Un repaso a los mercados

Mark Tinker, AXA IM  - Viernes, 31 de Marzo

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The quarter closes out with a win for the contrarian traders – emerging markets, Europe and even long bonds closed up, the S&P 500 underperformed the MSCI world, the dollar weakened and oil fell. 
This reflected a combination of market overshoot and a shift in the consensus narrative – away from ‘the reflation trade’ and away from the ‘protectionism trade’. Markets are reassessing what is desirable in terms of policy versus what is likely.
Markets are also likely to revisit issues such as the Fed balance sheet, the US budget ceiling and the likely path of Brexit, as well as thinking about France. Asia looks a safe haven by comparison.

Last week we discussed in some detail the market mechanics that appear to be working in the background as we close out the quarter, and for many people (especially Japan) the financial year.  Profit taking, window dressing, tax management all play their part and the mechanics of the delta one hedging desks of the investment banks mean that the observed price of portfolio insurance (as measured by the VIX) continues to move up. This is not because investors have necessarily become more fearful, it is simply how portfolios are being managed at the moment. The flip side of the same coin is that the bond markets have caught a bid, with the US 10 year moving back down smartly towards that 2.33% floor that we discussed last week as emerging from the technical indicators.

 

Markets however need a narrative to explain all this and market mechanics are a bit too arcane, so we have duly been given the ‘failure of Trump’s reset of Obamacare’ with a negative read across of the ability to achieve anything on tax reform and infrastructure. Obviously we need to be careful about the political stance of much of the economic commentary, but objectively the healthcare reform bill and the tax cuts do come from different places. While his political enemies may try and position this as a Trump failure, this was really Paul Ryan’s bill and ironically Trump may now find himself getting Democratic Party support for his version of tax reform (which favours the middle and lower income groups) as opposed to the Ryan versions which are seen as more biased towards the top 1%. For those interested, a nonpartisan assessment can be found here. The sad reality of US politics for a while now seems to be that party politics tends to dominate wider national interests such that the Democratic Party attempts to deny the new US administration the ability to achieve anything simply mirrors the actions of the Republicans who tried to ensure that Obama was a ‘one term President’. Ironically here, perhaps the best angle that President Trump could play to get his version of tax reform would be that it would split the Republicans.

 

As we close out the first quarter, one of the more noticeable things is how many of the consensus trades from the beginning of the year have unwound. In particular we would point to emerging market equities, which began the year very out of favour on the basis of nervousness over the new US administration and its stance on tariffs and trade as well as the notion of a stronger dollar and higher commodity prices, especially oil, all of which were seen as bad for emerging markets in general and Asia in particular. Three months into 2017 and we see commodities generally down a little under 5%, but with oil down twice that. Coal is essentially flat, but copper is about 6.5% higher and iron ore almost double that. Emerging market stocks meanwhile have done extremely well, supporting our case for contrarian investors at the start of the year, with the index up over 13% in US dollar terms, almost double that of the Eurostoxx index and way ahead of the return from early year favourite the S&P 500 that returned just over 5%.  Chart 1 is a little messy, but essentially shows that emerging markets, the Hang Seng and European mid cap stocks, the contrarian trades we discussed at the start of the year are all among the top performers in US$ terms.

These moves partly reflect mean reversion- the narratives had become sufficiently embedded in prices that there was always going to be some unwind, but they also reflect a more pragmatic stance, both by the US administration and by investors. The growing realisation that the US authorities do not wish to damage world trade and that this is merely part of a negotiation strategy has eased the fears of many, while the fact that instead of soaring away, the dollar index is actually about 2.5% weaker has also helped those worried about the damage of a strong dollar. Out here in Asia, perhaps a greater influence has come from the relative stability in China, which continues its slow and steady pace of reforms and its delicate balancing act of enough growth, but not too much. It is perhaps easy to forget just how panicked international investors were a year ago as the narrative took hold of a hard landing in China with some of the more excitable among them predicting 40% devaluations of the currency, massive capital flight and a banking collapse. Of course none of these came to pass, reflecting, in our opinion at least, a fundamental mis-reading of the current state and direction of travel of the Chinese economy. China is neither an emerging market dependent on foreign capital, nor is it an economy with a fully developed financial system able to efficiently recycle savings into investment. As such, western investors are constantly guilty of trying to impose the wrong template on the likely behaviour of the economy and its markets. In part this reflects an over-reliance on traditional demand indicators based on market prices without recognising the impact of supply shifts – China was neither going bust when oil and other commodity prices were falling in late 2015 and early 2016 nor was it overheating as they reversed direction in the latter half of last year. It also fails to recognise the speed and nature of the structural changes and reforms coming through, in particular the shift to the consumer and the build out of a financial sector capable of coping with a $16trn economy.

 

The more obvious initiatives on infrastructure building through One Belt One Road (OBOR) are attracting attention, as are the impacts of the Stock Connects between mainland China and Hong Kong that have helped the Hang Seng be one of the best performing markets so far this year. We are watching closely for the newly announced Bond Connect to take effect as foreign investors are soon to be able to trade in Chinese bonds through Hong Kong as China steadily integrates its economy and its markets with the rest of the world. The Hong Kong stock exchange announced a launch of a five year Ministry of Finance Treasury bond futures contract on 10th April 2017.

 

The next quarter will see much global attention focussed on the political scene in Europe, although as already noted the European markets have failed to extend the bearish position from the start of the year, which means there could be something of a shock, should the unexpected occur. Broadly though I suspect that the position is closer to the one pre the US election rather than pre Brexit. I suspect that people are following the old adage of expect the best, but prepare for the worst. Europe is (still) cheap, small and mid-cap stocks especially can make money under almost every scenario. Thus the default is likely to be wait for the outcome of the French election and fade the immediate reaction – just as with Trump I expect this will be a risk premia shift and they will buy the dip or sell the rally. Between now and then however, we still need to work out exactly who the final two candidates are and hence a tail risk ‘bet’ with the V1X - the European version of the VIX, was the choice for many as the options rolled over. Chart 2 shows the European and the US implied volatility indices and the spread between them - green line.

However in terms of fundamentals we believe that the results season in Asia has highlighted the variety of attractive stocks offering a combination of strong balance sheets, good cash flows and increasing payout ratios. As I pointed out last week, Asia contributes a third of all dividends paid globally but is probably barely 5% of global portfolios. Put that together with relatively low valuations and in a world starved of yield, that is looking increasingly interesting.

 

This is conference season in Hong Kong and so this week we had one of the two ‘big guns’ rolling into town with Credit Suisse (the other being CLSA in September). This used to be timed to coincide with the Hong Kong Sevens which gave an extra incentive to some of the international visitors, but this is not the case this year. It was nevertheless extremely full with a large roster of corporates as well as an eclectic mix of speakers on geo-politics, robotics, augmented reality (AR) and virtual reality (VR) and much besides. One ‘unscheduled’ speaker was the new Chief Executive of Hong Kong, Carrie Lam, following her ‘election’ this week. The quote marks around election are deliberate and in my view reflect the nature of the election process, which is effectively a selection based on votes from approximately 1200 representatives. There is no ‘one man one vote’ process and the winner is seen as the one appealing most to the various interest groups, the biggest of which of course is China. Mrs Lam was the number two in the previous administration and was the preferred candidate of Beijing and as such the result is seen as ‘business as usual’. In her speech she promised to tackle high property prices, but the only way to do that is to reduce the artificial constraints on land, something that is certainly not popular among the voting committee. We shall wait and see.  

 

On China, two distinguished speakers Jing Huang, professor of US China relations in Singapore and Dr Qiang Wu, former lecturer in political science at Tsinghua University, did not always agree on means and motives, but expected President Xi to consolidate his power this year, possibly through constitutional reform to allow him to rule beyond two terms. They agreed that China would not be a challenger to the world order – something echoed at a subsequent meeting I had with writer Robert Kaplan – who pointed out that President Trump’s withdrawal from engagement with the world has allowed Xi to position himself as the champion of globalisation.

 

On the US, Glenn Hubbard, former head of George W. Bush’s council of economic advisors, had some interesting points to make on potential tax reform and deregulation, notably that bank rules should be for banks and not applied to non-bank financial institutions and (in line with the proposals from the OECD) that debt and equity tax treatment should be equalised.

 

Among the companies, the tone from property and construction companies was pretty bullish although several were nervous about high prices in China, while there was much talk about fintech, automation and the strength of the Chinese consumer. We would rate the overall tone as neutral to positive, although following reporting season there was little in the way of shifting views.

 

As usual there were some interesting ‘future’ presentations, including one with a disturbing life like robot from Hanson Robotics. The Founder, Dr David Hanson pointed out that robotics were the inverse of VR, they brought the computer (in the form of a robot) into our world, whereas VR took us into the computer’s world. The robot in question, Sophia, interacted with Dr Hanson on stage with a full range of facial expressions including laughing, smiling and scowling that Hanson believes will enhance the artificial intelligence (AI) learning abilities of robots as people interact with them. This notion of deep learning and AI was also discussed by Sebastian Thrun of Udacity (who I unfortunately did not see live) who pointed out that if the human race is 100,000 years old then our entire technological revolution has occurred in less than 1% of that time  and, as he put it “only 1% of technologies have been invented”.  Most importantly, he noted that AI could be applied to all of them. However, it was interesting to note that most of the speakers did not see the dystopic notion of robots taking all our jobs, nor did they agree with Bill Gates’ notion of taxing robots – although it obviously appeals to governments looking for revenue. There were some interesting VR and AR discussions and demonstrations which simply reinforced my view that the two will merge as concepts very soon. The news flow on all of this may be in the background, but it is persistent and approaching very fast. Some of it will disrupt – who needs big screens when you have AR glasses? – but some will simply enhance the positions of the majors, especially the hardware companies such as Apple, who almost daily announce a new acquisition of software in the AI, VR or AR space.

 

Finally while few of the international investors I spoke to had come to Hong Kong via the middle east and were thus not too bothered about the latest ban on lap tops and tablets in the cabin of certain flights, a move that will hit flights operated by Royal Jordanian, Egypt Air, Turkish Airlines, Saudi Airlines, Kuwait Airways, Royal Air Marocco, Qatar Airways, Emirates and Etihad Airways. One particularly cynical one however did draw my attention to the press release issued the day that Donald Trump was elected from the Partnership of Open and Fair skies.  Essentially a lobby group for the major US airlines, it complained about unfair competition from Gulf carriers travelling to the US, specifically the three listed above as ones now requiring laptops to go into the hold. I wonder what they will do about VR headsets?

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