Download Breaking point

Nr. 2 · February 2016
MARKET COMMENTARY
Breaking point
Better luck this year?
The start in the New Year is
usually related to a positive
atmosphere. Stock exchanges
were no different in that. And
then it all happened ...
Contents >>
>> Breaking point
>> Macroeconomic outlook
>> Positioning of Ethna-AKTIV
[email protected]
ethenea.com
Nr. 2 · February 2016
MARKET COMMENTARY
Breaking point
Better luck this year? The start in the New Year is usually related to a positive
atmosphere. Stock exchanges were no different in that. And then it all happened ...
Breaking point. These are more than just twinges being felt in
every corner of the global economy – there is a threat of serious injury. My esteemed colleague Yves Longchamp will speak
in more detail on this in the second part of this month’s Market
Commentary. But this much can serve now as an appetiser, as
it were: global growth is weakening. The currency devaluations
being seen only lead to a redistribution of growth; they do
not create new wealth – quite the contrary. And the central
banks now seem almost ridiculous with their futile efforts to
stimulate growth in the economy with even more xxx (whatever
it might be). But, as stated, more on that later.
In the following pages, we would like to look at different facets
of the capital markets. After taking a blow that could be consi11500
45
11000
40
10500
35
10000
30
9500
25
9000
20
Dax Index, LHS
WTI Future, RHS
Source: Bloomberg, ETHENEA
Graph 1: German equity index Dax and crude oil futures
dered fairly disastrous for the risk markets in 2016 (Dax down
almost 10 %, EuroStoxx down almost 8 %, and the S&P 500
temporarily down almost 10 %), it is instructive to take a closer
look at the markets.
In purely technical terms, many market players seem to have
been yearning for the end of a very volatile 2015 and were
looking forward to January 2016, which was presumed to be a
risk-on month. The fact is that one intuitively takes a positive
view of the beginning of a new year. There are new inflows at
institutional investors and old losses are written off. So one
would think that the markets should actually rise. A brief
analysis of the German Dax index since 1960 reveals that of 57
Januaries, just 36 have delivered a positive return, i.e. only 63 %,
which is probably statistically within the uniform distribution,
even without a t-test. A rather disappointing percentage.
Either way, in almost all forms of equity-related investment,
major valuation adjustments were on the cards in January. It
should be noted that what is surprising in this context is that
so many players were caught off guard. One reason for this may
be the fact that the equity market, decoupled from any fundamental data, is tracking the development of the oil price nearly
one-to-one (Graph 1). Given the speed of the price decline, the
old truism that low energy prices are good for the economy
no longer applies. In fact, the opposite seems to be the case
today, considering the positive correlation between these two
variables. Instead of focusing on increased consumer spending
with simultaneous lower production costs, the capital markets
seem to be looking solely at the negative effects for crude oil
producers. This is a typical glass-half-full/half-empty debate.
ETHENEA | Market Commentary
No. 2 · February 2016
100
98
160
2.5
140
96
2
94
1.5
92
1
90
0.5
88
0
86
-0.5
84
-1
40
-1.5
20
Jan12
82
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3
11 11 12 12 13 13 14 14 15 15 16 16 17 17
Impl Stock rhs
World Supply
Million barrels per day
Million barrels per day
3
projections
120
100
80
60
Jul12
World Consumption
Jan14
Jul14
Jan15
Jul15
Jan16
Source: Bloomberg, ETHENEA
Graph 3: Option-adjusted spread (OAS) of all EUR corporate bonds in the
investment grade segment (5 years)
Graph 2: Global crude oil supply and demand and the implied excess
supply or demand
70000
200
60000
2015 IG issuance in EUR Million
220
180
160
140
120
100
Jul12
Jul13
EUR IG spread, in bp
Source: ETHENEA, EIA
80
Jan12
Jan13
Jan13
Jul13
Jan14
Jul14
Jan15
Jul15
50000
40000
30000
20000
10000
0
Jan16
USD IG spread, in bp
Source: Bloomberg, ETHENEA
Source: BoA Merrill Lynch, ETHENEA
Graph 4: Option-adjusted spread (OAS) of all USD corporate bonds in the
investment grade segment (5 years)
Graph 5: Issue volume in euros in the investment grade segment by origin
However, the fact is that we currently find ourselves in an
environment that is defined by a clear oversupply of crude oil
(Graph 2). According to the US Energy Information Administration (EIA), there is currently a worldwide oversupply of
crude oil of more than 1.5 million barrels per day. This may
sound like a lot at first: an excess of nearly a quarter-billion litres of oil. But this number loses much of its significance when
one considers that global consumption is 94 million barrels per
day. This means that 1.5 million barrels represent only 1.6 %
of total consumption or 23 minutes of global consumption.
So it is not really a great deal, and yet the price has fallen by
75 % since the beginning of the oversupply in the first quarter
of 2014. As a reminder, crude oil prices have fallen by 79 % in
2008. At that time, we were at the beginning of a deep global
recession, possibly even a depression, similar to the end of the
1920s. It is true that the macro data are currently deteriorating,
but we are miles away from a recession. Or are we … ?
it, we cannot trade it. Caution is our highest priority when it
comes to our investors.
Let us now take a look at corporate bonds. Graphs 3 and 4
show the average yield premium on corporate bonds in euros
or US dollars in the investment grade segment. There are at
least two remarkable aspects to these graphs. First, both markets bottomed out in early summer, although the euro market
actually hit its low point in March 2015, coincidentally (?) at
the beginning of the ECB’s QE. The USD market reached its
last low in late summer when the markets considered there
to be a very high probability that the Fed would make its first
interest rate hike in September.
In addition, it should be noted that the overall level of the USD
market segment is almost twice as high as in Europe. Does
this mean that the probability of default in the US is so much
higher than in Europe? This is unlikely, given that in some
cases the same companies are involved. Graph 5 shows this
clearly, because most of the new issues in EUR are actually
attributable to companies from the United States. This aspect
Indisputably, there are forces at work that (for now) defy rational analysis. As a result, we have greatly reduced our net equity
exposure, in keeping with our belief: If we do not understand
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ETHENEA | Market Commentary
No. 2 · February 2016
150000
in EUR million
100000
Supply < incoming cash
80%
9
75%
8
70%
50000
0
6
60%
-50000
5
55%
Supply > incoming cash
-100000
4
50%
-150000
45%
-200000
40%
-250000
7
65%
3
97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
US HG yield as % of Global HG yield (LHS)
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Global HG corporate yield (%, RHS)
Source: BoA Merrill Lynch, ETHENEA
Source: BoA Merrill Lynch, ETHENEA
Graph 6: Total of new issues and new cash in the EUR IG corporate bond
segment
80%
Graph 7: Global average yield for IG corporate bonds and the
corresponding proportion of US bonds
corporate bond market. If one also takes into account the
aspect of the attractiveness of US bonds for investors (Graphs
7 and 8), then from an investor’s perspective there is little in
favour of EUR corporate bonds and much in favour of those
in USD. As a very high proportion of the yield, more than
70 % of potential income, for global investors now comes from
US bonds, this leads to constant new inflows from non-US
investors (Graph 8).
200
75%
150
70%
100
65%
60%
50
55%
0
50%
-50
45%
40%
2
Allow us to briefly summarise our findings. On the one hand,
the equity market is currently dominated by variables that in
some cases defy our rational analysis. This is certainly true
not just for us, but for many market players. Many bond
investors who turned their backs on bonds in summer 2015
in order to invest in equities, which were supposedly more
attractive particularly in light of the anticipated rate hikes by
the Fed, have now learned their lesson. The equity markets are
weakening and global economic growth is slowing down. The
probability of a series of rate hikes by the Fed in this cycle is
currently very low.
-100
Foreign investors buying of US IG ($bn, RHS)
US IG yield as % of Global IG yield (LHS)
Source: BoA Merrill Lynch, ETHENEA
Graph 8: Total of cash inflows and outflows from non-US investors on the
US IG market and the proportion of the yield for US bonds
is not surprising given the exchange rate history of the USD
against the EUR. US-based companies with activities in the
eurozone have suffered significant declines in profits at the
European subsidiaries in USD terms. An effective means to
combat this is obviously to increase euro liabilities, which can
be offset against euro income without any currency risk. In any
case, for US companies the interest rate advantage is an additional incentive to issue EUR bonds. As yields on EUR bonds
have in some cases been more than 200 basis points (bp) below
USD bonds with the same maturities, even after deducting the
cost of currency swaps, there is still enough left over in the end
to make such operations profitable. Since spreads are still very
positive for EUR issues, we can continue to expect a number
of EUR issues by US companies. For example, an 8-year bond
from Procter & Gamble is 140 bp cheaper in EUR than in USD.
In the case of AT&T, the advantage in the 10-year segment
reaches 190 bp.
If one combines the above-mentioned technical conditions
with the findings on the economic situation, US corporate
bonds offer a very attractive risk-reward ratio.
Authors >>
A look at graph 6 shows that total supply exceeds total demand.
This phenomenon alone should ensure rising yields in the euro
4
Guido Barthels
Yves Longchamp, CFA
Portfolio Manager
ETHENEA Independent Investors S.A.
Head of Research
ETHENEA Independent
Investors (Schweiz) AG
ETHENEA | Market Commentary
No. 2 · February 2016
Macroeconomic
outlook >>
In the previous edition of our macroeconomic outlook, we
assessed that risks were virtually all to the downside. In the
first month of this year, this proved true. In the US, manufacturing activity has deteriorated so much that this part of the
economy is now in recession. In Europe, growth has gained
momentum, but a low inflation is forcing the ECB to ease its
monetary policy frenetically. In China, capital outflows and a
weakening renminbi betray financial stress and potentially fuel
the contasian risk1.
In comparison to the US, manufacturing production in the
eurozone is set to keep expanding, as shown by all leading
indicators. A divergence among eurozone members persists
in this regard as well. According to the latest available data,
industrial activity has stabilized in Germany while it has grown
more robustly in France, Spain and Italy. Growth remains
weak, uneven and fragile, but it is improving.
In comparison to China and the US, it is striking that the
eurozone economy, which is doing better, is on the verge of
receiving a new monetary stimulus. In the US the Fed has
started a tightening cycle and in China the PBOC is facing
capital account outflows and is therefore reluctant to ease
monetary policy further.
All these downside risks have materialized, since the writing of
our previous outlook before Christmas. As a result, our outlook
has changed and we have thus downgraded our economic
scenario for 2016.
Why is Mr Draghi so eager to further relax monetary conditions? He keeps repeating to anyone willing to listen that
the inflation target is the only goal that the ECB pursues. “We
have the power, the willingness and the determination to act.
There are no limits to how far we are willing to deploy our
instruments within our mandate to achieve our objective of
a rate of inflation which is below but close to 2 %” 2 said the
president of the ECB in the press conference following the last
monetary policy decision.
Europe
In Europe, growth has continued to improve. Private consumption is supported by a declining unemployment and an overall
high consumer confidence. Differences among eurozone members persist, as reflected in divergent growth paths. In Spain and
Italy, we have strong reasons to believe that private consumption
will remain vigorous. The level of consumption is still low in
comparison to the period preceding the Global Financial Crisis.
Signs of fatigue are however to be observed in Germany and,
to a lesser extent, in France. On the investment side, the easing
of credit conditions and an improving non-financial corporate
credit demand are both encouraging; however a true catalyst for
a genuine investment recovery is still missing.
4.0
We have argued several times in this publication that lowflation
is a global phenomenon that cannot be addressed by a regional
central bank, as powerful as it might be. Mario Draghi shares
some similarities with Don Quixote. Don Quixote would ride
his exhausted horse Rocinante and attack windmills that he
believed to be ferocious giants, while Mario Draghi is using an
exhausted quantitative easing to fight the ferocious deflation
threat. Even more worrisome to us is the role of Sancho Panza,
his loyal squire, in whom we see parallels to the role of the
markets in our modern rendition of the novel. Sancho Panza
is fully aware that his master has a distorted perception of the
world, but follows him nonetheless. For the markets, more
easing rhymes with higher equity and bond prices.
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3.5
100
3.0
%
%
50
2.5
0
2.0
1.0
2008
Market participants have also a distorted perception of the
world, in particular when it comes to inflation expectations.
Current oil prices are well correlated with inflation expectations 5 years ahead (Graph 9) both in the US and in Europe.
In this respect a couple of questions are pressing: Is it realistic
that the price of a barrel today – which no one was able to
predict – has any ability to forecast what inflation will be in
-50
1.5
2009
2010
2011
2012
US 5 year inflation expectation
2013
2014
2015
2016
-100
EU 5 year inflation swap rate
Oil price inflation (rhs)
Source: Bloomberg, ETHENEA
Graph 9: Inflation expectations and oil price inflation
1
2
Contasian risk is a portmanteau word made from contagion and Asian. Read more about this subject in our January Market Commentary entitled The Tempest.
Source: http://www.ecb.europa.eu/press/pressconf/2016/html/is160121.en.html
5
ETHENEA | Market Commentary
No. 2 · February 2016
5
4
%
3
2
1
0
-1
2000
2002
2004
2006
HICP inflation
Fitted values
2008
$10
2010
$20
$30
2012
$40
2014
$50
2016
$100
Source: Bloomberg, ETHENEA
y/y, %
Graph 10: Eurozone inflation is massively influenced by oil price inflation
10
2.0
8
1.9
6
1.8
4
1.7
2
1.6
0
1.5
-2
1.4
-4
1.3
-6
1.2
-8
1.1
-10
1945
1950
1955
1960
1965
GDP
1970
1975
1980
NBER Recession
1985
1990
1995
2000
2005
2010
2015
1.0
Industrial production
Source: Bloomberg, ETHENEA; NBER
Graph 11: Industrial GDP cycle in the US
5 years? And is the ECB really able to move oil prices in one
way or another with additional quantitative easing or a further
rate cut in negative territory, so that the inflation rate increases
and inflation expectations stop declining? To both of these
questions, the answer is undoubtedly “no”.
United States
In the US, leading indicators have deteriorated further both
in the service and in the manufacturing sector. The latest
development in the ISM manufacturing index is in our view
particularly worrying for several reasons. First, the ISM index
declined to a level suggesting a contraction in manufacturing
activity. Industrial production, which encompasses the manufacturing activity to a large extent, but also mining as well as
quarrying and public utilities, declined for the first time since
the Global Financial Crisis, according to the latest available
data. Second, due to the indication of a contraction in manufacturing activity, industrial production is likely to decline
faster in the coming months. The risk of a GDP contraction
has become real, as Graph 11 shows. In the post-war period, all
recessions (begin and end dates of which are officially defined
by the National Bureau of Economic Research – NBER) have
been accompanied by a contraction of industrial production,
the reverse however not being necessarily the case. In 25 %
of cases, industrial recession did not lead to a GDP contraction. The odds thus suggest that there is a 75 % likelihood of
But what a further easing certainly does is to keep the single
currency artificially cheap, to help governments roll their
debts and finance structural reforms at low cost and to
provide cheap credit to the European economy. It is actually
a pro-growth monetary policy that is not constrained by
high inflation. The ECB is likely to cut rates and to expand
asset purchases in its next meeting on March 10th, except if
oil prices increase. Graph 10 shows the sole impact of oil
prices on inflation in Europe based on several scenarios. If
oil prices drop to 10 USD a barrel and remain at this level
over the coming 12 months, inflation will be negative in the
eurozone this year. Even if oil prices were to increase to USD
50 tomorrow, inflation is set to remain below the 2 % ECB
target in 2016, which raises some doubts on the efficacy of
quantitative easing in the fight against lowflation.
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ETHENEA | Market Commentary
No. 2 · February 2016
6
4
2
%, y/Y
0
-2
-4
-6
-8
-10
2005
2006
2007
2008
Government spending
2009
Net export
2010
2011
Inventories
2012
Fixed investment
2013
2014
Consumption
2015
2016
GDP (q/q, saar)
Source: Bloomberg, ETHENEA
Graph 12: US GDP and component contribution to growth
stronger dollar would be counterproductive for the slowing US
manufacturing industries as well as for all economies whose
currencies are linked to the dollar, such as China and most
oil exporters. As long as employment remains healthy and
growth evolves correctly, the Fed may hike. In our view, two
rate increases is the maximum the Fed can deliver this year.
6
5
4
y/y, %
3
2
1
In Q4 2015, GDP grew by 0.7 %, a poor result in comparison
to the previous quarters. The composition of growth shows
that consumption remains the key contributor. Net exports
and inventories contracted while investment was overall flat
(Graph 12).
0
-1
-2
-3
2000
2002
2004
Services
2006
2008
Goods
2010
2012
2014
2016
Private consumption
Private consumption represents about two thirds of US GDP
and has been a key contributor to growth in the last few
years. A detailed analysis of private consumption shows that
this cycle has been similar to those observed in the last 15
years: service comsumption is driving the whole consumption
cycle. In the most recent cycle, started in 2012, consumption
gained momentum because of services, consumption of goods
expanding at a steady pace as illustrated in Graph 13. This
observation potentially explains the large divergence between
manufacturing production and consumption. Notice that
healthcare consumption is mainly responsible for the actual
consumption growth, a cycle that followed closely the implementation of Obamacare. Most importantly to us, it shows that
the current consumption cycle is clearly losing steam, implying
a growth consolidation ahead.
Source: Bloomberg, ETHENEA
Graph 13: US private consumption decomposition in goods and services
experiencing an economic recession in the US in the coming
months. Investment in equipment, a small but crucial GDP
component that captures capital expenditure spending, acts
as the transmission mechanism from industrial production
to GDP cycles. According to the latest GDP data, equipment
investment was flat in Q4.
This slowdown reinforces our view that the US labour market
will lose momentum this year. Initial jobless claims have
stopped declining, for instance, and manufacturing employment is contracting. It is however fair to say that more than
90 % of all the new jobs were created in the private service
sector last year, a sector of activity unlikely to contract any time
soon. As a result, non-farm payroll data is very likely to show
healthy figures, in spite of losing some momentum.
Bretton Woods II
A stable exchange rate, free capital flows and an independent
monetary policy are three goals that all governments want
to achieve. A stable exchange rate fosters global trade, free
capital flows allow capital to be deployed efficiently and independent monetary policy means that national central banks
are free to adjust monetary conditions to reach their goals.
The problem is that these three goals cannot be achieved at
Against this background, the Fed is unlikely to hike aggressively this year, as the most recent FOMC statement suggests. A
7
ETHENEA | Market Commentary
No. 2 · February 2016
the same time: this is what economists called the impossible
trinity (Graph 14). Only two out of the three goals can be
achieved. In the eurozone, stable exchange rate – the single
currency – and free capital flows are granted, but at the cost of
losing full national monetary policy independence. In China,
stable exchange rate and independent monetary policy have
been preferred over free capital flows and thus lead to massive
accumulation of foreign currency reserves in order to neutralize the impact on the currency.
The tensions between these three goals develop in good times
and become an issue in bad times. In Europe, it only became
obvious when the euro crisis burst that a single monetary
policy was ill-designed to rebalance smoothly the large differences between the core countries and the periphery. In China,
global trade never fully recovered after the Global Financial
Crisis, shedding a ruthless light on the fragility of the growth
model of the world’s second biggest economy. The theoretical
independence of the Chinese monetary policy is not sufficient
to tackle the challenges faced by this economy. Rising interest
rates would be an option for China to maintain its currency
stable and to stop capital outflows, but in the face of a weakening growth this would surely trigger a hard landing – an
outcome that the Communist Party of China wants to avoid
at all cost.
Impossible Trinity
Fixed exchange Rate
Independent
Monetary Policy
Free Capital Flows
The cracks in the current global monetary system, known as
Bretton Woods II and revolving around the US dollar, stem
Source: ETHENEA
Graph 14: Impossible Trinity
60%
50%
40%
30%
AXJ: Asia ex- Japan currencies
20%
EMM: Emerging Market currencies
10%
0%
G10 currencies
CEE: Central Eastern European
Currencies
-10%
-20%
-30%
COM: Commodity currencies
-40%
Source: Bloomberg, ETHENEA
Graph 15: Movements in real effective exchange rate since 2013
10%
0%
-10%
-20%
-30%
-40%
-50%
-60%
-70%
no data available
Source: Bloomberg, ETHENEA
Graph 16: Movements in spot exchange rate versus the USD since 2013
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ETHENEA | Market Commentary
No. 2 · February 2016
30
4200
1200
3600
18
16
1000
3000
15
15
10
14
800
2400
600
1800
7
5
1
2
2
1
1 1
2
3
400
1200
200
600
In billion USD
20
in billion USD
Number of countries
1400
25
25
4 4
0
0
1990
1995
Japan
Number of countries in which FX reserves peak per year
Source: Bloomberg, ETHENEA
2000
Saudi Ariabia
2005
2010
Russia
2015
0
China (rhs)
Source: Bloomberg, ETHENEA
Graph 17: The end of FX reserve accumulation
Graph 18: FX reserves of the four biggest holders
from the combination of a weak global growth, low commodity prices and a strong USD. Weak global growth has been
particularly damaging for emerging markets that build their
economic success on heavy investments in export industries.
These countries, especially in Asia, have aimed at currency
stability and growth at the same time. This is why they have
tied their currencies to the US dollar – a currency that has
strengthened massively in the last couple of years. Most of
them have handled the impossible trinity in the same way as
China. They have chosen a stable currency and an independent
monetary policy at the expense of capital account openness. As
a result of this choice, foreign exchange reserves have grown
massively. Against this background, movements in foreign
exchange reserves and in exchange rates are good indicators
of the health of the global monetary system.
depreciated nominally versus the USD on a bilateral basis, as
Graph 16 shows. This confirms our view that the dollar is too
strong for the world economy and that all countries need to
weaken their currencies in order to reflate their economies.
Only the commodity currency group (COM) as a whole was
able to adjust its real exchange rate to the new environment
either via exchange rate adjustment or via lower inflation. The
Venezuelan Bolivar (VEF) has appreciated the most in real
terms, despite a one-off devaluation of more than 30 % versus
the USD, as hyperinflation (200 % in 2015) eats up the country
competitiveness.
According to the IMF statistics on FX reserves covering 147
countries, 116 countries (roughly 80 % of the observations)
have seen their FX reserves declining by at least 5 % compared
to their peaks. Graph 17 shows clearly that this trend started
right after the Global Financial Crisis and accelerated thereafter. Between 2013 and 2015 only, 50 % of FX reserves peaked.
The four biggest FX reserve holders – China, Japan, Saudi Arabia and Russia – own together 50 % of all the reserves. These
countries are very different in terms of economic development,
currency management as well as economic and political structures, but they have now all stopped accumulating reserves or
started to sell them (Graph 18) because their economies are hit
by weak growth, low commodity prices and/or a strong dollar.
These constitute an adverse combination of factors that the
global monetary system, stiffened by political choices on how
to manage the impossible trinity, cannot rebalance smoothly.
As far as commodity exporters are concerned, they have been
hit, obviously, by the drop in commodity prices, but also by
the strength of the dollar for those that have harnessed their
currencies to the US dollar 3.
To us the current global monetary system is like a pressure
cooker whose safety valves are leaking: currencies devalue if
they can, capital outflows are legion as currency reserves are
melting like snow in the sun, short-term rates spike to stress
levels and central banks ease their monetary policies.
Real effective exchange rates are a yardstick used by economists
to measure developments in international competitiveness.
According to these metrics, the USD and the renminbi (represented in red in Graph 15) appreciated by 21 % and 28 %
respectively since 2013. The Saudi riyal (SAR) and the Hong
Kong dollar (HKD), both pegged to the USD, appreciated massively as well. Among the currency baskets shown in light blue
in the chart, the Asia ex-Japan (AXJ) group has strengthened
the most in real terms in spite of successive devaluations versus
the USD. Over the same period, all currencies have actually
3
The stress experienced by some economies is visible in financial markets. In China, the difference between the on-shore
and the off-shore yuan, that is the prices of a unit of Chinese
currency that are supposed to be perfectly identical, are
expressions of the system’s cracks (Graph 19). The off-shore
renminbi, traded on international markets, is cheaper that its
on-shore counterpart, tightly controlled by the Communist
For our readers who wish to learn more about this topic, we recommend our Market Commentary from September entitled the China Syndrome 2.0.
9
7.0
150
7.84
40
6.9
120
7.83
36
6.8
90
7.82
32
6.7
60
7.81
28
6.6
30
7.80
24
7.79
20
7.78
16
7.77
12
0
6.4
-30
USDHKD
6.5
6.3
-60
6.2
-90
7.76
8
6.1
-120
7.75
4
6.0
2010
-150
7.74
2014
2011
2012
USDCNY
2013
2014
USDCNH
2015
2016
2015
USDHKD
Spread (rhs)
Source: Bloomberg, ETHENEA
2016
%
No. 2 · February 2016
Percentage in point (pip)
Exchange rate
ETHENEA | Market Commentary
0
Hong Kong dollar 1 week Hibor rate (rhs)
Source: Bloomberg, ETHENEA
Graph 19: Price difference between on-shore and off-shore yuan
Graph 20: Devaluation pressure on the Hong Kong dollar
Party of China. This spread reflects the depreciating force that
is weighing on the renminbi.
strategies consisting in pledging commodities to guarantee a
loan in USD whose proceeds are in turn invested in renminbi
explain part of the correlated movement between commodity
prices, credit and yuan fluctuations. This financial strategy
is successful if first of all the funding currency (USD) does
not appreciate, secondly if the profit margin, measured as the
spread between the lending rate and the return on investment,
is comfortable and thirdly if the value of the collateral does
not decline. None of these three conditions hold anymore,
meaning that part of the Chinese capital outflows have been
due to the unwinding of carry trades. These flows have been
large and may have triggered a second wave of outflows driven by Chinese citizens looking for assets abroad. This trend
is set to last for a while.
Hong Kong is a financial hub, linking China to the rest of
the world. Its currency, the Hong Kong dollar (HKD), has
been pegged hard to the US dollar for more than 30 years. In
January, the price of the HKD versus the USD moved heavily,
thus reflecting strong downward pressure on the HKD, a sign
of capital outflows. In order to keep the peg, the Hong Kong
Monetary Authority (HKMA) massively increased the 1 week
interest rates to almost 35 % (Graph 20) in order to discourage
those wanting to short the HKD.
Finally, fragile commodity exporters whose currencies are
tied to the dollar may soon need a hand. Azerbaijan and
Nigeria, both oil exporters whose currencies are pegged to
the USD, asked the IMF for financial assistance in January.
Chinese FX reserves have declined by USD 660 bn in the last
18 months. In December 2015 only, they have declined by
USD 108 bn, signalling an acceleration. We do not see why
this trend should reverse and we are wondering how long it
can last. What is the minimum level of FX reserves China can
tolerate? According to the IMF, reserves should cover at least
3 months of imports or all short-term international debt. This
suggests that China can go as low as USD 1000 bn according
to a back-of-the-envelope calculation. It seems however barely likely that China will let its hard-earned wealth flow away
smoothly until reaching this limit. A reading between USD
2 000 bn and 2500 bn seems more reasonable in our view
and could be reached this summer already. A continuation of
massive capital outflows would weigh on the global economic
sentiment and would trigger a policy response in China. On
the one hand, a one-off devaluation of the renminbi or the
implementation of strict capital controls are two obvious
responses, but on the other hand, they would lead to a sudden
stop in the process of internationalization of the renminbi, an
unwanted outcome.
China
In China, slowing growth and rapidly growing debt make for
an unstable blend. Declining FX reserves, coming along with
capital outflows as well as a weakening renminbi, are also
symptoms of the Chinese domestic imbalance. The recent
depreciation of the renminbi and the expectations that the
Chinese currency will weaken further call for more outflows
and additional pressure on the yuan. In case of rapid deleveraging, the risk of a financial crisis contaminating the rest of Asia
(the contasian risk) would increase massively.
In a Hong Kong Institute for Monetary Research (HKIMR)
paper published in December 2015 and entitled China: Credit,
Collateral, and Commodity Prices 4, anecdotal evidences
that have been gathered for months find a sound empirical
support. The two authors’ thesis is that risky carry trade
4
Source: http://www.hkimr.org/uploads/publication/433/wp-no-27_2015.pdf
10
ETHENEA | Market Commentary
No. 2 · February 2016
Conclusion
Downside risks have materialized or have become more likely
since we wrote our previous macroeconomic outlook. As a result,
our view has changed and we have downgraded our economic
scenario for 2016. In the US, the contraction in industrial production poses a serious risk to GDP growth and to the Fed’s newborn
hiking cycle. In Europe, growth data is overall encouraging but
fragile. Chinese capital outflows betray economic weaknesses and
affect the economic sentiment. Finally, weak global growth, low
commodity prices and a strong US dollar pose a threat to the
global monetary system. To cut a long story short, the economic
horizon is brimming with clouds.
Author >>
Yves Longchamp, CFA
Head of Research
ETHENEA Independent Investors (Schweiz) AG
11
0.2
3.2
6.3
ETHENEA | Market Commentary
No. 2 · February 2016
Positioning of
Ethna-AKTIV >>
Following heavy losses in the first weeks of January, markets
calmed down again, backed by the promise of further monetary easing of the ECB and a slight recovery in oil prices. The
latter might at least partly be related to Russia, signalling a
potential cut in production. The FOMC statement, published
on 27 January, was perceived as marginally dovish, given that
risks to the outlook were now balanced and the statement on
economic activity rather cautious. While the US job market
continued to experience a strong performance, underpinned
by a strong growth in the service sector, the manufacturing
sector is still weak and inflation pressure remains low due to
continuously low energy prices and tougher y/y comparison
of average hourly wages.
as we are still highly convinced of the stocks we hold in our
portfolio. On a sector level, we reduced the exposure to the
insurance sector given the expectation of lower interest rates
for a longer period of time. Furthermore, we started to reduce
our exposure towards healthcare, as recent statements by
Hillary Clinton signalled that the discussion about high drug
prices in the US is heating up and may continue to affect the
healthcare sector negatively.
Regarding currencies, we increased our net USD exposure,
which serves as a cross hedge for our US equity and bond
portfolio. Since we reduced our investments in Swiss bonds
and equities by 2.5 %, we also adjusted our net CHF exposure
accordingly. Given that polls are signalling an increased probability of a Brexit, we completely hedged the GBP exposure.
Given decreasing growth expectations in the US, we expect interest rates to remain low and therefore increased the modified
duration of the portfolio by 1.56 to 6.37. As we expect further
flight to safety on the back of volatile markets, we increased
our exposure to sovereign bonds, especially US Treasuries, by
16.8 % to 20.6 %. As we reduced simultaneously our exposure
to non-investment grade bonds, the portfolio’s average rating
increased by two notches to between A- and A.
Authors >>
Portfolio Management
Guido Barthels, Luca Pesarini, Christian Schmitt,
Niels Slikker, Daniel Stefanetti, Peter Steffen,
Arnoldo Valsangiacomo and Team
On the equity side, we reduced our net exposure by 36.1 % to
6.4 % at month-end. This happened mainly by using futures,
Ethna-AKTIV
Ethna-AKTIV
TotalNAV
NAV
%%
ofof
Total
0.9
11.7
Ethna-AKTIV
Ethna-AKTIV
allocation
Currency
% of Total
NAV
20.4
% of Total NAV
AAA
A
19.8 %
AA
0.2
3.2
BBB
1.7 %
CHFA
2.6 %
BBB
NON IG
USDNON
Not rated
Equities
89.4 %
EURAAA
AA
IG
Not rated
34.4
GBPEquities
16.3
Cash
Cash
Others
JPYOthers
0.0
12.9
DKK
7.2 %
72.5 %
0.0 %
3.5 %
0.6 %
0.5 %
1.2 %
1.2 %
Net
Gross
Source: ETHENEA
Source: ETHENEA
Graph 22: Portfolio composition of Ethna-AKTIV by currency
Graph 21: Portfolio composition of Ethna-AKTIV by issuer rating
12
ETHENEA | Market Commentary
No. 2 · February 2016
Ethna-AKTIV
Bonds
% of Total NAV
60
Equities
* including 8 other countries
58.7
50
40
30
20
10
5.3
3.7
3.7
3.4
3.1
2.9
1.2
0
1.0
0.9
2.5
0.9
Source: ETHENEA
Graph 23: Portfolio composition of Ethna-AKTIV by origin
Bonds
Source: ETHENEA
Equities
*including 8 other countries
Ethna-AKTIV
Bonds
% of Total NAV
20.6
20
15
10
8.3
5
Equities
* including 9 other sectors
8.0
7.6
7.6
5.2
4.4
4.2
2.7
2.2
2.2
1.9
0
Source: ETHENEA
Graph 24: Portfolio composition of Ethna-AKTIV by issuer sector
13
1.9
1.5
1.5
1.1
1.0
0.8
0.8
0.6
0.5
0.5
2.3
Publisher >>
The representatives of the Portfolio Management Team and the Head of Research
From left to right: Yves Longchamp – Head of Research at ETHENEA Independent Investors (Schweiz) AG, Guido Barthels,
Daniel Stefanetti, Luca Pesarini, Arnoldo Valsangiacomo, Christian Schmitt, Niels Slikker and Peter Steffen. The Portfolio
Management Team is also including (not pictured): Holger Brück, Jörg Held, Roland Kremer, Ralf Müller & Marco Ricciardulli
Contact >>
If you have any questions or suggestions please feel free to contact us at any time.
ETHENEA Independent Investors S.A.
16, rue Gabriel Lippmann · 5365 Munsbach · Luxembourg
Phone +352 276 921 10 · Fax +352 276 921 99
[email protected] · ethenea.com
Awards >>
DEUTSCHER
DEUTSCHER
ÖSTERREICHISCHER
ÖSTERREICHISCHER
LIPPER
FUND AWARDS 2015 WINNER
AUSTRIA
2011
2011
2011
2. Platz
2. Platz
Gemischte Fonds Europa,
ausgewogen, 3 Jahre
1. Platz
Gemischte Fonds Europa,
5 Jahre, ausgewogen
Gemischte Fonds Europa,
3 Jahre, ausgewogen
POWERED BY
SOFTWARE-SYSTEMS
POWERED BY
SOFTWARE-SYSTEMS
P O W E R E D BY :
software-systems.at
2011
2. Platz
Gemischte Fonds Europa,
5 Jahre, ausgewogen
P O W E R E D BY :
software-systems.at
Best Category EUR Cautious Allocation Belgium
Important notice >>
An investment in investment funds, as with all securities and comparable financial assets, carries the risk of capital or currency losses. The
price of fund units and income levels will therefore fluctuate and cannot be guaranteed. The costs associated with fund investment
affects the actual performance. Units are purchased solely on the basis of the statutory sales documentation. All information published here constitutes a product description only. It does not constitute investment advice, an offer to enter into an agreement
for the provision of advice or information or a solicitation of an offer to buy or sell securities. Contents have been carefully researched,
compiled and checked. No guarantee for correctness, completeness or accuracy can be provided. Munsbach, 31/01/2016.
[email protected]
ethenea.com