GLOBAL OUTLOOK ECONOMY & FINANCIAL MARKETS
ANDBANK’S CORPORATE REVIEW Strategic Outlook 2017
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
Contents Executive Summary
3
Country Pages USA
4
Europe
5
China
6
India
7
Japan
8
Brazil
9
Mexico Argentina
10 11
Equity Markets Fundamental Assessment
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Short-term Assessment. Risk-off shift probability
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Technical Analysis. Main indices
12
Fixed Income Markets Fixed Income, Core Countries Fixed Income, European Peripherals Fixed Income, Corporate Bonds Fixed Income, Emerging Markets
13 13 14 14
Commodities Energy (Oil)
15
Precious (Gold)
16
Forex
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Summary Table of Expected Financial Markets Performance
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Monthly Asset & Currency Allocation Proposal
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ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
Executive Summary What follows is the definition of our central scenario for the global economy and our projections for financial markets’ performance. Given the lack of relevant information regarding the implementation of key policies by the Trump administration, our projections may be altered as we incorporate the new information. USA – President-elect Trump must nominate a Fed Chair for the term that starts February 2018. While Mr Trump was sometimes critical of the Fed, his views on monetary policy are unclear. We are unsure to what extent he would favor a more hawkish Fed stance after taking office. We expect two hikes in 2017. We are neutral on equities, cautious on bonds and structurally positive in USD vs EUR. Europe – In the short term, the ECB is expected to announce further measures. On the macro front, GDP will grow circa 1.5% in 2017, with inflation near 1%-1.2% y/y. Political risks will persist, with Italy being the most disruptive factor after the NO vote in the referendum. We are neutral on equities, cautious on core bonds (just favorable to some peripherals) and structurally negative in the euro. Spain – The economy will keep traction that could last for most of 2017, although many doubts arise beyond 2017. We are positive on Spanish equities and cautious on Spanish bonds. China – Xi Jinping has been working hard over the past three years to strengthen China’s position in Asia, but Obama’s desire to continue exerting a strong influence in the affairs of the region have so far overshadowed China’s efforts to achieve a dominant position. Trump’s promise of a more isolationist stance shifts the advantage in the battle for regional influence towards China. We are neutral to positive on Chinese equities (neutral on Shanghai, positive on Shenzhen). Neutral on bonds, and structurally optimistic on RMB. India – India is (and will continue to be) the world’s fastest-growing large emerging economy. In the last World Economic Forum’s Global Competitiveness Report, India leapt an impressive 16 places to 39th out of 138 countries. Since Modi took office in 2014, India has gained 32 places. Looking at the impressive reform agenda, we believe that India is on course to continue moving up the table as further reforms kick in. Japan – Trading in 10-year JGBs has declined by 50% after the BoJ introduced its new yield curve control policy. This has removed the incentive for participants to trade JGBs in the secondary market. Consequently, Japan’s megabanks are paring back their presence in the JGB primary market, with unknown future consequences. We are positive on Indian equities and bonds. Cautious in the Yen. Brazil – The central bank’s focus is to decelerate headline inflation towards its annual inflation target of 4.5% in 2017. Prices have already moderated considerably in 2016. If inflation targets are reached, Mr Goldfjan will have much more room to support the economy through more aggressive rate cuts. The fiscal reform agenda continues slowly, with the cap on public spending facing a crucial vote in the senate at the end of 2016. Despite some mild advances in fiscal reforms, much more is needed to regain market confidence. A reform of “Previdencia” is one of the key points that Temer’s cabinet must face in the short-term if the government wants to control the spiral in deficit and debt. Mexico – The country is certainly undergoing a very complicated and unsatisfactory dynamic, with GDP slowing and the central bank tightening monetary conditions to prevent the collapse of the currency. We have received questions about the extent to which Donald Trump could make good on his campaign pledges to impose trade restrictions on Mexico. Some aspects hints at the softer approach of imposing small-scale trade restrictions within the NAFTA framework rather an straightforward withdrawal from NAFTA and the adoption of the harder WTO rules. We are positive on Mexican equity, bonds and currency after the deep sell-off. Argentina – Growth is taking more time than expected to recover, but this recession is mostly domestically driven and we expect a recovery to start soon. Our targets are that GDP will fall 2% in 2016 but grow 3.2% in 2017.
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ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
USA:
Sizeable fiscal stimulus ahead… with contradictory implications
Do you feel dizzy? Monetary conditions are clearly accommodative while fiscal policy is neutral
Growth in the US could keep pace but the structural shape is now vulnerable
Credit is already in its mature phase
Central Bank Slightly Hawkish Tilt New Fed Chair? President-elect Trump must nominate a Fed Chair for the term that starts February 2018 and fill two vacancies at the Board, which could result in a significant shift in Fed policy. Trump’s view on monetary policy: While Mr Trump was sometimes critical of the Fed, his views on monetary policy are unclear. He has expressed support for low interest rates on occasion, but has also raised concerns about the effect that low rates have had on asset prices. Tighter monetary policy? Many conservative economists favor tighter monetary policy, but Mr Trump’s views appear more nuanced. As such, we are unsure to what extent he would favor a more hawkish Fed stance after taking office, despite his past criticism of Fed policy. The expectations component is also likely to head higher if a reflationary mindset takes hold. Not only will markets likely price a faster pace of hikes, but also potentially a higher terminal rate to the hiking cycle for 2017. Consequently we see room for hikes in 2017 in fed funds and a target range of 1%-1.25%. Expected hike in December and two hikes in 2017. Is inflation a threat to debt markets? A reflation theme is building amid signs of rising price pressure. We see Donald Trump’s election and the majority in Congress amplifying this dynamic in the upcoming months. But much of this uptick in inflation comes as a result of one-off effects (oil, health premiums). Policy & Macro Front Sizeable fiscal stimulus ahead: Trump’s election has resulted in a Republican sweep. The GOP and its appointees will shortly control the presidency, both houses of Congress and the Supreme Court. That’s the executive, legislative and judicial branches. As a result, a Trump presidency should result in a greatly enhanced likelihood of sizable fiscal stimulus. Trump’s proposals have contradictory implications (large fiscal stimulus, tariffs on trade, restrictive immigration, hawkish Fed), which if enacted, could have contradictory implications for the US economic outlook over the next few years: (1) On the positive side, the fiscal stimulus from his tax reform and infrastructure proposals could provide a near-term boost for growth, although the implications of a fiscal stimulus and its effects on growth and inflation are not as straightforward as many believe, as public forces compete with private ones for resources to fund these projects. Present consumption usually falls at the same pace as investment takes place. (2) On the negative side, restrictions on foreign trade and immigration could have negative implications for growth, particularly over the longer term. (3) When it comes to inflation, infrastructure investment will probably have positive longer-run supply side effects (deflationary forces). Short-term and long-term views differ: The economic outlook is very dynamic, and thus complicated, with the short to medium-term view looking positive, while a longer-term view is not so positive due to the nearsighted nature of many of the Trump’s likely policies (that will probably result in worse debt dynamics and various externalities). In summary, the US economy was showing some signs of deceleration before the elections, suggesting that it was already in the second half of the cycle (JOLTs, ROICs, etc.). And although admittedly, the economy could be on a different path now, it remains to be seen whether the cycles can be manipulated so easily. 2017 Expectations: Inflation expected around 2.2%. GDP at 2.3%. Unemployment at 4.7% Financial Markets: (Very capable of shrugging off bad news) Equities (S&P): NEUTRAL. Fundamental target price 2233. Valuations remain elevated but remain below peaks, pointing to some potential for stocks to move up. Changed political environment and specific policy proposals are still unknown hence complicates earnings / growth forecast for 2017. Being extremely optimistic on sales growth (+10%) and margins (+10%) in 2017, and assuming that PE multiple comes back towards pre-election levels (17.5), a fundamental value (fair value) for the S&P could be 2233. Government Bonds: CAUTION. Fundamentally speaking we estimate Trump's win may drive 10Y UST premia as much as 75 to 100bp wider from the pre-election levels of 1.8%. The initial post-election sell-off has already priced a big portion of this in, with yields having increased by 53bps, suggesting that further upside is still possible. Our fundamentally driven target for the 10Y UST yield is circa 2.8% (depending on the expectations component, yields could rise to 3%). After the significant rise in yields, the 10Y UST is still some basis points below our fundamental fair value. Credit: CDX IG NEUTRAL (Target 70). CDX HY POSITIVE (340)
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ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
Europe:
Political risks will persist throughout the year
Although low, the growth structure in the Euro area seems more balanced than in the USA
Central Bank In the short term, the ECB is expected to announce further measures at its December meeting. Lower interest rates seem off the cards, but the extension of the current purchases program beyond March 2017 (six more months?) seems likely. Scarcity problems have abated due to the recent fixed income markets sell-off (just 34% of German bonds are now not eligible), which means less pressure for the ECB’s long term purchases. We stick to the view of further QE, if only not to jeopardize “the small green shoots” in inflation, but also because of the need to continue providing support to some governments. Despite the QE extension, as 2017 advances, rumors regarding a Euro tapering can be expected in the 2H. Though still premature compared to the American case when tapering was launched, it might well be part of the ECB talk during the last part of the year. In our view, the materialization of tapering would be a very disruptive element in the current circumstances Macro front – Modest growth with modest inflation 2017 GDP at 1.5%: EC latest estimates suggest modest growth for 2017, although above market consensus: 1.5% YoY in GDP for the Eurozone, with Spain leading (+2.3% YoY) and Italy lagging (+0.9%). Recent surveys suggest better “momentum” both on the industrial and service sides of the economy. Consumption is expected to remain supportive with employment performing well in most countries. Officials expect 2017 inflation at 1.2%: Inflation upticked mainly driven by the energy component. CPI numbers have already moved out of negative territory and officials expect headline CPI to rise to 1.2% yoy in 2017, and to nearly 1% yoy for core inflation. Inflation expectations have also risen and could maintain this trend as they are mainly driven by the realized upward inflation. No fiscal stimulus expected, even in those countries with room for it (Germany). Nothing to do with the American economy… Politics – Political risks could materialize • Italy: A “YES” vote in the referendum would have legitimized Renzi to face the much needed agenda of reforms. The “NO” vote means a de facto freezing of such reforms. A luxury that neither Italy nor Europe could afford. • Holland, France and Germany will also hold general elections. In Holland the centrifugal (extremist) forces are gaining ground. In Germany early polls point to a less clear victory for Merkel and her political allies. In France, Le Pen’s National Front is projected to gain a significant share in both the presidential election in April (although should lose in the 2nd round) and the parliamentary election in June. Still early to evaluate, but political risks in 2017 could finally materialize, as has been proven this year. • UK and Brexit. Article 50 of the Lisbon Treaty should be triggered in 1Q2017, starting the Brexit process. Theresa May is struggling to pull through with the disengagement without parliamentary approval (a step considered by some as necessary since it could smooth out the process, reducing the likelihood of a hard Brexit). Financial Markets Outlook Equity (STOX 600): NEUTRAL. Fundamental target price 360. Valuations are considerably more modest than in the US market. With a conservative projected sales growth (+3.7%) but a more optimistic estimate for 2017 margins (+7.6% from 7.2% last year), 2017 EPS could be around the 23 euros mark. We assume that Ltm PE multiples will remain lower than in the US (political risk) and stable at current levels (15.5). All this gives us fundamental value (fair value) for the STXE 600 of 360. Equity (SPAIN IBEX): ATTRACTIVE. Fundamental target price 9384. Valuations are even cheaper than in other European markets. Our sales projections are 3% (very conservative); we see margins expanding slightly to 8% (from 7.6%) due to a more stable political landscape; higher growth, and a banking sector that could stop dragging. We see 2017 EPS at 621 and stable PE (at 15.1). Bonds: NEGATIVE. Following Trump’s victory and given the potential effects of his measures on UST bonds, we uptick our fundamental levels for most European government bond yields. Bund 10yr 0.7%, Italy 2.1%, SP 1.9%, POR 3.3%, IE 1.4%. Main drivers: Treasuries and inflation expectations. Steeper yield curves, with the ECB trying to avoid increasing fragmentation Credit: IG Itraxx FAIRLY VALUED. Target at 80. Credit: HY Itraxx CAUTION. Target at 380, though too early to expect the last stage of the credit cycle. Rising financial costs and “ECB taper talk” in 2H17 may outweigh a less demanding primary market. Spreads might widen.
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ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
China:
The advantage in the battle for regional influence shifts to China.
China maintains its net capacity for external funding, which is crucial in the battle for regional influence
What would a tighter grip on regional influence mean for the exchange rate?
Composite PE in Chinese stocks points towards a lack of stress
Geopolitics Xi Jinping has been working hard over the past three years to strengthen China’s position in Asia, but the strong presence of the USA and Obama’s desire to continue exerting a strong influence in the affairs of the region, have so far overshadowed China’s efforts to achieve a dominant position. However, Trump’s promise of a more isolationist stance will shift the advantage in the battle for regional influence towards China. Should Mr Trump make good on his campaign rhetoric, this could signal the end of the US strategic rebalancing in Asia. We really believe that the regional balance of power could radically tilt towards China, especially considering that the Trans-Pacific Partnership (TPP), the center piece of Obama’s pivot towards Asia, is now lacking momentum (as both candidates in the US elections publicly opposed it). After Trump’s victory, the hope that TPP could be ratified in Congress is now dead, leaving China’s OBOR strategy of checkbook diplomacy unopposed, and with it the future for economic integration in Asia. China’s OBOR initiative has recently secured Beijing some victories in the region. In October, Philippines’ Rodrigo Duterte announced his country’s separation from the US, while returning home from Beijing with an investment and trade package worth US$24bn. In November, Malaysian PM Najib Razak followed suit, declaring Malaysia “a true friend” of China, while securing deals worth US$34bn. Nevertheless, China’s race to the top in the battle for political and economic influence in the region is not going to be easy as the US still has strong links with Japan, South Korea, Australia, Thailand, Singapore, Indonesia and more recently, with India. It could take many years for these alliances to erode. Nevertheless, it is undeniable that China has the winning narrative - erratic leadership in the US, and generosity from Beijing. All in all, the experts consulted believe that Xi Jinping and the rest of Chinese authorities are probably quite happy having to deal with Trump rather than Hillary Clinton (who would have worked much harder to maintain US primacy in Asia). Trump’s isolationist tendencies are so beneficial to China’s interests that some local experts believe Mr Xi may be inclined to reduce tensions with Trump. Geo-economics Low probability of a massive US tariff on imports: Trump’s main advisors appear to be extremely hawkish on China, but the experts believe that Trump will most likely not impose a massive across-theboard tariff on imports, since this would probably be self-defeating: (1) It would effectively be a huge tax on working-class consumers. (2) It would likely hurt American companies at least as much as Chinese ones (since China would likely respond to a tariff with severe retaliation against American products). A new wave of liberalization likely in China: A tariff war will probably undermine the issue of investment reciprocity, at a time when Chinese direct investment in the US has surged to US$18.4 in the 1Q16 (triple the figure for all of 2015). Although this may actually be what the US authorities are pursuing (a reduction in Chinese investment in the US). While many large Chinese companies find it easy to invest in foreign countries, US firms still find it hard to penetrate China’s foreign-investment barriers. As such, Trump could ratchet up the pressure to strengthen the foreign-investment screening process. The natural evolution of this issue would be a new wave of liberalization from Beijing on its FDI rules. Otherwise, Chinese firms could be shut out of the US. It will be interesting to see whether Trump starts a tariff war, which could lead to a war in investments. Limiting Chinese investments in the US would simply kill jobs and activity in the US. China could be another winner from Trump’s victory. Combine China’s accelerating regional influence with the muted volatility of the renminbi against the rest of region’s currencies, and the result is that it is hard to see how more investors will not want to join the growing band of Asian central banks shifting some of their reserves into renminbi bonds. Financial Markets Equity (Shanghai): NEUTRAL. Fundamental price 3,322. Equity (Shenzhen): ATTRACTIVE. Fundamental price 2,254 Bonds: NEUTRAL. 10YR bond target 2.8% FX: FAIR VALUE USDCNY fundamental target at 6.75
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ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
India:
On course to move up the table as further reforms kick in
Still room for further gains
Central Bank has serious options to ease conditions
The new approach in controlling the monetary base (shifting focus from quantity to price) has caused the volatility of rates to collapse
Economic Outlook India is the world’s fastest-growing large emerging economy. It is worth mentioning that many in the country believe that India has been rising in spite of the government (meaning that the country could grow at an even faster pace). Narendra Modi has promised (and taken steps) to change this perception. In the World Bank’s ‘Doing Business 2017 report’, India still ranks an ignominious 130th, something that we believe could change dramatically in the next few years if the Cabinet’s reform agenda does not lose steam (Modi’s goal is to push India into the top 50 by 2018). In fact, there are already some encouraging signs. In the last World Economic Forum’s Global Competitiveness Report, India has leaped an impressive 16 places to 39th out of 138 countries. Since Modi took office in 2014, India has jumped 32 places. What follows are just some of the examples of the reforms we have analyzed in depth and which we view as very constructive for this economy and its assets. 1. Red tape & corruption. Significant cut in red tape and a cleaner bureaucracy with new anticorruption campaigns that are already paying dividends. According to industrialists, there are now fewer big-tickets and backhanders in return for contracts, and an increase in the hours worked by central government officials, who must sign in for work with their biometric passport. The next step is to expand the system to local civil servants. 2. E-governance: An ambitious plan (at state government level) to integrate all government functions into a single online system to prevent duplication of governance and increase transparency. 3. Tax reform. Unification of the fragmented tax system into a general GST system, with high efficiency savings in terms of time and costs for logistic operations. 4. Insolvency and Bankruptcy Code that should significantly speed up insolvency proceedings, enabling the formation of a corporate bond market and boosting a new credit cycle. 5. New Companies Act (previous government) is considered to be a huge step towards in improving corporate governance and protecting shareholder rights (India ranks now 13th in this metric). 6. Digital India initiative: (1) Introduction of electronic filing in order to trim the 241 hours a year that companies currently spend paying taxes and employee state insurance contributions. (2) New electronic system that integrates customs declarations, bills of entry and shipping bills, reducing the time and cost of importing and exporting. (3) Improvement in internet connectivity to ensure that all public services are available to all and enables the Aadhaar bill (digital identity and use of biometric information for every citizen) to transform a leaky social services administration and bring hundreds of millions of households into the banking system. More than 1billion people registered. 7. Cooperative and competitive federalism, with state governments now having a larger say in important questions such as labor legislation, and enjoying increased borrowing capacity in exchange for keeping structural targets for deficits and debt. So far, some have argued that India’s history of political disunity represented a big problem for progress. Gurcharan Das (former head of Procter & Gamble in India and now an adviser to the Modi government) has stated that the recent approach to encourage “cooperative federalism” with the government decentralizing fiscal power to the states, has the potential to make governance more effective. Something vital for economic progress.
8.
Collaboration with the WB: Modi is working with the WB using its data to design reforms aimed at improving the business environment and its rankings in the “Doing business” surveys. Modi is putting pressure on ministers and administrators to implement policies that support private enterprise (it now takes 13 days for imports to get through customs, compared with 9 hours in OECD countries). 9. Bailout of state power distributors. It now takes 45 days to get connected to the power grid in Delhi, down from 138 days just a couple of years ago, pushing India up 25 places in the global ranking for this metric. 10. Integration of customs services. In short - there is still a lot of work to be done, with too much power resting in the hands of the core elite of Indian Administrative Service (IAS) officers, where there is a lot of political interference resulting in meagre results when it comes to policy implementation. Nevertheless, India has taken significant strides that pushed the country up the rankings faster than any other country in the last two years (according to the World Economic Forum), highlighting important improvements in the areas of quality of public institutions (+16 places), transparency in the financial system (+15), greater openness of the economy to FDI and international trade (+4) and transport infrastructure. India still ranks in the bottom half for health (85th), primary education (84th) and technological readiness (110th) but India is on course to move up the table as further reforms kick in, because these reforms are proven to have the potential to transform governance in the country. Financial Markets Equity (Sensex): ATTRACTIVE. Fundamental price 29126 Bonds: ATTRACTIVE. 10yr bond target 5.7%
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ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
Japan:
The new rules that could apply in Japan from now on.
As in the rest of the world, banks have outperformed the general index. Looking at 2017, banks could be damaged by a strong USD, since Japanese banks have been the most aggressive in USD lending to EM
A bizarre behavior of financial assets in Japan. Why? During 2016, foreign investors have been pulling money out at the fastest rate since 1987 and yet a funny thing has happened. While Japanese equities performed shockingly in 1Q16, it has been in an uptrend since 2Q16. Similarly, the BoJ and the government have done their best to stop the JPY appreciating, but with little success as the currency has appreciated considerably during the year. The third strange situation points to a disconnect between the currency and the stock market. During the 2H16 both stocks and the JPY have been on an uptrend, in what represents a break from the old rules. Even more surprising is the big “exporter” stock rally during this period – Sony (25%), Panasonic (30%) Honda (28%), Toyota (23%). Given that the Japanese economy remains stagnant, such resilience is counter-intuitive given the presumed tight negative correlation between exporter stock performance and the JPY. Maybe the answer lies in the strategic shift by Japan Inc. which is having a profound impact on the structure of Japanese business. Over the last four years Japanese companies have capitalized on the earnings boost delivered by the yen’s post-2012 depreciation by aggressively building up overseas operations (production and distribution bases) for foreign markets. This means that Japan has spent the last year moving production of its major products (automobiles, electric machinery, equipment, etc.) closer to the end market. The experts consulted claim that this makes sense, given that Japan's population is shrinking. Japan is also consolidating its strategic acquisitions, shown by Softbank’s purchase of the UK chip designer ARM Holdings. Japanese companies apparently passed the threshold of producing (or creating) more goods and services outside of the country than inside some time ago, with this ratio now standing at nearly 60% (it was 58.3% at the end of 2015 according to the Japan External Trade Organization). The implications are clear: (1) With offshore production moving towards 60% of total output, the old rules no longer apply. Consequently, a rise in JPY does not threaten the competitiveness and share prices of Japanese firms. Similarly, JPY depreciation is no longer so favorable for share prices. (2) Japan’s balance of trade will no longer tell us much about activity and corporate earnings. Some other curiosities: According to the US Bureau of Economic Statistics report on multinational activity, Japanese firms are selling most in the USA, while at the same time also exporting more US-made products (from the USA) than any other nation. In summary, Japan is making more stuff overseas and less at home. The reasons behind this strategic shift are diverse: Energy and labor prices are cheaper overseas. It is less costly to produce and distribute when your operations base is near the end market, or simply because the Japanese population is shrinking. The result of all this is that (1) residual investors are less concerned now about the translation effect of a strong yen on corporate earnings as competitiveness is no longer compromised by the yen’s ups and downs. (2) Admittedly, most of Japan’s multinationals have not yet reached an Apple-level of production outsourcing, but with the out/in production ratio at 60%, most Japanese multinationals should no longer be considered as “exporters”. Financial Markets Equity (Nikkei 225): NEUTRAL-NEG Fundamental price 18599. Bonds: EXPENSIVE. 10yr bond target 0% FX: EXPENSIVE USDJPY fundamental target at 115
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ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
Brazil:
Sizeable fiscal adjustment ahead, dependent on reforms…
Dramatic improvement in the external accounts following the sharp declines in imports and the effects of a low BRL. If this continues, it could turn the net borrowing requirement into a net lending capacity
BRL seems to be trading at fair value
Hawkish Central Bank Central Bank focus: Decelerate headline inflation towards its annual inflation target of 4.5% in 2017. According to Central Bank's Market Report ("Focus") as of November, expected annual inflation (IPCA) for 2016 is 6.8% and 4.9% for 2017. What is the Central Bank looking at? (1) Impact of food inflation on headline inflation; (2) Deceleration of services inflation; and (3) Approval of structural reforms by Congress and their implementation by the executive branch. Where are we on that? Food and services inflation are showing a downward trend, but they are still above their targets. Structural reforms have majority support in Congress, but they have not been approved yet. What do we expect? The Central Bank will be successful in reaching its inflation target by the end of 2017. We believe the risk to our forecast is the Central Bank ending up delivering an IPCA below its target for 2017 (full year) due to an economic recovery slower than current market consensus. Structural Reforms. As far as structural reforms are concerned, we expect a significant move from Temer’s cabinet that will provide the necessary signals to international investors, and will pave the way for capital inflows as well as some Rating action: (1) The "Government Expenses Ceiling" will be approved by mid-December, (2) The "Social Security Reform“ is expected to be passed during the first semester of next year, and (3) the "Political Reform" and/or the "Labor System Reform" by December 2017. Said this, we expect global market conditions to remain less friendly to emerging markets, including Brazil during 1H17, as a result of the likely hikes in fed funds, wherewe expect a target range of 1%1.25%. We forecast a hike in December and two in 2017. Policy & Macro Front Sizeable fiscal adjustment ahead: The approval of the aforementioned structural reforms, the reduction in administrative expenses, and the revenues from asset sales and public concessions will help the federal government to implement its fiscal adjustment. The government will achieve its target reduction for the consolidated public sector primary surplus from 2.6% of GDP in 2016 to 2.1% in 2017. Obstacles to GDP growth: Government's forecast for next year's GDP growth is 1.2%, while market consensus is 1.1% (ranging from 0.5% to 2.0%). We see GDP growth for 2017 at 0.8%. If we are wrong, we believe GDP growth is more likely to be below rather than above that level. The high indebtedness of federal, state and municipal governments, corporates and consumers, not to mention high unemployment and interest rates, and low consumer confidence will present severe obstacles to GDP growth. Headwinds from "Car-Wash Operation": The ongoing “Car-Wash Operation” may put reforms and economic recovery at risk by implicating even more politicians, including congressmen and government executive members, than it has so far. Unemployment rate in 2017 (outlook): 12.5% (IBGE/Continuous PNAD; Unemployment Rate as of August 2016: 11.8%). Financial Markets: Equities (Ibovespa): POSITIVE. Fundamental Value of 66,423. Valuations are in line with historical average at the current Ibovespa level. We see some upside potential (10%-15%) as long as structural reforms get approved by Congress. High debt-to-equity ratios, high unemployment and interest rates, and low consumer confidence will be obstacles to higher corporate revenues, profits and equity prices. Government Bonds: POSITIVE. Even with possible global and local headwinds, we still see local interest rates heading lower. We forecast the Selic rate at 10.0% per annum (market consensus: 10.75% p.a.; current level: 14.0% p.a.) and real interest rates around or below 5.5% per annum at the end of 2017 (currently between 6.1%-6.5% p.a. across the curve). Credit: HIGH GRADE: POSITIVE. LOW GRADE: NEGATIVE. FX: NEUTRAL. Structural reforms will reduce Brazil risk and therefore somewhat smooth the pressure from US interest rate hikes. Outlook: BRL 3.25/USD in December 2016 (market consensus: BRL 3.22/USD) and BRL 3.35/USD in December 2017 (market consensus: BRL 3.40/USD).
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ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
Mexico:
What will President Trump do with NAFTA? Economy The country is certainly undergoing a very complicated and unsatisfactory dynamic, combining fiscal deterioration, slowing GDP growth, the central bank tightening monetary conditions to prevent the collapse of the currency, and inflation on the upside. 2016 GDP growth will end at 2.1% but we are reducing our target for 2017 GDP growth considerably to 1% Trump & Protectionism. We have received several questions about the extent to which Donald Trump could make good on his campaign pledges to impose trade restrictions on Mexico. It’s worth stressing that the US constitution gives power to Congress to “regulate commerce with foreign nations”. Accordingly, the “immediate renegotiation” of NAFTA would need to go through Congress. Given that Congressional Republicans are generally supportive of free trade, it is questionable whether President Trump would want to waste valuable political capital pushing a wholesale renegotiation of NAFTA. Still, there are at least two ways in which he could impose trade restrictions on Mexico without having to go through Congress – one soft and one hard. The softer option would be to use Section 201 of NAFTA, which enables the president to proclaim “additional duties” on member states following “consultations with Congress”. Note that in this context “consultations” with Congress are not the same thing as a full vote. It is possible that President Trump could use this mechanism to impose trade tariffs on Mexico (albeit nowhere near as large as the 35% tariff he proposed). Some sources point out that Mexico itself could agree to voluntary trade restrictions in order to mitigate the possibility of more severe measures. In the 1980s, Japan agreed to voluntary export quotas with the US in order to head off the threat of much tougher action by the Reagan administration. The hard option open to President Trump would be to shelve the idea of renegotiation and withdraw from NAFTA altogether. Most legal experts agree that it could be done without the need for Congressional approval. If the US goes down this route, then trading relations with Mexico would be set according to WTO rules. Under NAFTA, all trade in goods and services is liberalized with tariffs set to zero. Under WTO rules, tariffs for different goods are set according to bands – and tariffs on most goods imports to the US are already at the top end of the ranges allowed by the WTO. Mexico would face an average tariff of around 3.5% on exports to the US. President Trump could then supplement this with additional restrictions permitted under WTO rules – for example anti-dumping measures. It is highly likely that these would then be subject to challenge at the WTO, but any challenge would take several years. The upshot of all this is that while the US constitution gives Congress authority over trade, the president can also wield substantial power in this area. In the case of Mexico, Trump’s options range from imposing small-scale trade restrictions within the limits of NAFTA, to pulling out of NAFTA and reverting to WTO rules. Some aspects hint at the softer approach of imposing small-scale trade restrictions within the NAFTA framework: (1) Mr Trump’s more conciliatory since the election. (2) The possibility of significant disruption to the complex supply chains that have been developed between Mexico and the US over the past decades. (3) Substantial pressure from corporate America. Financial Markets Equities (IPC GRAL). ATTRACTIVE. Fundamental target price 48560. Based on favorable projected sales growth (+7.7%) with slightly less optimistic estimates for 2017 margins (+7.3% from 7.4% last year) results in 2017 EPS that could be fixed circa 2428 MXN. We assume that Ltm PE multiples will remain near current levels or uptick once the dust settles to be fixed circa 20x. All this gives us a fundamental value (fair value) of 48560 for the IPC. Fixed Income. ATTRACTIVE. Our fundamental target yield for the M10 bond is 7%, and 3.50% for the USD-denominated Mexican bond (UMS10). FX: NEUTRAL-POSITIVE. Our fundamental target for the peso is now 19.75. The Trump effect has materialized and lower oil prices will have an influence. Also, the expected Fed decisions and the lower liquidity in the FX market are among the reasons that could keep MXN subdued. Despite this, and after the situation normalizes, we feel comfortable fixing our target at 19.75.
10
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
Argentina:
Is Trump bad news for Macri’s plan? Latest Developments: The rally we have seen in US Treasury yields after the US
election represents a new challenge to President Macri's plan to stabilize Argentina’s economy. The previous government used monetary issuance to cover fiscal gap (which caused high levels of inflation). After the 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 necessary reforms to recover fiscal balance (gradualism). Tax Amnesty: We are approaching the main deadline in the plan (31/Dec/2016). Results so far are promising since the results of the first phase (cash deposits in special accounts) were better than expected.
It seems as if the initial euphoria over the change of government had dissipated
Macro: Economic Activity: Growth is taking more time than expected to recover with three quarters of GDP decline now recorded (Q4 2015 to Q2 2016). This recession is mostly domestically driven and we expect a recovery to start in Q4 2016. It is key for the government to restart economic growth before next year’s midterm elections (October 2017) as they are seen as a test of support for the government. Our targets are that GDP will fall 2% in 2016 and grow 3.2% in 2017. Fiscal: We believe that the government’s target for 2016 will be achieved (4.8% primary deficit), and depending on the tax amnesty results, could be better than that (approx. 4.6%). For 2017 the target was set at 4.2% which seems to be little improvement. However it will require a major effort from the government as there will be increases in pensions and one-off revenues that will not repeat in 2017, all of which will take place in an election year. Inflation: Knock-on effects of devaluation and tariff adjustments will take inflation to nearly 40% by the end of 2016. For next year the government has set an inflation target of 12-17%. Considering that we think the government will prioritize economic growth over other variables, we set our inflation target for year-end 2017 at 20%. Financial Markets: Fixed Income: NEUTRAL. Current 10yr Govt Bond in USD (Global 2026) is trading at 7% YTM. Considering latest developments and prospects for 10yr US Treasuries, we set our target for 2017 at 7.50%. Strategy: Short term bonds continue to offer interesting spread despite the fact that their yield has come down considerably. These bonds will add very low volatility and very low repayment risk (Global 22/4/19, Buenos 14/9/18, Buenos 15/6/19, Bonar 7/5/24, YPF 4/4/24). Equities: There has been a strong recovery this year in Argentinean ADRs. Some equities still look cheap but this will mostly depend on the success of Macri’s measures to reestablish macro-equilibrium in Argentina. Examples of companies that could benefit from Macri’s policies are YPF, Financials (BMA, BFR, GGAL) and Utilities (PAM,EDN, TGS) FX: NEGATIVE. ARS spot depreciated after BCRA started to cut rates at the front end of the curve, moving the 35-day rate from a high of 38% to 25.75%. This change is due to an improvement in the core inflation trend. The 2016 year-end target for ARS/USD is 16 (approx. 24% depreciation for the year). Next year we think that ARS will continue to depreciate, although less than inflation, and that it could end 2017 at 18.50 (approx. 16% depreciation for the year).
11
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
Equity Markets GLOBAL EQUITY INDICES - FUNDAMENTAL ASSESSMENT Sales
Net
Andbank's
Sales
Andbank's
2017
Index
2016
2016
2016
2017
2017
2017
2017
2017
2016
2017
PRICE
Price
USA S&P 500
1.160
119,0
10,3%
10,0%
1.276
10,0%
128
7,2%
18,56
17,50
2.209
295
21,3
7,2%
3,7%
306
7,6%
23
9,0%
16,15
15,00
345
7.542
570,0
7,6%
3,0%
7.768
8,0%
621
9,0%
15,60
15,10
Mexico IPC GRAL
30.886
2.291,0
7,4%
7,7%
33.264
7,3%
2.428
6,0%
19,62
Brazil BOVESPA
51.104
3.900,0
7,6%
5,5%
53.915
7,7%
4.151
6,4%
15,62
Japan NIKKEI 225
19.494
995,7
5,1%
2,5%
19.981
5,2%
1.039
4,4%
China SSE Comp.
2.501
212,7
8,5%
8,0%
2.701
8,2%
221
China Shenzhen Comp
821
67,5
8,2%
9,0%
894
8,0%
Hong Kong HANG SENG
12.170
1.807,0
14,8%
3,0%
12.535
India SENSEX
14.280
1.503,0
10,5%
11,0%
379
47,8
12,6%
7,5%
Spain IBEX 35
MSCI EM ASIA (MXMS)
EPS
INDEX
EPS
Europe STXE 600
Margin Sales growth per Share Net Margin
EPS
per Share
2017
Growth PE ltm PE ltm CURRENT Fundam. E[Perf] to
Exit
Fundam
Point
Point
2.233
1,1%
2.009,7
2.456,3
349
1,2%
313,9
383,7
8.893
9.384
5,5%
8.445,7
10.322,5
20,00
44.959
48.566
8,0%
43.709,2
53.422,3
16,00
60.919
66.423
9,0%
59.780,6
73.065,2
18,44
17,90
18.361
18.599
1,3%
16.738,8
20.458,5
4,1%
15,04
15,00
3.199
3.322
3,8%
2.990,1
3.654,6
72
6,0%
30,67
31,50
2.071
2.254
8,8%
2.028,6
2.479,4
14,5%
1.818
0,6%
12,55
12,50
22.675
22.720
0,2%
20.447,9
24.991,9
15.851
10,5%
1.664
10,7%
17,56
17,50
26.393
29.126
10,4%
26.213,3
32.038,4
407
12,6%
51
7,4%
8,82
8,75
421
449
6,6%
404,3
494,1
ANDBANK ESTIMATES
Andbank's Global Equity Market Composite Indicator (Breakdown)
o
o
o
o
2017
Entry
RISK-OFF PROBABILITY
Buy signals Positive Bias Neutral Negative Bias Sell signals FINAL VALUATION
2017
Previous
Current
Month
Month
2 2 13 3 2 -0,2
4 3 8 5 2 0,5
Andbank’s Global Equity Market Composite Indicator Preliminary assessment of the level of stress in markets
previous
0
-5
-10 Market is Overbought
current
+5
Area of Neutrality Sell bias
Buy bias
+10 Market is Oversold
Score: NEUTRAL. Our Andbank GEM Composite Indicator has moved from -0.2 to 0.5 (in a -10/+10 range), suggesting that the market is not overbought and is still trading in a zone of no-stress (or neutrality). Therefore, and strictly under a flow, positioning & sentiment analysis, we cannot say that the general equity market is expensive. At current levels, a riskoff probability in the equity markets seems unlikely in the absence of disruptive events. If a risk-off shift takes place, the market would become oversold again. Positioning indicators: POSITIVE reading (+1 in a -7/+7 range). Fund managers are not optimistic enough yet as only 35% expect a stronger economy next year, and allocators remain cautious as suggested by the outsized cash allocations. The trend is bullish, with the last month being the strongest in 2016. Speculators positioning in US equities point to a rebound in its biggest short position on record. In spite of a recent uptick the current level remains largely short. Consequently as our position is contrarian, our indicator is bullish. Flow indicators: POSITIVE reading (+1 in a -3/+3 range). JP Morgan’s Flow & Liquidity analysis explains that ETF investors flocked into US equity ETFs, leading the widest weekly disparity between stock and bond flows ever. The biggest banks started talking about a rotation after a record inflow into equity ETFs (financial sector) accompanied by a record outflow from bond ETFs (especially in EM debt). Merrill Lynch’s flow also showed the largest equity inflows in 2 years ($28bn), biggest bond outflows in 3½ years ($18bn), record outflows from EM debt funds ($6.6bn) and the largest outflows from Govt/Tsy funds in 12 months ($3.4bn). Precious metals registered the largest outflows since Jun’13 ($2.7bn). All this suggests positive momentum for equity (bullish signal). Nevertheless PE blended forward 12M keeps widening and thus it is getting expensive (bearish signal). Sentiment: NEUTRAL reading (-0.5 in a -9/+9 range). Most of the indicators in this category are neutral this month.
TECHNICAL ANALISYS: Short-term (ST) and medium-term (MT) o o o o o o
S&P: SIDEWAYS. Supports 1&3 month at 2072/1991. Resistance 1&3 month at 2193. STOXX600: SIDEWAYS-BEARISH. Supports 1&3 month 327/351. Resistance 1&3 month at 348/327 IBEX: BEARISH Supports 1&3 month at 8393/8229. Resistance 1&3 month at 9255/9360 €/$: SIDEWAYS Supports 1&3 month at 1.07. Resistance 1&3 month at 1.136/1.143 Gold: BEARISH. Supports 1&3 month at 1190. Resistance 1&3 months at 1343/1391 Oil: BULLISH. Supports 1&3 month at 39.24. Resistance 1&3 month at 51.93
12
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
Fixed Income – Core Country Bonds: UST 10Yr BOND: Floor 1.85%, Ceiling 3%. Target 2.80% 1. Swap spread: Swap rates continued to recover and rose to 2.26% (from 1.58% last month). The 10Y Treasury yield also rose sharply to 2.43% (from 1.78%). The swap spread therefore remained stable at -17bps (from 20bps). For this spread to normalize towards the +25bp, with 10Y CPI expectations (swap rate) anchored in the 2%-2.2% range, the 10Y UST yield would have to move towards 1.75% (this could be considered a floor). 2. Slope: The slope in the UST yield curve rose to 129bp (from94bp). With the short end normalizing towards 1.25% (today at 1.14%), to reach the 10yr average slope (of 181bp), the 10Y UST yield could go to 3.06%. 3. Real yield: Given the new normal of ZIRPs, a good entry point in the 10Y UST could be when the real yield hits 1%. Given our CPI forecast of 2%-2.2%, the UST yield would have to rise to 3%-3.2% to become a “BUY”.
BUND 10Yr BOND: Ceiling 0.90%. Fundamental target 0.70% 1. Swap Spread: Swap rates rose to 0.70 (from 0.38% last month), and the Bund yield also rose to +0.25% (from -0.07%). Hence the swap spread ticked up to 46bps (from 45bps). For the swap spread to normalize towards the 30-40bp area, with 10Y inflation expectations (swap rate) anchored and normalized in the 1%1.25% area, the Bund yield would have to move towards 0.77% (entry point). 2. Slope: The slope of the EUR curve rose to 96bp (from 60bp). When the short end “normalizes” in the -0.25% area (today at -0.71%), to reach the 10yr average slope (115bp), the Bund yield would have to go to 0.90%.
Fixed Income – Peripheral Bonds: Spain: Fundamental target for the 10yr bond yield at 1.90%. Less political risk compared to Italy plus better economic conditions deserve a lower yield target. Italy: Fundamental target for the 10 yr bond at 2.1%. Growing political concerns have led to the spread widening vs. Spain. A “YES” vote in the referendum would have legitimized Renzi to face the much needed agenda of reforms. The “NO” vote means a de facto freezing of such reforms. A luxury that neither Italy nor Europe could afford. We can start thinking about a call for new elections (this time, maybe, in terms of a plebiscite on Italy remaining in the Euro area). Portugal: Fundamental target for the 10 yr bond at 3.30%. DBRS confirmed Portuguese rating at BBB (Low), Stable Trend. Fiscal measures already presented to comply with 2017 deficit target: As long as the budget is roughly consistent with maintaining the fiscal adjustment efforts, a “green light” is expected for the budget from the European Commission. Ireland: Fundamental target for the 10yr bond yield set at 1.4% post APPLE affair. It should now trade at levels closer to the semi-core space. 13
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
Fixed Income – EM Govies: No crisis looming •
Emerging markets have faced selling pressure since Donald Trump’s US presidential election win started to drive treasury yields higher, with EM debt funds experiencing their largest ever outflow the week after the election on fears of trade protectionism and more talk of the US dollar being primed for a 1980s-style super-spike.
•
No crisis Looming: (1) Despite EMs having received lots of capital inflows over the last six months, the 12-month rolling measure remains below the level seen just before the mid-2013 “taper tantrum”. As a result, foreign ownership of local currency bonds in most markets sits below the level observed just before that 2013 sell-off. Taken together, such readings suggest that emerging economies do not face an imminent systemic risk of the type seen in the early 1980s or the late 1990s. (2) In general, Current Account deficits have improved in most of these economies. (3) Their economies are now more synchronized to the US economy.
•
Opportunities: According to the Vulnerability Indicators gauging the ability to withstand capital outflows for the main EM economies, Thailand, China, Brazil and Indonesia have seen improved readings seen 2015. Russia could also be a good opportunity in 2017. It ranks third worst in terms of its currency decline on a REER basis and is undervalued by most other measures. This situation contrasts with the fact that Russia is not particularly exposed from a balance sheet perspective. Given talk of a “normalization” in US-Russia ties, which could end economic sanctions, the ruble’s recent weakness makes for an especially attractive entry point.
•
Threats: The Philippines, Colombia and Mexico’s reading have worsened as its external position has deteriorated, as has Malaysia, which now stands as the most exposed of the grouping. Malaysia stands out as banks have a foreign currency funding mismatch that makes them vulnerable to a short squeeze if US dollar liquidity tightens. Foreign investors’ share of Malaysian domestic government securities (52%) is the highest in our EM group, which makes the market vulnerable to any risk-off move. Turkey is similarly exposed (although its reading has remained stable).
Our Rule of Thumb: To date, our rule of thumb for EM bonds has been “buy” when the following two conditions are met: (1) US Treasuries are cheap or at fair value; and (2) Real yields in EM bonds are 150bp above the real yield in the UST bond.
CPI (y/y)
10 Year
Yield
Last
Yield
Govies
reading
Real
Projected change in Yield
3,07% 4,25% 2,30% 1,90% 1,46% 0,37% -0,28% 1,20% 0,33%
4,82%
-1,00%
1,96%
-0,50%
2,40%
-0,75%
1,12%
-0,50%
2,78%
-0,75%
2,31%
-0,75%
2,61%
-0,75%
0,94%
0,00%
Taiwan
7,89% 6,20% 4,70% 3,02% 4,24% 2,68% 2,33% 2,13% 1,07%
0,75%
0,00%
Turkey
10,88%
7,28% 6,40%
3,60%
-1,00%
Russian Federation 8,65%
2,25%
-0,75%
11,98% 7,24% 7,29% 6,66%
9,15% 2,96% 7,38% 3,13%
2,83%
-0,75%
4,28%
-1,00%
Indonesia India EM ASIA
Philippines China Malaysia Thailand Singapore
EME
South Korea
Brazil LATAM
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%2.2%, a theoretical fair value (entry point) should be with nominal yields at 3%-3.2%. The first condition is not met. Do real yields in EM bonds provide sufficient spread? A good entry point in EM bonds has been when EM real yields are 150bp above the real yield in the UST when this is at fair value. Thus, we should just buy those bonds with a real yield at 2.5% (See the bonds in green in the table).
10 Year
Mexico Colombia Peru
-0,09%
1,00%
3,53%
-1,00%
14
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
Commodities ENERGY (OIL): Fundamental target at $45 // Buy at $30. Sell at $55. Short term oil drivers point to flat/higher prices. (+) Producers struck an agreement to freeze production: However, this fact suggests that it is necessary to manipulate the market to defend prices. A clear signal that, in the absence of such intervention, the current state and nature of the sector push prices down. Until when can producers withstand producing below their capacity? (-) The cartel's total output still growing in the days previous to the agreement. November output hits record high, rising to 34.19M bpd from a level of 33.82M bpd in October. This level is 1.69M bpd higher than the 32.5M production target it agreed to adopt last week in Vienna. Record exports from Iraq and a rise of 40K bpd from Iran, along with strong rises from Nigeria and Libya (which are both exempt from OPEC's agreed production cut) are behind the record output. Russia, which has pledged to contribute ~300K bpd in cuts to the OPEC agreement, reported November average daily production of 11.21M bpd, its highest in nearly 30 years. This record in monthly output contrasts with forecasts for modest demand in 2017. (-) Trump’s action plan points to higher oil output: The first 100-day action plan of Donald Trump’s administration includes the intention to lift the restrictions on the production of $50trn dollar’s worth of job-producing American energy reserves including shale, natural gas and clean coal. This is more supply ahead. (-) Russia suggests that oil output freeze could be easily offset by a quick recovery in shale oil output, suggesting that a freeze agreement would be ineffective. Russia is producing at +3.7% MoM in September at an all-time high of 11.1 mn bbl/day. In other words, Moscow has shown little willingness to cut its output. (-) A freeze in output means business as usual: Saudi production typically falls by around 2% in the last quarter, but Saudi was pumping at record levels of 10.7mn bpd over the summer. So even in the case that the proposed cuts were struck, this will still mean business as usual. (-) BP CEO Dudley: There is a tremendous amount of oil storage. He said that oil prices will probably stay around current levels if OPEC fails to implement the deal it reached in Algiers to limit output. He added that supply and demand are generally in balance in the market but also pointed out that there is a tremendous amount of oil in storage that will take a long time to draw down. In this regard, the American Petroleum Institute reported crude oil stockpiles rose by 3.6M barrels in the latest week (vs the 1.5M rise expected).
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 keenly aware that the value of their reserves depends on the time they can pump at current levels before new and tougher environment-inspired regulation comes in. For example, Saudi Arabia has between 60 to 70 years of proven oil reserves at current output pace, 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 could 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 3.6mn to 4mn 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. This is something 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: There are good reasons to believe that any deal reached from now on involving the freezing of production would prove ineffective. Back in the 1970s or the early 2000s, the exporter’s 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 other alternative sources of energy. Energy cut from conventional oil will easily be offset by a quick increase in shale oil production, which is to say that OPEC’s 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 1mn 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 agency said that $60 price for oil would be enough for many US shale companies to restart stalled production, although it would take around nine months for the new supply to reach the market. In summary, the dynamics of the energy market mean that there are solid reasons to believe that the cartel no longer has the power to maintain the oil price significantly above a threshold (50$-55$ pb) for any appreciable length of time.
15
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
Commodities - 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 base year 2009, as a proxy for the global deflator) rose this month to $1200 (from $1141 last month). Nevertheless, in real terms gold continues to trade well above its 20-year average of $778. Given the global deflator (now at 1.118), for the gold price to stay near its historical average in real terms, the nominal price (or equilibrium price) must remain near US$869. 2. Gold in terms of Silver (Preference for Store of Value over Productive Assets): This ratio has ticked down to 69.87x (from 72.6x last month) and remains well above both its 10-year average of 61.03 and its historical average of 61.66, suggesting that Gold is expensive (at least in terms of silver) 3. Gold in terms of Oil (Gold / Oil): This ratio has risen during the month to 26.42x (from 25.01x last month) but still remains well above its 20-year average of 14.52. Considering our fundamental long-term target for oil at US$40pbl (our central target), the nominal price of gold must approach US$580 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 15.62x (from 14.33x last month), still below its LT average of 20.4x. Given our target price for the DJI of $18522, the price of gold must approach US$908 for this ratio to remain near its LT average. 5. Gold in terms of the S&P (Gold / S&P500 index): This ratio has ticked down to 0.553x (from 0.591x last month), but is still above its LT average of 0.581x. Given our target price for the S&P of $2233, the price of gold must approach US$1,297 for this ratio to remain near its LT average. 6. Speculative Positioning: CFTC - CEI 100oz Active Future non-commercial contracts: longs fell sharply to 245.7k (from 274.3k last month). Shorts stay at 68.1k (from 94.7k) => Net positions decreased to +117.6k (from +179k). Therefore, although less pronounced, speculators still remain long in gold => Negative reading. 7. Financial liberalization in China. Higher “quotas” each month in the QFII are widening the investment alternatives for Chinese investors (historically focused on gold). 8. Central bank gold buying. Gold stocks at central banks are still considerably higher than 2008 levels. 9. Monetary stimulus by ECB and BoJ continues, but not by the Fed (the price of gold is in USD and therefore much more affected by the Fed’s decisions). This points to the following dynamics: gold stable or downward in terms of USD; gold price following an upward trend versus the EUR and JPY, which means that the USD must rise relative to the EUR and the JPY. 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. 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
Long Futures
Net Futures Short Futures 16
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
Currencies – Fundamental Targets The global USD position increased sharply last month and is now net long against the other currencies to the tune of US$25.02 (from US$ 17.47bn last month and $8.9 two months ago). This is the longest position in USD since February, but despite this buying of US dollars, the global position in the greenback is still far below the US$+44.3bn net long position seen in April 2015, which means that long US dollar positions could still be much larger.
• EUR/USD: Fundamental Target (1.00) The flip side of the USD buying was a cut in the position of non-dollar reserve currencies. Most notable was a big increase in CHF shorts to -3.01bn notional (from -2.1bn last month) or the increase in EUR shorts to -15.87bn (from -14.99bn). JPY positioning was also trimmed (from net +4.45bn to +0.03bn). There is still room to build long USD positions by selling more EUR, as EUR shorts are still far below the -24.3bn seen during the last 12 months. GBP positioning was little changed, though still hovering at historically short levels.
JPY: Target (112); EUR/JPY: Target (112). Very stressed shorts in JPY’s Z-score. GBP: Target (0.83); EUR/GBP: Target (0.83). Trump trade vs Brexit uncertainty. CHF: Target (0.95); EUR/CHF: Target (0.95). Net shorts & stressed levels in CHF’s. MXN: Target (19.75); EUR/MXN: Target (19.75) BRL: Target (3.35); EUR/BRL: Target (3.35) ARS: Target (18.5); EUR/USD: Target (18.5) RUB: NEUTRAL RUB AUD: NEUTRAL AUD CAD: NEUTRAL-OW CAD CNY: Target (6.75)
• • • • • • • • • •
Mkt Value of Change vs Net positions last we e k 1-yr Max (Bn $) (Bn $) (Bn $)
Curre ncy USD vs All USD vs G10 EM EUR JPY GBP CHF BRL MXN RUB AUD CAD
25,02 24,95 -0,07 -15,87 -0,03 -6,10 -3,01 0,41 -1,32 0,85 1,57 -1,38
4,67 4,23 -0,44 0,10 -2,40 0,15 -0,24 -0,04 -0,21 -0,19 -1,57 0,00
44,3 43,6 1,2 0,0 8,6 0,0 1,4 0,6 0,0 1,3 4,6 2,0
1-yr Min (Bn $)
1-yr Avg (Bn $)
-6,9 -7,1 -2,2 -24,3 -8,0 -7,8 -3,2 -0,1 -2,3 0,0 -4,7 -4,7
12,5 11,6 -0,8 -11,9 4,6 -4,6 -0,2 0,2 -1,3 0,3 1,0 -0,6
Current Z-score 3-yr 0,23 0,24 0,29 -0,24 0,50 -1,39 -1,98 0,79 -0,48 2,83 0,83 0,14
ANDBANK
7,0
Max Min Current
SPECULATIVE POSITION IN THE FX MARKETS (3Yr - Z SCORES. Max, Min & Current in 1Yr)
3-year Z-Score:
5,0
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
Values below -1 suggest positioning may be oversold
-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
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ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
Market Outlook – Fundamental Expected Performance 1m
Performance
Performance
Current Price
Target
Expected
07/11/2016
Last month
YTD
06/12/2016
Year End
Performance*
2.131,52
3,6%
8,1%
2.209
2233
1,1%
333,84
3,2%
-5,8%
345
349
1,2%
8.918,80
-0,3%
-6,8%
8.893
9384
5,5%
48.050,25
-6,4%
4,6%
44.958
48566
8,0%
BRAZIL - BOVESPA
64.051,65
-5,0%
40,4%
60.864
66423
9,1%
JAPAN - NIKKEI 225
17.177,21
6,9%
-3,5%
18.361
18599
1,3%
CHINA - SHANGHAI COMPOSITE
3.133,33
2,1%
-9,6%
3.199
3322
3,8%
CHINA - SHENZEN COMPOSITE
2.066,81
0,2%
-10,3%
2.071
2254
8,8%
HONG KONG - HANG SENG
22.801,40
-0,6%
3,5%
22.675
22720
0,2%
INDIA - SENSEX
27.458,99
-3,9%
1,1%
26.393
29126
10,4%
437,31
-3,6%
4,4%
421
449
6,6%
1,83
-4,5%
1,0%
2,40
2,80
-0,8%
Asset Class
Indices
Equity
USA - S&P 500
06/12/2016 EUROPE - STOXX 600 SPAIN - IBEX 35 MEXICO - MXSE IPC
MSCI EM ASIA Fixed Income Core countries
US Treasury 10 year Govie UK 10 year Guilt
1,19
-1,7%
6,2%
1,41
2,00
-3,3%
German 10 year BUND
0,15
-1,7%
2,7%
0,36
0,70
-2,3%
-0,06
-0,8%
2,9%
0,04
0,00
0,4%
Japanese 10 year Govie Fixed Income
Spain - 10yr Gov bond
1,24
-1,9%
3,9%
1,48
1,90
-1,9%
Peripheral
Italy - 10yr Gov bond
1,70
-1,7%
-1,2%
1,93
2,10
0,6%
Portugal - 10yr Gov bond
3,22
-2,9%
-6,7%
3,61
3,30
6,1%
Ireland - 10yr Gov bond
0,63
-1,7%
3,3%
0,85
1,40
-3,5% -0,8%
7,21
5,1%
16,7%
6,58
7,50
Fixed Income
Greece - 10yr Gov bond Credit EUR IG-Itraxx Europe
77,62
0,0%
0,7%
77,79
80
0,0%
Credit
Credit EUR HY-Itraxx Xover
345,41
1,4%
3,4%
307,08
380
-2,0%
Bono EUR 5y
-0,43%
IG & HY
Credit USD IG - CDX IG
76,51
0,2%
3,0%
71,75
70
0,2%
Credit USD HY - CDX HY
406,82
1,6%
8,8%
363,76
340
1,1%
Bono USD 5y
1,29%
Turkey - 10yr Gov bond
10,21
-4,5%
6,3%
10,88
9,91
18,6%
EM Europe (Loc) Russia - 10yr Gov bond
8,45
-0,9%
17,6%
8,65
8,01
13,8%
Fixed Income
Indonesia - 10yr Gov bond
7,24
-4,6%
15,6%
7,89
6,70
17,4%
Asia
India - 10yr Gov bond
6,83
5,6%
19,7%
6,20
5,67
10,4%
(Local curncy)
Philippines - 10yr Gov bond
4,01
-5,2%
-1,5%
4,70
3,78
12,1%
China - 10yr Gov bond
2,71
-2,3%
0,8%
3,02
2,87
4,2%
Malaysia - 10yr Gov bond
3,61
-4,8%
3,3%
4,24
3,57
9,6%
Thailand - 10yr Gov bond
2,13
-4,2%
0,4%
2,68
1,82
9,6%
Singapore - 10yr Gov bond
1,95
-2,9%
4,4%
2,33
1,57
8,4%
South Korea - 10yr Gov bond
1,65
-3,8%
1,7%
2,13
2,07
2,7%
Taiwan - 10yr Gov bond
0,96
-0,8%
0,4%
1,07
1,29
-0,7%
Fixed Income
Mexic o - 10yr Govie (Loc)
6,22
-7,7%
-2,1%
7,24
7,00
9,2%
Latam
Mexic o - 10yr Govie (usd)
3,30
-7,3%
2,4%
4,25
4,00
6,2%
Brazil - 10yr Govie (Loc)
11,33
-4,3%
51,2%
11,98
11,50
15,8%
Brazil - 10yr Govie (usd)
4,91
-6,4%
22,4%
5,76
5,25
9,8%
Argentina - 10yr Govie (usd)
6,11
-7,9%
7,16
7,50
4,5%
183,5
5,1%
9,4%
192,8
190,0
-1,4%
Fixed Income
Commodities
CRY Oil (WTI)
44,9
13,1%
37,1%
50,8
45,00
-11,4%
1.281,3
-8,9%
10,0%
1.167,5
1.100
-5,8%
EUR/USD (pric e of 1 EUR)
1,10
-3,1%
-1,5%
1,070
1,00
-6,5%
GBP= (price of 1 USD)
0,81
-2,2%
16,2%
0,79
0,83
5,2%
EUR/GBP (price of 1 EUR)
0,89
-5,2%
14,5%
0,84
0,83
-1,6%
GOLD Fx
CHF= (pric e of 1 USD)
0,97
3,7%
0,8%
1,01
0,95
-6,0%
EUR/CHF (pric e of 1 EUR)
1,08
0,5%
-0,7%
1,08
0,95
-12,1%
JPY= (price of 1 USD)
104,45
9,2%
-5,2%
114,05
112
-1,8%
EUR/JPY (price of 1 EUR)
115,32
5,8%
-6,5%
122,04
112,00
-8,2%
MXN= (pric e of 1 USD)
18,59
9,4%
18,4%
20,33
19,75
-2,9%
EUR/MXN (pric e of 1 EUR)
20,51
6,1%
16,6%
21,76
19,75
-9,2%
BRL= (price of 1 USD)
3,20
6,1%
-14,2%
3,40
3,35
-1,4%
EUR/BRL (price of 1 EUR)
3,53
3,1%
-15,3%
3,64
3,35
-8,0%
18
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
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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ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
Principal Contributors
Alex Fusté – Chief Global Economist – Asia & Commodities: Equity, Rates, FX +376 881 248 Giuseppe Mazzeo – CIO Andbank US – U.S. Rates & Equity. +1 786 471 2426 Eduardo Anton – Portf. Manager US – 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 – Bonds, FX & Equity Brazil. Andrés Davila – Head of Asset Management Panama – Venezuela. +507 2975800 Mª Angeles Fernández – Product Manager, Europe – Macro & Rates. +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
20
ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 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 analyzed investments 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. Additional major factors influencing this decision are also 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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ECONOMY & FINANCIAL MARKETS CORPORATE REVIEW STRATEGIC VIEW 2017
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