Javblog

Javblog

Tuesday, May 3, 2016

Stronger dolllar? Apparently not...

At the start of the year, the logic behind expectations of a stronger dollar seemed rock-solid:

(1) The US economy, although growing slowly, was still producing stronger growth than any other developed economy,
(2) This strength led to suggestions by the Fed that interest rates would likely rise on 4 occasions this year to head off any inflationary pressures caused by rising employment and such steady growth,
(3) The other developed economies, notably the Eurozone and Japan, were being led by central bank policies that seemed committed to maintaining a low interest rate environment almost indefinitely, with the result that the interest rate differentials between the USD on one side, and the Yen and Euro on the other would likely only widen, thus making the USD more attractive on a relative basis. For one currency to be strong the obvious point is that its counterpart must be correspondingly weak.

As we go into May, the narrative seems rather different (to put it mildly) as the Fed in the US has postponed its planned rate increases in the face of sluggish global growth, and as the effectiveness of central bank action in the Eurozone and Japan seems questionable, if not totally ineffective.

This was brought into stark relief at the end of last week when the Bank of Japan (BoJ), opted to do.... precisely nothing, despite a nearly unanimous consensus expectation ahead of its April meeting that the moribund state of the Japanese economy would force it to take extreme measures to devalue the Yen. Reflecting this view, last month we actually said that in April:

"the Japanese market could be boosted by the Abe government’s moves to front-load fiscal stimulus in to H1CY16. A majority of economists expect BOJ QE action next month, and we continue to feel that this will be reflected in resumed Yen weakness",

but what ACTUALLY happened was

"For the second time in three months the BoJ stunned financial markets last week, this time for holding monetary policy settings steady when most were expecting either an increase in asset purchases or a further reduction in interest rates, or both.

The fallout for the decision was instant, and epic.

The Japanese yen screeched higher, recording its largest one-day percentage gain in more than five years, while the Nikkei 225 — Japan’s benchmark stock market index — tumbled more than 8% in just over one session of trade.

For other central banks, it served as a timely reminder as to just how savage markets can react when lofty expectations aren’t met by policymakers" (Business Insider May 3rd 2016).

As Goldman Sachs - whose expectations of BoJ action were every bit as lofty as everyone else's - noted in a research piece:

“Unconventional easing is above all an expectations game, where it is necessary to shock markets again and again, until they have no reason to question a central bank’s commitment to its inflation target” 

Last week, however, the BoJ chose to shock markets by doing nothing.

The trouble is that the BoJ and possibly other central banks are now running headlong into market doubters who question their ability to get inflation moving, a doubt which will only be exacerbated by what looks to be a disconnect between words and actual deeds. This means that the size of any future "shock" they will need to deliver in order to convince markets of their seriousness will have to get progressively bigger too.

Good luck with that. Since the beginning of this year the USD index has declined by nearly 6%, and against the Yen by over 13%. This is good news if you are a USD based investor, but not if you are not: any gains that the latter might have seen in underlying investments will have been eliminated by the depreciation of the USD.

What now?

A Yen rate at 106 or so means that many Nikkei constituents will be posting earnings declines this year. At the start of 2016 the forecast was for earnings growth of between 10% and 20%, based on a year end Yen forecast of about 120. Although that now looks a challenging target to meet, since "Abenomics" appears to have no plan 'B', it would seem logical that both the Japanese government and the BoJ will have no choice but to double down further with an expansion of the negative interest rate regime savers in Japan so dislike, whilst pushing harder for more corporate reform.

At the same time, the first of the delayed US rate increases seem likely to come through in Q3 2016 which should help increase demand for the USD and a sell down in the JPY and EUR.

That's the theory anyway...

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186
Find us on Facebook: http://www.facebook.com/JavelinWealth
Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.


Thursday, March 31, 2016

Our views on Q2...

The two major overhangs for risk assets for much of CY16 will be the vagaries of the Fed’s rates guidance and PRC’s risk of a hard landing (capital flight, financial crisis and now political challenge to Xi Jinping are the alarmists’ favoured ‘bear’ trades). 

We are puzzled by the Fed Chair, Janet Yellen’s recent reiteration of her markedly more dovish outlook, which seem to be based on concerns about weaker global growth and a belief that recent core inflation gains might not be sustained. 

In the short term, Yellen’s comments may move risk assets higher, in the longer term, we need to see stronger growth and earnings to sustain the S&P 500 index’s (SPX) multiples given evident margin pressures. After recently mixed US data, the monthly US Non-Farm Payrolls and Global Manufacturing ISM data (due late this week and early next) will be important in determining how markets perform in Q2. 

Earnings results for Q1 will be another catalyst, as these start to come out next week in the US, and expectations currently seem too pessimistic. We had expected risk assets to move sideways or down a little after comments from the US Fed were digested, but Yellen’s behaviour may see the rally continue a while longer.

We expect political risks to pick-up as we near the US election in November as any of the possible GOP candidates appear much more anti-business than any previous potential nominees, whilst Hillary Clinton has tacked left to burnish her anti-Wall Street credentials.

In Europe, we still expect FY16 to be a year of robust EPS growth, perhaps the first such since 2010, although we are aware consensus FY16 EPS have been reduced to +4% (which doesn't seem particularly "robust"). Time will tell if our optimism is mis-placed. However, we also feel it is prudent to remain neutral until after the UK referendum on EU membership on June 23rd: although ultimately we think British voters will choose to stay put, there is no doubting rising disquiet about surging levels of immigration since 2010, and this seems certain to herald a very close result. 

In Asia, the Japanese market could be boosted by the Abe government’s moves to front-load fiscal stimulus in to H1CY16. A majority of economists expect BOJ QE action next month, and we continue to feel that this will be reflected in resumed Yen weakness.

China shares could rally further in the short term, as macro data continues to point towards stabilisation. However the difficulty of determining whether this data is genuine, has combined with policy mis-steps in January to put  a big question mark over whether or not the risks of investing directly in Chinese stockmarkets outweigh the potential rewards. We think they do. Political risk is also critical. Xi Jinping’s moves to centralise authority could face a serious backlash.

India, which is a market we like, could under-perform in an EM beta rally led by commodity producers, but it offers longer term positives and would benefit from further RBI rate cuts in April and from the eventual passage of the long-stalled GST bill.

Vietnam remains the most attractive frontier market globally and our preferred AXJ/ EM equity market. Although it missed Q1 GDP forecasts due to a combination of drought and lower fiscal oil revenues, we see these as temporary.

In fixed income, OECD government bonds rallied again after Yellen’s speech last week, although the 10Y US Treasury yield remains in the long-term range of 1.75% -2.5%. Having said that, UST volatility is at its highest since records started in ’75; foreign central banks have been selling, and are being replaced by hedge funds. This adds to volatility concerns since the former were mostly buy and hold, whilst the latter tend to be shorter term investors.

For this reason, we remain underweight fixed income, notably higher quality issues. This may be costly in the short term, given Yellen’s comments, but any eventual rise in inflation and employment levels will inevitably result in a violent sell-off, and we think that there’s not enough upside left in the fixed income markets to justify taking the timing risk.

On currencies, the USD recently fell back below strong support at 96. Its weakness so far this year has been somewhat baffling, given the longer term prospects for firmer US interest rates, especially in comparison with those for the Euro and Yen.

Steve
e-mail: steve.davies@javelinwealth.com
contact: +65 65577186
Find us on Facebook: http://www.facebook.com/JavelinWealth
Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.