Markets: Follow Through

The key to finding alpha is to know where the beta is – and in a market filled with little economic news, summer vacations and lack of new interest, momentum becomes a key risk factor along with liquidity. Over the last 2 days the USD has washed out long positions with Trump comments against the FOMC hikes and the dollar gains the first driver. Like a golf swing, markets need to follow-through to be believed and go the distance – so the balancing act this morning is about equities vs. politics. Headline impacts aren’t enough.

Call this keeping your eye on the ball and continuing to swing. US political concerns rose to the front of the worry list last night, but there is no follow through in Europe.

Trump’s former lawyer Cohen plead guilty to hush money payments to two women influencing the election and he is willing to cooperate with Special Counsel Mueller, while his former campaign manager Manafort was convicted of tax evasion, all driving up odds for a US impeachment of the President and driving down the USD, US shares and US yields into the Asia open. This wasn’t sufficient this morning for risk-off and the lack of follow through is the story of the day so far. Beyond the fact that the S&P500 printed a new record high yesterday, much of the concerns about global disorder from Turkey to China have been on hold with hopes for resolutions as China/US trade talks start later today. One other positive overnight came from a Politico story, which suggested that the Trump Administration is to announce on Thursday that it has reached a 'handshake' deal with Mexico in NAFTA talks, subsequently denied by source reports. So the follow-through matters today with the US existing home sales and FOMC minutes likely big drivers for a market searching for momentum. USD has become the turf war reflecting the political angst against the economic momentum.

Question for the Day:Are markets overvalued? Growth vs. Value was the key last week with value winning as momentum stalled and worries about China and Turkey dominated. This week is the opposite putting the data ahead into keen focus with flash PMI reports from Japan, Europe and the US all a compare and contrast exercise for those looking at macro growth stories to matter. In the interim, we get the reaction function of the FOMC, ECB and others to the present headlines about trade, politics and new record equity highs. The problem of value is like any model, the output is dependent on the input. This chart from Topdown Charts is worth highlighting in that it gets to the heart of the micro world – earnings drive shares first - and they are in an uptrend.

Against this point about earnings expectations comes the reality of credit and the fragility of US shares outside of the big names where as BoAML points out – 60% of the Russell 2000 is below investment grade. The risk of FOMC continuing to tighten policy seems obvious here. The US balancing act for value rests on growth being strong enough to pay for the costs of debt.

What Happened?

New Zealand 2Q retail sales up 1.1% q/q after 0.3% q/q – more than 0.3% q/q expected. 1Q revised from 0.1% q/q. The largest contribution to Q2 sales came from hardware, building and garden supplies that rose 4.7% q/q after a small 0.6% rise in Q1. Core retail sales rose 1.4% from 0.6% q/q. Fuel was -0.7% after -1.7% q/q, Supermarket and grocery -1.1% from +1%. Overall retail sales value was up 1.3% from 0.3% q/q.

Australia July Westpac leading indicator 97.89 from 97.88 – as expected– with deviation from 6M trend up 0.55% after 0.06% but this is down from February peaks at 1.31%. Westpac's expectation is that growth over the remainder of 2018 and into 2019 will hold slightly below trend particularly in the light of an uncertain outlook for the consumer.

Australia 2Q construction spending 1.6% q/q after 2.4% q/q revised –stronger than 1% expected. 1Q revised higher from 0.2% q/q. Non-residential work rose 1.3% q/q, building work , residential rose 3.1% q/q and engineering work rose 0.4% q/q.

RBA Debelle: Willing to wait on hikes to be more confident on CPI target. Debelle suggested the cash rate is likely to be remain on hold for longer because the RBA would like to be more confident that inflation will be sustained at a rate consistent with the target. He spoke in detail about the forces contributing to low inflation in recent years and while he said the RBA expects these forces to dissipate, he also said there is uncertainty about how much longer they will persist. He highlighted the index issue for Tobacco prices, the uncertainty of utility prices and retail competition. He also saw rent inflation reversing from a 0.2% y/y drag but that the costs of child-care are likely going to reverse.

Market Recap:

Equities: US S&P500 futures are off 0.1% - were off 0.3% in Asia - after 0.21% gain yesterday. The Stoxx Europe 600 is up 0.05% while the MSCI Asia Pacific index was up 0.1% with Japan leading and China lagging. The MSCI EM index is up 0.4% best levels in a week.

Japan Nikkei up 0.64% to 22,362.55
Korea Kospi up 0.14% to 2,273.33
Hong Kong Hang Seng up 0.63% to 27,927.58
China Shanghai Composite off 0.70% to 2,714.61
Australia ASX off 0.14% to 6,373.80
India NSE50 closed for holiday
UK FTSE so far up 0.35% to 7,593
German DAX so far up 0.05% to 12,391
French CAC40 so far up 0.25% to 5,422
Italian FTSE so far off 0.10% to 20,762

Fixed Income: Bonds have held a safe-haven bid in the US in Asia and gave it back in Europe with focus on supply, US FOMC minutes, politics still driving – German 10Y sale was weak but not a surprise - 10-year Bund yields up 1.2bps to 0.34%, French OATs up 1.5bps to 0.68%, UK Gilts up 0.5bps to 1.27% while periphery mixed after early gains – Italy up 0.5bps to 2.98%, Spain off 1bps to 1.35%, Portugal flat at 1.76% and Greece off 2.5bps to 4.14%.

Germany sold E2.423bn of 10Y 0.25% Aug 2028 Bunds at 0.33% with 1.0 cover– previously 0.47% with 1.4 cover – after Bundesbank holdings cover 1.2 from 1.8.
US Bonds are lower with bear flattening– 2Y up 0.8bps to 2.604%, 5Y up 0.7bps to 2.717%, 10Y up 0.5bps to 2.83%, 30Y up 0.5bps to 2.998%.
Japan JGB rally and reverse on equities and BOJ policy views– talk of CPI at 1% leading to 10Y at 0.25% mid drives. Curve snaps back steeper with 2Y up 0.5bps to -0.131%, 5Y up 0.4bps to -0.089%, 10Y up 0.9bps to 0.08% - touched 0.074% - and 30Y up 2.5bps to 0.84%. BOJ leaves rinban buying unchanged at Y665bn, sees higher cover in 5-10Y 3.35 from 2.78 and 10-25Y at 3.72 from 3.34 but lower in 25+ at 2.6 from 3.8.
Australian bonds see curve steepening on RBA and better data– 3Y off 0.5bps to 2.01%, 10Y up 0.5bps to 2.54%. The AOFM sold A$1bn of 5Y 2.25% Nov 2022 TB153 bonds at 2.1415% with 4.615 cover – previously 2.1839% with 4.67 cover.
China PBOC skips open market operations, leaves liquidity neutral. Money market rates fell with O/N off 10bps to 2.527% and 7-day off 1bps to 2.651%. 10Y bond yields fell 1bps to 3.625%.

Foreign Exchange: The US dollar index is off 0.2% to 95.14. EM FX continues to diverge MXN likely key focus given NAFTA 118.83 up 0.6% with 18.75 lows so far – EMEA: ZAR up 0.75% to 14.28, RUB off 1.2% to 67.975, TRY up 0.4% to 6.05. ASIA: TWD off 0.1% to 30.738, INR flat at 69.83, KRW flat at 1119.

EUR: 1.1615 up 0.4%. Range 1.1553-1.1617 with focus on US politics, FOMC minutes break of 1.1680 needed for bigger pain trade.
JPY: 110.25 flat. Range 110.03-110.50 with EUR/JPY 128.10 up 0.35% - risk on helping with 110 back a pivot and 111 resistance.
GBP: 1.2905 up 0.05%. Range 1.2868-1.2915 with EUR/GBP .8995 up 0.35% - all about EUR positioning more than GBP with 1.2990 key.
AUD: .7365 flat. Range .7334-.7369 with focus on metals, politics – NZDup 0.4% to .6705 with retail sales keeping RBNZ at bay.
CAD: 1.3005 off 0.2%. Range 1.3008-1.3046 with oil, NAFTA hopes, politics driving 1.2880 still in play with 1.3050 resistance.
CHF: .9820 off 0.35%. Range .9819-.9857 with EUR/CHF 1.1405 flat. Focus is on EUR not CHF but Italy and EM still in play.
CNY: 6.8271 fixed 0.15% stronger from 6.8360, trades weaker at 6.8415 from 6.8380 close yesterday with range 6.8349-6.8507 today.

Commodities: Oil up, Gold up, Copper off 0.4% to $2.7260.

Oil: $66.95 up 1.7%. Range $65.98-$67.01 with $66 now base and $68 target. Oil is bid with larger than expected US crude drawdown from API. Brent up 1.75% to $73.91 with $74.50 key.
Gold: $1199 up 0.25%. Range $1195-$1200 – back in play with USD lower - $1204.60 next resistance. Silver up 0.4% to $14.85, Platinum up 0.2% to $798 and Palladium up 0.4% to $921.50.

Conclusions: Are bonds going to become the equity hedge again? The days of bonds and stocks tracking each other as QE and coordinated global efforts to stoke animal spirits has changed. With it the way the term risk premium works is changing. Read @soberlook for a thoughtful discussion of this issue. The lesson from overnight is clear, as US futures in equities fell on the Cohen headlines, the US bonds rallied. This is the balancing act with a positive carry and one that changes the way money managers look at their portfolios. While much has been written about risk-party failing this year – (average according to Salient is off just under 3%), the diversity effects of owning bonds and stocks mixed with commodities and other things maybe the hedge – particularly if they have the right yields.