The market has been quite volatile last week with many sharp intraday reversals in almost all regions mainly due to a continuous unclear news-flow on US-China trade war. Despite better global Macro data, growth re-pricing and increased reflation expectations, it seems the current leading driver of this market is the investor expectation/mood about US-China trade deal (it makes sense as tariffs are strongly affecting global growth). As already mentioned, it is a market of hopes and tweets (chart), with movements exacerbated by low volumes and algorithm trading.
How US-China news-flow is moving the market
Have a look at the current impact of news on the market, while at the beginning of the year it is was about the US economy now it’s all focus on US/China trade-war.
The market is higher this morning following the decision of China to raise penalties on violations of intellectual property rights. This is an important point as the US wants China to commit towards implementing a system for IP rights protection, which is a major issue US companies are currently dealing with. The Communist Party on Sunday released guidelines to strengthen the protection of IP rights that local governments will be required to follow. It is another sign that China is strongly interested in closing a deal with US asap.
Also in Hong Kong, the election saw the victory of pro-democracy candidates that received almost 85% of the votes in Hong Kong’s district council (seven times more than the pro-government camp). It’s quite clear that these results represents support to protesters. Will China decide to give some concessions?
If we revisit the latest news on Trade-war, on the positive side, it seems that Chinese are pretty open to a deal, want to avoid a trade war but will retaliate and fight if necessary. Liu He, senior government executive, “cautiously optimistic” while Xi Ping, Chinese president, “We want to work for a ‘phase one’ agreement on the basis of mutual respect and equality”. In addition, US officials are likely to go to China for further discussion. On the negative side, the worst looming threat on a successful completion of phase one is the Hong Kong pro-democracy bill, recently approved by US Senate and House, currently waiting to be signed or rejected by Trump. China sees this law as an intrusive and abusive, announcing that will retaliate if enacted. Also, Trump stated that if no phase one is completed, then he will increase tariffs further (worst case scenario, unlikely but possible).
Politico headlines on Friday were about the Trump administration is considering a new trade investigation into EU autos as the window is closing for tariffs, small negative that keeps pressure on EU to negotiate.
Christine Lagarde, new ECB president after replacing Draghi, confirmed that the ECB will continue to support the economy, but that higher government spending, especially on investment, is key. Europe needs a new policy mix in a challenging environment. Just for your information, Lagarde has always been pro-monetary expansion. A clear message to Germany for a new fiscal stimulus.
According to Finance Minister Scholz, Europe’s banking union urgently needs deepening and Germany expects to see the first signs of progress by December. More properly, Germany is concerned about further risk reduction of non-performing loans and sovereign on bank balance sheets, improvement to the resolution regime and harmonization of minimum taxation. Is a joint deposit insurance scheme going to be implemented?
UK Elections Poll for Independent: Conservatives on 41%(+4% vs. Nov 15th but in line with last week), Labour 28%(-1%), Liberal Dems 18%(+2%), Brexit 3%(-6%); Also Observer newspaper shows British Conservative Party’s lead over the opposition Labour Party has grown to its widest since 2017.
As far as Macro, is concerned we saw mixed numbers on Friday. Overall Manufacturing PMIs rebounded in November while Services PMIs declined on average. It seems that the prolonged deterioration in Manufacturing spread further into Services. However, the key takeaways from the November PMI data are that forward-looking components look healthier but still soft. In France the expansion extended to 8 months, positive data with Manufacturing PMI 51.6 vs 50.9 consensus; in Germany the drag on manufacturing eased a bit with Manufacturing PMI 43.8 vs 42.8 consensus; in UK still very weak and uncertain situation with Composite PMI 48.5 vs 50.2; in Europe mixed results, with Manufacturing PMI 46.6 vs 46.4 consensus, both Composite and Services missing along with new orders slump for third-straight month and slower employment growth.
An important point here is that European markets are pricing in a return of the Eurozone Manufacturing PMI to 55 (from 46 now). The last time there was such a degree of dislocation between the market vs PMIs was in 2006/7. Again, if US-China escalates further, the current market valuation might be wrong….
Eustoxx50 3-month change vs EU PMI 3-month change
Important to note that the flagged early inflows into equities have already stopped with a 1.5bn$ outflow last week while Bond funds have seen the 46th consecutive week of inflows (+7bn$ last week). For European equity funds, the positive streak has lasted just 5 weeks. The week could start well with this positive tone, let’s see if flows will come along.
As we have seen over last updates, QE forces are helping the market to stay buoyant despite some negative news. The latest help is coming from China where the PBOC is trying to stimulate the economy, the latest tool used was lowering the LPR (loan prime rate) but as you can spot from the chart below, the 3-Month interbank borrowing costs, known as Shibor, climber to its highest since January.
This round of QE for the ECB has so far been notably more skewed to corporates than to sovereigns and covered bonds. We should witness a share of corporates within QE to rise over time, and ultimately see the ECB owning the bulk of the Eurozone-domiciled corporate market.
One of our solid ideas is that we believe the market will now start creating some hedging positions. As we reported last week, the number of puts on the Eurostoxx has moved from 2-year highs (at beginning of October) to nearly zero. The main catalyst is obviously a potential disappointment on Phase 1 deal but it is actually easier to time the tail risk on UK elections for the 12th of December. Corbyn is getting through some coalition and Investors might soon start to hedge their long portfolios which are much invested than a couple of months ago.
Political uncertainty is not helping and has been constantly rising (blue line) showing a decent correlation with the data coming from declining exports.
We already talked about the bearishness of Mr. Dalio, Bridgewater hedge fund’s founder, but we had no idea about his next moves. According to several newspapers, Bridgewater spent approximately $1.5Bln of premium to buy several puts expiring March 2020 on the S&P500 and the Eurostoxx50, covering a monster nominal of $100Bln. To put that in context it means Dalio bought protection for a position of $100Bln, almost 70% of Bridgewater’s total AUM.
This come in a moment where the Hedge fund industry is suffering huge outflows because of the ongoing poor performances. The latest fund which is closing is Moor Capital Management (AUM of 10bn$ in 2018), one of the highest-profile closures in the hedge fund industry.
The latest HFs predictions show that they will continue to loose market share even for next year while Investors are switching allocations to Private Equities and Real Estate.