Top of the Pops: What will be the market’s Christmas No.1?

Just when you thought risky assets could not go any higher or quantitative easing any better, welcome to 2017: the year of the relief rally. The year when asset returns made the TMT bubble of 2000 lore palatable if not possible. Among the cornucopia of rising risk assets, which one will end the year on top?

We might have the tried and true US Equities. A bit like Mariah Carey’s “All I Want for Christmas Is You”, this one’s an easy crowd pleaser. While maintaining historically high margins of nearly 10%, US S&P 500 earnings have grown 10.4% through Q3 2017[1] and are expected to grow slightly higher in 2018 with the majority of earnings growth coming from the IT sector.

Or alternatively, the Christmas number one could go to an asset class coming in from the shadows, like EM equities: a bit like the comeback of Wham’s “Last Christmas”, one of this year’s favourites in homage to George Michael. The last calendar year MSCI EM equities topped the asset class charts was 2009.

Normally the winner of X Factor does well on the Christmas list. This year’s contender is Rak-Su and give it to me or “Demelo”. The market wanted inflation and a strong USD in 2017 but got neither of them in spades. Not surprisingly, with negative real rates, cash is a strong contender for worst asset class of 2017. Holding onto cash in most major currencies would have lost you money in real terms. The Zero Lower Bound (ZLB) turned out to not be a lower bound after all with negative short-term nominal rates in Japan, Europe, Sweden, Switzerland and Denmark during 2017.

The odds on favourite for this year’s Christmas number one is Ed Sheeran’s remix with Beyoncé of “Perfect”. And our Christmas chart wouldn’t be complete without the perfect asset class stocking stuffer, the bitcoin. According to COINBT:SS the lead crypto currency is up 1,575% year-to-date.

Stormzy’s “Blinded by Your Grace” might apply to the impact of currency if you valued your assets in US dollar rather than sterling in 2017.  Based on the negative sentiment in the options market, the historic trade deficit and/or stubborn fiscal deficit the GBP lost nearly 10% against the USD. Despite a formal end to QE and the first serious Federal Reserve rate rises since 2006, the USD surprised the market and lost nearly 10% of its value over the year. [2] So to hedge or not currency hedge became a serious question again for investors.

Jason Lejonvarn – Investment strategist, Mellon Capital

[1] Bloomberg, as at 30 September 2017

[2] Bloomberg YTD as at 13 December

Just when you thought risky assets could not go any higher or quantitative easing any better, welcome to 2017: the year of the relief rally. The year when asset returns made the TMT bubble of 2000 lore palatable if not possible. Among the cornucopia of rising risk assets, which one will end the year on top? We might have the … read more

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Decoding the complex web of a Brexit trade deal

The lead EU negotiator, Michel Barnier, has indicated that negotiations on trade and other aspects will not commence until an agreement has been reached on the divorce and the free movement of people. Given the potentially fractious nature of these discussions and ensuing delays, this could result in the UK exiting the EU without a formal trade agreement in place or even without transition agreements that may need to last at least five years or more. Unsurprisingly, the UK wishes to pursue parallel negotiation streams, with trade negotiations progressing alongside other discussions.

The chief UK negotiator, David Davis, has prompted alarm in recent weeks by suggesting that the government did not have sufficiently detailed projections of the economic impact of leaving the EU without a formal trade agreement, reverting to trade under the Most Favoured Nation status of the World Trade Organisation. Nonetheless, he acknowledged that certain industries could face tariffs of 30-40% on exports to the EU under those circumstances and that financial firms would lose their ability to passport services to the EU. May has stated, “No deal is better than a bad deal,” a startlingly blithe approach in the absence of a comprehensive assessment of the impact and the likely implications for the UK economy.

Negotiations of this magnitude are typically slow and ponderous. To provide context to the scale of the complexities of the trade agreement negotiations alone, discussions on the recent Comprehensive Economic and Trade Agreement (CETA) between the EU and Canada started in 2009 and concluded in August 2014 (although final ratification took a further two years, and did not occur until early 2017).

Sinead Colton and Jason Lejonvarn – Mellon Capital, a BNY Mellon company

The lead EU negotiator, Michel Barnier, has indicated that negotiations on trade and other aspects will not commence until an agreement has been reached on the divorce and the free movement of people. Given the potentially fractious nature of these discussions and ensuing delays, this could result in the UK exiting the EU without a formal trade agreement in place … read more

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Where will Trump find tax-cutting wriggle room?

Since Donald Trump’s election, the markets have been abuzz on the transition from monetary to fiscal stimulus. President Trump has promised tax reform, both personal and corporate, as well as “yuge” fiscal stimulus and a lower overall budget deficit. But how much room does the new administration have to manoeuvre?

President Reagan argued for a tax cut based on high marginal tax rates that dissuaded people to work. But the marginal tax rate was 69% when Reagan took office in 1981. The highest marginal tax rate today is 40%. Between Presidents Reagan and George H. W. Bush the marginal tax tumbled from 69% to a modern low of 28%. Will a drop from today’s 40% make a difference and increase tax receipts? Can President Trump afford to drop the marginal tax rate as low as 30%?

The fiscal deficit during earlier tax cuts started from smaller deficits. With today’s deficit at -3.5% compare that to a +1.9% surplus during President George W. Bush’s tax cut and -2.2% deficit during Reagan’s first tax cut, does President Trump have much wiggle room on a fiscal balance sheet that has yet to recover fully from the global financial crisis? Will the fiscal hawks in the US House of Representatives lower their guard for the sake of party over principles? These are questions that remain unanswered but one aspect is clear: the current US budget context seems more restrictive than any in recent memory.

Karsten Jeske – Mellon Capital, a BNY Mellon company

Since Donald Trump’s election, the markets have been abuzz on the transition from monetary to fiscal stimulus. President Trump has promised tax reform, both personal and corporate, as well as “yuge” fiscal stimulus and a lower overall budget deficit. But how much room does the new administration have to manoeuvre? President Reagan argued for a tax cut based on high … read more

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Factoring in US growth expectations

In the US, economic growth rebounded in the third quarter however the sources of this growth appear transitory. GDP grew at 2.9% annualized in the third  quarter of 2016, following sub-2% growth the three previous quarters. Weakness in inventory accumulation and export growth had been a major drag on growth before the third quarter. A jump in both series this quarter may reflect a rebalancing effect rather than a sustainable change in GDP trend growth. Nevertheless, we revised up our US GDP forecast over the next year to 1.9% from 1.7% which is below many commercial forecasters. We currently assign a probability of about 61% of below 2% growth, a 39% probability of 2-4% growth and essentially zero weight on above 4% growth.

At the November Federal Open Market Committee (FOMC) meeting, the US Federal Reserve decided not to raise its target federal funds rate. In its press release the FOMC stated that “some evidence” was already apparent towards its objectives implying that some current data already points to a rate rise. Also the revised dot chart forecasts one rate rise in 2016 and at least two in 2017. We believe the FOMC came close to “broadcasting” a strong desire to increase rates in December 2016. We thus maintain our forecast of a rate hike at the December meeting.

Karsten Jeske – Mellon Capital, a BNY Mellon company

In the US, economic growth rebounded in the third quarter however the sources of this growth, inventories and exports, appear transitory. GDP grew at 2.9% annualized in the third  quarter of 2016, following sub-2% growth the three previous quarters. Weakness in inventory accumulation and export growth had been a major drag on growth before the third quarter. A jump in … read more

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Goldilocks stocks?

Mid-sized companies are mature enough to have successfully overcome the growing pains that upend many small- and micro-cap equities. But as established players with proven track records, they also benefit from better access to capital markets. The ability to redeploy lower cost capital often allows mid-caps to move into new markets, expand product lines and otherwise execute their strategies.

At the same time, these mid-sized businesses do not typically suffer from the growth challenges that plague many of the largest, most recognizable global brands. Mid-caps do not necessarily need to deliver results through financial engineering, cost cutting, or risky acquisitive strategies as many of the largest companies may do. To the contrary, mid-caps are just hitting their stride.

In our view, this combination of stability, attractive growth potential, and relatively strong liquidity makes mid-sized companies compelling.

Syed Zamil – Mellon Capital, BNY Mellon company

Mid-sized companies are mature enough to have successfully overcome the growing pains that upend many small- and micro-cap equities. But as established players with proven track records, they also benefit from better access to capital markets. The ability to redeploy lower cost capital often allows mid-caps to move into new markets, expand product lines and otherwise execute their strategies. At … read more

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Can Q2 earnings reinstate the customary “surprise”?

Revisions to quarterly S&P 500 earnings forecasts have followed a familiar pattern every quarter for a number of years, until the two most recent quarters.

Previously, in the year leading up to the beginning of the quarter, the forecast is reduced an average of 6%. Then during the quarter and right up to the report date, earnings are cut an additional 4%. Subsequently, when actual earnings are announced there is a positive “surprise” of around 3%.

This pattern comes from analysts and the companies they follow doing a quarterly ‘kabuki dance’. Nobody wants a negative earnings surprise since it would embarrass the analysts, company management and stockholders. Instead they would rather under promise and over deliver.

In the fourth quarter of 2015 the 5% cut during the quarter was a bit larger than normal and we were well set up for the usual “surprise”. This time, however, the surprise didn’t arrive.

During Q1 2016 earnings forecasts were cut a lot, by around 10%, which came mostly from energy and financial stocks and should have left plenty of room for a positive “surprise”. So far, with 74% of companies reported, actual earnings have been only 2.6% above the forecast, so the positive “surprise” pattern has returned, but only because the forecast was drastically reduced.

The first quarter is usually the worst seasonally for earnings and the US economy. Despite the grim result in Q1, spring typically brings higher hopes, and so far analysts are optimistic for better results for the rest of the year.

Jeffrey Ricker – Mellon Capital, a BNY Mellon company

Revisions to quarterly S&P 500 earnings forecasts have followed a familiar pattern every quarter for a number of years, until the two most recent quarters. Previously, in the year leading up to the beginning of the quarter, the forecast is reduced an average of 6%. Then during the quarter and right up to the report date, earnings are cut an … read more

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Is the S&P 500 in for a prolonged plateau?

Historically, we have seen a few indicators from the Federal Reserve (Fed) for forecasting stock market returns. One of these was positive stock returns in the day or two surrounding the release of Federal Open Market Committee meeting minutes. A less-watched indicator is particularly interesting – one from the St. Louis Fed, which it publishes on its ‘Fred’ website.1

The St. Louis Fed’s adjusted monetary base chart is a favourite of inflation hawks, aghast that the monetary base has quadrupled since 2008, increasing $3.1 trillion from the Fed’s massive quantitative easing.2 If you plot the recent history of S&P 500 returns against the monetary expansion over the past few years, it makes an artful case for QE-induced asset price inflation. Since the Fed ended its QE party, the monetary base has been relatively flat; will the S&P500 returns flatten with it? 3

Jason Lejonvarn – Mellon Capital, a BNY Mellon company

1: https://research.stlouisfed.org/fred2/

2: The adjusted monetary base is meant to reflect changes in demand due changes in reserve requirements of the relevant depository institutions.

3: While the adjusted monetary base has varied over the last two years it is now at the same level it was in early March 2014, $3.9 trillion.

Historically, we have seen a few indicators from the Federal Reserve (Fed) for forecasting stock market returns. One of these was positive stock returns in the day or two surrounding the release of Federal Open Market Committee meeting minutes. A less-watched indicator is particularly interesting – one from the St. Louis Fed, which it publishes on its ‘Fred’ website.1 The St. … read more

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Are rising energy spreads a portent of default doom?

On 22 January, ratings agency Moody added 175 energy and companies to its downgrade watch-list, citing the slowdown in China and a collapse in commodity prices.

Fears over credit risk in the energy sector is reflected in the sharp spike in option adjusted spreads in US high yield energy bonds since the third quarter of 2015.

We believe the relatively high and increasing energy spreads reflect the increasingly stressed cash position of US energy companies, particularly non-conventional and higher priced energy producers. Given the “lower for longer” view of crude oil prices, we believe this pressure on higher priced energy producers will continue for the foreseeable future. The difficult question is to what extent this increase in spreads and eventual defaults rates will contaminate other sectors of the US economy.

Jason Lejonvarn – Mellon Capital, a BNY Mellon company

On 22 January, ratings agency Moody added 175 energy and companies to its downgrade watch-list, citing the slowdown in China and a collapse in commodity prices. Fears over credit risk in the energy sector is reflected in the sharp spike in option adjusted spreads in US high yield energy bonds since the third quarter of 2015. We believe the relatively … read more

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2016: Key market drivers for the year ahead

For the world’s markets, 2016 looks set to be another challenging and volatile year. In politics, the US election promises to be a headline event but other countries’ voters will also be heading to the polls. In Europe, for example, a potential EU referendum in the UK and the rise of extremist parties could have profound implications for the future of the world’s largest economic block.

On the macro-economic front, world GDP growth looks likely to continue to be driven by diverging and idiosyncratic stories over the medium term.

In the US, key questions will be whether the economy can detach from external affairs – and whether increased consumer spending can translate into significant interest rate rises. Additionally, the strength of the dollar will be an important factor to consider. In Europe, the Central Bank’s policy intentions will remain front and centre, while in emerging markets, a further slowdown in China could have a tremendous impact on resource-based economies across the world. In Latin America, meanwhile, select economies are seeing some nascent signs of stabilisation even as inflation remains worryingly high.

Finally, the commodities story can be expected to remain a crucial factor governing global growth prospects in 2016, with the supply and demand dynamic for basic materials driving fundamentals across broad swathes of the currency, equity and fixed income markets. Will commodity producers have enough currency reserves and the right policy toolkit to survive ‘lower for longer’ commodity prices? And will commodity-consuming countries see a more sustained pick-up in confidence?

These questions, among others, will form a large part of our analysis over the coming year. Click here to access more outlook pieces for 2016.

Jason Lejonvarn – Mellon Capital, A BNY Mellon company

For the world’s markets, 2016 looks set to be another challenging and volatile year. In politics, the US election promises to be a headline event but other countries’ voters will also be heading to the polls. In Europe, for example, a potential EU referendum in the UK and the rise of extremist parties could have profound implications for the future … read more

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How will commodity prices sway developed market growth in 2016?

More than a year on from the collapse in commodity prices we can see how quickly the global growth prospects of energy exporting countries – in this Australia and Canada – have been affected. We’re not witnessing any restriction in oil and gas supply or any sustained pick-up in demand or pricing – and, given the US’s newfound status as a global non-OPEC producer, nor do we expect to see any concerted action on tackling chronic levels of oversupply. Typically with commodities you see significant overinvestment followed by swift declines in pricing due to overcapacity. It’s a cycle that can last several years to play out and we’re really only at the start.

The reality for 2016 is likely to be a divergent world with different rates of growth and hence a variety of approaches to interest-rate policy. We believe developed economies will continue to expand into 2016 although at different and, on average, moderate rates. It is certainly unlikely to be an environment in which growth picks up to a point where major central banks across the globe will drastically withdraw from their accommodative monetary policy regimes.

Vassilis Dagioglu – Mellon Capital, a BNY Mellon company

More than a year on from the collapse in commodity prices we can see how quickly the global growth prospects of energy exporting countries – in this Australia and Canada – have been affected. We’re not witnessing any restriction in oil and gas supply or any sustained pick-up in demand or pricing – and, given the US’s newfound status as … read more

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