Below is a round-up of Longview related views/research & trade ideas – the intention is to publish this most Fridays, updating key themes and highlighting key pieces of (often contrarian) research. Feedback, as always, is appreciated. Equally just ‘unsubscribe’ at the bottom if you don’t want to receive the email.
Is the Risk Appetite Regime Shifting?
After several weeks of a ‘seemingly relentless’ upward move in equity markets, the momentum in global risk assets has shifted this week. That was led by some of the higher beta (typically leading) markets like the Philly SOX, Russell 2000 and US biotech, while other US sub sectors have been signalling weakness for longer. The Dow Jones Transportation index, for example, has been rolling over since late February (FIG 1).
FIG 1: DJ Transports index candlestick chart shown with key moving averages
With that shift in psychology, the key question is: Are markets rolling over into a renewed bout of risk aversion? i.e. is the risk appetite regime changing?
Our fast moving (medium term) risk appetite scoring system is interesting in that respect. A few weeks ago, it generated a SELL signal. Last week it reached strong SELL (FIG 2).
FIG 2: Longview medium term ‘risk appetite’ scoring system vs. S&P500
That prompted us to examine how good it has been as an indicator in this bull market since 2009. In section 2 in this week’s monthly ‘Tactical Equity Asset Allocation’ publication, we undertook that analysis. In summary our findings were as follows:
“While there are always challenges associated with classifying the effectiveness of signals, in the 3 charts above/below [i.e. in the piece] the success-failure rate is broadly as follows: Nine/Ten signals were efficacious and timely in signalling some noteworthy weakness in equities, one signalled a modest pullback (i.e. November 2010), three/four signals were early (i.e. by approx. a month or so) but then followed by some notable/tradable weakness, while two were patently false (i.e. early 2013 & September 20103). Of interest, both false signals occurred during phases of QE (or just ahead of the start of one of those phases, i.e. at times of aggressive monetary stimulus).”
Source: Longview Tactical Equity Asset Allocation, 5th March 2019 – available HERE
In other words, the risk appetite models highlight a high probability that some meaningful giveback in equity markets is likely at this juncture or over the next few weeks.
Over and above the risk appetite analysis, though, it’s also interesting to note that the US (and other) macro data has been disappointing during this recent rally (FIG 3), while volumes (a sign of conviction and participation in this rally) have also been weak (up until yesterday – FIG 4).
Overall, therefore, those factors point to a high likelihood of some near term giveback in equity markets (or potentially something more meaningful). For short term investors we have been recommending buying put options (see recent Daily RAG publications). For medium term investors (i.e. with a 1 – 2 month outlook), we have recommended removing overweight positions (and standing back at this juncture – see recent Tactical Asset Allocation publications for detail).
FIG 3: US economic surprise index vs. S&P 500
FIG 4: S&P500 e-mini volumes (2019 YTD, median, and range from 2009 – 2018)
US 10 Year Treasuries: Still Attractive
With that renewed risk aversion, and no doubt helped by yesterday’s comments from the ECB/Draghi*, government bonds have recently been rallying sharply. US 10 year yields closed yesterday at 2.64%, just shy of their recent multi week lows (but above their lows from 3rd January this year). German 10 year bunds, having performed poorly in the relief rally in January into February, closed yesterday at a new multi-year yield low (i.e. lowest since late 2016) – FIG 5.
FIG 5: German Bund yields (shown with key moving averages, %)
* In particular Draghi’s comment that the Eurozone was “in a period of continued weakness and pervasive uncertainty”.
Looking forward from here, we continue to recommend overweight positions in US government bonds (both from a strategic and trading perspective). Our central case scenario is that: German yields will turn negative again in coming months and US 10 year yields will likely fall to around 2.20%.
Three key factors are driving that expectation:
1. the US mini cycle dynamic (driven by a destocking cycle, a slowing housing market, softening shale activity and weak global trade) – see HERE for analysis;
2. our expectation of some near term giveback over coming weeks in risk assets (with a commensurate switch into defensive bonds); &
3. potential for the bond trading models to move higher until they reach clear and across the board SELL signals. Naturally these models have moved notably since their clear BUY message in 2H 2019, further room remains until they are generating a clear SELL message. Speculative positioning, for example, remains net SHORT (FIG 6), while sentiment remains below complacent bullish levels.
FIG 6: Net speculative LONG/SHORT positions vs. 10-year Treasury futures
How Strong is Chinese GDP Growth Really?
For years western economists and market practitioners have questioned the credibility and wondered about the accuracy of the official growth rate of the Chinese economy. That scepticism increased markedly in 2015-16 as the Chinese economy seemingly experienced a marked slowdown in growth yet official GDP growth slowed only modestly (with reported rates of: +7.3% (2014); +6.9% (2015); & +6.7% (2016)).
In response to that, the Brookings institute published a paper this week reworking GDP growth rates using other, more reliable (in their view), data. Its findings more convincingly fit with the narrative of recent years, and are neatly summarised by this abstract (link to full paper below):
“China’s national accounts are based on data collected by local governments. However, since local governments are rewarded for meeting growth and investment targets, they have an incentive to skew local statistics. China’s National Bureau of Statistics (NBS) adjusts the data provided by local governments to calculate GDP at the national level. The adjustments made by the NBS average 5% of GDP since the mid-2000s. On the production side, the discrepancy between local and aggregate GDP is entirely driven by the gap between local and national estimates of industrial output. On the expenditure side, the gap is in investment. Local statistics increasingly misrepresent the true numbers after 2008, but there was no corresponding change in the adjustment made by the NBS. Using publicly available data, we provide revised estimates of local and national GDP by re-estimating output of industrial, construction, wholesale and retail firms using data on value-added taxes. We also use several local economic indicators that are less likely to be manipulated by local governments to estimate local and aggregate GDP. The estimates also suggest that the adjustments by the NBS were insufficient after 2008. Relative to the official numbers, we estimate that GDP growth from 2008-2016 is 1.7 percentage points lower and the investment and savings rate in 2016 is 7 percentage points lower”
Source: Brookings Institute – https://www.brookings.edu/wp-content/uploads/2019/03/BPEA-2019-Forensic-Analysis-China.pdf
One of the paper’s findings is that, because of the downward revisions to savings and investment, Chinese growth is “now more associated with consumption rather than investment and external surpluses”.
That consumption is, of course, in large part driven by a household credit boom. Coupled with the higher debt to GDP ratio (which is the outcome of an economy that is actually smaller than estimated), that adds to concerns about the long term sustainability of the Chinese growth model (especially if the market’s worries, about the current account moving into deficit, are correct). Naturally these are longer term considerations. The country’s poor demographic trends, though, enhance those concerns.
Source: Brookings Institute
Longview Research Recently Published
This week:
Tactical Equity Outlook, 5th Mar 2019:
"Caution Advised - Some Giveback Likely" – see HERE
Weekly Market Positioning Update, 4th Mar 2019:
"Sharp shift in copper positioning"
Last week:
Longview on Friday, 1st Mar 2019:
“What are the Risks” – see HERE
Commodity Fundamentals Report No. 91, 28th Feb 2019
“Iron Ore – Fade the rally” – see HERE
Quarterly Global Asset Allocation Alert No. 6, 26th Feb 2019
“Increase Chinese/EM weightings in strategic portfolios (5 key reasons)” – see HERE
Weekly Market Positioning Update, 25th Feb 2019:
"Precious metals - LONG positioning sharply higher (in recent weeks)"