Yesterday we had a dramatic downturn of markets (Eurostoxx -2% intraday, S&P -1.7%) after an awful US ISM data with all measures unexpectedly falling into recession territory: ISM Manufacturing at 47.8 vs 50 consensus, the lowest level in 10 years, ISM Employment 46.3 vs 47.5 prior data, the lowest level since 2016, ISM New orders trending lower at 47 in line with previous estimate. On the positive side, HIS Markit Manufacturing PMI rebounded to 51.1 in line with consensus.
The response from Trump was pretty quick on Twitter:
As we ended the third quarter, it feels very similar to last year in many ways. The S&P 500 is near its all-time high at 3000, while the MSCI EM Index and the Topix sit 20% and 15% below their highs and the Eurostoxx is 7% lower, leaving all these indices exactly where they traded a year ago.
But there are important differences too. Cyclical stocks have completely fallen out of bed and trade 20% lower than last September, while long-duration sovereign debt has been the best investment by far over this period, with 10-year Treasury yields 50% lower than just 12 months ago. To put this into context, over the past 50 years such a dramatic move in yields over the prior 12 months has only happened twice (during the global financial crisis in 2008 and the European sovereign debt crisis of 2011-12).
After some cyclical performance (properly, the pro-cyclical trade), where Auto, Energy and Banks outperformed the broader market, in the past 8/9 session we saw the Momentum factor gaining traction, up almost 8%, with the short leg selling off.
The Market, the S&P 500 is not currently cheap trading at 16.9X and is entering in Q4 with the biggest Ytd gain since 1997.
Paying extraordinary valuations for anything is a bad idea, particularly for businesses that may never generate a positive stream of cash flows.
S&P500 and forward P/E multiples
We think that the market might be trading in a range (little moves, no new trend starting) until the next earning season, we still believe that Equity markets are likely to be trending lower in the mid-run.
There has been pain in the Momentum caused by the short leg outperformance but then last week the ‘long leg’ caused the pain and finally the private market. We saw that with some negative reading headlines in 2 very large pre-IPO private vehicles recently.
If we have to explain why we think we might stay in a range for the moment, we should also consider that:
- Investors are better hedged with options this time around owning almost $7bn of put delta as we enter Q4(vs. $4.5bn this time last year, or $2bn this time 2017) so less likely to hit the panic button
- Positioning across all HF styles invested in EU stocks, L/S ratios are lower (1.73x now, vs. 1.85x this time last year). Gross leverage is also lower than last year. This reduces overall need to panic de-risk and convexity on the downside
- There is some P&L cushion there to avoid major panics. L/S HFs up 8% YTD (best YTD since 2009), the most actively held Mutual Funds stocks up 19% (vs. benchmark up 16%), Multi-asset funds are +9% (best year since 2009) and all HF groups in aggregate are +6% (best year since 2009)
- In Eurostoxx Futures, Investors are long a modest +$4bn (vs. +$20bn in Aug) so there is no large futures position to cover/unwind in either direction
The World Trade Organization revised down global trade forecast for the current and future years, the lowest in a decade, respectively from 2.6% to 1.2% in 2019 and from 3% to 2.7% in 2020. In addition, Fitch‘s world GDP growth forecasts for both 2019 and 2020 have been lowered by 20bps since June in response to the sharp escalation in the US-China trade war over the summer. Global growth is projected to fall to 2.6% this year and to 2.5% next year from 3.2% in 2018. This would be the slowest pace of expansion since 2012 when the Eurozone crisis was at its peak. Indeed we don’t have to forget that the OECD revised its growth forecast too and currently see global economy’s growth at 2.9% and 3% in 2020 (higher than Fitch).
It seems that many investors are betting against raising inflation, then against Central Banks expansionary monetary and fiscal policies. The ongoing pressure on inflation break-evens in both Euro and Dollar shows signs of switching from low-inflation to deflation. Without any doubt, it seems inflation is falling worldwide, then the wording “deflation” is scaring the market. So far, September South Korea CPI declined more than expectation 0.4% vs 0.5% consensus, the Euro-area inflation is struggling at 0.9% slightly below consensus but still far away from ECB’s 2% target. Interestingly, options markets are increasingly betting on an inflation slowdown (deflation trade), US 10Y break-even recently touched the lowest level since 2016, while the Euro 5Y5Y inflation swap rate (market expectation on inflation in 10 years) is very close to multi-year lows, at 1.175.
Euro inflation forward
On Brexit, Johnson is due to unveil his detailed Brexit proposal to EU leaders within next 24 hours. Conservative Party’s annual conference in Manchester is held today. It seems that key EU officials already rejected his plan. Key Brexit deadline, 31 October, is approaching. By law, Johnson is required to ask for an extension if no deal, or there will be a legal battle.
Hong Kong protests remain elevated, Bloomberg reported Hong Kong protesters planned a fresh round of disruption on Wednesday after violent clashes led police to shoot a demonstrator for the first time since the unrest began in June. Press attention turning to police use of live ammunition, previously used for warning shots. Police chief Stephen Lo said the firing of live rounds was lawful and fair (Reuters).
North Korea fired what appeared to be a submarine-based ballistic missile into the sea off its coast just hours after saying it would resume stalled nuclear talks with the US. Japan earlier said it tracked two ballistic missiles, with one apparently landing in its exclusive economic zone in the Sea of Japan. Kim Jong Un is likely angling for leverage as he seeks a reprieve from US sanctions.
It is interesting to highlight the sudden move on Bitcoin often anticipates moves on wider markets. In November last year the Bitcoin lost 45% in 2 weeks ahead of Equity market sell-off. Interestingly, Bitcoin has lost 24% in the past 3 weeks, another “canary in gold mine”? Also note that Tether, not Bitcoin, is the most traded cryptocurrency since April. Although Tether’s market capitalization is 30 times smaller, it is increasingly outpacing Bitcoin, trading approximately 20% higher volume-wise. Unfortunately, it seems Tether is a black-box, little is known about its ownership (No one owns Bitcoin vs Tether Honk-Kong based private firm), and recent rumors disclosed that 74% of the Tethers is covered by cash and short-term products, not 100% as previously announced.
Correlation between Bitcoin (blue) and S&P (red)