Market Commentary – 1st September 2018

Market Commentary - 1st September 2018

Turkish delight?

In Turkey, the supreme leader has declared that if interest rates go down so will inflation. He has borrowed his economic theory from his counterpart in the US who believes that making America great necessitates a trade war. Official Turkish inflation is around 16%; unofficially it is heading for 100%. Small beer when compared with Argentina and not forgetting Venezuela where officially it’s 32,000%...and rising! The local currencies in all three countries have fallen significantly against the US dollar which is one of the drivers of inflation (it makes your imports much more expensive) but also makes the servicing of dollar denominated debt problematical.

This then transfers the problem to the institutions that have lent the money in the first place which of course are, in the main, the banks, many of them European. In the case of Argentina this has necessitated a record $50bn loan from the International Monetary Fund (IMF). Even this palliative hasn’t helped as the central bank raised interest rates to 60%. Venezuela appears to be on its own as it severed ties with the IMF years ago. For Turkey the problems are just starting but given the rhetoric the IMF won’t be welcome there either.

The spotlight thus falls on the ECB who have been single-handedly supporting the European sovereign debt market. ECB purchases are currently 7 times the net issuance of bonds by European governments. There is no evidence of any real demand for Eurozone sovereign bonds at these yields or even close...none at all.

Italian, Spanish and French banks have the largest exposure to Turkish debt, which, whilst in total, relative to overall assets, is not large, just adds to the problems the European banking sector and in turn the ECB faces. Keeping real rates in negative territory and buying huge quantities of sovereign debt cannot go on forever.

“Cheap money becomes very expensive in the long run.” This recent quote from the Spanish fund manager, Daniel Lacalle captures succinctly the myriad fallacies associated with modern, activist, inflationist central banking and misguided economic policy more generally. EU/Erdogan/Trump et al please note

Central banks do not print growth; bond markets are slowly beginning to wake up to this reality; equity markets won’t be far behind.

UK

In the UK we are seeing tentative signs that the bull market is running out of steam. The large cap index is now below the 200 day moving average and the mid and small caps are not far behind. The banking sector is also rolling over and is at critical support.

The Brexit debate is rarely out of the headlines although when May pronounces on “the Deal” be assured that another piece of news will be contrived to deflect attention from the real issue.

US

Market breadth remains weak in the US. At the recent all-time high in the S&P 500 only 7% of stocks came into the same category compared with 35% of stocks at the January peak. The US is now in the longest bull market ever and the newspaper headlines suggest that this is just the beginning; it was ever thus at the end of bull markets.

Europe

European markets never got close to testing the January highs and are in a downtrend below the long term moving average. The fall out from the Italian elections continues with the new anti-euro coalition threatening to move away from EU mandated austerity policies. In Spain Mariano Rajoy has been dumped as PM and the possibility of further elections is not helping sentiment. The EU ‘s Brexit stance, typified by lead “negotiator” Michel Barnier, is not going down well in Europe either. German manufacturers say that a no-deal is out of the question.

Japan

The Nikkei is stuck in a narrow trading range and a break of 23,000 or 22,000 will give an indication of the next trend. The bank sector is declining below a falling long term moving average, but, as in other parts of the world, value stocks in Japan are not expensive.

Asia Pacific and Emerging Markets

In the long term these regions will be the drivers of global growth; arguably they already are. However, nothing ever goes up in a straight line although until the peak earlier this year it was beginning to look like they would! We now have markets below a falling 200 day moving average which suggest a period of consolidation at the very least. Currency devaluations in Turkey, Argentina and Venezuela have had a contagious effect on all emerging markets which may well present some buying opportunities.

Commodities and Gold

The oil price has bounced from the long term moving average and looks set to retest the highs at $75. In the UK, petrol prices have climbed by over 30% since early 2016. Who said there isn’t any inflation?

Nobody likes gold; as we said last month the futures positions held by speculators is at an all-time low, which very often coincides with a low in the price and that does seem to be what is happening.

Gold is still the only real insurance policy against central bank mistakes. Repeating our earlier statement - Central banks do not print growth. Gold is the only real money

Commodities in general have been out of favour for some time as the chart of the GS Commodity index relative to the S&P 500 clearly shows. A rising line indicates commodities outperforming the S&P and vice-versa. Given our views on the US equity markets and the bullish potential for gold and oil, this trend could be about to change. Commodity plays are good providers of portfolio diversification and will do well in an inflationary environment.

Bonds

The last five years of the 35 year bond bull market show evidence of a topping process with vital support at the 2015, 2016 and 2018 lows. However the fat lady is still not singing and we wonder whether the bond market is waiting for an equity market fall out which normally results in a flight to sovereign debt or whether the bond bulls will wake up to valuations and incipient inflation and take equity markets down too.

Summary

Central bank rhetoric has changed, and options for withdrawing QE are on the table (although not in Japan) while rate rises in the States are rising apace. As usual central bankers caveat their prognostications and are likely to return with further accommodation if asset markets show any serious weakness. We doubt that such an outcome would be as well received as the central banks anticipate.

  • Government bonds are heroically expensive – the trend in rates appears to be on the turn.
  • Spreads on corporate bonds are still tight and several European issues are trading on negative redemption yields. On that basis, they are ridiculously expensive and default risk can only rise from here, also making high yield potentially less attractive. Is the yield premium adequate? Emerging market debt is the latest casualty. There is also significant concern over liquidity risk, despite central bank buying (Europe and Japan) and regulatory stress testing.
  • Western equity markets are long overdue a correction; have we had it? The jury is still out.
  • Property is attractive, as a real asset offering a higher spread against most fixed interest markets, but with the gating of many UK bricks and mortar funds in 2016, due to large redemptions, their attractiveness is now questionable. REITs are equities in disguise.
  • Draghi is slowly removing the QE punch bowl with the final bond purchases scheduled for December. It is unlikely, however, that the ECB would allow things to get out of hand: but how well will any response be executed? The Nikkei index has pulled back to the 21,000 region and looks poised to move higher; domestic issues are preferred. Emerging and Asia Pacific markets are not overly expensive as a long-term position, but they will nevertheless continue to be volatile and affected by dollar machinations and currency devaluations, trade wars and Chinese economic weakness as we are seeing currently
  • Gold is an insurance policy against central bank monetary policy mistakes. Raising rates at the same time as engaging in quantitative tightening appears to be one of them.
  • Commodities have potentially reached a bottom relative to equity markets.
  • Not for the first time in recent history, sovereign bond yields are rising on expectations of higher interest rates. Global economies are still fragile and any shock to the system is likely to be met with further central bank “largesse”. We observe closely for signs of success… or failure.

Clive Hale – 1st September 2018

www.aspim.co.uk

© 2018 Albemarle Street Partners Ltd. All Rights Reserved.

The information, data, analyses, and opinions contained herein (1) include the proprietary information of Albemarle Street Partners, (2) may not be copied or redistributed without prior permission, (3) do not constitute investment advice offered by Albemarle Street Partners, (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be correct, complete, or accurate. Albemarle Street Partners shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses, or opinions or their use.

Albemarle Street Partners is a trading name of Thornbridge Investment Management LLP,
which is authorised and regulated by the Financial Conduct Authority (“FCA”)

© 2018 Albemarle Street Partners Ltd. All Rights Reserved.

The information, data, analyses, and opinions contained herein (1) include the proprietary information of Albemarle Street Partners, (2) may not be copied or redistributed without prior permission, (3) do not constitute investment advice offered by Albemarle Street Partners, (4) are provided solely for informational purposes and therefore are not an offer to buy or sell a security, and (5) are not warranted to be correct, complete, or accurate. Albemarle Street Partners shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, this information, data, analyses, or opinions or their use.

Albemarle Street Partners is a trading name of Thornbridge Investment Management LLP,
which is authorised and regulated by the Financial Conduct Authority (“FCA”)