GLOBAL ECONOMICS & MARKETS
ANDBANK CORPORATE REVIEW July 2017 Alex Fusté Chief Global Economist +376 881 248 Alex.fuste@andbank.com
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
JULY 2017
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Contents Executive Summary
3
Country Pages US
4
Europe
5
Spain
6
China
7
India
8
Japan
9
Brazil
10
Mexico
11
Argentina
12
Equity Markets Fundamental Assessment
13
Short-term Assessment. Risk-off shift probability
13
Technical Analysis. Main indices
13
Fixed Income Markets Fixed Income, Core Countries
14
Fixed Income, European Peripherals
14
Fixed Income, Emerging Markets
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Commodities Energy (Oil)
16
Precious (Gold)
17
Forex
18
Summary Table of Expected Financial Markets Performance
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Monthly Asset & Currency Allocation Proposal
20
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
JULY 2017
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Executive Summary US - Yellen stated in her press conference that the balance sheet plan could be put “into effect relatively soon”. The announcement of a detailed balance sheet proposal, along with Yellen’s words lead us to expect that the FOMC will probably start the cuts in September. We see the Fed unwinding cautiously– akin to crossing the river by feeling the stones. S&P Equity Index: CAUTIOUS (EXPENSIVE); exit point remains unchanged at 2456. 10Y UST bond: CAUTIOUS (EXPENSIVE). Fundamental target for 10Y UST yield at 2.68%. Corp credit - CDX IG index: EXPENSIVE. Target at 70bps. CDX HY Index: FAIR VALUE. Target at 323. Europe - We currently believe that the favorable economic data could continue until the end of the year. This, along with technical reasons (key capital rules), will put pressure on the ECB to abandon the stimulus. However, even if this materializes and looking forward to 2018, there are still some key aspects that concern us, with serious doubts about the ability of some states and banks to handle the exit of the ECB. We are therefore keeping our yield targets for peripheral bonds well above current levels. STXE600 Europe Equity Index: FAIR VALUE Target: 368; exit point at 405. IBEX: FAIR VALUE/CAUTIOUS. Target 10,116; exit point at 11,128. European Bonds: NEGATIVE (EXPENSIVE). Targets: Bund 0.70%, IT: 2.3%, SP 1.9%, IE 1.4%; PO: 3%. Corp. Credit Corp. Credit: CAUTIOUS (EXPENSIVE). Investment Grade entry point at 80bp (current 52pb). High Yield entry point at 350bp (current 245pb). China – The unexpected strength of the renminbi is making news. Chinese Ashare were finally accepted into the MSCI. Equity Shenzhen Composite Index: POSITIVE. Fundamental price 1,979; exit point at 2,078. 10Y Govt Bond: POSITIVE, y/e target yield 2.9%. FX CNY: FAIR VALUE. target at 6.75-6.80. India – With 270 million new bank accounts recently opened and presumably many new accounts after the demonetization, there has been a huge mobilization of savings that may unleash growth and lower interest rates. Equity India Sensex Index: FAIR VALUE (MAINTAIN). Fundamental price 29,958; exit point at 32,953. 10Y Govt Bond: POSITIVE. New year end yield target at 5.5% from 5.7%. Japan – Banking watchdog to loosen regulatory oversight. Topix seems to be performing rationally again. The balance of money market funds (MMF) dropped to zero at the end of last month leading to the abandonment of this asset class after its introduction 25 years ago. Equity Nikkei Index: CAUTIOUS (EXPENSIVE); exit point at 19,528. 10Y Govt Bonds: NEGATIVE (EXPENSIVE). 10Y bond target 0%. FX JPY/USD: EXPENSIVE. USD-JPY fundamental target at 115. Latam –Political situation remains delicate in Brazil but Temer resists. Brazil Bovespa Equity Index: NEGATIVE (Short Term), POSITIVE (Long Term); exit point at 69,744. Mexico IPC Equity Index: FAIR VALUE; exit point at 52,400. Government bonds: Brazilian 10Y bonds POSITIVE (Targets: 9.75% in Loc, 5.25% in USD). Local Mexican Bonds POSITIVE (Target 7.0% in Loc), USD Mexican bonds NEGATIVE (target 4.30% in USD). Argentinian Global bonds in USD: NEGATIVE (Target yield 7%). FX targets: BRL 3.25, MXN 19.75, ARS 18.
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
US:
JULY 2017
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Asset reductions as a tightening tool? Crossing the river by feeling the stones
Do you feel dizzy? Monetary conditions are clearly accommodative while fiscal policy is neutral
Democrats
Republicans
Democrats
Growth in the US could keep pace but the structural shape is now vulnerable
FED The Federal Open Market Committee raised rates 25bps at its June meeting. President Kashkari of the Minneapolis Fed dissented again. The committee released an addendum to its policy normalization principles which laid out a relatively hawkish balance sheet policy with caps gradually rising to $50bn per month over the course of the next two years. Importantly, at her press conference Yellen stated that the balance sheet plan could be put “into effect relatively soon”. The announcement of a detailed balance sheet proposal, along with Yellen’s words lead us to expect that the FOMC will probably start the cuts in September and postpone a third rate hike in early 2018 given the disruptive stand-off around the debt ceiling that could last longer than expected. White House The chance of an impeachment has shifted from negligible to nonnegligible and this has weighed on the dollar index. Nevertheless, the Republicans’ firm control of both houses of Congress leads us to expect that this risk will dissipate and the dollar could regain ground later. US growth is likely to accelerate The US growth has been rather modest so far this year. Real GDP grew only 1.2% in Q1 although this was probably another instance of the wellknown Q1 downward bias. We still expect economic recovery to show a Q2 tracking around 2.5% and we see FY US GDP growing at 2.3%. Sentiment: The University of Michigan’s consumer sentiment index fell to 94.5 (-2.6points), a seven month low. The expectations component led the decline, falling 3.0 points to 84.7. Industrial production was unchanged in May, as a rise in mining and utilities output offset a 0.4% decline in manufacturing production (2.0% drop in motor vehicles and parts production and a 0.7% decline in the capex-sensitive business equipment category). Prices: We revised our inflation projections down to 2% After two consecutive disappointing months, core CPI inflation came in below expectations again in May, rising just 0.1% MoM (the lowest core CPI inflation print since April 2013). The YoY reading slipped further to a two-year low of 1.7%. Many FOMC officials have noted that recent soft inflation prints were driven largely by one-off factors, but the latest figure should instill some doubts that we are approaching the 2% target. Reform agenda & Trump’s bonus The ability of President Donald Trump to push through comprehensive tax reform has diminished markedly, which may result in the passage of simple tax cuts. Given the differences among members of President Trump’s own party, even this task may prove difficult without potential support from some Democrats. Failure to make some sort of progress on tax policy could not only weigh on financial markets, which have rallied on expectations of tax reform, but also harm Republican chances in next November’s midterm elections. Financial Markets: Equities (S&P): CAUTIOUS (EXPENSIVE). Target: 2,233. Exit point at 2,456. This was a strong reporting season in terms of companies beating consensus on EPS and sales, or companies raising guidance. Negative aspects: (1) The uplift to 2017 EPS growth expectations is not quite as apparent today as it was earlier in reporting season. (2) Uncertainty associated with Washington policy does not help. (3) Post election, broad market direction has been tied to trends in Trump’s favorability, and we see risk of disappointment on the policy front. (4) Valuations are back at the top end of their historical range, with forward P/E still around 18.8x, off its recent highs of ~19x, but not cheap yet. (5) We still think progress on corporate tax reform is needed to sustain higher incremental moves and we are concerned that investor expectations on the size and timing of corporate tax reform may still be overly optimistic. In sum, we remain concerned about the potential for a pullback or sideways move in the broader equity market in the months ahead. Bonds: CAUTIOUS (EXPENSIVE). UST10 target 2.68%. The Fed is proceeding with its policy normalization, yet weak inflation had a larger impact on rates. The Fed has never before used asset reductions as a tightening tool. As such, we see the Fed unwinding cautiously– akin to crossing the river by feeling the stones. The disconnect between Fed normalization and falling long-term rates is partly a result of markets overly focusing on softening inflation data, while the Fed focuses more on the outlook. This dynamic could persist but we expect an acceleration in US growth ahead, meaning the impact of the Fed's pace of normalization may be greater than bond markets currently anticipate. Global demand for income, fueled by still globally accommodative monetary policy, should help limit yield spikes. Credit: CDXIG: EXPENSIVE Target 70 CDX HY: FAIR VALUE Target 323
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
Europe:
JULY 2017
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ECB’s tapering is expected to be openly discussed in 2H 2017
Although low, the growth structure in the Euro area seems more balanced than in the USA
ECB: first steps towards normalization The June meeting included a change of risk assessment: from risks “tilted to the downside” to a “broadly balanced view” regarding growth. In addition, the ECB changed its forward guidance on rates by eliminating the possibility of lower rates taking deflation risk off the table. Next moves involve tapering which we expect to be openly discussed in the second half of 2017 as we get closer to 2018 when scarcity problems could arise. What next? (after the ECB abandons its stimulus) At the moment we believe that the favorable economic data can continue until the end of the year. This, along with technical reasons (key capital rules), will put pressure on the ECB to abandon the stimulus. Once this materializes, and looking forward to 2018, there are still some key aspects that concern us. In Italy, political risk needs to be considered (the coalition of the Liga Norte and Forza Italia won in 13 out of 25 cities in the municipal elections). Even more worrying is Italy’s banking problem, still unresolved. After the government’s bail-out of Vicenza and Veneto, the total NPL will be set at 332bn, meaning that aggregate NPL ratio will barely improve from 17.3% to 16.45%. If we add that the common equity tier one ratio will remain similar to the one seen as of Friday 23rd (proven that these two banks have been considered as “not relevant” by the EU’s Single Resolution Board”) it will be fixed circa 11.5%, still some 2pp below Eurozone average, and suggesting that the Italian banking system’s position is certainly precarious. Banca Monte dei Paschi di Siena, the third largest bank, has found it impossible to raise more capital from the market. (after burning through €12bn of new capital since the onset of the financial crisis). A proposed €5bn rights issue from BMPS fell through in December. Against this backdrop, we have serious doubts about the ability of some states and banks to handle the ECB’s exit and we are therefore keeping our yield targets for peripheral bonds well above current levels. Macro Front: broad-based recovery along with low prices In terms of growth, better prospects have led the ECB to slightly revise GDP figures upwards for the 2017-2019 period. Two questions are on the table: How long can the optimism last? Will hard data follow the positive trend in soft data? On the fist issue, we have seen PMI levels such as the current ones previously in 2010-2011, which remained at that level for over a year, so if the past is any guide, steady expansionary levels could still be present at the end of 2017. Sentiment and data are coming together and this trend may continue in the coming months: PMIs and industrial production on the rise; retail sales upbeat along with supportive high consumer confidence. Inflation figures remain “choppy”: May data (both headline and core CPI) fell having picked up in April and could well stay around these levels for the rest of 2017. New “ECB mantra” from Draghi: “patient, confident and persistent” regarding the inflation recovery. Politics: Brexit talks start • France: Macron’s party has just won an absolute majority in the French Parliament. En Marche, has outlined a reform agenda, kicking off this summer with the labor reform. As Oddo’s analysts stressed, it may be useful to decentralize the negotiations of labor conditions at the company-level and ease regulations to lift some obstacles to recruitment. But these factors are not the sole culprits in stifling economic activity. There is also France’s record level of tax pressure, needed to finance an unprecedented level of government spending, bearing little resemblance with that of its neighbors. The information which has been unveiled regarding Emmanuel Macron’s proposed reforms contains nothing targeting a genuine overhaul of the state’s role or a reduction of public spending. • As for Italy, rumors regarding the call for early elections in September were watered down as the different parties failed to reach an agreement on the electoral reform. Financial Markets Outlook Equity (STOX 600): FAIR VALUE. Target: 368. Exit point at 405. Bonds: NEGATIVE (EXPENSIVE). With the ECB’s tapering issue gaining relevance in 2H17 bonds could struggle. We stick to our targets for 2017: Bund 0.70%, IT: 2.3%, SP 1.9%, IE 1.4%; PO: 3%. Credit: Itraxx IG: EXPENSIVE. Target 80. Itraxx Xover (HY): EXPENSIVE. Target 350. Spreads continued to narrow in both IG and HY on the back of reduced political risk, earnings optimism, low yields and low volatility. A Spanish bank was bailed-in with its sub-debt erased, but with a very positive market reaction (with financials narrowing considerably). The message: No contagion risk and boost to the credibility of the EU’s management framework for banking crisis.
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
Spain:
JULY 2017
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More upward revisions for GDP growth
BRL seems to be trading at fair value
Economic outlook Another month and another economic institution upgrades its estimates for Spanish GDP growth. The Bank of Spain has raised its projections for GDP growth to 3% for FY2017 and 2.5% for 2018. This move is much in line with our last month upward revision of our FY2017 GDP Growth target to 2.7%, on the back of improved Gross Fixed Capital Formation in the first quarter. Fixed Capital formation is a necessary condition for further economic growth in the future. In fact, recent figures show that manufacturing orders are performing much better than initially expected, with broad-based positive readings, from energy through to capital and durable consumer goods. Unlike last year, when the bulk of the economic improvement (employment) came from the services sector, partly because the industrial side of the economy was deleveraging and cutting its workforce to maintain ROIs, this year looks like a bit different with demand for intermediate goods skyrocketing in Q1, resulting in a much broader recovery on the employment front. Political Risk We already have new polls on intended voting, with recent corruption issues affecting the governing party and the new leader of the PSOE (the main opposition party in Congress) being the main potential drivers in the political arena. Watching these initial projections from the polls, we still think that neither of the two main parties are in a strong enough position to call for early elections. We do not consider the risk of a new motion of no confidence (this time promoted by the PSOE) to be high, with 176 votes in favor required to succeed. PSOE and Podemos could contribute 156 (85+71) which would require additional support (20 seats) from nationalist parties, which we do not see. We have already assumed that no party will have a clear majority over the next few years, although we are now more confident that “pro-reform� parties (PP, Cs, PNV, CC) could improve their joint results in the next election process. They currently have a combined 175 members, with the latest polls giving them 180+ members. Labor Market Solid labor market data in June. While it is usually a positive month due to the strong creation of employment in the service sector, it is worth mentioning that job creation has been broad based across many sectors. The only negative aspect is that most of the new jobs created are temporary (91% of the new contracts registered in June). Said this, the figure brings us closer to the official goal of unemployment rate of 16.5% between now and the end of the year. PGE 2018: A tax cut ahead? To be discussed after summer vacations but the PP does seem to already have the support of Ciudadanos, once reached an agreement to cut taxes on lower incomes and more family support. There is also the increase in the ceiling of non-financial public spending by 1.3%, already approved in Cabinet. Upcoming improvement from rating agencies? Although last week Moody's left unchanged its vision on the Spanish debt prospects, there is the likelihood that the S&P could revise the Spanish rating in September. Financial Markets: Equities (Ibex): FAIR VALUE/CAUTIOUS. Target 10,116. Exit point at 11,128 We maintain our year-end target, despite the positive news on labor and financial costs. We already have data from the National Statistics Institute for the first quarter and labor costs have been one of the main surprises, which could directly impact our profit target. However, we prefer to wait for Q2 results to hear directly from companies that their costs are not going up before revising our target on profit margins (8.3%).
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
China:
JULY 2017
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More optimism about A-share acceptance into MSCI
China will continue being a global exporter of deflation
PBoC has been selling Treasuries during most of 2H16, and this could explain the rise in the 10YUST yield. What if the PBoC stops selling Treasuries? Look at the recent performance of the UST.
FX: Surprising strength of the renminbi is making news Over the last month and a half the renminbi has appreciated 1.48% against the US dollar in the onshore market, and 2.48% in the offshore market. It seems as if China wants to send a set of signals about its currency. The central bank has once again decided to show nefarious currency speculators who’s the boss and put the squeeze on market speculation just after Moody’s downgraded China’s sovereign credit rating—a move that, admittedly, incited a spate of negative press coverage of China’s financial problems, just as the government was trying to show it was taking steps to fix them. It’s worth mentioning that there weren’t actually any speculative attacks on the renminbi. The PBOC wants to send a message that Fed rate hikes will not put significant pressure on the renminbi. Short-term interest rates have already risen considerably in China and the recent tightening of financial regulation has also meant a de-facto tightening of financial conditions. The PBOC could be trying to signal a longer-term shift in its currency strategy. Over the past year and a half the PBOC pursued an “opportunistic” strategy. During periods of dollar weakness, the renminbi was stable against the dollar and so followed it down on a trade-weighted basis. However, when the dollar was strong, the renminbi was allowed to depreciate a certain amount, meaning that the renminbi appreciated less intensively on a trade-weighted basis. This strategy meant that the CNY was among the most stable EM currencies against the USD. A more balanced currency strategy that allows the renminbi to rise against the dollar—not just stay stable—during periods of dollar weakness could be a more effective deterrent to capital outflows and a greater enticement to capital inflows. Market changes Chinese A-shares were finally accepted into the MSCI (having been previously rejected on three occasions over concerns about restricted access to Chinese markets). The likelihood of inclusion dramatically increased after the criteria were relaxed this year. Macro Front Economy steadies on structural upgrade: National Bureau of Statistics emphasized that China's economic growth held steady during the first five months as key service indicators rose rapidly. NBS data showed service sector growth remained stable in May at 8.1% YoY. Fixed Asset Investment growth was +8.6% YoY while retail sales grew +10.7% YoY in May. Chinese employment stable: National Bureau of Statistics data showed that some 5.99M new jobs were created in China's urban regions from Jan to May, up 220K from the same period last year. The NBS reported a 54.4% completion of the 11M annual target. China added 13.14M jobs in 2016 while the urban jobless rate stood at 4.02%. Power consumption continues to rise: National Energy Administration (NEA) data showed China's electricity consumption reached 496.8kWh in May, up 5.1% YoY. YTD consumption was up 6.4% YoY. According to the NEA, service sector usage jumped 10.7% YoY, outpacing growth in the industrial (+3.9%) and agricultural sectors (+4.4%). Reforms Tighter credit conditions: Banks have started to increase lending rates again as a result of tight liquidity. Aside from mortgage rates, banks have also raised preferential rates for qualified clients, driven by deleveraging and tighter regulations on banks' credit quotas. Vacancy at insurance regulator: The China Insurance Regulatory Commission (CIRC) has been without a chief for over two months amid Beijing's corruption crackdown. Former head Xiang Junbo was placed under a corruption investigation in early April. House prices cool on tough controls: The Chinese Academy of Social Sciences’ report showed house prices in major cities rose just 1.11% MoM last month, down from 1.2% in April, while prices in Beijing fell 4.09%, accompanied by lower prices in neighboring cities. A spate of measures introduced in the past few months, including higher downpayments and increased mortgage rates (up 10-20% for second home purchases while around 20 banks have stopped issuing mortgage loans) are aimed at reining in house prices and quash potential asset bubbles. Financial Markets Equity (Shanghai): FAIR VALUE. Fundamental price 3,226. Exit: 3,387 Equity (Shenzhen): POSITIVE. Fundamental price 1,979. Exit point at 2,078 Bonds: POSITIVE. 10Y bond target 2.9% FX (RMB): FAIR VALUE . USD-CNY fundamental target at 6.75-6.8
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India:
270 million new bank accounts open! The mobilization of savings may unleash growth and lower interest rates.
This is essential for the stability of the currency
One of the best forms of exposure to India is fixed income instruments
GDP growth is the highest within the EM category (both in q/q and YoY terms)
Analysts misunderstood some of Modi’s decisions India was considered to have shot itself in the foot when highdenomination bank notes were abruptly demonetized, eliminating 85% of the cash in circulation in one fell swoop. Critics failed to realize that the goal of demonetization —forcing the country’s vast “savings under the mattress” into the formal banking system— could also sow future growth. With 270 million new bank accounts opened in the past three years, the mobilization of savings may unleash growth and lower interest rates. Of course, India is everyone’s favorite EM equity market now, which causes us to wonder whether valuations are somewhat stretched? Not necessarily. A comparison between the leading online travel agencies in the US, China and India shows that India’s “Make My Trip” has the lowest valuation, despite having the brightest growth prospects. Supportive recent developments Oil price: Lower commodity prices are good news. Rather than signaling weaker demand, they reflect more accurate pricing of abundant supply and the liquidation of speculative long positions. The dollar: In spite of rising US rates, the dollar appears to have rolled over and spent the year setting lower lows and lower highs. The fact that the dollar is at best range-trading and at worst weakening, even as the Fed hikes rates and prepares to shrink its balance sheet, suggests that EM currencies are now a much safer bet than in the past few years. Synchronized growth globally: Cyclical growth measures have picked up globally, as shown by the OECD’s latest composite leading indicator. Historically, such an upturn in the developed world has been a reliable signal for identifying turning points in Asia’s growth and profit cycle, especially in India. Economic growth in EM Asia has historically tracked world trade growth closely (see chart 2). Since Asian firms typically work in globalized supply chains, their earnings and investment cycles are disproportionally impacted by changes in global demand. EPS growth has soared in EM: So far this year, upward EPS revisions have been stronger in both MSCI EM and India’s Sensex than in any other major regional index. At 19%, EM earnings growth is now stronger than any index. Some might argue that the recovery in EM EPS is built entirely on Chinese reflation and is doomed to falter once Chinese growth inevitably slows in 2018. But the fact is that EM balance sheets are strong and consumer spending is now a solid growth driver, especially in India (see chart 3). Foreign investors are calling for Indian debt market to join global indices Foreign portfolio investors (FPIs) are once again pushing to make India part of the global bond indices (created by index providers such as JP Morgan and Barclays). This was done in recent interactions with the Securities and Exchange Board of India (Sebi), during the latter's roadshows to countries such as the US and the UK earlier this year. According to sources, Sebi has informally indicated to these investors that this is a difficult issue considering the apprehension around the volatility that such a move could generate in the bond market. India first began talks with global index providers in 2013 but abandoned its plans to be included in their indices a year later over differences on removing restrictions on capital flows into the bond market. The government as well as the RBI may not be in favor of making a pitch for India's entry into global bond indices at this juncture. Why? Unlike in 2013, India is in much better shape with regard to the stability of its currency and its current account deficit situation, and is seeing robust inflows into the debt market. So, there is no immediate need to relax the limits in the bond market (FPIs have pumped $12.9 billion into the debt market in the year to date). At present, India has hard limits imposed on the quantum of investments in G-secs and the corporate bond markets. As of May, FPIs had utilized nearly 81% of the total investment limit for G-secs and 85% of the corporate bond limit. The RBI had raised the FPI limit on investment in government bonds in March. Reforms The Government of India has emphasized that the Goods and Services Tax (GST) is scheduled to come into effect on 1 July 2017. Preparations are in full swing for a smooth implementation of the landmark tax reform. Financial Markets Equity (Sensex): FAIR VALUE. Fundamental price 29,958. Exit point in 32,953 NEW! Bonds: POSITIVE. 10Y bond target at 5.5% (from 5.7%) FX: FAIR VALUE
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Japan: Banking watchdog to loosen regulatory oversight. Topix: Back to rationality
Sanity
Insanity
Insanity
Sanity
Corporate profits & Equity market: A quick assessment If we believe that equity returns must follow corporate earnings over the long term, then it is relatively simple to assess whether the equity market has behaved rationally during the intervening period. We would underline the following conclusions from our findings: i. There have been three distinct episodes in the last 40 years: 1) 19781985, when the stock market followed corporate profits and therefore behaved rationally. 2) 1985-2003, when the stock market bore no relationship to corporate profits and the market was totally irrational. 3) Since 2003, when the market has followed corporate profits and appears to be rational again. ii. If we rebase both the Topix index and corporate index to 100 (base 1978), we find that the market is at 435 and earnings are at 420. Both are at a very similar level, which allows us to say that the market has normalized and is now behaving sanely again. Conclusions & Outlook: The great bull market during the 1985-2003 period (dubbed the “Insanity period”) was largely explained by the collapse of both the Plaza and the Louvre Accords. In February 1987, Eduard Balladur (French finance minister) hosted an international conference in the Louvre to consolidate the results of the 1985 Plaza Accord, under which the G5 developed economies had agreed to appreciate their currencies against the US dollar. The Louvre Accord stipulated that the yen and the deutsche mark would only be allowed to move within a controlled band. Neither the Germans nor the Japanese fulfilled their part and both currencies continued to depreciate in real terms (see the chart 2 in the case of Japan). This prompted two supportive factors for the Japanese equity market: 1) A low yen in real terms helped exporters in an extraordinary way and, with this, their respective export-oriented equity market. 2) At the time, the Japanese were printing mountains of yen (causing inflation to rise See chart 3). This yen was trapped in Japan (by expectations of a future revaluation in line with the Louvre Accords). All of this money was channeled into the financial markets and Japan entered the mother of all bubbles (of course, a bubble is nothing but an uncontrolled rise in PE ratios). Outlook: Similarly, the fact that the JPY is no longer cheap in real terms (in fact a little bit expensive) is causing the Topix index to trade rationally again and follow corporate profits. Thus, good EPS forecasts in Japan will give higher estimates for Japanese equities performance. Japan is back in the real world, with multiples back to pre-86 levels. Moreover, these are close to the bottom of their historical range during rational periods, so do not expect big declines in PE ratios. Structural Changes The balance of money market funds (MMF) dropped to zero at the end of last month from ~¥1.6T before rates turned negative. Money managers have progressively pulled out of the market as the BoJ's negative rate policy lowered bond yields. An NHK report noted that this asset class has effectively disappeared since its introduction 25 years ago. BoJ & QQE Kuroda: “The Bank of Japan is set to keep monetary settings unchanged and reassure markets it will lag way behind the Fed in dialing back its massive stimulus program”. A majority of economists expect BoJ Governor Kuroda to get a second term after his current one ends in 2018. Banking watchdog to loosen regulatory oversight The Financial Services Agency is preparing to loosen its oversight of the banking system in a bid to improve credit flow and channel more funding towards the real economy. The FSA's changes include scrapping the manual for bank inspections introduced in 1999 following the bursting of Japan’s asset bubble, which the aforementioned article blamed for curtailing lending activity. The FSA is keen to unlock the more than ¥700T in bank deposits that have been accumulated since then. Macro Front GDP 1Q17 revised: 1% SAAR (from 1.4%) Bank Lending: 3.2% YoY Retail Sales: 3.2% YoY; Total Household Spending: -1.4% YoY LEI: -1.2 (from 0.8). CEI: 3.3 (from -0.6) Financial Markets Equity (Nikkei 225): CAUTIOUS (EXPENSIVE). Exit point at 19,528. Bonds: NEGATIVE (EXPENSIVE). 10Y bond target 0%. New! FX: EXPENSIVE. USD-JPY fundamental target at 115.
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
Brazil:
JULY 2017
Page 10
Political situation remains delicate. Temer resists
Cheap
Expensive
Political turmoil
Politics • Temer’s current situation: Nearly one month after JBS’ plea bargain content has been released, president Michel Temer has managed to hold on. Despite Temer’s allegedly corrupt behavior in conversations with JBS executive Joesley Batista, the accusations that he was attempting to buy Eduardo Cunha’s silence were not explicitly confirmed in the audios. This prevented Temer’s situation from worsening and gave him time to structure his defense and for the dust to settle. The latest development, the potential suspension of the Dilma-Temer joint candidacy by the Supreme Electoral Court, finally moved in the president’s favor. The Dilma-Temer electoral campaign has been acquitted of illegal funding by four out of seven votes. A suspension was initially the most likely scenario, given the facts relating to campaign financing and the erosion of Temer’s political capital. Moreover, the main allied party (PSDB) has decided not to leave the government coalition for now. • Short term risks? What to expect? Temer has been fighting for his mandate both in Court and in Congress. The immediate risks lie with: (1) Attorney General files criminal charges against the president (for passive corruption and obstruction of justice), which must be accepted by the Lower House for the process to start. We believe that these charges won’t move forward, since the congressional base has a majority to dismiss it (342 votes out of 513 are needed for approval); (2) New plea bargain deals with names close to Temer (such as Lucio Funaro, Rodrigo Rocha Loures and Eduardo Cunha). In this case, new facts and material proof could complicate Temer’s life further. Despite the president’s still delicate situation, the political class in general has little to gain from his dismissal for the moment, since he’s positioned to take the burden for the unpopular reforms. • Structural reforms status: Social security reform is still lacking a new schedule, while the government claims it will be voted on before congressional recess (July 18). Important allies expect the discussions to resume in August. As for the Labor Reform, the agenda is moving forward despite the recent defeat in the Economic Affairs Committee (CAE). Analysts expect the bill to be approved by the end of the month. The government is also trying to approve a positive tax agenda, with more generous state level funding, readjustments to the Bolsa Familia welfare program and income tax easing. Economics Hard data is improving, agriculture is booming: GDP grew by 1.0% on Q1 during the last quarter, with major contributions from agriculture and larger inventories. Crops are estimated to reach 238.6 tons by the end of 2017, about 29% higher than 2016. On the consumption side, retail sales rose by 1.0% MoM in April, with higher increases in supermarket sales. However, GDP growth is expected to be around -0.3% in Q2 and close to zero for FY2017. Despite the downward correction in food prices, improving consumer confidence and lower interest rates, the unemployment rate has been rising sharply, becoming an obstacle to economic recovery. Inflation remains consistently low. May’s IPCA reading stood at 0.31%, below market expectations (0.47%) and increases the likelihood of a figure below 4.0% by year end. Central Bank’s tightening cycle: the monetary policy committee (COPOM) has cut the Selic rate by 100 bps to 10.25%. Despite the economic slowdown and substantially low inflation, the latest political crisis has led the committee to slow down the pace of cuts, which was interpreted by the market as a hawkish stance. In the minutes released afterwards, the message was that the end of the cycle is not yet clear, as additional easing depends on the fiscal agenda (now endangered in Congress). We expect the Selic to end 2017 at 8.50% p.a. Financial Markets: Equities (Ibovespa): FAIR VALUE. Central point 66,500. Exit point 69,700. Stocks are more sensitive to volatility than bonds, providing less absorption capacity. We remain negative in the short-term. Long-Term positive. Government Bonds: POSITIVE. 10Y bond Loc target 9.75%. 10Y bond in USD target 5.25%. Yield curve still has premia, after the JBS pleabargain event. We continue to forecast a Selic rate of 8.50% per annum (market consensus: 8.50% p.a.; current level: 10.25% p.a.) and real interest rates around or below 5.0% per annum at the end of 2017 (currently between 5.80%-5.60% p.a.). Foreign Exchange: FAIR VALUE. While strong political uncertainty remains, we should see BRL trading at higher levels, such as 3.20– 3.40/USD, rather than the previous range of 3.05–3.20/USD. Outlook: BRL 3.25/USD in December 2017 (market consensus: BRL 3.30/USD; current level: 3.32).
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
Mexico:
JULY 2017
Page 11
The US sticks to its hardline stance and signals that is willing to play hard ball
Cheap
Expensive
NAFTA negotiations have officially started: The U.S. and Mexican governments announced an “agreement in principle” designed to avert a trade war over sugar, helping to set the scene for bigger talks on rewriting the North American Free Trade Agreement. The preliminary agreement imposes new limits on Mexican imports to the U.S., and appears to provide longer-term clarity to a market that has been overshadowed by cross-border tensions for three years. Secretary Wilbur Ross: “The Mexican side has agreed to nearly every request made by the U.S. industry,” but he added that the wider U.S. sugar sector isn’t ready to support the pact. Washington protects U.S. sugar growers and refiners from some foreign competition, but policymakers also have to take into account confectioners who want easy access to sugar at the lowest possible price. Mexican Economy Minister Ildefonso Guajardo said, “The deal protects Mexico’s status as the major supplier to the U.S. market, with the right to supply extra amounts needed in the U.S.” In our view, Mexico may have had little choice but to give way, since this outcome forestalls broader trade tensions with the U.S. and keeps Nafta renegotiation talks on track. The U.S. has gained a tactical advantage in further trade talks by sticking to its hardline stance and signaling that it is willing to play hardball to extract ostensibly favorable terms. If completed, a sugar settlement would eliminate one trade irritant between the U.S. and Mexico as they prepare –along with Canada– to begin renegotiating Nafta as soon as August, aiming to complete talks by the end of the year. BANXICO We continue to believe that the board will opt for another moderate rate hike of 25bps, pushing the overnight rate to 7% p.a. This is also the quasi-monolithic view among market participants. General OUTLOOK The strengthening of the Peso lends credence to a more benign outlook, but given the number of uncertainties both domestically and abroad, it seems too early to count on it entirely. On growth, the scenario still points to weaker momentum. But so far weakness has been more concentrated in the industrial sector, despite the improved (albeit still volatile) performance of manufacturing. The labor market –an area of interest to the board– continues to show tightness. Last but not least, the Fed confirmed expectations and increased its policy rate in this month’s meeting. So, given the board’s usual framework, we believe that Banxico will hike again this June. Financial Markets NEW! Equities (IPC Gral): FAIR VALUE. Fundamental target price at 49,500; Exit point: 52,000. Despite numerous recent geopolitical events, the global environment is holding up well and recent upward revisions in emerging markets have had a positive knock-on effect for the Mexican IPC index, which is currently trading at record highs (49,200). The CPI Index has remained around 49,000 during the last 2.5 months. Measured in dollars, the index has rebounded almost 30% from its low this year and is now at its highest level since November 2015. We recommend taking measures to favor liquidity (slightly reducing exposure to this market). Bonds: MIXED. 10Y bond Loc target 7.0%. 10Y bond in USD target 4.30%. The Mexican curve has flattened. Given the medium and longterm inflationary expectations, the slope of the curve is not expected to steepen, but there could be generalized increases with more rate hikes by Banxico, even implying a reversal in the yield curve. A bearish cycle has also started being discounted for next year due to the inflationary environment and local growth. The spread of the 10-year peso rate over the 10Y treasury bond has narrowed from 480 to around 400 bp and we expect it to close the year at around 420. If we estimate a rate of 2.70% for the 10Y treasury, our level for the Mexican bond (M) will change from 7.50% to 7.00%. The spread on the dollar bond has remained at 150 bp, so we maintain our target at 4.30% NEW! FX: CAUTIOUS. In the absence of other major economic indicators, the Mexican peso will continue to be strongly correlated with crude oil prices. In general, analysts' estimates for year end have been cut (to between 17.50 and 18.00 pesos per dollar). However, negotiation of the FTA will begin in this half of the year and election issues for 2018 will probably weigh on Mexican assets and MXN, which could curb the recent appreciation or even cause a reversal. We set our year-end target at 19.75 (from 20.25) because MXN is cheap in REER terms –see chart 1– suggesting that a strong depreciation from current levels is unlikely.
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
Argentina:
JULY 2017
Page 12
Political turmoil in Brazil adds risk to Macri’s plan
Cheap
Expensive
Thousand Million
+130% in just 1.5 years!!
Previous Government used monetary issuance to cover fiscal gap. After holdouts issue was resolved, current government changed the source of financing and tapped international debt markets to cover fiscal needs until it can implement the reforms needed to fix fiscal problems (gradualism). Two aspects are key for this plan to succeed: Low leverage offering a good starting point (Debt to GDP @53.8% and External Debt to GDP @31.7%) and government legitimacy. Latest developments: As we approach mid-term elections (where half of the seats of the Lower Chamber and one third of the Senate will be renewed), it seems that the opposition will remain fragmented which is good news for the government. Morgan Stanley did not eventually reclassify Argentina from Frontier to Emerging Market. The market estimated US$ 1.5bn of passive inflows into Argentinean equities if this materialized. Uncertainty in Brazil adds risk to Argentina in four ways: 1) Trade: External sector recovery could be hurt as Brazil is Argentina’s biggest trading partner. 2) Inflation: The nominal FX rate is the most important anchor for inflation. BRL depreciation has already impacted ARS. Should this continue, it will add more inflation pressure which will ultimately impact the recovery in consumption expected this year. 3) Funding: Macri’s plan is dependent on debt until they can gradually address fiscal imbalances. Any reemergence of problems in neighboring countries could make debt issues harder (e.g. Province of Buenos Aires suspended its bond sale due to market turmoil that came from Brazil). On the upside, 85% of hard currency financial needs for 2017 are already covered. 4) Elections: A key witness in the Car Wash Operation told Argentinean prosecutors that the company had paid bribes to Gustavo Arribas, the current head of the intelligence agency, AFI. If this is confirmed, it could derail Macri’s main political strength – transparency. On the positive side (for Macri), it is possible that Kirchnerist officials are also involved. Macro Front Economic Activity: Argentinean economy grew 0.8% YoY in March according to EMEA proxy for GDP growth. Recovery is led by agriculture, transport, construction and financial services. High frequency indicators are generally showing good signals: cement sales +8.7% YoY in May, construction activity +10.5% in April YoY, the slowdown in retail sales decelerated (-2.3% in May vs -3.8% in April), agricultural , industrial and road machinery sales rose +73% YoY in May, property sales in the City of Buenos Aires +20.5% YoY in April. Meanwhile, growth in new car sales decelerated, and supermarket and retail sales rose less than expected. Following this data, private estimates expect +1.2% growth in March. For the time being, we keep our target at 2.75% GDP real growth for 2017. However, if the situation in Brazil worsens there is a risk that this could push lower. Median estimates point to 2.60% growth in 2017. Fiscal Fiscal: April’s cumulative primary fiscal deficit was equivalent to 0.60% of GDP, in line with the government’s target. The government has a 2017 goal of 4.2% primary deficit which we think will be met. Prices Inflation in the City of Buenos Aires fell to 1.3% MoM in May (accruing 10.50% YTD), mainly due to the lower impact of regulated prices. Despite this lower figure, the Central Bank is keeping its reference rate at 26.25% (the last move was a 150 bp hike in April). The government’s target range for inflation is between 12% and 17%. For this to be achieved, inflation needs to average 0.80% between June and December, which is why we still think the target will not be met and expect inflation to end 2017 at approximately 20%. Median estimates point to 21.60% inflation for year end. Financial Markets: Equities: There has been a strong recovery this year in Argentinean ADRs. Some equities still look cheap but performance will mostly depend on Macri’s success. Examples of companies that could benefit from Macri’s policies are YPF, Financials (BMA, BFR, GGAL) and Utilities (PAM, EDN, TGS) Bonds: EXPENSIVE. Target Govt Bond 10Y USD: 7%. Current 10Y Govt Bond in USD (Global 2027) is trading at 5.90% YTM. Argentinean bonds have rallied strongly this year, mainly due to spread compression. Considering that spreads could widen in the months ahead of mid-term elections and taking Brazil’s situation into account, our target for 2017 is 7.00%. FX: We think that ARS will continue to appreciate until at least August’s primary elections, but will depreciate towards the end of the year. Our year-end target for the FX rate in 2017 is 18.
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
JULY 2017
Page 13
Equity Markets GLOBAL EQUITY INDICES - FUNDAMENTAL ASSESSMENT Net
Andbank's
Sales
Andbank's
EPS
Current
Anbank's
INDEX
2017
2017
Margin Sales growth per Share Net Margin
EPS
Growth PE (forward) PE estimate CURRENT Central Point
Index
2016
2017
2017
2017
2017
2017
E[EPS 2017]
2017
PRICE
USA S&P 500
10,3%
10,0%
1.276
10,0%
128
7,2%
19,13
17,50
2.441
2.233
Europe STXE 600
6,9%
3,7%
313
7,6%
24
14,6%
16,23
15,50
386
Spain IBEX 35
7,3%
4,4%
7.714
8,3%
640
18,8%
16,72
15,80
Mexico IPC GRAL
7,4%
7,0%
33.048
7,1%
2.356
2,9%
20,94
21,01
Brazil BOVESPA
7,6%
5,5%
53.915
7,7%
4.151
6,4%
14,94
Japan NIKKEI 225
5,1%
2,5%
19.981
5,2%
1.039
4,4%
China SSE Comp.
8,5%
7,5%
2.689
8,0%
215
China Shenzhen Comp
8,2%
8,5%
890
7,8%
69
Hong Kong HANG SENG 14,8%
3,0%
12.535
14,5%
India SENSEX
10,5%
11,0%
15.851
MSCI EM ASIA (MXMS)
12,6%
7,5%
407
2017
E[Perf] to
Exit
E[Perf] to
Point
Exit point
-8,5%
2.456,3
368
-4,5%
405,3
10.703
10.116
-5,5%
11.127,9
49.340
49.506
0,3%
52.427,2
16,00
62.018
66.423
7,1%
69.744,1
19,46
17,90
20.220
18.599
-8,0%
19.528,6
1,1%
14,82
15,00
3.187
3.226
1,2%
3.387,6
2,8%
27,25
28,50
1.892
1.979
4,6%
2.078,2
1.818
0,6%
14,28
12,50
25.963
22.720
-12,5%
24.991,9
10,5%
1.664
10,7%
18,68
18,00
31.083
29.958
-3,6%
32.953,8
12,6%
51
7,4%
9,98
8,75
512
449
-12,3%
494,1
0,6% 5,0% 4,0% 6,3% 12,5% -3,4% 6,3% 9,8% -3,7% 6,0% -3,6%
(Fundam range) Centr. Point
ANDBANK ESTIMATES
RISK-OFF PROBABILITY: Short-term view Andbank's Global Equity Market Composite Indicator (Breakdown)
Buy signals Positive Bias Neutral Negative Bias Sell signals FINAL VALUATION
Previous
Current
Month
Month
3 4 3 2 10 -2,7
6 2 5 3 6 -0,2
Andbank’s Global Equity Market Composite Indicator Preliminary assessment of the level of stress in markets
previous
0
-5
-10 Market is Overbought
current
+5
Area of Neutrality Sell bias
Buy bias
+10 Market is Oversold
Andbank GEM Composite Indictor: WE REMAIN IN A NEUTRAL AREA WITH NO SELL BIAS. Our broad index has cooled from -2.7 last month to -0.2 (in a -10/+10 range), settling in an area that suggests that the market is no longer overbought. In this Goldilocks setting, our score continues to display no levels of stress in US (and global) equity markets due to the confluence of the following events: 1. The relative hawkish call from the Fed did not impact bond markets, and 2. A strengthened stock market thanks to a buying frenzy and over-complacency (lowest levels in volatility and Macro Risk Index). Positioning: US equity market is being propped up by synchronized global growth (around 40% of investors expect a better economy next year) and low inflation across regions (partly due to increased global competition and subdued oil prices from persistent oversupply). Fund managers’ US allocation rebounded but remains depressed (-15% underweight, near the lowest level since January 2008). At below -10% underweight, this sentiment positioning indicator becomes a tailwind that could lead the US equity market to outperform. Flows: Fund managers’ cash levels rose to 5%, since many investors sold their overvalued positions, reaping the benefits. Excess cash levels are pushing investors into fixed income investments and supporting the bond market. Retail investors are currently in the driver’s seat and continue to pour more into bond funds ($200bn this quarter). IG credit was the primary beneficiary ($68bn in 2017 vs $63bn 2016). However, equity funds attracted outsized positive net flows too last month. Retail equity investors are on track ($17bn last week, $27bn over last month). The difference between flows into equity and bond funds is currently quite balanced with a modest bias in favor of bonds.
TECHNICAL ANALISYS: Trending view 1/3 months. Supports & Resistances o o o o o o o
S&P: BULLISH/SIDEWAYS-BULL. Supports 1&3 month at 2322. Resistance 1&3 month at 2500 STOXX600: SIDEWAYS-BULL/SIDEWAYS. Supports 1&3 month 376/368. Resistance 1&3 month at 404/409 IBEX: SIDEWAYS/SIDEWAYS. Supports 1&3 month at 10,564/10,216. Resistance 1&3 month at 11,249 €/$: BEARISH/SIDEWAYS. Supports 1&3 month at 1.095/1.076. Resistance 1&3 month at 1.137/1.143 Oil: SIDEWAYS-BULL/SIDEWAYS. Supports 1&3 month at 43.78/42.2. Resistance 1&3 month at 52.2/55.2 Gold: SIDEWAYS/SIDEWAYS-BEAR. Supports 1&3 month at 1194/1180. Resistance 1&3 months at 1303 US Treasury: SIDEWAYS-BEAR/BEARISH. Supports 1&3 month 2.09/1.97. Resist 1&3 months at 2.3/2.42
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
JULY 2017
Page 14
Fixed Income – Core Country Bonds: UST 10Y BOND: Floor 1.84%, Ceiling 3.2%. New Target 2.68% 1. Swap spread: The swap spread rose to -3 bps (from -6 bps last month). For this spread to normalize towards the +16 bp area, with our CPI expectations (reflected in the swap rate) anchored in the 2.0% area, the 10Y UST yield would have to move towards 1.84%. 2. Slope: The slope of the US yield curve fell to 80 bps (from 98 bps). With the short-end normalizing towards 1.4%-1.5% (today at 1.34%), to reach the 10Y average slope (of 177 bp) the 10Y UST yield could go to 3.2%. 3. Real yield: A good entry point in the 10Y UST would be when real yield hits 1%. Given our CPI forecast of 2%, the UST yield would have to rise to 3% to become a “BUY”.
BUND 10Y BOND: Ceiling 0.90%. Fundamental target 0.70% 1. Swap Spread: The swap spread rose to 43 bp (from 39 bp last month). For the swap spread to normalize towards its long-term average of 35 bp, with our CPI expectations (reflected in the swap rate and anchored in the 1.25% area), the Bund yield would have to move towards 0.90% (entry point). 2. Slope: The slope of the EUR curve flattened to 97 bp (from 111 bp). If the short end “normalizes” in the -0.25% area (today at -0.63%), to reach the 10Y average slope (124 bp), the Bund yield would have to go to 0.99%.
Fixed Income – Peripheral Bonds 10Y Government Bond yield targets Spain: 1.90% Italy: 2.30% Portugal: 3.00% (from 3.30%) Ireland: 1.40% Greece: 7.50%
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
JULY 2017
Page 15
Fixed Income – EM Govies. Why so calm? The known negative factors: 1. Higher interest rates (Fed) in the US did not help in the past (think of the Taper Tantrum of 2013). 2. The prospects of greater protectionism smell like something "toxic" to emerging markets. The not-so-known positive factors: 1. The new intervention “playbook” used by central banks to defend their currency: “Sell USD exposure through Non-deliverable Forward Contracts settled in Local Currency”. The advantages are clear: (1) Standard forward contracts do not immediately affect the value of FX reserves. (2) The buyers of fw USD exposure are local branches of international banks (interested in paring loses). To hedge this higher forward exposure, they sell USD against local currency in the spot market, resulting in de facto outsourcing of the central bank’s open market operations. (3) These commercial banks benefit from higher o/n rates or any increase in o/n rates resulting from a fall in the currency. Further depreciation in the local currency results in a loss in their spot trade but a gain in their forward transaction. (4) The central bank can withstand downward FX pressures while satisfying demand for its USD held as FX reserves. (5) This strategy is not a magic bullet. If depreciation persists, forward contracts must be rolled over, with the CB making a loss each time. However, the strategy is aimed at buying time for fundamental structural reforms. 2. After prudent restructuring, most EMs now have better external balances (India, Brazil, Turkey, etc.), which makes them less dependent on external financing in dollars. 3. In past episodes, emerging markets generally had overvalued currencies. Today however, most are undervalued (MEX, TRY, RUB...), which means that the risk of capital flight is lower. 4. If EMs are now more synchronized with the developed economies, emerging assets should hold up well in a monetary tightening environment in the US. Furthermore, a marginal tightening in EMs (caused by higher yields) may even be useful in containing any risk of overheating. 5. EM firms now increasingly rely on debt markets and less on their domestic financial systems. In 1997, bank loans in USD accounted for 65% of domestic debt in USD. Today, USD bank loans represent 54%. Therefore, banks in EMs are not so exposed to USD volatility.
Our Rule of Thumb: CPI (y/y)
10 Year
Yield
Last
Yield
Govies
reading
Real
4,33% 2,17% 3,10% 1,50% 4,41% -0,07% 0,40% 1,99% 0,57%
2,44%
Taiwan
6,77% 6,49% 4,64% 3,52% 3,88% 2,41% 2,05% 2,10% 1,04%
Turkey
10,21%
11,72% 4,10%
-1,51%
1,00%
Russian Federation 7,66%
3,56%
-1,00%
10,59% 6,67% 6,48% 5,83%
3,35% 6,20% 4,42% 3,07%
7,24%
-1,00%
0,47%
0,00%
2,05%
-0,75%
2,76%
-0,75%
India Philippines E M A SIA
Is the UST cheap or at fair value? Historically, a good entry point in the 10Y UST has been when real yields are 1.75%. Given the “new normal” of ZIRPs, a good entry point in the 10Y UST bond could be when the real yield is 1%. Given our 2017 target for US CPI of 2%, a theoretical fair value (entry point) should be with nominal yields at 3%. Therefore the first condition is not met for 2017. With a longer-term view, our expected average inflation is around 1.5%, meaning that a good entry point in the UST could be 2.5%. Do real yields in EM bonds provide sufficient spread? A good entry point in EM bonds has been when EM real yields were 150bp above the real yield of the UST when it is at fair value. Assuming that the first condition is met, we should only buy those EM bonds with a real yield 1.5% above the real yield in the UST.
Indonesia
China Malaysia Thailand Singapore South Korea
EME
2.
The US Treasury bond is cheap or at fair value. Real yields in EM bonds are 150 bp above the real yield of the UST bond.
Brazil LA T A M
1.
Projected change in Yield
10 Year
To date, our rule of thumb for EM bonds has been “buy” when the following two conditions are met:
Mexico Colombia Peru
-0,75%
4,33%
-1,00%
1,54%
-0,50%
2,02%
-0,75%
-0,53%
1,00%
2,48%
-0,75%
1,65%
-0,50%
0,11%
0,00%
0,47%
0,00%
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
JULY 2017
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Commodities – Energy (Oil, WTI) Fundamental target at $45. Buy at $30. Sell at $55. Short term drivers for oil prices (news flow): “Market is becoming weary of OPEC jawboning”. (-) Global glut: The WSJ reports that the global oil glut is proving to be resistant to the production limits set by OPEC and allied non-OPEC producers, fueling the idea that the output cap of almost 2% of world crude supply was a miscalculation. It adds that the cartel said yesterday that rising inventories were concerning but they couldn't abandon the production-cut deal. (-) Global glut: Traders are increasingly storing crude in aging supertankers, with ~15 very large crude carriers (VLCCs) between 16-20 years old being chartered since the end of May in Southeast Asia. The charter rate for older ships is notably cheaper than that for newer tankers. A shortage of spare onshore storage in China is impacting storage choices in the region. (-) Global glut: In its latest Oil Market Report, the International Energy Agency sees supply growth outpacing demand. It sees an increase in global demand in 2018 of +1.8M bpd (vs +1.7M bpd in 2017), but the growth in total non-OPEC production in 2018 will outpace the higher demand, suggesting that excess inventories will persist well into 2018, dealing a blow to global crude producers enacting output cuts to bring down stubbornly high stockpiles. (+?) The new Saudi strategy: Saudi Arabia and other major producers may try to reduce US inventories, the most frequent and visible metrics of oil-storage data. News reports suggest that the kingdom may be planning to hold back some exports to the US in July, which could show up immediately in EIA data and might be interpreted as a bullish signal. However, recent tanker data suggest that shipments to the US are already below the seasonal norm (Reuters). (-) Shale: US shale drillers only contemplate the possibility of retrenchment if oil prices persist in the $40s. “A drop to $40/barrel could halt rig growth for smaller drillers in less active shale basins”. (-) Shale: Eight prominent hedge funds have reduced the size of their positions in ten of the top shale firms by more than $400M, over concerns that producers are pumping so fast they will undo the nascent recovery in the industry. (-) Shale: Meanwhile, big oil companies including CVX, XOM, and RDSB.LN are piling into the Permian basin in pursuit of the kind of profitability that has eluded smaller drillers. These companies hope that their massive scale, deep pockets and ability to bring experience in global techniques will help them succeed where other companies have struggled. (-) Output cut agreement: There are signs that the agreement is not well balanced. As such it could be broken at any time. Iraq is already the top supplier to India, the world's fastest-growing oil market, while OPEC competitor Saudi Arabia's market share continues to fall. Oil producers are facing increasing competition in major markets, with Iraq able to gain an edge in India. (-) Demand: India is poised to become the world's fastest-growing oil consumer over the next two decades with some 86% of its crude imports coming from OPEC countries. Nevertheless, India is looking to reduce its dependence on foreign energy sources by embracing electric cars and alternative fuels.
Structural drivers for oil point to low prices in the long run... (-) Alternative energies picking up the baton: Producers must bear in mind that the value of their reserves is no longer dictated by the price of oil and the quantity of their reserves, but rather by the amount of time for which they can pump before alternative energies render oil obsolete. In order to delay this deadline as long as possible, it is in producers’ interests to keep the oil price low as long as possible (keeping the opportunity cost of alternative energy sources as high as possible). (-) Growing environmental problems will gradually tighten legislation and production levels: Producers are aware that the value of their reserves depends on the amount of time they can pump at current levels before tougher environmentinspired regulation comes in. For example, Saudi Arabia has between 60 to 70 years of proven oil reserves at current output, but with mounting concern about climate change and growing environmental problems that will likely continue to put big pressure on the market for fossil fuels over the coming decades, Riyadh’s most serious risk is of sitting on a big chunk of “stranded reserves” that it can no longer extract and sell. Saudi Arabia (and other producers) therefore has a powerful incentive to monetize as much of its reserves as soon as possible by pumping as much oil as it can (if only to fund the construction of a less oil-dependent economy). (-) The re-entry of Iran is a game changer equivalent to a structural change in the global energy market. Iran insists that it must be allowed to step up its output from 3.6M to 4M bbl/day. This would imply that Saudi Arabia (the world’s largest producer) would have to take most, if not all, of the proposed cuts in its own output, but this is somewhat incompatible with the condition imposed by the Saudis of not losing market share under the agreement. (-) OPEC’s producers are no longer able to fix prices: Back in the 1970s or the early 2000s, the exporters’ cartel agreed to cut output and the approach worked well since it was easy to defend market share as the principal competition was among oil producers (in particular between Opec and non-Opec producers). That is not the case today. Today’s biggest threat to any conventional oil producer comes from non-conventional producers and alternative energy sources. Energy cuts from conventional oil will easily be offset by a quick increase in shale oil production, which means that Opec producers are no longer able to fix prices. (-) Global imbalance of supply over demand runs at 1M bbl/day: Even if the proposed output cuts are confirmed, this deal will not be a game-changer for the international oil market. The global oil market’s imbalance of supply over demand continues to run at 1M bbl/day according to Opec itself. Opec’s proposed production cut will therefore be insufficient to reverse the oil glut. (-) Shale producers to raise output heavily at $60 in oil price: The IEA said that an oil price of $60 would be enough for many US shale companies to restart stalled production.
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Commodities – Precious (Gold) Fundamental price US$ 1,000/oz. Buy at US$ 900/oz. Sell above US$1,200. Negative drivers: 1. Gold in real terms. In real terms, the gold price (calculated as the current nominal price divided by the US Implicit Price Deflator-Domestic as a proxy for the global deflator) fell to $1,102 (from $ 1,109 last month). Nevertheless, in real terms gold continues to trade well above its 20-year average of $794. Given the global deflator (now at 1.1298), for the gold price to stay near its historical average in real terms, the nominal price (or equilibrium price) must remain near US$897. 2. Gold in terms of Silver (Preference for Store of Value over Productive Assets): This ratio has ticked up again to 76.02x (from 73.41x last month) and remains well above its 20-year average of 61.15, suggesting that Gold is expensive (at least in terms of silver). For this ratio to reach its long term average level, assuming that silver is well priced, then the Gold price should go to $1,002 oz. 3. Gold in terms of Oil (Gold / Oil): This ratio rose dramatically during the month to 29.34x (from 24.58x last month) moving well above its 20-year average of 14.77. Considering our fundamental long-term target for oil of US$45pbl (our central target), the price of gold must approach US$664 for this ratio to remain near its LT average level. 4. Gold in terms of the DJI (Dow Jones / Gold): This ratio has moved to 17.18x (from 16.76x last month), still below its LT average of 20.29x. Given our target price for the DJI of 20,000, the price of gold must approach US$985 for this ratio to remain near its LT average. 5. Gold in terms of the S&P (Gold / S&P500 index): This ratio fell to 0.512x (from 0.521x last month), but is still above its LT average of 0.5837x. Given our target price for the S&P of $2,233 the price of gold must approach US$1,303 for this ratio to remain near its LT average. 6. Speculative Positioning: CFTC-CEI 100oz Active Future non-commercial contracts: longs rose sharply to 297.2k (from 221.5k). Shorts slightly rose to 106.9k (from 94.84k) => Thus, the net position increased sharply +190.3k (from +126.7k). Speculators are now significantly long in gold. 7. Financial liberalization in China. Higher “quotas” each month in the QFII are widening the investment alternatives for Chinese investors (historically focused on gold).
Positive drivers: 1. Negative yields still make gold attractive. The disadvantage of gold relative to fixed income instruments (gold does not offer a coupon) is now neutralized, with negative yields in a large number of global bonds, although the importance of this factor is diminishing as yields continue to rise. 2. Relative size of gold: The total value of gold in the world is circa US$6.9tn, a fairly small percentage (3.2%) of the total size of the financial cash markets (212tn). The daily volume traded on the LBMA and other gold marketplaces is around US$173bn (just 0.08% of the total in the financial markets).
SPECULATIVE GOLD POSITIONS
Longs Net Shorts
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Currencies – Fundamental Targets •
EUR/USD: Year-end target raised to 1.05. Long-Term Fundamental Target at 1.00
Net notional in USD Global positioning declined again to a fresh recent low of $3.31bn net longs from +$6.9bn the month before, down from a recent peak of +$28.7bn net longs seen in September 2016. This is the smallest long positioning in USD since August 2016, and now showing 1.2-sigma underweight on a 3-year z-score basis (see the bar chart below). Meanwhile, EUR positioning posted a new largest notional long position since Oct 2013(!!) to +€11.08bn notional long (from +€9.1bn last month), compared to the recent low of -19bn in notional shorts last year (see table). It is worth mentioning that despite the increase in EUR positioning, this was not enough to prompt further appreciation of the single currency, meaning that a very significant flow towards the EUR (above the +1.98bn seen last month) is required to see further appreciation. Of course, if the economic momentum persists in Europe then new record positioning in the Euro could materialize. However, it remains to be seen whether this economic jump in the Euro area can be sustained, especially if we consider that the Chinese-triggered reflation trade is ebbing. Other aspects that are supportive for USD (negative for EUR) are: (1) The chance of an impeachment has jumped from negligible to non-negligible and this has weighed on the dollar index. Nevertheless, the Republicans’ firm control of both houses of Congress (55% and 52%) gives Trump a stronger starting point compared to past scandals affecting the President. (2) Expectations of Trump’s ability to push through major growth-enhancing economic measures are pretty much extinguished, hence any sign of the White House getting its way with Congress could result in renewed confidence in the USD. Our year end target for the EUR/USD is 1.05, although our fundamental value for EUR/USD at 1.00 remains unchanged.
•
NEW! JPY= Target (115); EUR/JPY: Target (115).
Several aspects suggest that JPY cannot continue to outperform: (1) With political shock in Europe allayed, investors switched to Risk-on mode, meaning that safe haven flows into Japan are less likely now. (2) Real Yield is lower in JGBs, and with the 10Y JGB controlled at 0%, there is little prospect that Japanese real yields will rise. (3) The BoJ has reiterated that it intends to stick to its ultra-loose monetary policy, at least until it hits the 2% inflation target (unachievable in the short-term). (4) Instead, the Fed is set to continue in its rate-hiking path, which in turn will push up real yields in USD. (5) The prospect of the Fed paring back its balance sheet makes USD more attractive (or JPY less appealing). (6) JPY is no longer cheap in REER terms (it is expensive) • GBP= Target (0.83); EUR/GBP: Target (0.87). GBP should depreciate vs USD (see chart). Fair value vs € • CHF= Target (0.95); EUR/CHF: Target (1.00). Room for longer positions in CHF.
• • • • • • •
NEW! MXN= Target (19.75); EUR/MXN: Target (20.74) NEW! BRL= Target (3.25); EUR/BRL: Target (3.41) ARS= Target (18.0) Mkt Value of RUB: NEUTRAL-POSITIVE Net positions AUD: NEUTRAL-POSITIVE in the currency CAD: POSITIVE-POSITIVE Currency (Bn $) CNY: Target (6.75-6.80) USD vs All USD vs G10 EM EUR JPY GBP CHF BRL MXN RUB AUD CAD
3,31 6,36 3,05 11,08 -5,74 -3,14 -1,87 0,12 2,65 0,28 -0,11 -6,69
Change vs last week in the currency 1-yr Max (Bn $) (Bn $) -2,03 -1,77 0,26 0,65 0,55 -0,18 0,29 -0,01 0,33 -0,06 -0,11 0,33
28,7 28,4 3,1 11,1 8,6 -1,9 1,4 0,8 2,7 1,3 4,1 2,3
1-yr Min (Bn $)
1-yr Avg (Bn $)
3,3 3,0 -1,7 -19,0 -9,3 -8,4 -3,1 0,0 -2,3 0,2 -1,2 -7,3
14,3 14,5 0,2 -7,7 -0,5 -5,8 -1,1 0,4 -0,8 0,6 1,7 -0,8
Current Z-score Z-score 3-yr -1,28 -1,14 2,33 2,79 -0,45 -0,03 -0,80 0,14 2,84 0,17 0,02 -2,45
ANDBANK
3-year Z-Score: Current Position - 3 year average position 3-year Standard Deviation
Values above +1 suggest positioning may be overbought Values below -1 suggest positioning may be oversold
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JULY 2017
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Market Outlook – Fundamental Expected Performance
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Monthly Global Asset & Currency Allocation Proposal
This recommended asset allocation table has been prepared by the Asset Allocation Committee (AAC), made up of the managers of the portfolio management departments and the product managers in each of the jurisdictions in which we operate. Likewise, the distribution of assets within each customer profile reflects the risk control requirements established by regulations.
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
JULY 2017
Principal Contributors
Alex Fusté – Chief Global Economist – Asia & Commodities: Equity, Rates, FX +376 881 248 Giuseppe Mazzeo – CIO Andbank USA – US Rates & Equity. +1 786 471 2426 Eduardo Anton – Portf. Manager USA – Credit & Quasi governments. +1 305 702 0601 J.A Cerdan – Equity Strategist Europe – European Equity. +376 874 363 Renzo Nuzzachi, CFA – Product Manager LatAm – Rates & FX. +5982-626-2333 Jonathan Zuloaga – Analyst, Mexico – Macro, bonds & FX. +52 55 53772810 Albert Garrido – Portfolio Manager Andorra – European Equity. +376 874 363 Luis Pinho – CIO Andbank LLA Brazil – Macro, Politics & Markets Brazil. +55 11 3095-7089 Gabriel Lopes – Product Analyst Brazil - Bonds, FX & Equity Brazil. +55 11 3095 7075 Andrés Davila – Head of Asset Management Panama – Venezuela. +507 2975800 Marian Fernández – Product Manager, Europe – Macro, ECB & Gov. bonds. +34 639 30 43 61 David Tomas – Wealth Management, Spain – Spanish Equity. +34 647 44 10 07 Andrés Pomar – Portf Manager Luxembourg – Volatility & ST Risk Assessment +352 26193925 Carlos Hernández – Product Manager – Technical Analysis. +376 873 381 Alejandro Sabariego – Portfolio Manager Luxembourg – Flow & Positioning. +352 26 19 39 25 Alicia Arriero – Portfolio Manager Spain – European Banks. HG & HY Credit. +34 91 153 41 17
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ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
JULY 2017
Legal Disclaimer All notes and sections in this document have been prepared by the team of financial analysts at ANDBANK. The opinions stated herein are based on a combined assessment of studies and reports drawn up by third parties. These reports contain technical and subjective assessments of data and relevant economic and sociopolitical factors, from which ANDBANK analysts extract, evaluate and summarize the most objective information, agree on a consensual basis and produce reasonable opinions on the questions analyzed herein. The opinions and estimates contained herein are based on market events and conditions occurring up until the date of the document’s publication and cannot therefore be decisive in evaluating events after the document’s publication date. ANDBANK may hold views and opinions on financial assets that may differ partially or totally from the market consensus. The market indices have been selected according to those unique and exclusive criteria that ANDBANK considers to be most suitable. ANDBANK does not guarantee in any way that the forecasts and facts contained herein will be confirmed and expressly warns that past performance is no guide to future performance, that investments analyzed could be unsuitable for all investors, that investments can vary over time regarding their value and price, and that changes in the interest rate or forex rate are factors which could alter the accuracy of the opinions expressed herein. This document cannot be considered in any way as a selling proposition or offer of the products or financial assets mentioned herein, and all the information included is provided for illustrative purposes only and cannot be considered as the only factor in the decision to make a certain investment. There are also additional major factors influencing this decision that are not analyzed in this document, including the investor’s risk profile, financial expertise and experience, financial situation, investment time horizon and the liquidity of the investment. As a consequence, the investor is responsible for seeking and obtaining the appropriate financial advice to help him assess the risks, costs and other characteristics of the investment that he is willing to undertake. ANDBANK expressly disclaims any liability for the accuracy and completeness of the evaluations mentioned herein or for any mistakes or omissions which might occur during the publishing process of this document. Neither ANDBANK nor the author of this document shall be responsible for any losses that investors may incur, either directly or indirectly, arising from any investment made based on information contained herein. The information and opinions contained herein are subject to change without notice.
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