RESEARCH REPORT For June 2018
Fears of trade wars sparked again in June as the market was prepared for an escalation in the trade wars. The hostile encounters shaded over global markets and led the risk-off sentiment. American equities continued to present pleasant strength on the back of the intact backdrop in the technology sector but the road to survival was just as lonely. By and large, world equity indices delivered a tough case to have secured a fair balance in MSCI World Index last month, merely down 0.17%, amid various uncertainties. No doubt, tensions between the U.S. and China have brought additional burden to the already stressed emerging markets as money flows inevitably to the US Dollar. Still, in the near term, EM might welcome a very short rebound as soon as a technical trough is made upon recent sell-offs. South Korea UK Hong Kong India MSCI ASIA Vietnam MSCI EM Nasdaq Japan MSCI World Taiwan Germany Singapore Indonesia Dow Jones France Malaysia Thailand Shanghai Australia Brazil Russia -7.61% -8.01% -4.00% -0.54% -4.97% 0.29% -4.12% -1.08% -4.57% 0.92% 0.46% -0.17% -0.35% -2.37% -4.65% -3.08% -0.59% -1.39% -2.82% -5.20% 3.04% -0.30% -10% -8% -6% -4% -2% 0% 2% 4% 3 Tariff and Trade Battles Shock the World
Production Deals Still Take Time 12% 10.61% 8% 4% As for the rest, wheat prices fell from the previous record highs last month while gold plunged over 3%. Markets Growl under Tariff Battles 0% -4% -8% -12% -3.49% -3.21% -5.94% -7.69% Gold Crude Oil Platinum Copper Wheat Fate has set its path. Now that the first gun has been fired, we could only expect more retaliation to follow. As tariffs came into effect, trade wars shall be underway for a considerable period of time in the markets. In terms of commodities, oil outperformed the rest as it went on to soar despite OPEC+ s attempt to raise production in effort to offset the yield declines in Venezuela, Iran as well as the expansive shortfall in Libyan oil. Moreover, the compensation plan not only failed to stabilize the oil price but drew risks after using up a marked volume in the spare capacities. Consequently, the tightened market could become vulnerable to any small amount of output loss afterward Latest, OPEC+ plans to increase production by a million barrels a day but the means to achieve such target are uncertain. Meanwhile, the led in crudes brought way to the energy stocks, we could see from last page, energy-led countries like Russia gained support. 4 In the market point of view, upon the materialization of June Swoon, the negative market sentiment might continue into the summer. As said, EM shall welcome a wave of rebound shortly but the medium outlook remains blurry, dependent on trade war developments. Our preference for DM equities retains based on the strong case in the uptrend momentum and the probable optimism in the upcoming earnings season. Without a doubt, volatilities are evident but DM outlook stays intact for now. At this moment of a time, it would be necessary to keep a distance from either the overwhelming disquiet or optimism way too far. Always stick to the fundamental facts and stay away from rumors.
RECESSION ON ITS WAY? ---------------- Moving onwards to the second half of the year, global markets shall bode well the continuous tensions from geopolitics, rising bond yields and tightened liquidity. With surprising news coming one after the other, the market looks set to undergo turbulences now. What s waiting ahead of us? Howe shall we be prepared? Tentative Yields Again Brings Mess Shall anything be blamed for the mounting speculation of an economic downturn to come, that would be trade wars, perhaps the hardly-predictable ways Trump presented as well. As soon as trade war kicked off, recession worries came to light again. Many are asking if it is the time. Is recession truly on its way already? The question that draws everyone s attention only rose to the horizon when fears of an unprecedented war between the two largest powers on earth drove yields mad. Note that the yield differential between 2 and 10-year U.S. government bonds has been narrowing near the zero line and the downtrend sped up in recent weeks. 5
Over the recent days, this particular yield advantage of long over short term securities has been running under 30 base points. Shall an inversion (i.e. short over long term) come up, the warning would come clear, the validity of which is verified by history. As shown, a crossover like that appeared every time in advance of a recession (Notice the shaded areas). The time gap between the inversion and the NBER-recognized start of recession ranges from 9 to 23 months and tends to be generally broader over time. Start of Recession Inversion 2Y/10Y Lead in Months Jan-80 Jul-81 Jul-90 Mar-01 Dec-07 Sep-78 Nov-80 Jan-89 Feb-00 Feb-06 16 8 18 13 22 Sources: Fed, Global Insight, NBER, Commerzbank Research; July 2018 So, perhaps there s simply no need to worry so soon even for a flattening curve as such a recession would still take a year or two after an inversion is made. After all, here we are discussing things that might only be possible after an inversion. Especially in time of a dynamic global taper tantrum, the growing recession speculation could be great headache for central banks. For instance, though trying to be as confident about its policies and the economic outlook as much, the Fed is still a lot bound amid volatile politics and other external risks. To price in all the external factors and market signals like the flattening yield curve, the Fed s rate hike path would certainly need to take more discretion into account. Speaking of the external factors, apart from the technical signals, markets are also particularly vulnerable to political chaos and their relevant big changes. The graph indicates clearly that the recessions tend to come amid hiking political uncertainties. This year, trade tension haunted the equities and caused multiple sell-offs. Though the sell-offs were impromptu, investors would still need to take the precaution. Given the troubled uncertainties and tentative yield curve, a recession might come in the foreseeable future. Yet the still intact uptrend in DM equities, especially in the U.S., suggests for a strong fundamental backdrop for now. In addition, the still low rate 6 environment provides more ground for a positive outlook, at least for the year ahead.
EUROPEAN ECONOMIES CONTINUOUS DOWNTURN HOLDS ECB STILL Despite the confidence the ECB held in the inflation outlook, in which the Bank believed warmth would come along, the data suggested the otherwise. Further, the confirmed exit to its bond purchase program has shed some concerns in the market. June s consumer prices proved that the previous growth in inflation was solely due to the push from elevated oil prices. 3 2 Ann. Inflation Ann. Core Inflation 3 2 Apparently, the underlying inflation is still building up slowly notwithstanding the long economic recovery and low unemployment but not as fast-growing as the ECB had predicted. 1 0-1 2012 2013 2014 2015 2016 2017 1 0-1 Last month, CPI headed up to 2.0% whereas 65 65 that less energy and food fell back to 1.0% from the prior 1.1%. 60 Service Industrial 60 Meanwhile, trend still points down in most growth parameters. There, the manufacturing sector continued its retreat where the PMI stood at 54.9, compared to the previous 55.5. The reading again refreshed the record to mark the slowest expansion since December 2016. 55 55 50 50 2015 2016 2017 2018 To sum up, above figures were indicative in suggesting a constant rather than one-off weakness is in the region s growth. 7
In wake of the downtrend in growth, the European Central Bank is forced to stay put on keeping the monetary environment as loose as it could and to hold its rates low until September 2019 the earliest. Besides, the Bank admittedly lowered its real GDP growth projection for 2018 to 2.1% on these grounds. There are two factors to be blamed for the weakness. On one hand, the strong Euro since early 2017 has been hampering businesses in price competitiveness. On the other, Trump s protectionist policies could bring more harm to the industry sector. May Left to Cheer or to Cry? The renowned Euro-skeptic Foreign Secretary Boris Johanson followed suit hours after Brexit Secretary David Davis resigned. Clearly, their departures calls for protest against Prime Minister Theresa May s Brexit plan which appeared to be too soft to accept for the two hardliners who wanted to gain more bargaining power in Brexit negotiations. Regardless, this would now increase the likelihood May could get her government to accommodate the Brexit compromise. It might be true that the focus on economic integration over a clear-cut Brexit could be positive for the economy. However, sacrificing the negotiation power with the EU could challenge May in her own government, pointing to a greater instability within the UK. In light of the uncertainties, investors would tend to be wary of taking large bets thus we are neutral on GBP for the time being and expect rather muted moves based on a blend of upside and downside factors. In general, we remain neutral on European equities based on the combination of various political turbulences including Brexit and cheaper hence more beneficial valuations than the U.S. stocks. As such, the market could hardly be at ease at the moment given the potential threats this might bring. And the reaction of the EU 8 remains unclear.
THE UNITED STATES INFLATION CONTINUES TO RESURFACE Broadly speaking, most growth measures satisfied but the industry sector revealed some impact from the ongoing trade disputes with China. More details follow. In June, the U.S. manufacturing PMI stood at 55.4, down from the record fast expansion of 60 60 56.4 in May but still an upward revision from 55 55 the preliminary. Within, factory activity went slower. 50 50 Meanwhile, the escalating trade conflicts haven t yet slowed U.S. employment. In June, non-farm payrolls added 213K while the unemployment rate surprised to 4.0% and wage growth remained moderate at 2.7% In the labor market, the month created more jobs than expected but steady wage gains pointed to moderate inflation pressures that should keep the Federal Reserve on gradual rate hikes for now, hence possibly lowering rate hike anticipation. Noteworthy, the annual inflation rate edged up to 2.9% in June, this set a new high in years but was mainly the mere result of the heightened oil and gasoline prices. Meanwhile, the core inflation rate met the market expectation and ended at 2.3%. All in all, the U.S. shall be leading most other 9 economies at the moment and that paves good grounds for the market performance. 45 400K 350K 300K 250K 200K 150K 100K 50K 3 2 1 0-1 Industrial Service 2015 2016 2017 2018 0K Non-Farm Payrolls Gwth (Left) Ann. Jobless Rate (Right) Avg Hrly Rates Growth (Right) 2012 2013 2014 2015 2016 2017 Ann. Core Inflation Ann. Inflation 2012 2013 2014 2015 2016 2017 45 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 3 2 1 0-1
In sense of fundamentals, the ongoing trade tensions could cause more fluctuation in the U.S. stock market and but various technical parameters still point to a positive outlook. Fed s Hands Tied under Trump s Policies You might call him a madman but you cannot criticize him for inactivity. To the contrary, Trump has already fulfilled a long list of his election promises in less than 2-years time, whether be economically counterproductive or beneficial. Whatever his deep-down intentions are, the protectionist policies might help win his November s mid-term election. Under such turbulences that Trump made lately, the Fed became more bound than in early June. Therefore, the likelihood for four rate hikes this year might possibly lower. Still, a combination of trade tensions and rate hike anticipation, though lower, tends to further strengthen the greenback. As of writing, the USDJPY pair hits 112.2. In equities, SPX is now likely to extend the uptrend given the positive momentum as shown and might test January s highs. As support, 2,680 would be the short-term key where the 200-day moving average lies. Sector-wise, CCMP has long been the victor since 2017 s start. Also given the upcoming earnings season, the rapid growth is expected to continue the drive to technology sector s outperformance. Worth looking at, RTY outran SPX lately, mostly likely due to the fact that the smallcap sector is largely based on domestic business and thus more tolerant to international trading risks. Despite the uneasy atmosphere, we stay positive on the U.S. equities especially the technology and small-cap sectors as mentioned above. Adding that the uptrend structure still stayed intact amid the earlier turbulences, we believe that the market tends to gain 10 increasing momentum now.
CHINESE ECONOMY HARDER WORK TO BE DONE Under trade tensions with the U.S. and the transforming economic structure of the country itself, the economy is expected to suffer in the near term. Still, recent data signaled fair surprises in different sectors to suggest abundant domestic consumption. In June, Caixin China manufacturing PMI only dropped slightly from the previous 51.1 to 51 latest. Still, the reading indicated a further marginal advance in operating conditions and marked rise in output and new orders. 60 55 50 Industrial Service 60 55 50 In terms of trade, the trade balance widened to $41.6 billion, well above the previous $24.9 billion. The further upside of trade balance might be another trigger to the already tense trade relations with the U.S. Meanwhile, foreign reserve headed a little up to $3112 billion last month. Meanwhile, the inflation momentum remained soft in June in which CPI climbed 1.9% on year. More importantly, PPI jumped 4.7% annualized last month, continuing the strong momentum in the past few months. After all, there are still uncertainties to be cleared out. Any tariff and further trade policies the U.S. or China further act on would definitely bring significant impact to the economy. 11 45 2015 2016 2017 2018 $80B $60B $40B $20B -$20B -$40B 12 8 4 0-4 -8 $B Trade Balance (Left) FX Reserve (Right) 2012 2013 2014 2015 2016 2017 Ann. PPI (Left) Ann. Inflation (Right) 2012 2013 2014 2015 2016 2017 45 $3.7T $3.3T $2.9T $2.5T 4 3 2 1
This June was definitely one of the months China would have chosen to avoid. Owing to the hit the equity market took from new implementation of tariffs, Shanghai Composite Index plummeted over 8% to close at 2,847 whereas Renminbi fell over 3%. After all, it is unavoidable to see growth to slow as a result of the accelerated deleveraging since last year. Adding that the authorities have no will to ease the financial tightening schedule, we believe the weakening effect would continue into the next year. Before the trade war, the equity market climate was basically supported by the strong global growth in both DM and EM, which actually allowed for a stable environment where China could focus on their structural reforms, raising the focus on quality over quantity at the same time. However, focusing on quality doesn t erase the fact that the productivity and direct trend growths would be harmed in both trade exports and domestic growth. Bearish Outlook Pending in EM and Asia Entering the latter part of 2018, investors has shifted their focus and are taking more in the negative than positive news, distorting the once-resilient market. With the ongoing trade tensions, the Chinese government would be bound in its reforms. If it insists to pursue the reforms around the clock, it would be doubtless that the economy shall brace for a short-term shock, affecting the employment along. However, once it stops restructuring, China would lose the chance to create new growth incentives. Therefore, the short-term shock to the country s economy would be inevitable. Now that we saw different signs of warnings in EM and Asian markets, like the frequent death cross (i.e. a shorter-term moving average lower than the longer one) and strong downside momentums in a few stock markets, we believe that the outlook would 12 likely turn bearish in a reasonable time.
TRADE WAR, JUST A START --------------- Soon upon the escalation of the tariff tit-for-tat, the U.S. finally imposed a total of $200 billion in Chinese imports, which largely includes half of all imports from China. Though surprising enough, is there light of any kind of settlement sooner or later? Or would it be simply an outbreak of a world cold war? As discussed earlier, if trade war is simply another election campaign of Trump for his mid-term election in the coming November, this may probably last for a while and end reluctantly by then. Before that, in the short run, we could hardly predict how an end would be brought upon. Therefore, we believe that concerns would soon cool off after most concerns have been effectively reflected in the markets. Now What? Said tariffs would be effective by August-end with two public consultations beforehand. That means, if any sort of settlement or surrender would be made, there s time. To see if there would be any further escalation or back down, it would be in the EU s hand. 13
Impact on Global Economy So, now what? Though the fight is between the U.S. and China, the consequences and the indirectly relevant parties are of the entire world. For now, the two countries are on a tight standoff, the European Union s response would be most crucial as that would represent the key opinion outside-leader. Whether the EU would give a helping hand to China or to slave China s trade misdeed together standing by the U.S. is still unclear. Before the outbreak of the trade war, most were simply worried but didn t truly believe for a fully-blown war, basically meaning many might not be prepared to brace for the loss. Now that it truly realized, it might be time for us to sit back and lay out all the preparations, at least analyze the risks before us. Anyhow, it is not the end of the world after all. While looking into what developments the trade war would turn into, we would have to analyze what possible directions there are. Frankly, both sides could hardly back down, especially after all the harsh words Trump said earlier which would shame him be the first surrender. In any case, Trump s domestic support improved after the trade war, thus we believe such a risky election campaign might 14 last through November. So, we might expect GDP be dampened by the loss in global trades. We believe that the consequences would be soon be revealed in the earnings and economic data in the coming months. And that would be of paramount weight as from the graph below, data showed that global growth already surprised downward in the recent months. Yet, for now, as we hardly see any tendency of a further escalation, we tend to believe the impact on the economic surprises would be temporary, merely in effect of the recent outbreak of the trade war. We believe, the major push for the market would still be the economy and corp earnings in the near term. Now, we remain fond of DM equities, especially on the growth-based sectors including technology as well as consumer discretionary as they turns out to be more tolerant to trade wars, major in domestic businesses.
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