (U.S. dollar shown inverted, Chart 19). In sum, the exponential rise in global gold miners is in need of a breather. Sentiment is stretched, the restating of global QE will likely reverse or at least halt the drubbing in global yields and the U.S. dollar inverse correlation should reassert itself and weigh on relative share prices Chart 19Gold Miners/Dollar Correlation Re-establishment Risk Bottom Line: Downgrade the global gold mining index to neutral, but stay tuned. Anastasios Avgeriou, U.S. Equity Strategist anastasios@bcaresearch.com Footnotes 1 Please see U.S. Equity Strategy Weekly Report, “Capex Blues” dated September 3, 2019, available at uses.bcaresearch.com 2 Please see The Bank Credit Analyst Special Report, “Big Trouble In Greater China” dated August 29 , 2019, available at bca.bcaresearch.com Current Recommendations Current Trades Size And Style Views Stay neutral cyclicals over defensives (downgrade alert) Favor value over growth Favor large over small caps
Highlights The lingering global manufacturing recession and the substantial drop in U.S. bond yields have been behind the decoupling between both EM stocks and the S&P 500, and cyclical and defensive equities. Neither the most recent economic data, nor the relative performance of global cyclicals, China-related plays and high-beta markets herald a broad-based and lasting risk-on phase in global markets. On the contrary, economic and market signposts continue to indicate either further bifurcation in global markets or a risk-off period. We review some of our long-standing themes and associated recommendations. Feature Global financial markets have become bifurcated. On one hand, numerous segments of global financial markets leveraged to global growth, including EM stocks, have already sold off (Chart I-1). On the other hand, share prices of growth companies, defensive stocks and global credit markets have remained resilient. Chart I-2 shows that a similar divergence has taken place within EM asset classes: EM share prices have plummeted while EM corporate credit excess returns have not dropped much. Chart I-1Bifurcated Equity Markets Chart I-2Bifurcated Markets In EM How to explain this market bifurcation? Financial markets sensitive to global trade and manufacturing cycles have been mirroring worsening conditions in global trade and manufacturing. Some of the affected segments include: Global cyclical equity sectors. Emerging Asia manufacturing-related currencies (KRW, TWD and SGD) versus the U.S. dollar (Chart I-3). EM and DM commodity currencies (Chart I-4). Chart I-3Total Return (Including Carry): KRW, TWD And SGD Vs. USD Chart I-4EM And DM Commodity Currencies Industrial and energy commodities prices. U.S. high-beta stocks as well as U.S. small caps (Chart I-5). Chart I-5U.S. High-Beta Stocks DM bond yields. Crucially, the current global trade and manufacturing downturns have taken place despite robust U.S. consumer spending. In fact, our theme for the past several years has been that a global business cycle downturn would occur despite ongoing strength in American household spending. The rationale has been that China and the rest of EM combined are large enough on their own to bring down global trade and manufacturing, irrespective of strength in U.S. consumer spending. At the current juncture, one wonders whether such a market bifurcation is justified. It is not irrational. The basis for decoupling between cyclical and defensive equities has been U.S. bond yields. The substantial downshift in U.S. interest rate expectations has led to a re-rating of non-cyclicals and growth company stocks. Corporate bonds have also done well, given the background of a falling risk-free rate. Will the current market bifurcation continue? Or will these segments in global financial markets recouple and in which direction? What To Watch China rather than the U.S. has been the epicenter of this slowdown, as we have argued repeatedly in the past. Hence, a major rally in global cyclical equities and EM risk assets all hinge on a recovery in the Chinese business cycle. The basis for decoupling between cyclical and defensive equities has been U.S. bond yields. The substantial downshift in U.S. interest rate expectations has led to a re-rating of non-cyclicals and growth company stocks. Even though Caixin’s PMI for China was slightly up in August, many other economic indicators remain downbeat: The latest hard economic data out of Asia suggest that global trade/manufacturing continues to contract. Korea’s total exports in August contracted by 12.5% from a year ago, and its shipments to China plunged by 20% (Chart I-6). The import sub-component of China’s manufacturing PMI is not showing signs of amelioration (Chart I-7). The mainland’s import recovery is very critical to a revival in global trade and manufacturing. Chart I-6Korean Exports: No Recovery Chart I-7Chinese Imports To Remain Weak Chart I-8German Manufacturing Confidence German manufacturing IFO business expectations and current conditions both suggest that it is still early to bet on a global trade recovery (Chart I-8). Newly released August data points reveal that U.S., Taiwanese, and Swedish manufacturing new export orders continue to tumble. To gauge whether bifurcated markets will recouple and whether it will occur to the downside or the upside, investors should watch the relative performance of China-exposed markets, global cyclicals and high-beta plays – the ones that have already sold off substantially. The notion is as follows: These markets’ relative performance will likely bottom before their absolute performance recovers. If so, their relative performance will likely foretell the outlook for their absolute performance. Concerning share prices of growth companies, defensive equity sectors and credit markets, these segments are at risk because of expensive valuations and crowded investor positioning. In other words, they could sell off even if a global recession is avoided. Concerning share prices of growth companies, defensive equity sectors and credit markets, these segments are at risk because of expensive valuations and crowded investor positioning. To assess the outlook for global cyclicals and China-related plays, we are monitoring the following financial market indicators: The Risk-On/Safe-Haven currency ratio is the average of high-beta commodity currencies such as the CAD, AUD, NZD, BRL, CLP and ZAR total return (including carry) indices relative to the average of JPY and CHF total returns (including carry). This ratio is dollar-agnostic. This ratio is making a new cyclical low (Chart I-9). Hence, it presently warrants a negative view on global growth, China’s industrial sector and commodities. Global cyclical equity sectors seem to be on the edge of breaking down versus defensives (Chart I-10). This ratio does not signal ameliorating global growth conditions. Chart I-9The Risk-On/Safe-Haven Currency Ratio Chart I-10Global Cyclicals Versus Defensives Chart I-11U.S. High-Beta Stocks Versus S&P 500 Finally, U.S. high-beta stocks continue to underperform the S&P 500 (Chart I-11). This is consistent with overall U.S. growth deceleration. Bottom Line: Neither the most recent economic data, nor the relative performance of global cyclicals, China-related plays and high-beta markets herald a broad-based and lasting risk-on phase in global markets. On the contrary, economic and market signposts continue to foreshadow either further bifurcation in global markets or a risk-off period. Continue trading EM stocks and currencies on the short side, and underweighting EM risk assets versus DM. Our Investment Themes And Positions Some of our open positions often run for years because they reflect our long-standing themes. Our core theme has for some time been that a global trade/manufacturing recession will be generated by a growth relapse in China. To capitalize on this theme, we have been recommending a short EM stocks / long 30-year U.S. Treasurys strategy since April 2017. This recommendation has produced a 25% gain since its initiation (Chart I-12). Continue betting on lower local interest rates in emerging economies where the central bank can cut rates despite currency depreciation. To implement this theme, we have been recommending receiving swap rates in Korea and Chile for the past several years. Our reluctance to recommend an outright buy on local bonds stems from our bearish view on both currencies – the Korean won and Chilean peso. In fact, we have been shorting both the KRW and the CLP against the U.S. dollar. Chart I-13 shows that swap rates in Korea and Chile have dropped substantially since our recommendations to receive rates in these countries. More rate cuts are forthcoming in these economies, and we are maintaining these positions. Chart I-12EM Stocks Have Massively Underperformed U.S. Bonds Chart I-13Continue Receiving Rates In Korea And Chile We have been bearish on EM banks in general and Chinese banks in particular. We have expressed these themes in a number of ways: Short EM and Chinese / long U.S. bank stocks. Short EM banks / long EM consumer staples (Chart I-14). Within Chinese banks, we have been short Chinese medium and small banks / long large ones. All these strategies remain valid. In credit markets, we have been favoring U.S. corporate credit versus EM sovereign and corporate credit. Ability to service debt is better among U.S. debtors than EM/Chinese borrowers. We have been playing this theme in the following ways: Underweight EM sovereign and corporate credit / overweight U.S. investment-grade corporates (Chart I-15). Chart I-14Short EM Banks / Long EM Consumer Staples Chart I-15Underweight EM Credit / Overweight U.S. Investment-Grade Corporates Underweight Asian high-yield corporate credit / overweight emerging Asian investment-grade corporates. As a bet on a deteriorating political and business climate in Hong Kong, in our Special Report on Hong Kong SAR from June 27, we reiterated the following positions: Short Hong Kong property stocks / long Singapore equities. Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Mexico: Crying Out For Policy Easing The Mexican economy is heading into a full-blown recession. Most segments of the economy are in contraction, and leading indicators point to further downside. Both manufacturing and non-manufacturing PMIs are well below 50 (Chart II-1). Monetary policy remains too restrictive: Nominal and real interest rates are both very high and plunging narrow money (M1) growth is signaling further downside in economic activity (Chart II-2). Chart II-1The Economy Is Deteriorating Chart II-2Narrow Money Points To Negative Growth An inverted yield curve signifies that the central bank is behind the curve and foreshadows growth contraction (Chart II-3). Fiscal policy has tightened as the government has remained committed to achieving a primary fiscal surplus of 1% of GDP in 2019 (Chart II-4, top panel). Consequently, nominal government expenditures have been curbed (Chart II-4, bottom panel). The government’s fiscal stimulus has not been large and has been implemented too late. Chart II-3A Message From The Inverted Yield Curve Chart II-4Fiscal Policy Has Tightened A Lot Finally, business confidence is extremely low due to uncertainty over President Andrés Manuel López Obrador’s (AMLO) policies towards the private sector. The president is attempting to revive business confidence, but it will take time. Chart II-5Mexico Versus EM: Domestic Bonds And Sovereign Credit Our major theme for Mexico has been that both monetary and fiscal policies are very tight. Consequently, we have been recommending overweight positions in Mexican domestic bonds and sovereign credit relative to their respective EM benchmarks. (Chart II-5). Recessions are bad for share prices, but in tandem with prudent macro policies, they can be positive for fixed-income markets. Meanwhile, we have been favoring the Mexican peso relative to other EM currencies due to the fact that AMLO is not as negative for the country as was initially perceived by markets. With inflation falling and the Federal Reserve cutting rates, Banxico will ease further. Yet, it will likely cut rates slower than warranted by the economy. The longer the central bank takes to ease, the lower domestic bond yields will drop. Concerning sovereign credit, investors should remain overweight Mexico within an EM credit portfolio. Mexico’s fiscal position is healthier, and macroeconomic policies will be more prudent relative to what the market is currently pricing. We continue to believe concerns about Pemex’s financing and its impact on government debt are overblown, as we discussed in detail in our previous Special Report. In July, the government released an action plan for Pemex financing. We view this plan as marginally positive. To supplement this plan, the government can use the $14.5 billion federal budget stabilization fund to fill in financing shortfalls in the coming years. Importantly, the starting point of Mexican public debt is quite low, which will allow the government to finance Pemex in the years to come by borrowing more from markets. Recessions are bad for share prices, but in tandem with prudent macro policies, they can be positive for fixed-income markets. Lastly, our overweight recommendation in Mexican stocks has not played out. However, we are maintaining it for the following reasons: Chart II-6 illustrates that when Mexican domestic bond yields decline relative to EM ones (shown inverted on Chart II-6), Mexican share prices usually outperform their EM counterparts in common currency terms. Consistent with our view that Mexican local currency bonds will outperform their EM peers, we expect Mexican stocks to outpace the EM equity benchmark. The Mexican bourse’s relative performance against EM often swings with the relative performance of EM consumer staples versus the EM equity benchmark. This is due to the large share of consumer staples stocks in Mexico (34.5%) compared to that in the EM benchmark (7%). Consumer staples stocks are beginning to outpace the EM equity index, raising the odds of Mexican equity outperformance versus its EM peers (Chart II-7). Chart II-6Local Bond Yields And Relative Stocks: Mexico Versus EM Chart II-7Consumer Staples Have A Large Weight In Mexican Bourse We do not expect a major rally in this nation’s stock market given the negative growth outlook. Our bet is that Mexican share prices - having already deflated considerably - will drop less in dollar terms than the overall EM equity index. Bottom Line: We continue to recommend an overweight stance on Mexican sovereign credit, domestic bonds and equities relative to their respective EM benchmarks. The main risk to the Mexican peso stems from persisting selloff in EM currencies. Traders’ net long positions in the MXN are elevated posing non-trivial risk (Chart II-8). We have been long MXN versus ZAR but are taking profit today. This trade has generated a 9.7% gain since March 29, 2018. A plunging oil-gold ratio warrants a caution on this cross rate in the near term (Chart II-9). Chart II-8Investors Are Long MXN Chart II-9Take Profits On Long MXN / Short ZAR Trade Juan Egaña, Research Associate juane@bcaresearch.com Arthur Budaghyan Chief Emerging Markets Strategist arthurb@bcaresearch.com Footnotes Equities Recommendations Currencies, Credit And Fixed-Income Recommendations