US 15% tariff on 110bn$ in Chinese goods takes effect and have also started the Chinese retaliatory tariffs on US imports.

Markets are set to open small up thanks to a sharp reversal in China (from negative to up 1.5%/2%) on some comments from the Central Bank ready to intervene with fiscal and monetary measure. Japan closed down 0.3%, US futures indicated down 0.4% (they won’t do settlement as US is officially closed today for Labor day). We should expect very low volumes today. Despite the bounce, worth to note that China PMI missed and still in contraction (Caixin PMI beat but quality of inputs still point to weakness, rise driven by production side while demand side struggling).

On Italy, headlines on  Saturday were saying that Conte may give up on Government attempt. More headlines yesterday suggesting that we will see plans from the Government by Wednesday….clearly not as stable as hoped.

Saxony and Brandenburg elections confirm Angela Merkel’s coalition in Germany despite a surge in populism with Afd (extreme right) coming second with around 20% of preferences in both states. CDU (Christian Democrats) still holds 32% in Saxony while SPD (Social Democratic Party) gathers around 28% of votes in Brandenburg. Overall, decent win for Angela Merkel’s coalition (CDU allied with SPD) although populist threat is rising.

Central Bank imposed capital control in Argentina to halt a slump in foreign currency reserves. Since primary election in late July, Argentina total forex reserves lost about 20% plummeting from $66Bln to $54Bln with Peso collapsing around 25%. This move is probably the last chance for current president Macri to control the crisis and win some electoral support back.

On Friday we mentioned that the current positive factor for the market was the low positioning and that the pain-trade could have therefore been only upwards.

Today we would like to go more in detail on this topic as it is crucial to understand the next market’s move on broad Index level underinvestment. The aggressive de-risking that occurred in August shows that investors are not complacent anymore. Global equities outflows have now reached 3% of assets under management since December, about half the outflows sustained during the 2008-2009 downturn. On Eurostoxx futures, almost 20bn$ were unwounded over the last 6 weeks taking the position to down to a small 1.3bn$ net long. Over the same period, clients bought roughly 4.5bn$ of Eurostoxx Put option delta and sold 4.1bn$ of call delta.

The current situation is that Volatility Control 10% strategies are below 50% exposures, CTA’s have cut massively (short-term signals are short on main global indexes), Risk Parity has cut, Retail has been flushed, Long Only investors have reduced exposures and market hedges (as evidenced by one metric, S&P put open interest) are very high.

Let’s have a look at the single investor’s categories:

  • Systematic strategies: Vol Control, CTA and Risk Parity strategies have significantly reduced their positioning, driven by the increase in realized volatility we’ve witnessed over the past 3 weeks or so. As you can spot from the chart below, the current systematic positioning is nearly as low as it was in December.

These investors have been responsible for more than 50% of the market move we had since the end of July!

  • Long/Short Hedge Funds: while gross exposure is still high (150% beta adjusted), the net is near the 0th percentile on the 1/3/5 year basis. There is therefore no risk-on positioning should the market continue to go higher.
  • Long only funds: this category is harder to track but looking at Prime Brokerage’s data, both Asset Managers and Pension Funds have been selling into rallies and they have not been active over the last few days. As we have already mentioned, we do expect that Pension Funds will start to switch soon some exposures from Bonds into Equites after the strong divergences in performance.

Yields have continued to stabilize even on Friday

Negative-yielding debt has spread to more than 30% of the world’s investment-grade bonds, the most ever. Sub-zero bonds have reached a 17trln$ record.

Everybody is talking about the “risk premium” of 10Y US Yield vs the S&P. It is now very large again, similar to the level we have seen in December last year (see chart). We can explain this mainly with the fact that bonds are very overbought now (very low yields) vs the S&P. The last time risk premium was this high was exactly on the 3rd of January and the S&P moved upward by 24%. But as in January equities were oversold, what about now? Is the reversion to the mean likely to be guided by bonds? On Bonds, please have a look at the following chart which is comparing the 30-Y US Treasury Yield vs the S&P dividend yield. There have been only few instances where we got these levels and every time the S&P tended to benefit and bounce relative to bond prices. Statistically, on a daily basis, there have been 9 instances over the last 10 years and 7 of 9 of those instances saw a significant move upward in the S&P in the 3, 6 and 12 months following those breaches with returns that were respectively up on average +3.5%, +8% and +19%.

And finally, let’s also have a look at seasonality of Bonds. September and October (for the US 10Y, but a decent proxy across maturities) appear to be bullish for bond yields (bearish for bonds) while August is normally bearish yields as it is the period where investors are on vacation and they hide in Bonds. From now until the end of the year, corporate Issuance will pick up and investors are likely to sell bonds in order to diversify their holdings with other asset classes. It is a bit an hazardous call but we are starting to think that we might soon see a directional move downward in Bonds which would cause investors (including systematic money like CTAs, Risk Parity and Vol Control) to sell their Bonds and move into equities…

On the Macro side, mixed bag of data Friday in US with a still strong consumer spending which is the driving force behind growth in the current and latest quarters, personal spending at 0.6% vs 0.3% prior and real personal spending at 0.4% vs 0.2% prior. Despite some strong data, be aware that consumer might decrease spending due to upcoming tariffs and market volatility. Also consider that US consumer sentiment is down the most since 2012 with University Michigan sentiment at 89.8 vs 92.4 consensus and US personal income is down 0.1% vs 0.4% prior in July. Interestingly, the inflation steady below 2% in line with consensus at 1.6% YoY calls for further rate hikes.