10/10/2019 - Markets: FMM-Strategie October
Tailwind for Cyclical Stocks …
... provided that the US and China can at least reach a provisional agreement on the trade conflict. We think: From this perspective the current situation is better than generally perceived. But no improvement can be expected without an agreement.
In September, we continued to be positioned neutrally, but somewhat more cautiously overall. And, as we had expected, the improvement particularly in the news situation helped the international stock markets to take off in September, despite the continued weakening of the economy.
We are not afraid of the future for October: our confidence is based on the technical market factors and the pessimism that we have encountered at numerous meetings with corporate executives and investors.
In our opinion, the situation in China is better than generally perceived. We also expect a minimum consensus in the trade conflict between the USA and China and expect Germany to benefit in this scenario. In this environment, we no longer see the USA as such a positive investment regione, but only as a neutral one. We then believe that Japan, like Germany, will achieve an above-average performance.
If an agreement were reached, economic expectations would also brighten and cyclical, i.e. cyclically sensitive sectors would receive a tailwind. This would argue in favour of maintaining the short duration of bonds. This was previously a disadvantage, but could now pay off.
We expect a positive outcome to the talks. Should they fail, however, we will sell procyclically in the short term, as no economic upswing is to be expected in this case.
Fundamental – the Basis
- Trade conflict between the USA and China
- The weal and woe of the markets currently depends on the outcome of the trade dispute. At the heart of this dispute is the issue of state subsidies for Chinese state-owned enterprises (SOEs)1.
- It is hard to imagine that China is prepared to give in on this point: China's state-owned enterprises contribute about 30% to the gross domestic product.2
- However, the issue of state subsidies could possibly be left out or postponed and discussed only next year.
- In our opinion, US President Donald Trump cannot afford to let the deal go: his survey results are too low and the US economy is too weak. In addition, farmers in the US - who tend to be counted among Trump's electorate - need planning security for their investments. Trump also runs the risk of losing the traditional bill-of-exchange states3 .
- An agreement in the trade conflict could kick-start the inventory cycle4 and improve purchasing managers' indices. However, this should not lead directly to increased investment.
- If trade talks fail, the psychological component of negative feedback should not be underestimated.
- The economy
- Germany's economic situation will not improve without a trade agreement.
- Fiscal policy measuresthat could help avoid a recession are not yet in place in Germany.
- Trump cannot make much more than a 5% budget deficit. This limits the fiscal tailwind in the USA.
- The US economy is still doing well. If there were a recession, this would be the longest and most extensively announced economic shock.
- In our view, Brexit has not yet been fully priced in, and that is a disadvantage for Germany. But perhaps Prime Minister Boris Johnson is only playing poker in order to achieve a resignation agreement that has been amended according to his proposals. We cannot judge that conclusively. The Irish conflict is being played up: It is about how the border between EU Member Ireland and British Northern Ireland can remain open after the Brexit.
- Purchasing manager data are still declining worldwide. In China, however, there are signs of an upturn. This was also confirmed by the company talks we held during our most recent trip to Asia in September.
- The next balance sheet reporting season will probably be mixed: The outlook in particular is likely to be formulated very cautiously by companies, as the market will certainly not reward them for bold forecasts.
Monetary - the question of money
- The euro area is in a very good monetary position by international standards.
- Monetary growth in the euro area has picked up again recently.
- Overall, the major central banks are loosening their monetary policy.
- We assume that the US Federal Reserve (Fed) will cut key interest rates further at the next date - not because US President Donald Trump wants it, but because the economic data are forcing the Fed to do so.
- China is also likely to cut interest rates to support the economy.
Market technique - the mood
- Overall, the market analysis is constructive. Not yet panic-stricken in its breadth, but very tense nevertheless.
- In the coming weeks, we believe that the sentiment indicators will be more relevant than the fundamental indicators.
- The highly regarded Bull & Bear indicator of the Bank of America Merrill Lynch (BofAML) is an important barometer of sentiment. It is currently at its lowest level since June 2016 and more or less "screams": Buy!
- The two volatility indices VIX and VXV are regarded as "fear barometers". From their quotient, the VIX/VXV ratio, buy signals can be derived for values below 1. Currently the quotient is exactly 1.0.5
- The Sentix6 is another sentiment indicator that is currently very bullish and signals rising prices. The index sees an anti-cyclical buy-signal within 6 weeks.
- The put/call ratio (PCR)7, i.e. the ratio between call and put options, is currently very one-sided negative.
- The seasonal rhythm could help the markets again from October.
- Gold outperformed equities and bonds in the current year. Due to very high bull market speculations8, however, we will wait for a slowdown for the time being.
- Gold mines have outperformed gold in recent months. We are maintaining a basic weighting in gold mines.
- For bonds, we only see real further potential if we slide into recession. That would be the case if the trade dispute cannot be resolved and escalates.
- So far, high yield corporate bonds have held up well. These are usually a good early indicator for the equity markets. Although high-quality corporate bonds have performed better and risk premiums have widened, the high yield market is stable in absolute terms.
- The economic surprises are currently much more pronounced in the US than in the euro area, which speaks for the US dollar. The market indicators for the euro have not worked recently: According to them, the euro should not have tended towards further weakness. However, these indicators for the euro are better suited as sell signals than buy signals, as our back-testing shows.
- A rate cut in China would give the bonds there a tailwind. After all, they still offer yields, unlike their counterparts in the USA or Europe.
- Should the USA and China reach an agreement in the trade conflict, the German economy would benefit directly. With a little delay, however, auto tariffs should then move back into focus. In this respect, the following applies: After the trade dispute is before the trade dispute. In general, however, the weak euro is also helping in the euro zone - both in terms of profits and in the valuation of foreign capital investments.
- We are keeping a low profile on the Brexit issue. We have no final opinion on this.
- As mentioned at the beginning, we are more positive about Japan. The reasons in favour of Japan are as follows:
- a favourable valuation compared with the global stock market, measured by the price-earnings and price-to-book ratio
- Catch-up potential after long below-average development
- Increasing share buybacks
- sharply reduced corporate debt
- a weaker yen
- We take a positive view of China's economic prospects. However, we are keeping our distance from our former hobbyhorse Hong Kong. The political situation there still has to be dealt with and is unlikely to improve any time soon.
1 SOEs = state-owned enterprises.
2 Source: China Briefing, Dezan Shira & Associates; https://www.china-briefing.com/news/chinas-soe-reform-process/
3 US swing states include Colorado, Florida, Iowa, Michigan, Minnesota, Ohio, Nevada, New Hampshire, North Carolina, Pennsylvania, Virginia and Wisconsin.
4 Inventory cycle = the sometimes very considerable, often seasonal fluctuations in inventory keeping. The inventory cycle is also related to the general economic cycle. Accordingly, companies voluntarily increase their inventories when they expect an upswing and reduce them again during the upswing with then increased production costs. They reduce their inventories in the event of an expected downturn. In the event of an unexpected upswing or downturn, the trend is reversed. Companies have to satisfy a sudden increase in demand from inventories.
6VIX = Volatility Index of the Chicago Board Options Exchange (CBOE). The volatility index of the Chicago Options Exchange is calculated from the implicit volatilities of the options of the S&P500 with a residual term of 30 days and reflects an indication of the expected range of fluctuation in the equity market. The VXV (VIX3M) is the corresponding three-month volatility index of the CBOE.
The ratio between the VIX and the VXV indicates whether the expected short-term fluctuation margin exceeds the long-term fluctuation margin or vice versa: values above 1 mean that the VXV is more expensive than the VIX; thus a normal situation exists. If the ratio is exactly 1, long-term hedges cost the same as short-term hedges. If the ratio is less than 1, this indicates a buy signal as a result of a low point in the markets. The more extreme this value is, the clearer it becomes.
7Sentix = Sentiment Index = Market sentiment indicator
8 Put/call ratio = ratio between call and put options
If put options predominate, the prevailing opinion is that this indicates a negative market sentiment (stock market sentiment). If, on the other hand, call options predominate, this indicates a positive market sentiment from this point of view. In fact, prices often rise after high put-call ratios. The PCR is therefore regarded as a contraindicator. It should be noted that under normal conditions fewer put options are in demand than call options; a balanced PCR close to 1 is therefore considered to be a sign of a slightly negative market sentiment.
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