The market has bounced on new fresh “last minute” hopes for a Trade-deal to be discussed from today in Washington. It seems that China is still open to agreeing a partial trade deal with the US, as long as no more tariffs are imposed.

What is certain is that constant barrage of tweets, chaotical geopolitics and lack of earnings are not helping for a stable market and are instead:

  • Making the market extremely vulnerable to quick swings (also because of poor volumes)
  • Eroding confidence and likely setting the tone for earnings to be more about visibility and capes plans both of which will be hard to see.

This makes the market much more challenging and volatile than perceived.

Overnight the press gave mixed signals. SCMP reporting that the Chinese delegation was prepared to cut its trip early and head back on Thursday after a lack of progress at deputy level talks. The Global Times talked down prospects of any deal suggesting that the fundamental disputes between the US and China had become more deeply entrenched. Bloomberg reported that the US is exploring a partial deal which includes a currency pact. If from here the US is willing to accept a partial deal then there is likely willingness from both sides for that to move forward. A partial deal that involves currency would be a positive. Alternatively if the Chinese delegation were to leave with no progress today…market is likely to have a further sell-off.

The chart below shows the average tariff rate on all US imports from China assuming announced future tariffs take effect. August saw the biggest escalation in the trade war to date. Acute recent global manufacturing weakness is closely related to the uncertainty shock this tariff hike has caused.

Trade uncertainty is not the only thing weighing on global manufacturing, but it is the most important. Global industrial production has slumped for twelve months and the weakest stretches within that have come just after tariff escalations.

Average tariff rate on US import from China weighted by value of imports assuming announced tariffs take effect

It is important to note that the total market cap of Chinese ADRs listed in the US is $1.1T. The Index of Chinese ADRs is down 20% from the 5th of May 2018 trade tweet. It is estimated that US investors currently hold around $785bn US of Chinese equity exposures, spreading across HK ($335bn), A shares ($75bn), and the ADR market ($375). Hypothetically, if US investors were to liquidate their holdings in Chinese stocks, it would severely affect their prices, especially on ADRs.

Turkey invasion has started with warplanes bombing Kurdish key locations. According to several sources, troops are crossing the borders in a well-flagged invasion of Northern Syria. Why is Ankara invading Syria though? It seems that the main goal is a political one. Despite Erdogan always considered Turkish US-backed forces as terrorists (heroes against ISIS though), now he wants to create a buffer zone inside Syria, resettling some of the more than 3.6Mln Syrians who fled their country’s civil war in the buffer area. With this move Erdogan wants to regain political consensus inside Turkey (bad momentum for the Economy etc.), and also wants to use the refugee as a bargain against the International community.

The ECB has followed the Fed and expended its balance sheet considerably. Total assets have risen by 56.5bn€ mainly due to a revaluation of gold reserves. Balance sheet now at 4,695bn€, very close to all-time high and equal to 40.7% of Eurozone Gdp (vs Fed’s 18.5%). Today we will have the minutes of the last ECB meeting.

Fed minutes released yesterday night somewhat more hawkish than expected, with members showing sharp divisions about the future path of policy rate.  It seems that some are worried about markets discounting too much easing, more rate cuts, that will not probably be delivered. The “dot plot” of member expectations released also showed that five members favored the Fed not approving any additional cuts this year. While the current Fed fund future rates are currently discounting a probability of 82% for a 25bps rate cut at October 20 meeting.

Another sign of desperate investor yield-seeker behavior is the recent Italian dollar-denominated issue. So far, Italy has collected orders for more than $18Bln dollar on 5-10-30Y issues with more than 50% demand on short-term duration, in a first sale of dollar-denominated bonds since 2010 which allocated approximately $7Bln. Eventually, negative yielding debt is favoring peripheral Countries (it’s cheaper to borrow money) while harming investors, banks and virtuous Countries (i.e. Switzerland has a primary surplus which, if invested in national bonds, is not yielding a positive returns).

Negative yielding debt, currently at $14.7Trln (was $17Trln in August), is also touching Greece. Greece was bankrupt, had its debt restructured in 2012 (it took years to come back issuing on financial markets) and is still going through a really tough patch (bad economy, high unemployment etc.). But it doesn’t matter; due to a perverse global grab for yields, the market has been buying so much Greek short-term debt that 13-week bills drew a yield of minus 0.02%. Right now, Greece is getting paid to issue short term-debt, along with 10-year paying 1.4% (was Italy just couple of months ago).

Unicredit will be the first Italian bank to charge negative interest rates to clients, whose deposits exceed €100k. Although charges are still unknown, Swiss banks along with some German and Danish banks are charging negative rates between 0.5-0.75%. This trend seems to be quite clear, one by one each bank will have to frustrate clients with negative rates. The question is where should investors put extra liquidity without bearing market risk?

Q3 Earning season. Next week we will have the start of Q3, markets have rallied in Q3, but not on earnings prospects. Following the sharp cuts to EPS growth estimates, now at -4% YoY in Europe and -3% in the US, soft Q3 results may not come as a surprise to investors, however, the September market rebound to near Ytd highs reduces the cushion, in our view, in particular for cyclicals. The main issue may be consensus growth forecasts for Q4 which are the moment are possibly too optimistic. Consensus 2020 estimates also look materially too high. While the wider market has held up well in the face of weaker macro data so far, the potential for an increase in corporate guide-downs and analyst downgrades suggests an unattractive risk-reward profile just here.

Finally another interesting stat about how overheat is Gold in terms of positioning.

Worldwide holdings in bullion-backed exchange-traded fundshave expanded for 17 days in a row, the longest run of inflows since 2009!