Japan
This month's <i>Special Report</i> reviews the literature on equity market timing, and identifies the key indicators that historically have had the best track record. We then aggregate the indicators into an overall scorecard that should prove to be valuable for investors in these volatile times.
This week, we present five of the more interesting yield curve trades in the Developed Markets for the latter half of 2016.
As the sole shock absorber left in the global economy, FX markets will grow more volatile. The currency market's reaction to the recent Fed minutes exemplifies this phenomenon. Despite its sores and blisters, the U.S. economy wins the global beauty contest. Caught between those forces, the USD will continue to weaken over the next quarter or two before resuming its broader bull market.
China has fallen into the same "fiscal trap" that ensnarled Japan in the 1990s. Unprofitable investment projects undertaken by SOEs are a necessary evil. The underlying problem is not overinvestment, but an economy that is demand-deprived. Meanwhile, structural factors will ensure that savings remain high. Any efforts by the authorities to curb credit growth will result in a sharp economic downturn. China will continue to generate excess capacity and export deflation to the rest of the world, which is good for bonds. We recommend going long Chinese banks, the most hated equity sector.
Helicopter money is coming, and once deployed, will prove to be much more successful than most people imagine. Stay long Japanese and German inflation swaps. USD/JPY and EUR/USD are ultimately likely to reach 140 and 0.9, respectively, over the next two years. The U.S. economy will remain resilient enough to make helicopter money unnecessary but a strengthening dollar will greatly curtail the ability of the Fed to raise rates. Investors should overweight Treasurys relative to bunds and JGBs. Helicopter money will benefit gold as well as the beleaguered European and Japanese stock markets.
The Fed is accentuating bearish dynamics for the dollar over the next three to six months. The upcoming National Congress of the Communist Party of China provides Chinese authorities with an incentive to ramp up stimulus this year. The new Treasury semi-annual report pre-empts meaningful direct interventions to soften the yen. More than just Brexit risk is weighing on the pound.
The end of the Debt Supercycle will be a key theme influencing economic and financial trends for many years to come. Its hallmark will remain the inability of central banks to engineer a new credit cycle, despite extremely low interest rates. China is one of the few remaining countries where the Debt Supercycle has yet to end, and history suggests the catalyst for a turning point will be a financial crisis.
The trading action of gold is currently sending a bearish message on the dollar as the price of the precious metal has broken above critical resistance. Though the causation between the dollar and gold usually runs from the former to the latter, gold also has a tendency to sniff out broad-based moves in the greenback. We remain broadly short USD in our portfolio.
The factors that drove the recent rally - Fed dovishness, China reflation, and a pickup in economic data - are largely over.