Longview Economics. Chris Watling, CEO & Chief Market Strategist, Longview Economics September Eat, Sleep, Rinse, Repeat

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1 Longview Economics Chris Watling, CEO & Chief Market Strategist, Longview Economics September 2018 Eat, Sleep, Rinse, Repeat The outlook for global financial markets: A market that is both fearful and greedy. Aug-18 1

2 Every three year (or so..) The last such occurrence was the back end of Prior to that it was (i.e. chapters of the Euro crisis*), before that (major global recession); in 2004 markets struggled as they absorbed the pricing in of Fed tightening; from a major bear market (aftermath of capex boom & TMT bubble); prior to that it was the 1997/98 emerging market crises; in 1994 equities again struggled as they absorbed the pricing in of future tightening; in 1990/91 a small US recession/first Iraq war and a small bear market; in 1987 the stock market crash; in 1984 markets struggled as they absorbed tightening; late the double dip US recession; and so on. What that list reminds us, is that equity markets rarely have 3 consecutive up years without significant setbacks, and whilst it s possible that the Jan-April SELL-off earlier this year is such a setback, the current divergence in global markets and sentiment that is both greedy and fearful, (as well as the models and macro backdrop) point to a challenging year that is not yet complete. FIG 1: S&P500 index (2016 present) Aug-18 2

3 A market that is both fearful and greedy. GREEDY FIG 4: Longview safe haven positioning model vs. S&P500 cash index FIG 2: Longview US equity sentiment scoring system vs. S&P500 Aug-18 3

4 A market that is both fearful and greedy. FEARFUL JPM EM currency index Spanish IBEX index Aug-18 4

5 So what is going on? Aug-18 5

6 1. Divergent global macro: US economy: Robust Chinese economy: Euro zone economy: Deleveraging (attempting)/credit crunch in parts of economy Caught in middle Sep-18 6

7 Theme: FROM synchronised global growth ---- >>> to US Global Growth leadership US = Robust US Money Velocity: Accelerating US money velocity * Corporate Financing Gap* (% of GDP) after adjusting for buybacks *measured as M2 & M1 (both) relative to the monetary base. *corporate financing gap defined as internal funds less capex less dividends 7 Sep-18

8 Chinese Monetary policy has been tightening for past 12+ months Chinese M1 money supply growth (Y-o-Y %) vs. TSF credit growth (trillion RMB, 12 months smoothed) Slowing Chinese consumer Chinese retail sales (Y-o-Y %, real, various measures) 8 Sep-18

9 Europe: Stuck in the Middle Terms of trade shock Fig 6: Euro zone s terms of trade (EZ export price index relative to import prices) Fig 6b: Real EZ M1 money supply growth vs. real GDP growth (Y-o-Y %) Aug-18 9

10 Divergent global central bank policy; & Slowest Global Money Supply Growth since GFC FIG 1: GDP Weighted global M1 money supply growth (Y-o-Y %) FIG 5: Official cross border transactions in US securities by foreigners (of US treasury bonds & notes, agency & corporate bonds), US$, billion Sep-18 Tightening Global Dollar liquidity 10

11 Signs of stress in global financial system = increasing Chinese (EM) & Italian stress, amongst others China & Asia high yield corporate bonds (%, yield) Spreads: Italian over German (10 & 2 year) Aug-18 11

12 Hence unusual breakdown in cross correlations (across global financial markets) Average global cross correlations (>150 asset prices) Aug-18 12

13 And narrow market leadership.. Breadth of local and global market(s) (from all angles) is confirming the rising global macro risk narrative/thesis Globally breadth remains poor/clearly of concern (similar, in some ways, to 2015) Percent of US stocks which are overbought (i.e. with RSI>70) vs. S&P500: 2017 & 18 Aug-18 13

14 Aggregated scoring system in 2018 Longview aggregated scoring system vs S&P500 Aug-18 14

15 Model/market behaviour: Current 2018 Parallels with 2015/2014 & 2011 & contrast with other recent (non global macro shock years, e.g. 2016) Aug-18 15

16 Three types of SELL-offs in Bull Markets SELL-offs in cyclical bull markets tend to take three forms: i) a risk event (when investors/traders have become overly euphoric/overly risk-seeking then a sharp wave of risk aversion follows); ii) a SELL-off into a bear market typically accompanied by/anticipating a US/global recession; & iii) a SELL-off that reflects/anticipates a global macro shock. This third type of SELL-off (much like the 2 nd ) evolves over several months and is relatively rare (i.e. typically every few years, e.g & 2011). It also has the potential, if not addressed with an appropriate policy response, to morph into a bear market (rather than a volatility event). Aug-18 16

17 BUY (US) BONDS Fig 4: US 30-year Treasury bond futures vs. UST bonds net speculative LONG/SHORT positions US 10 year bond yields, shown with key levels/moving averages US 10 year bond yield vs bond sentiment 17 Sep-18

18 Gold price has broken down: BUT How far will it go? When is Gold attractive? (answer: ) Gold price candlestick futures chart shown with key levels and moving averages Longview Market Timing Signal (Gold) long term history 18 Sep-18

19 Key Questions/Risks;& Potential triggers Key questions: 1. How aggressively will China continue its deleveraging attempts? By how much have they (already) restimulated/re-liquified? Is it enough? 2. How risky is Italian situation? What would reverse that risk? 3. When will Fed stop tightening? What might bring that about? a) Subset qu: Will the US$ reverse recent strength? 4. Are EM markets at a notably cheap level (i.e. such that they are attractive on valuation grounds alone)? Potential triggers/things to watch: Some of the risk factors/possible triggers: 1. (implementation of) China Tariffs 2. Trump Impeachment 3. Italian budget process/clash with EU 4. Acceleration of US inflation (CPI or wages) leading to acceleration of rate hikes 5. US mid-term elections 6. Policy error China/acceleration of mini credit crunch 7. Other EM issues 8. Canaries in coalmine incl: Aussie/UK/Swedish/Canadian housing Aug-18 19

20 By how much have the Chinese authorities (already) stimulated/re-liquified? Is it enough? Liquidity proxy* (China) aggregate OMOs plus MLFs From Caixin, 21 st August 2018 The growing stream of new stimulus measures and easing credit policies has raised fears that Beijing is putting debt reduction efforts on the back burner again. However, PBOC Vice Governor Zhu Hexin told the briefing that authorities will stay the course in their multi-year campaign to reduce risks in the financial system. The direction of structural deleveraging won t change, said Zhu. The campaign is already paying dividends, with the macro economic leverage ratio stabilising and growth in the household debt ratio slowing, he added. *i.e. as it assumes zero total liquidity as at start Jan 2015 (albeit totals at that time were close to zero) The effectiveness of deleveraging needs to be improved. It s the bad, inefficient leverage that needs to be gotten rid of. Some departments with high efficient leveraging can still add more debt. Aug-18 20

21 Two way risks: Acknowledged by J Powell (most recently/emphatically speech Fri 24 Aug 18) Traditional Phillips Curve: Behaving differently from prior cycles risk management in the face of shifting stars Scatter diagram: Unemployment rate (%) vs. wage inflation (Y-o-Y %) two opposing questions that regularly arise in discussions of monetary policy unemployment rate well below estimates.why isn t FOMC tightening more sharply no clear signs of an inflation problem.why is the FOMC tightening Source: Fed chair J Powell, 24 August 2018 Jackson Hole speech Aug-18 21

22 Global Strategic Asset Allocation (6 month 2 year global portfolio recommendation) Recommended Global Portfolio Key OW/UW positions Aug-18 22

23 Quarterly Global Asset Allocation: Performance of Recommendations Absolute performance (pp), as at end August 2018 For complementary free trial, please use enter this URL: -trial Password: tryforfree2018 Website: Quarterly Asset Allocation Performance January February March April May June July August September October November December YTD % 0.00% 0.00% 0.00% 0.00% 0.41% 6.60% -0.17% 6.59% 3.53% -2.40% 5.18% 21.05% % 1.81% 1.06% 3.42% -1.87% -0.88% 0.13% -3.96% -7.04% 7.65% -2.58% -0.62% -3.55% % 3.77% -0.99% 0.01% -5.88% 3.34% 1.76% 1.51% 2.78% -0.90% 1.11% 2.64% 14.73% % -1.46% -0.26% 1.98% -1.35% -3.77% 3.42% -1.53% 4.64% 2.82% 0.44% 0.72% 6.80% % 3.27% 0.38% 0.82% 1.57% 1.42% -1.02% 1.33% -2.26% 0.53% 1.66% -0.94% 5.33% % 3.54% -0.08% 3.08% -0.56% -2.00% -0.28% -4.17% -1.95% 4.43% -0.97% -0.31% -0.80% % 0.58% 3.16% 0.40% -0.02% 1.32% 1.54% -0.20% -0.11% -1.91% -1.29% 0.40% 2.38% % 2.15% 0.24% 1.23% 1.61% 0.13% 1.94% 0.31% 0.99% 1.31% 1.50% 1.23% 15.50% % -3.29% -0.82% 0.06% 0.59% -0.15% 1.04% 0.80% 0.00% 0.00% 0.00% 0.00% 0.71% Relative performance (pp) i.e. relative to a benchmark Quarterly Asset Allocation Performance (Outperformance, bps) January February March April May June July August September October November December YTD Aug-18 23

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