Andbank corporate review june 2017 by Andbank

GLOBAL ECONOMICS & MARKETS

ANDBANK CORPORATE REVIEW June 2017

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

JUNE 2017

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Contents Executive Summary

Country Pages US

Europe

China

India

Japan

Brazil

Mexico

Argentina

Equity Markets Fundamental Assessment

Short-term Assessment. Risk-off shift probability

Technical Analysis. Main indices

Fixed Income Markets Fixed Income, Core Countries

Fixed Income, European Peripherals

Fixed Income, Corporate Bonds

Fixed Income, Emerging Markets

Commodities Energy (Oil)

Precious (Gold)

Forex

Summary Table of Expected Financial Markets Performance

Monthly Asset & Currency Allocation Proposal

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ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

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Executive Summary US - The chance of an impeachment has shifted from negligible to non-negligible

and

this

has

weighed

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. S&P Equity Index: NEUTRAL. Exit point remains intact at 2456. 10Y UST bond: CAUTIOUS. We down ticked our year end target for the 10Y UST yield to 2.68%. Corp credit - CDX IG index: NEUTRAL. Target at 70bps. CDX HY Index: NEUTRAL. Target at 350). Europe - Economic surprises remain and this trend may carry on for a few more months. The ECB’s minutes signal that we are closer to normalization. STXE600 Europe Equity Index: NEUTRAL. Exit point remains intact at 405. IBEX Index: NEUTRAL. Exit point revised to 11,127. Core Government bonds: German bund NEGATIVE, yield target at 0.70%. UK Guilt NEGATIVE, yield target at 1.50%. Peripheral bonds: Spanish bond NEGATIVE (target 1.90%). Italian bond NEUTRAL (target 2.3%). Portuguese bond POSITIVE (New target at 3%). Irish bond NEGATIVE (target at 1.4%). FX EUR/USD: NEGATIVE, new year end target 1.05. Fundamental target 1.00. China – PBoC’s macro-prudential approach seeks a balance between deleveraging and liquidity stability. “Market participants should expected continued strong supervision and regulation. Shenzhen Composite Index: POSITIVE. Fundamental target at 1979 (current price 1810). 10Y Gov Bond: POSITIVE, year end yield target at 2.9%. FX CNY NEUTRAL, target at 6.75 India – Indian equities have been the best performer this year with their 22% currency-adjusted gain YTD. India Sensex Equity Index: POSITIVE. Exit point at 32953 (current price 31089). 10Y Gov Bond: POSITIVE, year end yield target at 5.7%. Japan – Low rates still squeezing bank profits, although although aggregate FY17 net profits by listed companies are expected to grow 4% YoY, compared to 21% in FY16. Kuroda & BoJ: “I am not considering a change in the policy mix”. Nikkei Equity Index: NEGATIVE. Exit point at 19528. 10Y Gov Bond: negative, year end yield target at 0%. FX JPY/USD NEUTRAL. Year end target at 112. Latam - Brazil Bovespa Equity Index: NEGATIVE (Short Term), POSITIVE (Long Term). Exit point at 69744. Mexico IPC Equity Index: NEUTRAL. Exit point at 52000. Government bonds: Brazilian 10Y bonds POSITIVE (Targets: 9.75% in Loc, 5.25% in USD). Mexican Bonds POSITIVE (Target 7.5% in Loc), NEGATIVE (target 4.35% in USD). Argentinian Global bonds: NEGATIVE (Yield target at 7%). FX targets: BRL 3.25, MXN 20.25, ARS 18.

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US: Trump, for better or worse, will have less effect on the US and world economy than was widely anticipated. 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

Political risk & the US dollar The revelation of memos suggesting the president obstructed justice means 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 (55% and 52%) gives Trump a stronger starting point compared to past scandals affecting the President (Nixon & Watergate in 1972, with congressional control of 44% and 43% in House and Senate respectively; Reagan & the Iran-Contra affair in 1986, with 42% and 53% control in both houses; or Clinton & Lewinsky in 1998, with just 48% and 45% control). As such, we think that this risk will dissipate and the dollar could stabilize and begin to regain ground later. US growth is likely to accelerate. Why should the data pick up? 1. When soft data moves sharply higher, the two series normally converge; 2. Seasonality. Weak first quarter growth has certainly not been uncommon over the past 7 years. On average, Q1 growth has been less than half that seen in each of the other 3 quarters, and at the time of writing the Atlanta Fed has a forecast of 3.6% annualized growth in Q2. 3. Employment growth continues to be the main driver of US growth. The Kansas City Fed's labor market conditions indicator is consistent with a reacceleration in employment growth to 3%. 4. The rebound in capex (a high beta element of GDP growth) could easily contribute positively to growth (especially considering current corporate confidence and credit availability). On average over the last 7 years, fixed investment has added 80bp to GDP growth in each quarter, accounting for around 40% of the pace of growth during this period. Reform agenda & Trump’s bonus In the last edition of the Milken Global Conference (where technology billionaires, financiers, globalists, etc. gather), the focus was on how much they could hope to gain from the tax reform, deregulation and public investment projects. Here is a summary of the main impressions that our sources came away with: Deregulation: Mnuchin and Wilbur Ross seem determined to deregulate whatever they can. Even if the Congressional Democrats manage to block legislative changes in the Dodd-Frank or Clean Air Acts, the administration has scope to weaken energy and financial regulations simply by reinterpreting existing laws. “You do not have to change the regulation, if you change the regulators”. As a result, the prospect of less regulation is a much stronger reason for an upsurge in business confidence than hopes for public investment programs or tax cuts. Small businesses, which complain most about regulation, may get less benefit at first since so much red tape comes from State rather than Federal agencies. However this will be offset by the fact that the one major industry that will gain from deregulation is finance, specially small business banking and mortgage banking. Infrastructure: Elain Chow, Trump’s Transport Secretary, said three times that the Federal Government accounts for only 16% of US infrastructure spending, meaning that less than $200bn would leverage $1trn in spending. Obamacare: Full-scale repeal is almost out of the question. Taxes: What sort of tax reform Trump can achieve will depend on how much deficit the fiscal conservatives in Congress will accept (especially if we consider that savings from Obamacare and border adjustment taxes are vanishing). Protectionism and border-adjusted taxes: Large scale changes in trade policy are unlikely. W. Ross expressed satisfaction with the improvements achieved in trade relations with China and the Senate Finance Committee’s staff director said, “Big importers and retailers have done a good job of educating our members about the cost of border adjustments”. Financial Markets: (Very capable of shrugging off bad news) Equities (S&P): NEUTRAL. Target: 2,233. Exit point at 2,456. We remain concerned about the potential for a pullback or sideways move in the broader equity market in the months ahead, but are constructive on a 6-12 month view. Valuations remain the key negative, but revisions of earnings, economic indicators and policy are supportive factors. New! Bonds: CAUTIOUS. UST10 target 2.68%. Near-term Fed hike expectations have been broadly stable, with year-end OIS drifting back down for 2018 and 2019. We acknowledge that the timeline for a broader move higher in yields has extended given the lack of fiscal progress and distractions from the legislative agenda, although we think that the market is pricing too little in the way of Fed hike risks. Term-secured funding costs are not accounting for the likely persistent lack of bill supply as Treasury continues to operate under extraordinary measures with no debt limit deal in sight. Bill supply will remain under pressure. Credit: CDX IG: NEUTRAL Target 70. CDX HY: NEUTRAL Target 323

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

Europe:

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ECB’s minutes signal we are closer to normalization Politics: French risk abating, UK next on stage France: Macron’s first steps as President, such us the appointment of the Prime Minister and the rest of the Cabinet, have been well received (61% public support). Macron has advanced in the polls for the Parliamentary elections, leading without an absolute majority. Reforms: Skepticism remains about Macron’s ability to reform further, though early indications seem to point in the right direction (focus on employment and the pursuit of further European integration). EU’s Moscovici backs Eurozone budget and Finance Minister. Schäuble and Le Maire call for corporate tax harmonization. UK’s version of Brexit: The UK wants (1) To be exempt from ECJ control, (2) Exit the EU customs union (as it limits FTAs with third countries), (3) Control its borders. Ironically, the EU has recently closed trade deals that are similar to arrangements demanded by the UK. DCFTA with Ukraine, Georgia and Moldova, with four main features: (1) Free access to goods, services and capital (zero tariffs, appropriate customs procedures, appropriate standards and regulation, effective competition, intellectual property rights, antidumping rules, basic rules for taxation, etc.) (2) Passporting rights for Ukraine’s banks once they meet EU standards. (3) Restrictions on the movement of people. (4) Civil aviation pact (part of the single EU aviation system). The UK could seek a not dissimilar deal, with the most obvious feature being money (contributing some €3.5bn annually based on the EEA agreement with Norway). Conclusion: A template roughly matching the UK’s goals exists, meaning an objective basis for a deal is in place. The problem is that the political basis for a deal does not yet exist: (1) An agreement has to be reached first on the exit bill (some €100bn), and (2) The fact that the DCFTA is designed to attract new members into the EU’s sphere of influence, which means it is not in the EU’s interests to offer them to members that decide to leave. Admittedly, with election season coming to an end, a more realpolitik approach could dominate, although this has yet to be seen. Canada-EU deal would not be an aim in itself for the UK because, while it removes almost all tariffs for exports, eases restrictions on services, allows more labor mobility and recognizes professional qualifications, the deal falls well short of the market access demanded by the City of London. On the macro side: improving economic backdrop Economic surprises remain likely and this trend may carry on for a few more months. Sentiment and data are converging: PMIs and German factory orders are on the rise (manufacturing and services), with consumer confidence and retail sales rising. ECB: “The economy has evolved from being fragile and uneven into a firming, broad-based upswing”. Inflation figures picked up in April more than expected due to calendar effects (Easter) and higher energy prices, while inflation expectations remain subdued.

Although low, the growth structure in the Euro area seems more balanced than in the USA

Financial Markets Outlook Equity (STOX 600): NEUTRAL. Target: 368. Exit point at 405. Government Bonds: NEGATIVE. With political risk receding, a better macro outlook and a more hawkish monetary talk, we are seeing some pressure on yields as the year advances. We stick to most of our targets for 2017: 10yr Bund 0.70%, Italy: 2.3%, SP 1.9%, IE 1.4%. New target for PORTUGAL 10Y yield 3% (3.3% previously) due to further financial restructuring, more fiscal discipline, EC considering removing Portugal from the EDP. Credit: Itraxx IG: NEUTRAL (Target 80). Investors substantially increased their net long risk positions since the 1st round of the French elections. ECB scaled back its corporate purchases during April and May and has been asked (by EU lawmakers) to be more transparent on corporate bond buying. Tight valuations in secondary market leave Euros credit exposed to increased profit-taking and spreads could also widen on new issue announcements. Credit: Itraxx HY: NEGATIVE (Target 350). Primary activity has finally gained momentum. The appeal of ultra-low funding yields and high M&A driven issuance needs, should keep primary market busy heading into the summer. We are not going to change our recommendation, but we think the path is more difficult now.

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Spain:

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Good data outweighs lack of reforms (for the time being) Economic outlook The shape of the economy improved at the start of this quarter. We had better hard data readings for consumption, industrial production and exports. Surveys about the future also show improvements across all sectors, even in the housing market with prices and activity rising in these first three months. Good news too from the labor market. The fact that Easter Week was in April means the service sectors will retain some workers through the summer. We therefore believe that our 2.5% GDP growth and 1.5% CPI fall short as the Spanish economy shows better internal dynamics than we forecasted at the start of the year. The strong growth in investment has been one of the main contributors to GPD growth in Q1 (+0.8% QoQ). Gross fixed capital formation growing at 2.0% and equipment surging 3.0% indicates more growth in the future. We are raising our GDP estimate for 2017 to 2.7%. For CPI, we had forecast 1.5%, but assuming that the CPI will probably continue to ease, we set our new target at 1.7% by year-end. And this improvement in the economy and sentiment was accompanied by an increase in inflation (CPI rose to 2.6% YoY in April, although more recently this reflation mood has dissipated considerably, with the last reading for Consumer Price Index in May at 1.9% y/y compared to the 2.6% y/y on prior month. This leaves the y/y rate at its lowest level since December last year (1.6%) and is 0.1 p.p. lower than the previous month owed to the effect of lower fuel prices and the tourist packages after Easter. Political Risk Our base scenario of a weak government but with a constructive opposition on economic matters has been the case until now. The new PSOE leader could be more aggressive and less constructive. Neither the government (corruption issues) nor the PSOEâ&#x20AC;&#x2122;s new candidate have an interest in calling a general election this year. General budget negotiations will be the key in this new scenario. We expect the budget to be passed and approved by 176-174 votes, reflecting the division in Congress. With this Congress divided and without constructive opposition, we find it more difficult to see that the government can promote the much needed reforms for the Spanish economy. What concerns us the most with the new PSOE leader and opposition parties, is that they could draw up laws to undo various key reforms already in place. Things could become noisier as well with the Catalonian independence referendum. We will follow the new political scenario closely, but at this point we rule out any snap general elections in 2017.

Financial Markets:

BRL seems to be trading at fair value

Equities (Ibex): NEUTRAL. Target 10,116 Sell at 11,128. We are upgrading our target as we have updated our sales growth figure for the year to reflect our new GDP and CPI targets. Andbankâ&#x20AC;&#x2122;s new sales growth target for 2017 is 4.4%.Sales growth has been the principal surprise in the Q1 earnings season across all equities. In Spain, more than half of the companies (excluding banks) beat the sales consensus. All the listed banks beat their NII figures. Despite this upward revision, we are still more wary of the top and bottom lines for this year. At this point we prefer to assume some upside risk to our targets as there are still clouds on the political horizon and Latam exposure in some big companies. Moreover, the Banco Popular case shows that our banks are not completely out of the woods yet. With this new sales growth target (4.4% Andbank vs 5.1% consensus), EPS growth stands at 18.7%, still almost 10 points below the market consensus. Bonds (SP 10y bond): NEGATIVE. Target 1.9%. We stick to our target set at the start of the year. In fact, we expect that this new political scenario will weigh more heavily on bonds than equities.

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China:

Chinese go online while PBoC simplifies its key rates on its road towards a more market-based toolkit Online retail market thrives in 2016

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.

China's e-commerce research center shows online retail sales rose 39.1% YoY in 2016 to CNY5.3T ($770bn) accounting for 14.9% of total retail sales. A total of 500 million people used online shopping in 2016, up 8.6% YoY. Reforms: Deleveraging Campaign PBoC macro-prudential approach: PBoC released its latest quarterly report in which the highlights were stronger coordination of financial regulation and modest deleveraging in the economy. The PBoC reiterated that it will seek balance between deleveraging and liquidity stability, stressing that “the impact of previous action has started to appear in the economic data”. Future steps: The PBoC suggested that “market participants should expect continued strong supervision and regulation but should not panic”. “The introduction of new regulations should take into account the market's tolerance for changes and prevent liquidity risks”. PBoC provides breathing space by smoothing deleveraging fever when necessary: PBoC’s officials see little need to continue driving interbank rates any higher, refraining from increasing borrowing rates further. The yield on 10-year government bonds fell 7bp from a high on 10 May and the Shanghai Composite Index has rebounded 2%. PBoC simplifies focus on two key rates: PBoC announced it will mainly use seven-day reverse-repo operations and the one-year medium term lending facility (MLF) for short and medium term liquidity demand. The bank explained that two rates helps clarify policy intentions on the road to a more market-based toolkit and could prove vital in constructing a yield curve that is understood and trusted by investors. This policy is yielding fruit 25 Shanghai-listed banks cut CNY1.54tn in interbank liabilities in Q1 2017 with the acceleration of the government's deleveraging campaign and the central bank's macro-prudential assessment. Interbank business and off-balance sheet wealth management transactions are expected to fall further. Credit risks are easing: The China Securities Journal cited that default risk in China's bond market has eased amid improvements in the regulatory environment, with new bond default cases falling sharply this year. However, the market still faces pressure in 2017 with more than CNY4tn of bond funding products and more than CNY800bn in corporate bonds due to mature this year. Property developer bond issuance ceased: Bonds issued by real estate developers have largely stopped amid tighter restrictions implemented by regulators. Corporate Profits Listed firms forecast higher H1 profits: WIND data showed that 74% of Shanghai and Shenzhen listed firms that have released H1 guidance expect a rise in net profits, with 144 companies forecasting growth of over 100%. The article claims optimism was driven by computer, telecoms, electronics, chemicals, electrical machinery, equipment manufacturing and pharmaceutical industries. Only 21% of firms expect lower net profits. China to further reduce corporate costs: The State Council announced further measures this month to reduce the corporate burden and vowed more support for the country's "Made in China 2025" plan. According to the statement, China plans to cut annual corporate costs by CNY120bn (~$17.5bn) through measures such as lower business fees and lower logistics costs. Incremental measures include lower railway freight rates and annual freight inspection fees. Hard data: Housing: April new home prices +10.7 YoY vs previous +11.3% (+0.7% MoM vs +0.6% in prior month). Outbound Direct Investment: Jan-Apr ODI fell 56% YoY, steeper than the 48.8% decline in Jan-Mar reflecting capital controls introduced late last year. FX The yuan reference rate has been set higher than the forecasts on 25 of the last 32 trading days. The consensus is now that the yuan is stable against the dollar (and somewhat weaker versus other currencies) and suggests a sentiment-boosting move. Financial Markets Equity (Shanghai): NEUTRAL. Fundamental price 3,226. Equity (Shenzhen): ATTRACTIVE. Fundamental price 1,979. Exit point at 2,177 Bonds: ATTRACTIVE. 10Y bond target 2.9% FX (RMB): CHEAP. USDCNY fundamental target at 6.75-6.8

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India:

Indian market is already the best performer YTD with its 22% currencyadjusted gain. What next?

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)

If trend in prices continues, the INR will perform well

Financial markets & hard data Indian equities have been the best performer this year with their 22% currency-adjusted gain YTD. This is not surprising given that India has strong fundamentals and a reform-minded government that still enjoys popular support. Outlook: Our positive long-term view remains intact, though nearterm may be tough The backdrop seemed to get better last month with the central bank now free to impose a clean-up of bad loans that have weighed down the nation’s banks. Yet, as U. Sikand reminds me in one of her papers (that I love to devour) the near-term may be tough on three counts: Growth, Liquidity and Valuations. 1. Growth: Hopes for a rapid acceleration look fanciful. Allowing the Reserve Bank of India to micro-manage a resolution to about US$155bn in stressed loans may not be an outright positive driver, since the core problem remains a lack of capital that the government does not want to fully fix. Fitch estimates that India’s lenders need US$90bn of fresh capital to meet new Basel III capital requirements by 2019, but New Delhi has only offered US$11.5bn. It seems to me as if Modi’s administration is deferring the decision until after the 2019 general election. As a result, hopes for a reinvigorated and immediate strong credit cycle look fanciful. Furthermore, the demonetization episode, while laudable (intended to weed out corruption, pull more activity into the formal economy and enhance the tax base) could continue weighing on the economy until at least 1H17. And last, but not least, India will soon adopt the biggest change in its tax code since independence. Any shock to economic activity stemming from the GST rollout will immediately be reflected. 2. Liquidity: The picture seems to be more favorable. Admittedly, since the RBI narrowed the interest rate corridor for short-term liquidity operations, shifting its policy stance from “accommodative” to “neutral”, conditions seem to be tighter now. But these effects have been more than offset by capital inflows, with foreigners buying a net US$6.2bn in Indian equities. External liquidity conditions will remain favorable for India on the back of low commodity prices, a more stabilized US dollar (retreating from overvalued levels), and global protectionist tensions fading. Worries about the Fed raising rates will probably ease (as has been the case up to now) as the US current account balance widens. 3. Valuations: The picture looks more gloomy for this aspect, although there is still room for valuations to climb higher. Equities are trading on a forward P/E ratio of 18x. Such a premium could be justified if the NPL issue is fixed rapidly and the problem around the lack of capital is managed in a way that improves mid-term visibility, giving rise to a new investment cycle. That said, there is still a way to go before reaching the P/E levels of 22.5x and 25x seen in 2000 and 2007 respectively. The rupee is up more than 6% YTD against the US dollar, and in REER terms seems to be at its highest level since the early 90s. The plan to fix the NPL problem: Banks will have to find a buyer to solve this issue. The RBI signaled that it may introduce third-party assessments of bad loans. One proposal made by officials would place banks’ largest debts under the control of a private asset management company, which would then invite private investors to bid for the stressed assets. The new consolidated Insolvency and Bankruptcy Code will replace a mishmash of outdated laws. (1) It will rank lenders by seniority, with an understanding that junior creditors may never be repaid. (2) It will employ specialized bankruptcy courts to make decisions about collateral and write-offs, rather than much slower regular courts. (3) It aims to reduce the bankruptcy resolution process for companies to nine months and give debtors less room to hide. 1. This more radical approach could mean raising new private capital, widespread mergers and prevent failing banks from accepting deposits, funneling capital away from the weakest banks to healthier PSBs (with P/B ratios of about 1) and private sector banks (with P/B ratios of 1.54). The worst performers would then be allowed to wither and die, while the share prices of the surviving PSBs would soar. India may even achieve its long-awaited sovereign credit re-rating. Only by fixing the problem of its broken PSBs can India achieve its dream of 8-10% economic growth. Financial Markets Equity (Sensex): FAIRLY VALUED (MAINTAIN). Fundamental price 29,958. Exit point in 32,953 Bonds: ATTRACTIVE. 10Y bond target at 5.7% FX: NEUTRAL

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Japan: Abe to delay debt reduction. What next?

JPY expensive in REER terms

JPY cheap in REER terms

Economics (+) April Economy Watchers current conditions index 48.1 vs 47.4 in prior month. Outlook index 48.8 vs 48.1 in prior month. (+/-) March LEI index rose to 105.5 vs 104.7 in prior month, but Coincident index slowed to114.6 vs 115.2 in prior month. (=) April bank lending +3.0% YoY vs +3.0% in prior month. (-) March tertiary sector activity index fell -0.2% MoM vs consensus +0.1% and revised 0.0% in prior month. Fiscal Abe to delay debt reduction: Prime Minister Shinzo Abe indicates that he wants to implement a free education policy, though potentially at the expense of a further delay in the government's goal of achieving a primary surplus by 2020. An opposition party proposal to guarantee free education (requiring a constitutional amendment) would cost the government an estimated ¥5tn ($44bn) annually. BoJ & Banking sector Low rates still squeezing bank profits: The Nikkei reported Japan's five leading banking groups posted a third straight year of shrinking aggregate profits on Monday, hampered by the BoJ's negative rate policy, though partially mitigated by strong overseas operations. Combined net profits fell 3% YoY, with only Sumitomo Mitsui Financial Group (8316.JP) posting an increase of 9%, although a rebound from a sharp drop the previous year. Banks' unused money rises 23%: Among the three megabanks, aggregate “Cash and due from banks“, which represents unutilized money on their balance sheets and is mostly made up of customer deposits, grew 23% to ¥158tn ($1.4tn) in FY16 and has surged 4.6 times since March 2013 just before the BoJ launched its bond-buying program. Japanese banks have yet to see strong growth in loan demand after the BoJ launched massive stimulus measures in April 2013, while deposits have surged. Kuroda: “I am not considering a change in the policy mix”: Kuroda reiterated that despite improvements in economic growth, there is still a long way to go to achieve the price stability target of 2% as inflation momentum is not sufficiently firm, with the risks still skewed to the downside. Kuroda stressed the utmost importance that the BoJ maintains the current easing policy. Corporate profits & Equity market hurdles: Japanese companies heading for second straight record profits: Aggregate FY17 net profits by listed companies are expected to grow 4% YoY, compared to 21% in FY16, with improved results at more than 60% of companies. Most firms are assuming a USD/JPY rate in the 105-110 range, in line with the average of 108 for FY16. Summer bonuses to record first decline in five years: Japanese companies are set to pay an average summer bonus of ¥839,560 ($7,530) this year, down 2.75% (first decline in five years). Hurdles in the equity market: Factors ranging from a stronger-thanexpected yen to political turbulence in the US may keep the Nikkei index from making its long-awaited return above 20,000. Our approach when investing in the Japanese equity market: Buy carriers and companies leveraged to China. Sell high precision instrument firms (vulnerable to JPY’s strength) Mobile carriers expect earnings growth to continue: Growth among the three biggest mobile carriers is accelerating in spite of price competition with low-cost carriers. Japanese companies showing renewed interest in China: 40% of Japanese companies with operations in China plan to expand operations there in the next two years (the first increase in three years). The article noted investment in China had been pared back largely due to soaring labor costs, though wage growth has led to strong consumer demand. Major precision instrument firms' profits decline: FY operating earnings among the five major precision instrument names are under pressure from yen’s strength. Nikon (7731.JP) was highlighted after it posted its first decline in net profits in seven years. Commerce & Protectionism risks are waning. Protectionism risks are waning as the more hawkish advisers in the Trump team lose influence, with the removal of Steve Bannon from the Principals Committee of the US National Security Council, and the White House National Trade Council headed by Peter Navarro ceding power to the Office of Trade and Manufacturing Policy. This has coincided with a softer stance on China though pressure on Japan still appears high. Financial Markets • Equity (Nikkei 225): EXPENSIVE. Exit point at 19,528. Bonds: EXPENSIVE (USELESS). 10Y bond target 0%. FX: NEUTRAL. USD-JPY fundamental target at 112.

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Brazil:

Politics brings back uncertainty but does not weaken our optimistic longterm vision

Cheap

Expensive

Political turmoil

Politics • Car Wash probe causes damage in Brasilia: In the most relevant Car Wash probe outcome, JBS’ plea-bargain agreement has hit the federal administration hard, with audios implicating President Michel Temer. • Central scenario: Temer leaves the Presidency. Admittedly, the recordings supposedly involving President Temer in alleged practices of concealment and obstruction of justice are under analysis for the real possibility that they have been edited, making them immaterial in legal terms. However, according to the prosecutor, Batista's statements taken as part of the plea-bargain with the prosecutor, contain sufficient elements to investigate and accuse Temer. The situation is extremely delicate, as the President’s governability plummets and pressure builds for him to resign. Several impeachment requests have been filed in the Lower House. At this point, support for the government now seems much weaker, making the departure of Temer from the government likely. The risk is that political uncertainty will put an end to the reformist impetus, and social security or labor reforms will not go ahead. • What’s next? Prior to this episode, social security reform had been approved by the special commission and support in Congress was being addressed. It’s now certain that the reform agenda will be delayed, affecting both the Labor Law and Social Security reforms (according to rapporteurs, Ricardo Ferraço and Arthur Maia). The extent of the delay will depend on how fast the solution to the political crisis is addressed. Based on the information we currently have, the delay could be anything from one to four months, but is likely to be at the longer end of this range. Likely outcomes: The possible outcomes to the president’s current situation are: (1) Resignation; (2) Suspension by the Supreme Electoral Court (“TSE”); (3) Impeachment by Congress. We believe that suspension by the TSE is the most probable scenario, while impeachment is a less likely but more tortuous way out. In the case of Temer’s suspension, the next president would be elected indirectly, i.e. by Congress, with the main candidates being: Henrique Meirelles (current finance minister); Nelson Jobim (former minister of ex-presidents Fernando Henrique Cardoso, Lula and Dilma and also former president of the Federal Supreme Court; currently, a partner at Banco BTG Pactual); Rodrigo Maia (current chairman of the Lower House); Eunicio Oliveira (current chairman of the Upper House); and Tasso Jereissati (former governor of State of Ceara for three terms and currently a senator). In general, these names would be politically neutral and reform-friendly. In public statements, Temer stands by his decision not to resign, seeking to defend himself in court. Economics Latest figures were positive: Economic activity and inflation continue to improve. Inflation stood at +0.14% MoM, the lowest reading for the month since 1994 and 4.08% YoY (below BCB inflation target of 4.5%). IBC-Br, Brazil’s Central Bank proxy for GDP growth, rose by 1.12% in 1Q17, suggesting that the recession may have ended. On the employment side, the economy created 59,856 jobs in net terms. Central Bank’s tightening cycle: The BCB signaled that Selic-rate cuts could speed up (market was pricing a 125 basis point cut at the next meeting) as reforms are advancing and inflation remains low. However, the political crisis is casting doubts over the reform agenda, pressuring the Central Bank not to accelerate the current pace (100 bp). Financial Markets: Equities (Ibovespa): ST: NEGATIVE / LT POSITIVE. Target: 66,423. Exit point at 69,744. Stock markets should be more sensitive to short term volatility, providing less absorption than bonds. Government Bonds: POSITIVE. Target 10Y Gov bond Loc: 9.75%. 10Y Bond in USD: 5.25%. Market over-reaction on the day after release of JBS recording has pushed yields considerably higher (around 150 bp), adding premium to the yield curve. We believe the reform agenda will resume in a few months from now, with or without the replacement of Michel Temer. We continue to forecast a Selic rate at 8.50% per annum (currently 11.25% p.a.) and real interest rates around, or below, 5.0% per annum at the end of 2017 (currently between 6.00%-5.70% p.a. across the curve). Foreign Exchange: NEUTRAL. As long as the high 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 3.23/USD; current level: 3.28).

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

JUNE 2017

Page 11

Mexico:

Banxico seems to be ahead of the curve, defending the currency well and controlling inflation expectations.

Cheap

Expensive

Central Bank • Banxico increased its monetary policy rate AGAIN on May 18th by 25 bp. • Mexico’s central bank is showing a hawkish stance for the next monetary policy meetings, concerned about recent hikes in inflation and trying to keep inflation expectations well anchored. • The most recent surveys show that analysts expect the central bank rate to close 2017 at 7.25% (7.00% last month). • Agustin Carstens, central bank governor, said that Banxico will not necessarily follow the US Fed’s path of rate hikes, resulting in an unexpected movement, especially when the Fed kept its rate unchanged. Inflation • CPI keeps rising well above Banxico’s medium term target of 3% (+/1%) thanks to the pass-through effect from the FX depreciation that became more evident in April (CPI 5.82% annual base). • Although April is a deflationary month, because of government subsidies on electricity, non-core inflation picked up following the rise in agricultural prices and the highest non-food merchandise prices, which better reflect the cumulative depreciation of the currency. Economic indicators • Most important economic indicators showed a moderate pace of growth with the latest figures for 1Q17 GDP beating expectations. GDP estimates for 2017 rose and are now fixed at 1.9-2.0% by private analysts and the Ministry of Finance. Politics: • No advances on NAFTA renegotiation. A few comments of a possible NAFTA disintegration by Trump had a negative impact on Mexican peso and bond rates, but the rhetoric has been softening in recent weeks, with the leaders involved agreeing to proceed swiftly to enable a renegotiation of NAFTA to benefit all three countries. • Fiscal: There is still some social discontent over the diversion of federal funds by governors of states such as Veracruz, implying a risk for the federal government’s party for the next election in one of the most important federal states in the country in June. Our Outlook The US has a dominant position in the negotiation. However, Mexico also has a lot to say and this balances their positions in terms of reaching an agreement that satisfies both parties. For example, excluding cars, it is Mexico that runs a trade deficit with the US because the US exports a lot of agricultural products to Mexico, for example from the Midwest. This means that the US Midwest would be severely harmed if the US takes an aggressive stance resulting in a break from NAFTA, something to be seriously considered since this region is the heartland of Trump's electorate. Mexico has plenty of experience in trade negotiations, having been negotiating the TPP accords in the labor and environmental arenas. Mexico also has trade agreements with 45 countries (more than the vast majority of countries), proof of its indisputable experience of negotiating trade deals. Mexico has stated that it is open to negotiating and modernizing NAFTA, but will strongly resist anything that means restrictions on free trade. We guess that the bulk of the negotiations will refer to the “Rules of Origin”. These are a set of rules that determine if a product is eligible for free trade. One of the main rules is Value Added Content (or Regional Value Content), which in turn is divided into two groups: Product Specific or Wide Regime. The latter contains “De minimis” rules (that stipulate the maximum portion of external materials in one product) and the “Accumulation rule” (that allows imported products to be treated as if they were domestic). These rules are very flexible and the negotiation will come from this side. Financial Markets: NEW! Equities (IPC Gral): NEUTRAL. Fundamental central point at 49,500. Exit point at 52,000. We see little risk of contagion from Brazil’s latest turmoil and the recent tensions on the Korean Peninsula. Despite the numerous recent geopolitical events, the global environment is quite resilient, with recent upgrades in EM helping Mexico IPC equity index, currently at historical highs (49,490). We recommend a move towards liquidity (somewhat reducing exposure to this market) Bonds: MIXED. Target M10 Loc: 7.5%. M10 USD; 4.35% A one notch rating downgrade is already priced into the yield curve. While short term bond rates will keep rising, linked to the Fed’s moves, we expect a flattening in the yield curve due to stable inflation expectations and a low growth scenario. With a 2.68% rate projected for UST10, and the M10T10 spread stable at 480bp, our expectation for the 10Y Mexican bond would be 7.5%. For the US denominated 10Y bond we are expecting a 150-180 spread against the US treasury (target 4.30). NEW! FX: CAUTIOUS. Our y/e target remains unchanged at 20.25.

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

Argentina:

JUNE 2017

Page 12

Political turmoil in Brazil adds risk to Macri’s plan

Cheap

Expensive

Thousand Million

Tax amnesty is having a significant impact on FX reserves

Latest developments: Former Government used monetary issuance to cover fiscal gap (causing high inflation). After holdouts issue was resolved, current government changed the source of financing and tapped international debt markets to cover fiscal needs until they 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 (Total Debt to GDP @53.8% and External Debt to GDP @31.7%) and government legitimacy that will be tested in mid-term elections this year. Recent developments in Brazil add risk to this plan in four ways: (1) Trade: The recovery in the external sector could be hit hard as Brazil is Argentina’s biggest trading partner. On the positive side, the external sector with Brazil has been a drag on growth in the last 3 years, so this is nothing new. (2) Inflation: The nominal FX rate is the most relevant factor driving inflation and BRL depreciation has already impacted ARS. If this continues, it will pile on more inflation pressures, eventually affecting consumption and the precarious economic recovery. We see this as the main risk, since the economic recovery in 2017 is mainly based on the recovery in consumption led by real wage gains. (3) Funding: Macri’s plan is levered on debt until the government can gradually address fiscal imbalances. If problems in neighboring countries flare up again, this could make debt issuance difficult (E.g. Buenos Aires Province suspended its bond sale due to market turmoil that came from Brazil). On the positive side, 85% of hard currency financial needs for 2017 are already covered. (4) Elections: A key agent in the Car Wash Operation told Argentinean prosecutors that the company had made payments from 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. It is likely that Kirchnerist officials are also involved. Macro Front Economic Activity: Argentina’s economy shrunk 2.2% YoY in February according to EMEA proxy for GDP growth, and just +0.8% YoY in March (estimated +1.2%). This marks a change in path after it grew in Dec’16 and Jan’17. However high frequency indicators are showing good signs on average (cement sales +11% YoY in April, construction activity +10% in March YoY, retail sales decline slowed (-3.8% in April vs -4.4% in March), agricultural machinery +89% YoY in Q1’17, property sales in Buenos Aires city +44% YoY in March). On the negative side, new car sales growth decelerated, supermarket and retail sales rose less than expected. For the time being, we keep our target to 2.75% GDP real growth for 2017, however if the situation in Brazil worsens there is a risk we could lower this target. Fiscal Fiscal: Q1 2017 fiscal results show a primary deficit that was below target (0.4% vs 0.6%). However, after accounting for the one-off effects of the tax amnesty collections, the reading was pretty much in line on target. The government has a FY2017 goal of 4.2% primary deficit. Primary expenditure decelerated in March, with social transfers rising above the trend but other expenditures decreasing (i.e. cut in subsidies). Prices Inflation in Buenos Aires city was high at 2.6% MoM in April (accruing 9.1% YTD), due to increase in gas tariffs and clothing prices. However, after last Central Bank hike in April (150bp) and Lebac auctions at higher rates, inflation expectations fell in April to 21%. Remember that government’s target is to get inflation into 12-17% range. We still think target will not be met and expect 2017 inflation at approximately 20%. 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: Target Govie 10Y USD: 7%. Current 10Y Govt Bond in USD (Global 2027) is trading at 6.05% YTM. Argentinean bonds are enjoying a great rally this year, mainly due to spread compression (-78bp). Spreads could widen in the coming months ahead of mid-term elections and the evolving situation in Brazil. 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

JUNE 2017

Page 13

Equity Markets GLOBAL EQUITY INDICES - FUNDAMENTAL ASSESSMENT Net

Andbank's

Sales

Andbank's

Margin Sales growth per Share Net Margin

EPS EPS

Index

2016

2017

USA S&P 500

10,3%

10,0%

1.276

10,0%

Europe STXE 600

6,9%

3,7%

313

7,6%

Spain IBEX 35

7,3%

4,4%

7.714

Mexico IPC GRAL

7,4%

7,0%

Brazil BOVESPA

7,6%

5,5%

Japan NIKKEI 225

5,1%

China SSE Comp.

8,5%

China Shenzhen Comp Hong Kong HANG SENG

INDEX

2017

Growth PE ltm PE ltm CURRENT Central Point

2017

E[Perf] to

Exit

E[Perf] to

Point

Exit point

-7,5%

2.456,3

-5,6%

405,3

1,8% 3,8% 2,2% 5,6% 9,0% -0,6% 8,7% 14,9% -2,7% 5,6% -2,6%

2017

2016

2017

PRICE

(Fundam range) Centr. Point

128

7,2%

20,28

17,50

2.413

2.233

14,6%

18,83

15,50

390

368

8,3%

640

18,8%

20,20

15,80

10.890

10.116

-7,1%

11.127,9

33.048

7,1%

2.338

2,0%

21,51

21,01

49.278

49.118

-0,3%

52.015,5

53.915

7,7%

4.151

6,4%

16,40

16,00

63.962

66.423

3,8%

69.744,1

2,5%

19.981

5,2%

1.039

4,4%

19,74

17,90

19.651

18.599

-5,4%

19.528,6

7,5%

2.689

8,0%

215

1,1%

14,66

15,00

3.117

3.226

3,5%

3.387,6

8,2%

8,5%

890

7,8%

2,8%

26,78

28,50

1.808

1.979

9,5%

2.078,2

14,8%

3,0%

12.535

14,5%

1.818

0,6%

14,21

12,50

25.677

22.720

-11,5%

24.991,9

India SENSEX

10,5%

11,0%

15.851

10,5%

1.664

10,7%

20,76

18,00

31.196

29.958

-4,0%

32.953,8

MSCI EM ASIA (MXMS)

12,6%

7,5%

407

12,6%

7,4%

10,61

8,75

507

449

-11,4%

494,1

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

Current

Month

4 1 6 4 7 -2,0

3 4 3 2 10 -2,7

Andbank’s Global Equity Market Composite Indicator Preliminary assessment of the level of stress in markets

current previous

-5

-10 Market is Overbought

Area of Neutrality Sell bias

Buy bias

+10 Market is Oversold

Andbank GEM Composite Indictor: WE REMAIN IN A NEUTRAL AREA WITH A SELL BIAS. Our broad index has moved from a -2.0 level last month to -2.7 (in a -10/+10 range), settling in an area that suggests that the market is overbought (although not stressed). In this Goldilocks setting, our score keeps displaying no levels of stress in US (and global) equity markets due to the offset in various metrics: 1. Excess cash levels in investors’ hands. 2. 'Hard' vs 'soft' data gap to close and should converge in favor of soft. 3. Momentum of US net flows stalled over a month ago. 4. An uptick in CL1 COMB Comdty might stoke the reflation trade scenario again. Macro discretionary hedge funds’ rolling equity beta to the S&P500 seems rather cautious. Fund managers’ current cash allocation still at an excess level (above 10Y average) which would support further gains in equity markets. By contrast, US equities allocations continue to shrink (from -19% to -17% which means 0.7 SD below its long-term mean). Region allocation: Recent relative rotation, not in asset classes but geographically into European equities (exposure is significantly overweighted from +48% to +59% for over one month, +1.7 SD above its long-term mean), supported by confidence in the earnings outlook coupled with lower political risk, makes us fear that an overcrowded allocation might jeopardize the positive performance of European names in the coming months. Difference between flows into equity and bond funds reversed in favor of equities, due to the uptick in CL1 COMB Comdty which could fuel the subdued inflation, pushing interest rates up and consequently depressing bond prices. JP Morgan’s option skew monitor on the S&P500 (difference between the implied volatility of out-of-the-money [OTM] call options and put options) rebounded and reached a new high this month. Nevertheless, it is still showing that mangers prefer to write calls than puts.

TECHNICAL ANALISYS: 1 month trending view. Supports & Resistances o o o o o o o

S&P: SIDEWAYS. Supports 1&3 month at 2322/2245. Resistance 1&3 month at 2405/2450 STOXX600: SIDEWAYS-BULLISH. Supports 1&3 month 376/368. Resistance 1&3 month at 404/409 IBEX: SIDEWAYS. Supports 1&3 month at 10,216. Resistance 1&3 month at 11,249 €/$: SIDEWAYS-BULLISH. Supports 1&3 month at 1.095/1.076. Resistance 1&3 month at 1.137/1.143 Oil: SIDEWAYS. Supports 1&3 month at 43.78/42.2. Resistance 1&3 month at 55.22 Gold: SIDEWAYS. Supports 1&3 month at 1194/1180. Resistance 1&3 months at 1303 US Treasury: SIDEWAYS. Supports 1&3 month at 2.09/1.97. Resistance 1&3 months at 2.42

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

JUNE 2017

Page 14

Fixed Income – Core Country Bonds: UST 10Y BOND: Floor 1.84%, Ceiling 3%. New Target 2.75% 1. Swap spread: The swap rate remained stable in the month at 2.18% (from 2.19% last month). The 10Y Treasury yield down-ticked to 2.25% (from 2.27%). The swap spread therefore rose to -6 bps (from -8 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 98 bp (from 104 bp). With the short-end normalizing towards 1.25% (today at 1.26%), to reach the 10Y average slope (of 175 bp), the 10Y UST yield could go to 3.0%. 3. Real yield: A good entry point in the 10Y UST could be when the real yield hits 1%. Given our CPI forecast of 22.25%, the UST yield would have to rise to 3-3.25% to become a “BUY”.

BUND 10Y BOND: Ceiling 0.90%. Fundamental target 0.70% 1. Swap Spread: Swap rates rose to 0.83% (from 0.72 % last month), while the Bund yield did its part, rising to 0.44% (from 0.27%). The swap spread therefore fell to 39 bp (from 45 bp). For the swap spread to normalize towards its long term average of 35 bp, with our CPI expectations (reflected in the swap rate) 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 rose to 111 bp (from 99 bp). If the short end “normalizes” in the -0.25% area (today at -0.68%), to reach the 10Y average slope (123 bp), the Bund yield would have to go to 0.98%.

Fixed Income – Peripheral Bonds 10Y Government Bond yield targets Spain: 1.90% Italy: 2.30% NEW! Portugal: 3.00% (from 3.30%) Ireland: 1.40% Greece: 7.50%

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

JUNE 2017

Page 15

Fixed Income – EM Govies. Why so calm? The known negative factors: 1. A strong dollar has been synonymous with "bad news" for emerging markets in the past (1997). 2. Higher interest rates/yields in the US did not help in the past (think of the Taper Tantrum of 2013). 3. The prospects for 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) and to hedge this higher forward exposure, they sell USD against local currency in the spot market, resulting in a 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, 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 the debt market 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

6,91% 6,66% 4,59% 3,62% 3,88% 2,62% 2,06% 2,15% 1,03%

4,17% 2,91% 3,40% 1,20% 4,40% 0,36% 0,64% 1,92% 0,13%

2,74%

-0,75%

3,76%

-1,00%

1,19%

-0,50%

2,42%

-0,75%

-0,53%

1,00%

2,26%

-0,75%

1,43%

-0,50%

0,24%

0,00%

0,90%

0,00%

10,21% Russian Federation 7,57%

11,87% 4,10%

-1,66%

1,00%

Do real yields in EM bonds provide sufficient spread? A good entry point in EM bonds has been when EM real yields are 150 bp above the real yield of the UST, when this is at fair value. Hence, and assuming that the first condition is met, we should only buy those EM bonds with a real yield at 2.5% (See the bonds in green in the table).

3,47%

-1,00%

10,81% 7,29% 6,31% 5,93%

3,99% 5,85% 4,71% 3,74%

6,82%

-1,00%

1,44%

-0,50%

1,60%

-0,50%

2,20%

-0,75%

India Philippines EM ASIA

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 2-2.25%, a theoretical fair value (entry point) should be with nominal yields at 3-3.25%. Therefore the first condition is not met.

Indonesia

China Malaysia Thailand Singapore South Korea Taiwan

EME

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.

Turkey

Brazil LATAM

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

ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW

JUNE 2017

Page 16

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”. (+) OPEC agreement: Oil is still seeing some support from this month’s announcement by Russia and Saudi Arabia that they favor a nine-month extension to OPEC's production-cut pact. Crude stocks remain ~300M barrels above their five-year average (OPEC stocks are 3bn barrels). The aim is to cut stocks by 300M barrels to their five-year average by March 2018. But OECD stocks continued increasing in early 2017, falling in March by just 32M barrels. The calculations assume OPEC keeps its output at April levels of 31.7M bpd and Russia keeps supply steady at 11.15M bpd from May. (-) OPEC agreement: India has said that OPEC production cuts and the prospect of more expensive oil were pushing the world's third biggest consumer to consider US and Canadian suppliers, as well as encouraging it to turn to renewable energy resources. India now imports 86% of its oil needs from OPEC to meet its 4.6M bpd refining capacity. (-) Shale: North Dakota breakeven prices as low as $21/barrel. Data from ND's Department of Mineral Resources suggest that the state's breakeven price for crude production averaged $24/barrel, with the breakeven in the state's most active county averaging $21/barrel. These levels put the Bakken Shale play in economic competition with nearly any other play in the world, including Saudi Arabia. (-) Shale: US shale explorers are boosting drilling budgets 10 times faster than the rest of the world. North American drillers plan to lift their 2017 outlays by 32% to $84bn, compared with just 3% for international projects. Much of the increase is flowing into the Permian Basin. Wood Mackenzie estimates that new spending will add 800K barrels of NA crude this year, equivalent to 44% of the reductions announced by the Saudi and Russian led group. In fact, in its last monthly report, OPEC sharply raised its forecast for oil supply from non-member countries in 2017. Outside producers would boost supply by 950K bpd this year, up from 580K bpd expected previously. (-) Shale: Data from the US EIA’s Drilling Productivity report: higher drilling activity may lead to a 122K bpd increase in production for June, bringing the total to 5.4M bpd and hitting the highest levels since May 2015. The EIA report revised its December numbers higher, meaning US shale production will have gained ~617K bpd for the December-June period! (-) Shale: US shale groups surge back to life and calls for the US to become an energy powerhouse do not appear far fetched, with shale producers coming out of the downturn stronger than ever before. E&Ps are proving that they are able not just to stay in business, but increase production as well, with oil prices still below $50. They have cut costs by about 40% in the past three years, and many are now at the point where they are covering their spending from operating cash flows. (-) Market rebalancing: Vitol executive says market players not seeing the expected destocking. He said that while inventories were shifting, with cargoes moving from the Atlantic Basin into Asia, the overall drawdown that many hoped for had not yet materialized. He added that the market had continued to confound expectations since OPEC and other producers agreed to cut output last year. (-) (-) Market rebalancing: Separately, Iraq’s oil minister also said Iraq will increase its production capacity to 5M bpd by the end of the year, a plan that doesn't conflict with the nation's commitment under the output deal. Libya is pumping its highest volume of oil since 2014, with crude output exceeding 800K bpd, which would be almost 1M bpd if it were not for a disagreement between the state-run National Oil Corp and Libya's Presidential Council. 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 the 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 the 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 1mn 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 16 for many US shale companies to restart stalled production.

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Commodities â&#x20AC;&#x201C; Precious (Gold) Fundamental price US$ 1,050/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) rose to $1,109 (from $1,090 last month). Nevertheless, in real terms gold continues to trade well above its 20-year average of $794. Given the global deflator (now higher 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 73.41x (from 71.25x last month) and remains well above its 20-year average of 61.14, 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 $1,049 oz. 3. Gold in terms of Oil (Gold / Oil): This ratio fell to 24.58x (from 26.04x last month) and still remains well above its 20-year average of 14.73. Considering our fundamental long-term target for oil of US$45pbl (our central target), the price of gold must approach US$662 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 16.76x (from 16.30x last month), still below its LT average of 20.31x. Given our target price for the DJI of $20,000, the price of gold must approach US$984 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 0.521x (from 0.536x last month), but is still above its LT average of 0.5832x. Given our target price for the S&P of $2,233 the price of gold must approach US$1,302 for this ratio to remain near its LT average. 6. Speculative Positioning: CFTC - CEI 100oz Active Future non-commercial contracts: longs fell sharply to 221.5k (from 279.3k). Shorts remained rose to 94.84k (from 83.54k) => Thus, the net position decreased to +126.7k (from +195.7k). Speculators remain long in gold, although less intensively now. 7. Financial liberalization in China. Higher â&#x20AC;&#x153;quotasâ&#x20AC;? 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).

GOLD SPECULATIVE POSITIONS

Longs Net Shorts 17

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Currencies – Fundamental Targets •

EUR/USD: Year-end target raised to 1.05. Long-Term Fundamental Target at 1.00

(1) Net notional USD Global positioning declined to a fresh recent low of $6.9bn net longs from $+14.7bn the month prior, 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 screening 1.2-sigma underweight on a 3-year z-score basis (see the bars chart below). (2) Meanwhile, EUR positioning posts fresh largest notional longs since Oct 2013!!, to EUR+9.1bn notional long (from EUR-2.85bn last month), and compared to the recent low of -19bn in notional shorts seen during the last year (see the table). Any further appreciation of the EUR will set new record positioning. If the economic momentum persists in Europe then new record positioning in the Euro could materialize. It is to be seen, however, whether this economic jump seen in the Euro area is self sustained, specially if we consider that the Chinese-triggered reflation trade is ebbing. (3) The chance of an impeachment has jumped from negligible to nonnegligible and this has weighted in the dollar index. Nevertheless, the Republican’s firm control of both houses of Congress (55% and 52%) gives Trump a stronger starting point compared to past scandals affecting the President. (4) 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 a renewed confidence in the USD. We have raised our year end target for the EUR/USD to 1.05, although we keep intact our fundamental value for EUR/USD at 1.00.

•

JPY= Target (112); EUR/JPY: Target (112).

Several aspects suggest that the JPY outperformance can not last: (1) With political shock in Europe allayed investors switched to Risk-on mode, meaning that a save-haven flow into Japan is less likely now. (2) Real Yield is lower in JGBs, and with the 10YJGB controlled at 0%, there is little prospect that Japanese real yields will rise from here. (3) BoJ has reiterated 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 rise the real yields in USD. (5) Growing prospect of the FED reducing its balance sheet (Philly Fed stated that Yellen could stop reinvesting the proceeds from maturing bonds whit Fed fund rates at 1%), makes the USD more attractive (or the JPY less appealing)

• • • • • • • •

GBP= Target (0.83); EUR/GBP: Target (0.83). May’s early election point to a harder Brexit CHF= Target (0.95); EUR/CHF: Target (0.95). Room for longer positions in CHF. MXN= Target (20.25); EUR/MXN: Target (20.25) BRL= Target (3.20); EUR/BRL: Target (3.20) ARS= Target (18.0); EUR/ARS: Target (18.0) RUB: NEUTRAL-POSITIVE Mkt Value of Change vs AUD: NEUTRAL-POSITIVE Net positions last week CAD: POSITIVE-POSITIVE in the currency in the currency 1-yr Max 1-yr Min 1-yr Avg CNY: Target (6.75-6.80) Currency

(Bn $)

6,91 8,96 2,05 9,06 -5,78 -1,93 -2,53 0,23 1,46 0,36 0,20 -7,33

-4,85 -5,36 -0,51 3,86 0,86 0,73 0,15 -0,01 -0,42 -0,08 -0,27 -0,13

28,7 28,4 2,6 9,1 8,6 -1,9 1,4 0,8 1,9 1,3 4,1 2,3

-3,6 -4,6 -1,7 -19,0 -9,3 -8,4 -3,1 0,0 -2,3 0,2 -1,2 -7,3

14,1 14,1 0,0 -8,6 0,1 -5,8 -1,0 0,4 -1,0 0,6 1,7 -0,3

USD vs All USD vs G10 EM EUR JPY GBP CHF BRL MXN RUB AUD SPECULATIVE POSITION IN THE FX MARKETS CAD

Max Min 7,0

(Bn $)

(3Yr - Z SCORES. Max, Min & Current in 1Yr)

Current

Current Z-score Z-score 3-yr -1,06 -0,97 1,64 2,83 -0,44 0,33 -1,37 0,34 1,79 0,43 0,12 -3,00

ANDBANK

5,0

3-year Z-Score: 3,0

Current Position - 3 year average position 3-year Standard Deviation

1,0

Values above +1 suggest positioning may be overbought

-1,0

-3,0

ANDBANK -5,0 USD vs All

USD vs G10

EM vs USD

EUR vs USD

JPY vs USD

GBP vs USD

CHF vs USD

BRL vs USD

MXN vs USD

RUB vs USD

AUD vs USD

CAD vs USD

Values below -1 suggest positioning may be oversold

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Market Outlook â&#x20AC;&#x201C; 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.

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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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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 documentâ&#x20AC;&#x2122;s publication and cannot therefore be decisive in evaluating events after the documentâ&#x20AC;&#x2122;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 investorâ&#x20AC;&#x2122;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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