GLOBAL ECONOMICS & MARKETS
ANDBANK CORPORATE REVIEW November 2017 Alex Fusté Chief Global Economist +376 881 248 Alex.fuste@andbank.com
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
NOVEMBER 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
15
Commodities Energy (Oil)
16
Precious (Gold)
17
Forex
18
Summary Table of Expected Financial Markets Performance
19
Monthly Asset & Currency Allocation Proposal
20
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
Executive Summary
NOVEMBER 2017
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USA - 12 out of 16 Fed participants project a
India – Brighter prospects for the $2.3 trillion
third 2017 rate hike. The closely watched
Indian
economy,
decision on who the next Fed chair will be could
China
and
be announced on November 3. With global
investors into the market. Equity India Sensex
demand unusually strong, the 7% depreciation
Index: NEUTRAL. Fundamental price 29,958;
in the dollar providing a boost to exports and
Exit
domestic activity benefitting from loose financial
POSITIVE. Target yield stable at 5.5% (currently
conditions, the prospects for growth remain
at 6.7%).
supportive.
Equity S&P
Index:
point
Asia's
Japan,
at
third-largest
are
32,954.
drawing
Bonds
behind
droves
10Y
of
Govie:
NEUTRAL-
NEGATIVE. Target: 2,400. Exit point at 2,500.
Japan –Abe's ruling coalition in Japan regained
Bonds UST10y: NEGATIVE. Entry point at
a
2.65%. Credit - CDXIG: NEUTRAL. target
election, putting him in a position to move
55bp. CDX HY: NEUTRAL. Target 323.
toward
two-thirds
majority
revising
in
Sunday's
the
constitution. Abe's
general
country's
pacifist
victory is supportive
for
Europe – Asset purchase program: We stick to
equity markets. Concerns are that his win may
our central scenario of an open-ended reduction
encourage fiscal stimulus that could eventually
program, to start in 2018 and tapering monthly
further
purchases by 20 bill. euros at the start (from
Nikkei Index: NEGATIVE; Exit point at 20,459.
60bill. to 40 bill.€ per month), to be increased
Bonds 10Y Govie: NEGATIVE. 10Y bond target
afterwards. A rate hike would only take place
0%.
long after tapering had ended (presumably by
fundamental target at 115.
deteriorate
FX
public
JPY/USD:
metrics.
NEGATIVE
Equity
USD-JPY
the end of 2018 or 2019). Equity STXE600 Index: NEUTRAL-POSITIVE. Exit point at 405.
LatAm – In Brazil, the president is very likely to
Bonds, European Govies: NEGATIVE. Corp.
remain in office until the end of his term next
Credit: NEGATIVE. Investment Grade entry
year.
point at 80bp (current 55pb). High Yield entry
NEGATIVE;
point at 350bp (current 244pb).
Mexico IPC Index: NEUTRAL; Exit point at
Equity
Brazil
Exit
point
Bovespa at
Index:
72,000.
Equity
52,000. Bonds: Brazilian 10Y Govies POSITIVE Spain - The most complex scenario is the one
(Targets: 9.25% in Loc, 4.75% in USD). Local
that has materialized. It is very difficult for us
currency 10Y Mexican bonds POSITIVE (Target
to predict whether the political impasse will
7.27%), USD Mexican bonds NEGATIVE (Target
dissipate soon. In fact, uncertainty is likely to
4.30%).
persist for some time. Equity IBEX Index:
NEUTRAL (Target yield 6%). FX targets: BRL
NEUTRAL-NEGATIVE. Central point (within our
3.10, MXN 18.20/18.50, ARS 18.
reasonable
range)
fixed at
9,946.
Sell
Argentinian
Global
bonds
in
USD:
at
10,940. Fixed Income 10Y Govt. Bond:
Forex – The “USD Short” is still the most
NEGATIVE. We are keeping our year-end target
crowded position globally. In the absence of a
at 1.9%.
turnaround in the US that ends the political chaos inside the US Congress, we could see
China – China's Xi approaches new term with
further
souring
WSJ
speaking, our long-term stable equilibrium target
growing
for the EUR/USD pair still favors the greenback
aversion to open markets, which he considers
(based on interest rate spreads, PPP, REER, and
too risky and instead prefers state capitalism.
monetary policy normalization), although we
Equity
Index:
have to admit that traditional valuation criteria
POSITIVE. Exit point at 2,078. Bonds 10Y
are not proving useful in the short term.
Govie: POSITIVE, y/e target yield 2.9%. FX
Andbank's Investment Committee settled the
CNY: FAIR VALUE. Target at 6.75.
EUR/USD fundamental target for the next few
global
highlighted
taste
President
Shenzhen
for Xi
markets: Jinping's
Composite
USD
depreciation.
months in the 1.10-1.15 range.
Fundamentally
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
NOVEMBER 2017
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US:
Fed. 12 out of 16 participants project a third 2017 rate hike. Decision on next Fed chair to be taken on November 3 Fed rates & Chair decision
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
The last minutes from the FOMC suggested broadly unchanged views on the underlying pace of growth and inflation: “many” participants continued to believe “cyclical pressures would show through to higher inflation”. 12 out of 16 participants projected a third 2017 rate hike. Finally, the closely watched decision on who the next Fed chair will be could be announced on November 3. Macro front: the prospects for growth remain supportive. GDP growth looks to have slowed slightly in 3Q (partly due to the disruption caused by hurricanes) but the surge in the ISM surveys suggests that underlying growth continues to strengthen. A weighted average of the two ISM indices rose to a twelve-year high in September and is consistent with GDP growth of more than 5% annualized!! (Admittedly, the alternative Markit PMI surveys have remained more subdued.) US industrial production rose 0.3% MoM in September (due to gains in all three main industry categories – manufacturing, mining, and utilities). With global demand unusually strong, the 7% depreciation in the dollar providing a boost to exports and domestic activity benefitting from loose financial conditions, the prospects for growth remain supportive. We keep our 2017 GDP target at 2.2% and CPI at 2% Inflation. Still low but wages are gaining momentum CPI picked up +0.5% MoM in September on the back of rising fuel costs (the energy index saw a spike of 6.1%. Underlying core inflation remained subdued, increasing 0.1% MoM and 1.7% YoY. Wages & Inflation forecasts: We forecast core inflation to gradually improve over the next two months partly because wages are gaining momentum. Average hourly earnings grew +2.9% YoY (from 2.7% in August and 2.5% in July). This late-cycle reading suggests that Fed tightening will likely continue apace and a third rate hike in December is still in place. Progress on wage gains has been slow despite improved job creation, a phenomenon largely explained by technology substitution and the drag from the over-55 cohort. Politics & Reform agenda Some aspects of the uncertain policy terrain in the US have firmed up recently. The deal between the White House and Congressional Democrats put a temporary end to the debt-ceiling debate, although this issue could flare anew in 2018. On October 20, Trump's top legislative priority took a major step forward as the Senate narrowly (51 to 49) approved a budget vehicle for tax cuts. However, sharp divides over an array of non-binding amendments revealed the towering challenge he faces moving forward. Senator Rand (who split from the GOP vote) objected to a provision to raise military spending by $43 billion, and also broke with his party by voting with Democrats against an amendment to reduce the state and local tax deduction, which could raise tax bills for some. The recent collapse of successive health-care reform bills exemplifies how the divided Republican-controlled Congress may also find it difficult to pass meaningful tax reform or major spending initiatives. Financial markets outlook: New! Equities (S&P): NEUTRAL-NEGATIVE. Fundamental central point for the S&P at ~2,400. Exit point at ~2,500. Current multiples are a concern (high valuation on most metrics vs last 40 years). However, with recessionary risks contained, volatility depressed, and bond yields at fairly low levels, equities are still attractive vs. bonds. We expect further upside to multiples due to recent progress on tax reforms combined with light-handed regulation, a repatriation tax holiday on overseas cash, and possible infrastructure spending, which has buoyed hopes for faster economic growth. There is a 65% chance the tax bill will be enacted in 1Q18. Bonds: NEGATIVE. UST 10Y entry point at 2.65%. A solid global growth backdrop, potential for a US fiscal package, a more hawkish tilt in the future FOMC composition, and additional marketable supply from Fed balance sheet normalization to translate to a 20-25bp increase in term premia in the coming months and ~50-60bp over the entire normalization process. Credit: CDX IG: NEUTRAL Target at 55bp. OW Fins, Tech and Autos. UW Retail and Healthcare. Credit CDX HY: NEUTRAL Target 323. OW Fins, Tech, Media. UW: Materials, Energy and Retailers.
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
Europe:
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ECB's QE “recalibration” in the oven
The Norwegian solution for an agreement in the Brexit is very elusive (expensive for the EU)
Euro Area credit shows moderate growth. Spain and Italy still with negative readings
ECB faces a key meeting at month end. BoE more hawkish As for the ECB, the October meeting (26th) is the date when the bulk of decisions to recalibrate current QE would be taken. Asset purchase program: We stick most of time to our central scenario of an open-ended reduction program, to start in 2018, that could initially extend over 6-9 months, and tapering monthly purchases by 20-30 bill. euros at the start (from 60bill. to 40-30 bill.€ per month), to be increased afterwards. Rate hikes: A rate hike would only take place long after tapering had ended (presumably in 2H 2019). With euro appreciation having halted, currency levels should not impact the coming monetary normalization steps. Looking ahead, continued euro appreciation would increase the risk of the ECB normalization process slowing down. Regarding the BoE, inflation has kept on the rise and a rate hike at the November meeting seems to be already priced in (>80% probability). The open question remains if it will be a single hike or the first step towards further rises. This is supportive for the pound. Macro: robust growth but low inflation Soft data remain upbeat. Latest more positive surveys (PMIs) support the continuation of the bright economic scenario and a broad-based recovery. Hard data also on the rise: Industrial production has improved and consumption remains solid (wages on an upward trend). No material change in inflation dynamics: CPI numbers are low though we are witnessing a slight pick-up in inflation expectations. Draghi's words underlined the ECB's hard commitment towards inflation: “We are not resigned to low inflation”; “nothing will derail our will to reach our inflation goal”. GDP estimates: ECB projections are 2.2% in 2017 and 1.8% in 2018. Projections are for 1.7% growth in 2019. Politics: Voters want lower taxes and slower Euro Area integration After the German elections, a new Government coalition must be formed following the SPD decision to rule out a re-edition of the Grand Coalition. The only possible option is the so-called Jamaica Coalition (CDU/CSU + FDP + the Green Party). Some argue that Merkel will get a stronger grasp on European policy following the departure of Wolfgang Schäuble, but the fact that the Jamaica Coalition is actually the only option to form a government significantly reduces Merkel's role and influence. In fact, the FDP have already demanded to be in charge of the ministry of economy but this must be completely independent of Merkel. Negotiations are still taking place and could extend through December. Fiscal impulse is taken for granted, while doubts remain on the headwinds for a deeper European integration as outlined by Macron. Netherlands and Austria: We can find similarities across other European “new-born” governments in the Netherlands or Austria. The former has finally reached a four-legged coalition, 200 days after holding elections. In Austria, the most likely coalition (ÖVP+FPÖ) could draw important red lines not to be crossed, such as a European Ministry of Finance or a common budget. Both countries share tax cut plans for the coming years and a “no hurry mode” to impulse further steps in a more integrated Eurozone. Little headway regarding Brexit. Some limited progress has been achieved on aspects of EU citizens' rights, but both the Irish border and the financial settlement issue are far from being agreed. December's EU Summit appears critical as British business has warned that insufficient clarity would require activating “contingency measures”. No agreement would be the worst scenario, especially for the UK. May is facing strong internal resistance and uncomfortable polls. Financial markets outlook: Equity (STOX 600): NEUTRAL-POSITIVE. Target 368. Sell at 405. Bonds: NEGATIVE. Bund 0.70%, IT 2.3%, SP 1.9%, IE 1.2% (from 1.4%); PO 2.6%. Credit: Itraxx IG: NEGATIVE. Target 80. Itraxx Xover (HY): NEGATIVE. Target 350.
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
Spain:
NOVEMBER 2017
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Winter is here. There are warmer destinations to go
BRL seems to be trading at fair value
Politics The most complex scenario is the one that has materialized: An autonomous community intervened with proclaimed unilateral declarations. It is very difficult for us to predict whether the political impasse will dissipate soon. In fact, uncertainty is likely to persist for some time, during which the situation may even worsen before it improves. This could have an impact not only at the regional level, but could affect (albeit indirectly) macro figures nationally. The 2018 budget is far from being approved after the refusal of the PNV to give support while the political gridlock remains. In the area of reforms, we must dismiss any possibility of any of the necessary reforms going ahead in the short term. The only scenario that could break this loop in the short term would be elections in Catalonia with a clear result. We believe that this scenario is unlikely at this time. Economic outlook As we pointed out last month, new macroeconomic data released during the summer suggested that economic growth peaked during the second quarter. The data released this month confirm our thesis that the third and four quarters would see worse macro data for the whole economy. Indeed, there is still a positive contribution of domestic dynamics. Employment certainly represents a positive development, although most of this growth has been concentrated in low productivity sectors. There is also a positive contribution from a favorable external sector. Nevertheless, all these indicators are now rising at a slower pace. The current political situation is already having a visible effect, with consensus downgrading 2018 GDP growth between 0.2%-0.5%. In our case, we are focusing on the immediate effects on the tourism industry, which accounts for about 16% of GDP in Spain; without forgetting that Barcelona is ranked among the Top 10 cities in the World for international tourist spend, with Catalonia receiving more than 23% of this income. We then expect some slowdown through the fourth quarter, which we currently estimate at 0.1%-0.2%. Inflation Prices are indicating that our CPI target of 1.7% for year-end could prove accurate. Headline inflation rose to 1.8% YoY in September due to a regulated prices. Banking & Reforms Asset quality improved markedly in 2Q17. The NPL ratio was 8.74% in May 2017, a figure that compares positively with the figures in May 2016 (9.84%) and December 2016 (9.11%). The coverage ratio has remained largely stable: 59.4% in May 2017 vs. 58.9% in December 2016. This ratio should improve further following Santander's acquisition of Popular and the capital increase just announced by Liberbank to boost its coverage ratio to 50% (from 40%) Deleveraging has been impressive. Since its 2010 peak, private sector debt has decreased by 50pp of GDP, equivalent to around €448 billion in nominal terms (€269 billion by corporates and €180 billion by households). Nonetheless, private sector debt should still be monitored closely as it remains above the eurozone average. Financial markets outlook: New! Equities (Ibex): NEUTRAL-NEGATIVE. New central point (within our reasonable range) fixed at 9,946 (from 10,271). Sell at 10,940. We keep our targets for sales and margins stable, and thus for EPS. We admit that we would like to upgrade profit margins 20bp following guidance from companies, but the political impasse in a region that makes up a fifth of the economy could affect the cost side as well. To factor in some risk premium for Spanish assets during this situation, we downgrade the PER ratio estimate to 15.3 from 15.8 times for the short term. Maybe in the short term there are better markets that offers healthier risk/reward returns during this uncertain period. Fixed Income - 10Y Govt Bond: NEGATIVE. We maintain our fundamental (entry point) target at 1.9%. With no inflationary pressures, the ECB is not in a hurry to abruptly end its expansionary monetary policy. So we bet for a gradual rise in yields.
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
China:
NOVEMBER 2017
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Xi Jinping's growing aversion to “risky markets” lead him to prefer state
capitalism
Following the 2016 “big stimulus”, China will likely be the main exporter of global deflation once again
China will continue being a global exporter of deflation
Reserves are recovering steadily throughout the year
The slowdown in overall credit growth reflects the new macro-prudential approach. Credit growth is likely to continue decelerating until Q1 2018
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.
Politics Xi approaches his new term with a souring taste for global markets: WSJ highlighted China President Xi Jinping's growing aversion to open markets, which he considers too risky and instead prefers state capitalism (state intervention attempting to engineer economic outcomes, ranging from raw-materials prices, to the value of stocks and Fx). Party Congress to signal policy continuity: Fitch Ratings suggested the Party Congress is an opportunity for the leadership to signal a shift in policy priorities towards structural reform and could be a platform for stronger implementation of President Xi's agenda if he consolidates his power. However, the agency fears that the most likely outcome is “a status quo scenario, characterized by continued adherence to high growth targets and only gradual steps on supplyside reforms to boost productivity and stabilize debt levels”. Geo-politics: North Korea to top agenda in US-China talks The White House announced that President Trump will visit China between November 8 and 10 as part of his Asia tour to meet with President Xi Jinping. A key item on the agenda for Trump's talks with Xi is expected to be North Korea's nuclear program. The White House said Trump would “call on the international community to join together in maximizing pressure on North Korea.” Diplomacy: Xi to cut some FDI caps during Trump's visit The South China Morning Post cited experts who said China could loosen foreign ownership caps for joint ventures in certain industry sectors where Chinese companies already possess a competitive edge as part of a wider opening up of the world's second-largest economy during US President Trump's visit to Beijing next month. Central Bank: No room for further easing next year. PBoC could tighten monetary policy. The 21st Century Business Herald cited Zhu Baoliang, an economist at the State Information Center, as saying monetary policy has been too relaxed in the past and there is no room for further loosening next year. Banks: Wary of consumer loans being funneled to housing market Chinese commercial banks are demanding clients provide proof that consumers loans are not being used for property purchases. The South China Morning Post noted in an article that short-term household loans rose to CNY1.53T in Q3 and that banks and economists are worried part of the loans are being invested in the red-hot property market. The CBRC also announced it would investigate the matter in order to prevent property bubbles. Fiscal (good figures in September) September fiscal spending +1.7% YoY vs +2.9% in prior month. Revenues +9.2% YoY vs +7.2% in prior month Macro: Economy & Inflation PBoC sees 2H17 GDP growth at 7% YoY (accelerating from 6.9% YoY seen in 1H17), implying a FY17 expansion of 6.95% September outstanding loans +13.1% YoY (vs prior +13.2%). Total social financing rose to CNY 1.82T (from 1.48T last month). September CPI +1.6% YoY vs +1.8% in prior month. PPI +6.9% YoY +6.3% in July Financials: Risks in China's banking sector lower in Q3 Xinhua cited a CBRC statement on Saturday that risks in China's banking sector continued to dissipate in Q3, with falling interbank business and slower growth in wealth management products. Interbank assets and liabilities, a key indicator for shadow-banking activities, fell CNY2.6T ($400B) from the beginning of the year, with growth slowing for eight straight months to 4%. Yuan: Beijing will continue its tight grip on the yuan China has been busy cutting debt in state-owned enterprises and banks, and cheap currency is essential to prop up these companies at the expense of a free-floating yuan. Capital controls are also needed to ease overheated real-estate markets. The WSJ expects that the yuan will go sideways instead of forward over the next ten years. Financial markets outlook: Equity (Shanghai): NEUTRAL. Exit point: 3,387 Equity (Shenzhen): POSITIVE. Exit point: 2,078 Bonds: POSITIVE. 10Y bond target 2.9% FX (RMB): NEUTRAL-POSITIVE. USD-CNY target at 6.75
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
NOVEMBER 2017
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India: Brighter prospects for the $2.3 trillion Indian economy
GDP growth is the highest within the EM category (both in q/q and YoY terms)
MoU with external and domestic institutional investors Pursuant to the Memorandum of Understanding (MoU) between the Government of India and the Government of the United Arab Emirates (UAE) to channel long-term investment into the National Investment and Infrastructure Fund (NIIF), the first investment agreement between the NIIF Master Fund and a wholly owned subsidiary of the Abu Dhabi Investment Authority (ADIA) has been signed. Six Domestic Institutional Investors (DIIs) will also be joining the NIIF Master Fund along with the ADIA, apart from the Government of India. This is a significant milestone in operationalization of the NIIF, and the Agreement paves the way for creating significant economic impact through investment in commercially viable infrastructure development projects. The NIIF was envisaged as one or more Alternative Investment Funds (AIFs) under the SEBI Regulations. The proposed corpus of NIIF is around $6 billion. GOI's contribution to the NIIF will be 49% of the total commitment. NIIF has been mandated to solicit equity investments from strategic anchor partners, like overseas sovereign/quasi-sovereign/multilateral/bilateral investors. External dynamics, Domestic activity & Outlook Exports in September galloped 26% YoY, the fastest pace in six months, to $28.6 billion. Official data showed a narrowing of the trade deficit to its lowest level in seven months. "India's growth story is back," tweeted Commerce and Industry Minister Suresh Prabhu. Factory output in August pointed to the manufacturing sector regaining its foothold despite problems with the implementation of a new national sales tax. The Index of Industrial Production (IIP) climbed 4.3%, the quickest in six months and well up on the forecast of 2.4%. "The sharp upturn in IIP may be indicative of the restocking exercise before the commencement of the festive season in the economy," rating agency CRISIL said in a note. Brighter prospects for the $2.3 trillion Indian economy, Asia's thirdlargest behind China and Japan, are drawing droves of investors into the market. Central bank, Monetary policy and Inflation Data showed inflation held steady (at 3.28% YoY in September) instead of accelerating to 3.60% as expected, raising tentative hopes for the central bank to be less hawkish about interest rates. Analysts still expected the Reserve Bank of India to keep rates steady in the months ahead, and further signs of steady inflation would raise the odds of a rate cut. We expect the RBI to stay on hold in our base case (75% probability), and we also assign a 25% probability to a cut on the back of the Reserve Bank of India fixing its retail inflation projection for October-March to 4.2%-4.6% and lowering its economic growth estimates. This is supportive for bonds and equities since a shift in household savings into financial assets from traditional avenues such as gold and property has provided a springboard for equity markets to override volatile foreign cash flows. Political compulsions Prime Minister Narendra Modi, who faces crucial state elections in his home state of Gujarat and Himachal Pradesh in December, is under pressure to revive growth, which slipped to 5.7% for the April-June quarter, partly due to a crackdown on tax evaders (demonetization) and also due to the introduction of the GST reform, which heightened business uncertainty. Last week, the Government cut taxes on 27 items, mostly food products, and eased rules for SMEs, as it rushes to address growing criticism of its new tax launched in July. New Delhi, which is also facing the risk of a widening fiscal deficit this year (mainly due to lower growth in revenue receipts after many firms failed to register for the new tax code), wants the RBI to ease policy rates to support private investment and revive growth. Financial markets outlook: Equity (Sensex): NEUTRAL. Fundamental price 29,958. Exit point at 32,954 Bonds: POSITIVE. 10Y bond target at 5.5% (from 5.7%)
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
NOVEMBER 2017
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Japan: Abe's coalition regains two-thirds majority
Sanity
Insanity
Sanity
The “money” is not in the real system
Monetary policy (BoJ) & Inflation BoJ need to stick with current easing framework: Reuters cited BoJ board member Makoto Sakurai, who said that the effects of current monetary easing would become stronger as economic growth picks up. Sakurai reiterated that prices remain on track to reach 2%, though rising labor participation and increased productivity are weighing on wages and prices in the short term. Politics Japanese Abe's ruling coalition regained a two-thirds majority in Japan's Lower House after Sunday's general election, putting the prime minister in a position to move toward revising the country's pacifist constitution. Abe's Liberal Democratic Party and coalition partner Komeito gained 312 seats of the contested 465. Is an Abe's victory supportive for equity markets? According to a Reuters poll, Japanese companies overwhelmingly want Prime Minister Shinzo Abe's ruling coalition to stay in power. Exporters, nuclear power operators and defense firms to benefit: Abe's win would help these companies, although his win is posing challenges for retailers as they suffer sales tax hikes, while tobacco firms will see Abe hiking taxes on electronic tobacco products. Fiscal & Tax There are concerns that his major victory may encourage Abe to focus more on constitutional reforms aimed at encouraging fiscal stimulus that could eventually further deteriorate public metrics. The IMF sees a sales tax hike as an "obvious" choice. The IMF mission chief for Japan (Odd Brekk) said that given the country's fiscal “health” and debt woes, a sales tax hike would be an obvious choice for Japan. Opposition parties oppose the tax hike scheduled for 2019. Economists are also against Abe's plan to use sales tax revenue for education because it would add to Japan's massive debt burden. Nevertheless, 27 of 35 economists expect the Government will increase the tax. Macro figures (+) Manufacturers' confidence rebounded in October: Reuters Tankan showed that the sentiment index for manufacturers rose six points to 31 in October, matching a peak last seen in 2007. A weak yen and strong overseas demand were cited as catalysts for the increase. The Nikkei reported that Chinese companies are buying Japanese heavy machinery at a brisk pace as the country modernizes manufacturing. However, a few manufacturers are worried about a reversal when China winds down its stimulus, and the surge in orders may just be temporary. (+) August final industrial production +2.0% m/m vs preliminary 2.1% and (0.8%) in prior month. (-) Service sector sentiment, however, slipped by 4 points from last month to 30. (-) September bank lending +3.0% YoY vs +3.2% in prior month. (-) August tertiary sector activity index (0.2%) m/m vs consensus +0.1% and +0.1% in prior month. Corporate news The Nikkei reported that equity financing has recovered sharply as the Nikkei Stock Average rose to a 21-year high. New share issuances totaled ¥244.2B. However, Japanese companies are aware that equity financing is hurting RoE and could be hesitant on fundraising given strong earnings and ample cash. Notable Japanese companies are holding a large amount of cash and equivalents, reflecting the need for emergency funds as well as a lack of viable investment opportunities. Kobe Steel scandal affects 500 customers: Kobe Steel's (5406.JP) data falsification scandal worsened as the steelmaker revealed nine additional fraud cases, this time involving its flagship steel products. Including aluminum and copper products that the company disclosed earlier this week, the falsely certified products were shipped to a total of 500 customers. However, Kobe Steel's shares soared thereafter as financing worries receded. Financial markets outlook: Equity (Nikkei 225): NEGATIVE. Exit point at 20,459 Bonds: NEGATIVE. 10Y bond target 0%. FX: NEGATIVE. USD-JPY fundamental target at 115.
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
NOVEMBER 2017
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Brazil: Back to the Social Security reform game
Still room to ease conditions. We believe the Selic rate will be cut to 7.25% this year.
Politics Temer's current situation: As we move closer to 2018, the president’s predicament eases and most Congress representatives’ eyes and attention have fallen on next year’s electoral schedule. Having survived the Supreme Electoral Court trial in June and the first charge for passive corruption in August, Temer now faces his second trial for leading a criminal organization and obstruction of justice, following a claim lodged by the former General Attorney, Rodrigo Janot. As with the first trial, the president must obtain in Congress at least 172 votes out of a 513 total. The process began favorably for Temer, with the Constitution and Justice Commission endorsing the rejection of the charge. Congress is set to vote on the report on October 25, bringing to an end the criminal case against Temer. Thus, the president is very likely to remain in office until the end of his term next year. There is little incentive for the political class to dismiss Temer for now, given the oncoming electoral period and the fact that he is in a position to bear the burden of unpopular measures (Temer's approval rate is below 5%), amidst an economic recovery. Temer's congressional support is solid, but the prices required by the congressmen to maintain that support are increasingly higher. A product of this is the recent tensions between the PMDB and DEM (Democratas) which is the party of the President of the Chamber of Deputies, Rodrigo Maia (a key player in the relationship between the Government and Congress). These tensions are part of the political negotiations involving next year's elections and we believe that Temer will handle them accordingly. Additionally, there is still the risk of damage caused by the former minister Geddel Vieira Lima, which is still under arrest. Structural reforms The labor reform bill, the spending cap bill and the new long-term BNDES financing rate (“TLP”) have been approved. After the second charge against Temer has been settled, Congress is expected to resume negotiations on the Social Security reform. We believe that the bill will be passed in the Lower House in early/mid November, in a diluted form. It should proceed to the Senate by next May, before the formal start of the electoral schedule, when Congress representatives will pursue their own agenda seeking reelection. Macro front Marginal improvement in the labor market: The economy created a total of 34,392 jobs in September, with higher contributions in the industry and service sectors. The unemployment rate fell to 12.6% in August, after reaching 13.7% in the early months of the year. Important to highlight is that most of this downward movement is related to informal jobs and small, home-based entrepreneurship. Inflation remains well under control: IPCA in September rose by 0.16% (+2.54% in 12 months), falling a little ahead of expectations. The breakdown is similar to in previous months, with deflation in food prices (-0.41%). Transportation and personal expenses were the main contributors, with increases of 0.79% and 1.07%. Even if food prices are stripped out, we believe that inflation should remain low, given a still high unemployment and idle industrial capacity. Better tax revenues: Central government has registered BRL 105.6 billion in tax revenues in September, (+8.66% increase in real terms in comparison to September last year). The main contributors to this figure were Refis (renegotiation of corporate debt with the Union), higher taxes on fuels and better economic activity. Financial markets outlook: New! Equities (Ibovespa): NEGATIVE. Central point of our fundamental target range 68,500. Exit point 72,000. Currently at 76,000 points, the Ibovespa has already surpassed our optimistic exit point for the year end (72,000 points). Moreover, we expected that level to be reached only after the approval of all structural reforms planned by the Government. Government Bonds: POSITIVE. 10Y bond Loc target 9.25% (we expect real yield to fall to 4.75% from 5%). 10Y bond in USD target 4.75%. Foreign Exchange: NEUTRAL. Target BRL/USD at 3.1
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
Mexico:
NOVEMBER 2017
Page 11
NAFTA negotiations to be extended throughout 2018 NAFTA negotiations Before the conclusion of NAFTA’s fourth round of negotiations, a “no deal” outcome started to be discounted on Mexican financial markets. The economy minister said that the country should have a Plan B if NAFTA was dissolved. Although it was expected that there will be eight rounds of negotiations before the end of this year, on October 17 it was announced that the process will continue through 2018. The most important differences between the Mexico/Canada bloc and the USA is that Donald Trump's administration is reluctant to change its objective of reducing its trade deficit, and is even determined to establish a clause for the treaty to be reviewed every five years. In order to achieve his goal, Trump wants to change the current Rules of Origin that establish the minimum North America content of products to be imported into the US. Politics. 2018 presidential election Lopez Obrador is still leading the polls, with his closer competitor being the ruling party (PRI), that has not yet named its candidate, although they will most probably be a former finance or state minister. The 2018 election will have the largest ever number of independent candidates, with more than 30 already registered in the preliminary stages. Banxico & Inflation Banxico's rate rise cycle has come to a halt, although in its last monetary policy meeting, the monetary authorities showed a real concern about inflation and its resilience to moderate, raising doubts about new future hikes. In fact, Banxico's committee members, who anticipated a low chance of a new rate shift in 2017, made clear that a rate hike is more likely than a rate cut. Consensus is for a 25bps rate cut in 3Q18. Banxico expects inflation to be fixed in the 6.00%-6.30% range in 2017. With a longer term view, in the central bank's monthly inflation report the authorities projected a downward trend for inflation starting in September-October this year that could bring prices below the long-term goal of 3%+/-1% by the end of 2018. It is worth mentioning, however, that the September report showed negative inflation partly due to public transport and telecommunication service subsidies introduced temporarily after the September 19 earthquake. For the first fifteen days of October, the subsidized prices should be higher. This, added to a previously announced rise in electricity prices, will contribute to prices continuing along this path. Some other prices such as those of nonagricultural goods also trended upwards. Economic indicators: Bad figures in consumption and industry The central bank recently adjusted its growth forecasts to 2%-2.5% for this year and 2%-3% for 2018. Purchase expenditure continued to slow down but in September huge demand for first necessity products (water, blankets, medicine, food) impacted positively on sale reports. Industrial production continued to weaken as a result of the depression in the mining and construction sectors. On the other hand, manufacturing exports are still growing at a double-digit pace. Uncertainty over NAFTA accelerated goods and services sales. Financial markets outlook: Equities (IPC Gral): NEUTRAL. Fundamental central point: 50,000 points; Exit point: 52,000 points. Despite numerous recent geopolitical events, Mexican stocks are holding up well in a favorable global environment, with recent upward revisions for emerging markets having a positive impact on Mexico's IPC index. Any level above our central target should be used to increase liquidity. New! Bonds: MIXED. 10Y bond Loc target 7.27% (from 7.0%). 10Y bond in USD target stable at 4.30%. We expect the Local M10T10 spread to be around 450-475bps, and we are predicting a 10Y UST at 2.65%. For the US denominated 10Y bond, we forecast a 150-180 spread against the US T-bond. New! FX: POSITIVE. Target 18.20-18.50. MXN is still facing higher volatility as it is shaped by the NAFTA negotiations and next year’s presidential elections, among other factors.
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
NOVEMBER 2017
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Argentina: Time for genuine reforms has come
Cheap
Expensive
Thousand Million
Negative trade balance is offset by favorable terms of trade
Politics & Latest developments On October 22, midterm elections took place, in which half of the lower Chamber and one third of the Senate was renewed. This election was seen by the markets as a test of the legitimacy of the “Cambiemos” coalition government continuing with its reformist agenda. After a clear victory, president Macri's political capital is at its highest level ever. At a national level, the Government received 41.8% votes, more than doubling the sum of its nearest competitors (Cristina Kircher's Unidad Ciudadana and Peronist Party). Regionally, the Government won in the five biggest districts: Buenos Aires Province (PBA), Córdoba, Santa Fe, Mendoza and the City of Buenos Aires. The most resounding victory was in PBA, in which Esteban Bullrich defeated Cristina Krichner (CFK) by a 4% margin, after narrowly losing in the August primaries. All main possible presidential candidates for 2019 (CFK, Massa, Urtubey) were defeated by Cambiemos. Despite the fact that this election reinforced Macri's position in parliament, the Government still fails to have enough seats to achieve a healthy majority. So it will need to negotiate with the opposition to pass reforms. With the elections behind us, 2018 should be brighter, giving Macri the possibility (and the obligation) to use its renewed political capital to move forward with reforms in the areas of fiscal consolidation and responsibility law, inflation reduction, capital markets law, etc. Macro front The Argentine economy grew 0.7% YoY in July according to the EMEA proxy for GDP growth. This reading adds up to 2.1% growth in the first seven months of the year, led by Agriculture. Economic growth kept expanding across sectors, with 13 out of 15 sectors posting YoY growth. Important to note is the growth seen in Manufacturing and Commerce, which are important components of GDP. We keep our target at 2.75% GDP real growth for 2017, in line with median estimations that suggest a 2.80% rate in 2017. Fiscal Then cumulative primary fiscal deficit amounted to 2.2% in the first 9 months of the year. This reading represents just 52% of the yearly government target of 4.2% primary deficit (good news). The reasons behind this outperformance are: (1) 0.30% of GDP in fiscal revenues coming from tax amnesty extraordinary collections; and (2) null capital spending in the first part of the year. For the months ahead, increases in social transfers and capital expenditures are expected to rise. Our target is that the Government will meet its 4.2% primary deficit target. Prices The September inflation reading showed a 1.9% MoM rise (versus 1.4% in August). Year to date cumulative inflation adds up to 17.6%, already above the higher boundary of the Government's target range (12-17%). The central bank maintains its hawkish stance focused on getting inflation into the target range. The current official rate stands at 26.25% (last time it moved was in April, hiking 150bps). The CB stated that it intends to bring monthly inflation to 1% MoM by year end. Our target is that inflation will close 2017 at 22%, in line with median estimations. Financial markets outlook: New! Bonds: NEUTRAL-POSITIVE. Target Govt Bond 10Y USD: 5.5% (from 6%). Current spreads (310bps) are close to the lowest seen in the last 10 years, however the election results validate this level of spreads. Going forward, we think spreads could narrow a further 40 to 50bp if the fiscal deficit target is hit and reforms are pushed through. New! FX: NEUTRAL-NEGATIVE. 1H2017 showed an extremely stable stance for ARS, however a combination of factors drove the currency down 14% (from 15.60 to 17.80). These factors were: Brazilian political turmoil starting on May 18, MSCI's decision not to upgrade Argentina to Emerging Market on June 21, the CFK candidacy for the Senate on June 24, and favorable polls for CFK in PBA. After the positive election results, we consider appreciation pressures (foreign flows looking for local rates) will continue to be exerted on the peso. However, we continue to believe that depreciation should be adjusting more to inflation, also for the last part of the year, when there is seasonally higher demand for USD. We are therefore keeping our yearend target of 18 ARS/USD, which will represent a 13% yearly drop.
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
NOVEMBER 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
Current
Anbank's
INDEX
2017
Growth PE (forward) PE estimate CURRENT Central Point
2017
2017
E[Perf] to
Exit
E[Perf] to
Index
2016
2017
2017
2017
2017
2017
E[EPS 2017]
2017
PRICE
Point
Exit point
USA S&P 500
10,3%
10,0%
1.276
10,0%
128
7,2%
20,19
18,81
2.576
2.400
-6,8%
2.520
Europe STXE 600
6,9%
3,7%
313
7,6%
23,77
14,6%
16,56
15,50
394
368
-6,4%
405
Spain IBEX 35
7,3%
3,5%
7.648
8,5%
650
20,6%
15,69
15,30
10.197
9.946
-2,5%
10.940
Mexico IPC GRAL
7,4%
7,0%
33.048
7,1%
2.356
2,9%
20,85
21,50
49.118
50.661
3,1%
51.927
Brazil BOVESPA
7,6%
5,5%
53.915
7,7%
4.151
6,4%
18,32
16,50
76.052
68.499
-9,9%
71.924
Japan NIKKEI 225
5,1%
2,5%
19.981
5,2%
1.039
4,4%
21,18
17,90
22.008
18.599
-15,5%
20.459
China SSE Comp.
8,5%
7,5%
2.689
8,0%
215
1,1%
15,88
15,00
3.416
3.226
-5,6%
3.388
China Shenzhen Comp
8,2%
8,5%
890
7,8%
69
2,8%
29,14
28,50
2.023
1.979
-2,2%
2.078
Hong Kong HANG SENG 14,8%
3,0%
12.535
14,5%
1.818
0,6%
15,65
12,50
28.439
22.720
-20,1%
26.128
India SENSEX
10,5%
11,0%
15.851
10,5%
1.664
10,7%
19,92
18,00
33.157
29.958
-9,6%
32.954
MSCI EM ASIA (MXMS)
12,6%
7,5%
407
12,6%
51
7,4%
10,98
8,75
563
449
-20,3%
494
-2,2% 3,0% 7,3% 5,7% -5,4% -7,0% -0,8% 2,7% -8,1% -0,6% -12,3%
UPWARD REVISION
(Fundam range) Centr. Point
ANDBANK ESTIMATES
DOWNWARD REVISION
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
4 4 4 5 5 -0,7
2 2 4 8 6 -3,2
Andbank’s Global Equity Market Composite Indicator Preliminary assessment of the level of stress in markets
previous
current
0
-5
-10 Market is Overbought
+5
Area of Neutrality Sell bias
Buy bias
+10 Market is Oversold
Andbank GEM Composite Indictor: Our stance for equity indices in developed markets worsens this month and maintains a sell bias. Our broad index has moved from -0.7 last month to -3.2 (in a -10/+10 range), settling in an area that suggests the market is overbought. We have therefore removed the “slightly overbought” assessment from our statement and replaced it by a clearer “overbought”. Positioning indicators: In aggregate, these indicators show a mixed picture, with hedge funds and speculators showing cautious positioning (underweight), while classical asset allocators still remain exposed to the equity market with a certain intensity (versus historical patterns). Flows: According to Datastream, flows towards equity markets lost momentum in September ($-3.3bn in US and $5.2 in Europe), while we have seen inflows into MM instruments globally ($+102bn) and fixed income instruments ($+63.8bn). This lack of momentum in equity inflows could last, since flows have not been particularly aggressive.
TECHNICAL ANALYSIS: Trending view 1/3 months. Supports & Resistances o o o o o o o
S&P: BULLISH / BULLISH. Supports 1&3 month at 2489/2405. Resistance 1&3 month at 2621 STOXX600: SIDEWAYS-BULLISH. Supports 1&3 month 366. Resistance 396/404 IBEX: SIDEWAYS BEARISH. Supports 1&3 month at 9724/9360. Resistance 10,410 €/$: SIDEWAYS / SIDEWAYS-BULLISH. Supports 1&3 month at 1.1661. Resistance 1.2168/1.2397 Oil: SIDEWAYS-BULLISH. Supports 1&3 month at 48.9/45.4. Resistance 1&3 month at 55.2 Gold: SIDEWAYS BEARISH. Supports 1&3 month at 1241/1194. Resist 1&3 months at 1391 US Treasury: SIDEWAYS BEARISH Supports 1&3 month 2.02%/1.97%. Resist 1&3 months at 2.425
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NOVEMBER 2017
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Fixed Income – Core Country Bonds: UST 10Y BOND: Floor 1.85%, Ceiling 3.2%. Fundamental Target 2.65% 1. Swap spread: The swap spread remained stable around -4bps (from -4bps last month). For this spread to normalize towards the +15bps area, with our long-term CPI expectations (reflected in the swap rate) anchored in the 2.0% area, the 10Y UST yield would have to move towards 1.85%. 2. Slope: The slope of the US yield curve flattened to 75bps (from 82bps). With the short-end normalizing towards 1.5% (today at 1.55%), to reach the 10Y average slope (of 178bps), the 10Y UST yield could move 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 0.95%. Fundamental target 0.70% 1. Swap spread: The swap spread upticked to 50bps (from 46bps last month). For the swap spread to normalize towards its long-term average of 35bps, with our long-term 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 steepened significantly during the summer to 111bps (from 116bps). If the short end “normalizes” in the -0.25% area (today at -0.77%), to reach the 10Y average yield curve slope (126bps), the Bund yield would have to move to 1.01%.
Fixed Income – Peripheral Bonds 10Y Government Bond yield targets Spain: 1.90% Italy: 2.30% Portugal: 2.60% (from 3.00%) New! Ireland: 1.20% (from 1.4%) Greece: 7.50%
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
NOVEMBER 2017
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Fixed Income – EM Govies. Why so calm? The not-so-known negative factors: 1. The flurry of hawkish comments from developed world central bank officials threatens to call time on the EM rally. If the rise in developed market bond yields persists, investors face the possibility that liquidity will recede and emerging market bond yields will rise steeply too (as developed market bonds sold off last week, investors in the largest US dollar denominated emerging market bond ETF withdrew more than US$800mn—the biggest outflow in the fund's history). 2. The emerging markets have US$280bn of US dollar-denominated debt due to mature by the end of 2018. That is considerably more than the US$200bn raised by emerging market borrowers in new issues over the past 12 months. Clearing this “maturity hurdle” in an environment of rising yields will be challenging to say the least. The not-so-known positive factors: 1. As developed market yields rise on the back of improved growth prospects, the resulting rise in demand for emerging market exports will boost corporate margins in the emerging world. 2. The new normal for structural growth rates in developed economies is settling well below previous levels. This means that developed world yields may well prove to be capped. 3. 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 position. (4) The central bank can withstand downward FX pressures while satisfying demand for its USD held as FX reserves. (5) But 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.
Our Rule of Thumb: CPI (y/y)
10 Year
Yield
Last
Yield
Govies
reading
Real
3,72% 3,27% 3,40% 1,80% 3,69% 0,79% 0,40% 2,10% 0,46%
3,05%
-1,00%
3,55%
-1,00%
1,42%
-0,50%
1,99%
-0,50%
0,34%
0,00%
1,51%
-0,50%
1,86%
-0,50%
0,36%
0,00%
Taiwan
6,77% 6,83% 4,82% 3,79% 4,02% 2,30% 2,26% 2,45% 1,06%
0,60%
0,00%
Turkey
11,76%
11,20% 3,00%
0,56%
0,00%
Russian Federation 7,57%
4,57%
-1,00%
9,79% 7,27% 6,66% 5,60%
1,63% 6,40% 4,02% 2,93%
8,16%
-1,00%
0,87%
0,00%
2,64%
-0,75%
2,66%
-0,75%
India Philippines E M A S IA
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. With a longer-term view, our expected average inflation is around 1.5%2%, meaning that a good entry point in UST could be 2.5%-3%. 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 the UST 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 (that is, a 2.50% real yield).
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 150bps 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
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
NOVEMBER 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): Geopolitical: (+) Geopolitical tensions remain in focus with the US stance on Iran. Of special importance is the possibility of the USA unilaterally deciding to abandon the nuclear deal with Iran, threatening to revive the old regime of economic sanctions against Iran and limiting its oil exports and production. This comes after Trump refused on Friday to formally certify that Tehran was complying with the 2015 accord even though international inspectors say it is. On the other hand, Iran's oil minister said President Trump's hardened stance on the nuclear deal will not have much impact on global oil prices. (-) Iraq forces take control of all oil fields operated by state-owned North Oil in Kirkuk, completing an operation to seize the region over which the Kurds claim sovereignty. Iraqi oil officials said all the fields were operating normally. The US aims to remain neutral in the Iraq conflict where an all-out battle broke out between two of its closest ground partners in its campaign in Syria, although the US authorities raised concerns about a broader civil conflict erupting in Iraq. The current situation in northern Iraq laid bare the risks of Washington's decision to defeat Islamic State by backing a pair of local forces without addressing their long-simmering resentments against one another. President Trump said US forces would not take decisive action to support the Baghdad government or the Iraqi Kurds. (?) Goldman sees geopolitics haunting oil with unclear effects: “The oil market is grappling with intensifying geopolitical risks and uncertainty swirls over the impact of tensions with Iraq and Iran”. The bank said both sides in Iraq have an incentive to keep oil flowing due to low production costs and high revenue available per barrel. It added that the $1.50/barrel rally in Brent in the week of October 15 could be interpreted as reflecting expectations for an outage of 250Kbpsd over three months. Fundamental: (-) No Aramco IPO may mean no more oil rally: The oil rally could have the legs kicked out from under it if Saudi Aramco opts to forgo an IPO, which would bring into question its commitment to prop up oil prices. The Saudis have privately targeted an oil price of $60 to help the IPO generate tens of billions of dollars the kingdom has planned to use to diversify its economy. However, some of our sources suggested that Saudi Arabia is considering giving up on its plan to list its stateowned oil company, Saudi Aramco, on an international stock exchange and may instead offer shares only on the kingdom's exchange in Riyadh. Another option the company is considering is to perform the IPO in two stages, with a listing in Riyadh in 2019 and an international listing a year later. (--) An old fracking hot spot makes a comeback: One of the early centers of American shale drilling is making a comeback, boosted by a building boom of petrochemical plants, fertilizer factories and gas-export terminals along the Gulf Coast. The Haynesville Shale in northwest Louisiana was one of the hottest fracking spots a decade ago. Now, the formation is being reborn as companies with longstanding positions in the area and newcomers seeking opportunity rush back in and drill again. (-) World's largest oil hedge is completed. Mexico has completed its annual oil hedge for 2018, which will lock in an average export price of $46/barrel. The country's deputy finance minister said that in addition to the put options bought on the market, a larger Oil Revenue Stabilization Fund, with the help of the central bank's exchange-rate surplus, will help to offset any negative impact from a sharp decline in oil prices. Could this mean that Mexico is no longer incentivized to fight hard against a downward trend in the price of oil? Positioning (-) Investors could have hit peak bullishness on oil. A Reuters column said the wave of investor bullishness towards oil that started back in July may have peaked at the end of September. Hedge funds and other money managers cut their net long position in the five major futures and options contracts by a total of 32M barrels in the week to October 10. 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: The value of producers' reserves depends on the amount of time they can pump at current levels before tougher environment-inspired regulation comes in. Saudi Arabia has between 60 to 70 years of proven oil reserves at current output, but with 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. (-) 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 OPEC producers). That is not the case now. 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. (-) 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 $1,126 (from $1,145 last month). In real terms gold continues to trade well above its 20-year average of $802. Given the global deflator (now at 1.1316), for the gold price to stay near its historical average in real terms, the nominal price (or equilibrium price) must remain near US$907. 2. Gold to Silver (Preference for Store of Value over Productive Assets): This ratio has ticked down to 75.29x (from 76.4x last month) and remains well above its 20-year average of 61.25, 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 $1,037 oz. 3. Gold to Oil: This ratio fell to 24.37x (from 25.75x last month) still well above its 20-year average of 14.94. Considering our fundamental long-term target for oil of US$45pbl (our central target), the price of gold must approach US$672for this ratio to remain near its LT average level. 4. Gold to the DJI: This ratio has risen to 18.38x (from 17.24x last month), still below its LT average of 20.17x. Given our NEW central point (target price) for the DJI of 22,000, the price of gold must approach US$ 1,091 for this ratio to remain near its LT average. 5. Gold to the S&P500: This ratio fell to 0.496x (from 0.518x last month), but is still well below its LT average of 0.5865x. Given our target price (central point) for the S&P of $2,400, the price of gold must approach US$1,407 for this ratio to remain near its LT average. 6. Speculative Positioning: CFTC-CEI 100oz Active Future non-commercial contracts: longs fell to 284k (from 330k). Shorts also fell (though less) to 83.8k (from 94.5k) => Thus, the net position fell to +200k during the month (from +236k), suggesting that gold is relatively expensive. 7. Financial liberalization in China. Higher “quotas� each month in the QFII program 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: (NEW!) Mid-term target: 1.10-1.15
Flows: The net notional in USD Global positioning remained fairly low compared to historical standards, fixed in negative territory to the tune of $-16.33bn (vs $-16.65bn las month), near recent fresh lows and well below its peak of +$28.7bn net longs seen in September 2016. The global positioning in USD represents a -1.92 sigma underweight on a 3-year z-score basis, which makes the “USD Short” the most crowded position globally. This figure suggests that USD is now oversold. Meanwhile, EUR positioning remains in a net long position to the tune of $+13.30bn (from $9.41bn last month). Current net long positions are still far greater compared to the -19bn net shorts seen last year (see table). This EUR positioning represents a +2.0 sigma overweight on a 3-year z-score basis, suggesting that the EUR could be now overbought compared to historical standards. Drivers: In the absence of a political turnaround in the US, and with no firm steps to end the political chaos inside the White House (and within the GOP), technical analysis will dominate. According to our technical analysts, breaking through the 1.17 resistance level (which we thought would not be breached) fixes the new resistance at 1.21 (1 month) and 1.23 (3 months). However, the outcome of the recent German elections suggest a lack of momentum for the euro. Fundamental Mid-term Target at 1.10-1.15: We think it unlikely that we will reach our long-term equilibrium target of 1.05 this year (although it was already reached in 1Q17), so we set a new preliminary mid-term target in the 1.10-1.15 range. Our structural view, still favorable to the dollar vs the euro, remains unchanged based on several factors: 1) the Fed is much closer to real tightening by clearing its balance sheet and demonetizing its debt compared to the ECB, which will continue monetizing debt, albeit at a slower pace; 2) interest rate spread suggests that the EUR/USD should be around parity. See chart 2 on page 4; 3) in real terms, the euro is expensive at current levels to the tune of 5%, so no further drop in the greenback would be justified; and 4) the recent appreciation of the euro will contribute to importing deflation, leading to a tightening in real monetary conditions and threatening the economic recovery in the eurozone.
JPY= Target (115); EUR/JPY: Target (129). Several aspects suggest that JPY cannot continue to outperform: (1) with political shocks in Europe now allayed, investors are switching 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) meanwhile, the Fed is set to continue 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); and (6) JPY is no longer cheap in REER terms (it is expensive).
• • • • • • • • •
GBP= Target (0.83); EUR/GBP: Target (0.93) CHF= Target (0.95); EUR/CHF: Target (1.07) MXN= Target (18.3); EUR/MXN: Target (20.6) BRL= Target (3.1); EUR/BRL: Target (3.5) ARS= Target (18.0) Currency RUB: NEUTRAL USD vs All AUD: NEUTRAL-NEGATIVE USD vs G10 CAD: NEGATIVE EM CNY: Target (6.75) EUR JPY GBP CHF BRL MXN RUB AUD CAD
Mkt Value of Change vs Net positions last week in the currency in the currency 1-yr Max (Bn $) (Bn $) (Bn $) -16,33 -13,15 3,18 13,30 -11,29 0,42 -0,63 0,66 1,89 0,62 4,85 6,00
2,95 2,67 -0,28 -1,17 -0,01 -0,86 -0,08 0,00 -0,31 0,02 -0,53 -0,11
28,7 28,4 3,9 14,5 5,2 1,7 0,9 0,8 3,3 1,2 6,1 6,1
1-yr Min (Bn $)
1-yr Avg (Bn $)
-21,1 -17,9 -0,7 -19,0 -14,2 -8,4 -3,1 0,0 -1,7 -0,3 -0,3 -7,3
6,6 8,1 1,6 0,9 -6,4 -4,1 -1,4 0,4 0,7 0,5 2,9 -0,3
Current Z-score Z-score 3-yr -1,92 -1,87 2,01 2,00 -1,43 1,75 -0,07 0,62 1,62 0,47 1,48 2,53
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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NOVEMBER 2017
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Market Outlook – Fundamental Expected Performance
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW
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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
NOVEMBER 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 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
NOVEMBER 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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