Good Morning.. A mixed Asian session with weakness in HK and China but the Nikkei closing up 0.8% and this on more stimulus promises from the government. Markets are solely focused on this and seem to be ignoring risks like WH rhetoric on HK and China and talk of sanctions. They ignore the threat to global growth as globalisation passes its peak. In fact they ignore anything that is not central bank related. That cannot last and this move looks extremely speculative to me. The US/China spat over HK looks set to continue and relations are at a low. We are entering a phase of protectionism and more nationalism and that is bad for global growth, equity valuations and peace in the world. EU and UK still face strong headwinds and a trade deal needs to be sorted soon or the UK is walking. I note the Swedish Finance minister says the current form of the joint Franco-German deal is unacceptable; I think that makes 5 now! Risks are rising as the NASDAQ is a stones throw from all time highs!! That just makes me go hmmm. No data of note but Lagarde early and Bullard and Bostic later.. I am sticking with current positions but was stopped in Cable. I am looking to re-sell higher.

Keep the Faith.

Details 27/05/20

The EUR, GBP and AUD all still looks vulnerable to me, even as equities surge higher still.

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The problem for me, with the constant demand for equities, is that the risk on move is driving the USD down. My Cable trade hit its stop at 1.2350 (which looks like the high for a bit) and GBPJPY and AUD are in danger of doing the same. Yet again I am forced to admit that I have underestimated the power of the equity buying on a global scale. I don’t agree with the move but fighting it is expensive.

What pandemic? This rally is staggering when put in the context of Q2 real GDP estimates in the -30.5% (NY Fed) to -41.9% (Atlanta Fed) tracking range. Whether the realised contraction of the US economy is simply dismissed as priced-in or if it shocks risk assets off their upward trajectory will largely be a function of investors’ interpretation of the Fed’s reaction-function to additional weakness as the post-pandemic landscape comes into focus. Stocks rallied in Asia, led by Japan where there is talk of more stimulus (after Bloomberg reported that the Abe administration is compiling a new stimulus package of 117.1 trillion yen). Markets appeared to ignore stories of possible sanctions to be added on China over the HK democracy issue from the WH and the fact that USDCNH is trading up at 7.1760. US markets gave up gains into the close on the WH reports of sanctions but have again bounced right back. It is seemingly still all about central bank actions.

Will the Fed expand its balance sheet to larger than the $7bln level seen at present? Yes probably but markets are NOT the economy. I like the short AUD on the basis of China bashing from Trump and the on-going trade dispute between Oz and China over the virus enquiry. One would assume that both are bad for the AUD’s future and it may well be the case and in Cable, we are approaching the last talks before a decision on whether to continue trade talks between the EU and Britain continue. You can see my reasons for the positions but the USD is the focus at present as an inverse indicator for risk. The USD goes down as stocks go up; should it be that simple? The US, like so many others are reliant on the consumer and I still have issues over global growth when the consumer is suffering from job insecurity. Earnings still look extremely vulnerable to me.

I think the magnitude of the contraction (and the shocking data) are so extreme as to truly lack any context and therefore the mid-March repricing stands as the benchmark for, and adjustment to, the outlook going forward. Basically the numbers are too shocking for investors to base any assumption on and focus solely on the cure; central bank policies. To be honest it doesn’t matter; it is what it is and the USD is lower and risk trades are bid. But not only does the UK and US have some serious issues on the horizon, there is a danger that the EU does too; over and above Brexit and the battle over growth.

According to those “sources” which Reuters digs up every now and again but whom always manage to stay anonymous, suggest that plans are being made for the ECB to carry out its multi-trillion bond-buying programme without the Bundesbank in case Germany’s top court forces the main participant in the scheme to quit. Does that make any difference? Well, there are a couple of issues; if other central banks buy Bunds, it would break the “no risk sharing” principle the Bundesbank insisted upon when the programme was launched in 2015, under which each national central bank buys its own government’s bonds and the risk is shared over the limited amount of debt bought by the ECB itself. Also, what would happen to target2 balances? There is a potential fight brewing here but Germany may bring pressure upon the Bundesbank to cede to the ECB as the ECB would probably launch an infringement procedure against the German central bank for failing to fulfil its obligation as a member of the Euro-system if it has to stop buying bonds, the sources said. I am sure this will all be swept under the carpet but it does make one think about the long-term future of this union with this. In the worst-case scenario, the ECB would launch an unprecedented legal action against the German central bank, its biggest shareholder, to bring it back into the programme, said the sources. Really?

On top of this the Brexit negotiations are set to move to their (possibly) final set of meetings in early June and if there is no progress, there is a danger that the two parties decide that it is not worth continuing. The clock is moving closer to that 11th hour where concessions and compromise will need to be found on such emotive issues like fishing, freedom of movement and the role and power of the ECJ. A hard Brexit right now is almost as bad for the EU as it is for the UK but so far, Johnson is playing hard ball. He knows only too well this is the only way to get the EU leaders to focus on something they do not want to deal with. The risks are rising here (the main reason for having been short Cable). We also heard some forecasts from the ECB yesterday where the Eurozone governments’ budget deficits were expected to rise to 8 per cent of gross domestic product on average this year, far above the levels reached after the 2008 financial crisis. It’s all good; right, as debt doesn’t matter anymore as Public debt is set to approach 200 per cent of GDP in Greece, 160 per cent in Italy, will hit 130 per cent in Portugal and just below 120 per cent in France and Spain, the ECB said, adding: “The associated increase in public debt levels could also trigger a reassessment of sovereign risk by market participants and reignite pressures on more vulnerable sovereigns.” It could indeed but when? I think EUR upside is limited.

EU nations have a problem building ahead of them as Italy must refinance more than 15 per cent of its debt in the next year, while that figure is more than 10 per cent for France, Spain, Belgium, Finland and Portugal, the ECB said, calling some countries’ repayments in the coming two years “substantial”. Substantial? try flipping massive. Maybe a few of you are questioning, as I am, the recent bounce in the EUR so it will be good to see the ECB update its economic forecasts and review its monetary policy next week. It has predicted that the eurozone will suffer its deepest post-war recession this year, with GDP set to contract by between 5 and 12 per cent. The problem I have is that looking at China, Brexit and other trade issues, I fail to see who or what is going to lift the EU from the abyss. One thing that could spook investors is if the doom loop between governments and banks that hold high levels of their own domestic public debt starts to be acknowledged, to wit: “risks of negative feedback loops arising from sovereign or bank rating downgrades”. “Such a development could reactivate the negative feedback loops of the sovereign-bank nexus, especially for Italy and Portugal, as well as for Spain, where bank ratings are closest to non-investment grade,” it said. Nice of them to let us now at least.

Also the Swedish Finance minister joined a few others (five in total now I think) by suggesting they could not accept the terms of the Franco-German bail out package. This is NOT done yet. The European Commission will today unveil a plan to help the EU economy recover from its coronavirus slump with a mix of grants, loans and guarantees exceeding 1 trillion euros that raised controversy even before it was announced. The issues facing the UK, EU, Oz and global growth are pretty clear but the markets are simply focused elsewhere. The fact that USDCNH is breaking recent highs, the WH is pressuring China and turning up the heat over the emotive issues surrounding HK, Global growth is still under pressure as globalisation is in retreat are all issues I take seriously but many retail investors have woken up every day recently, bought stocks and watched them go up. Weekly USDCNH below.

These speculative moves in equities can gain momentum and I think we are seeing something of this but also we are seeing commodity markets rise too until just recently. I think the oil rally is just about done and look at gold; it got hit pretty hard the last couple of sessions and this with a lower USD. For me, the issue is not whether we are past peak of the virus or that the economies are unlocking; my concern is just how long it takes for the economies to recover. There are simply too many risks out there to justify this euphoric rise in stocks. A shock is coming.

Many academics, economists and strategists like myself have suggested the world may not be the same after all the impact on the global shutdowns. One of the casualties is the acceleration of de-globalisation started by Trump before the crisis began and the fight with China is starting to heat up. The second phase of the trade war (a cover for a greater battle) is upon us and HK gives Trump all the excuses he needs to press down hard with strong rhetoric and possibly actions on trade. But in the background the move away from the well-established globalised trade that has produced cheap goods, growth and low inflation (and a certain peace in the world) is ending. That has to matter to all of us, including equity valuations; things are changing. The early 20th century was also an era of globalisation and unbridled great-power rivalry, as the relative economic might of the UK fell and that of Germany, Russia and the US rose. The two major powers now stand toe to toe and there is not room for two.

The FT this morning makes a very valid point: “the rivalry between China and the US in the twenty-first century holds an uncanny resemblance to the one between Germany and Great Britain in the nineteenth”. Both rivalries took place in an era of economic globalisation and rapid technological innovation. Both featured a rising autocracy with a state-protected economy challenging an established democracy with a free-market system. Moreover, both rivalries featured “countries enmeshed in profound interdependence wielding tariff threats, standard-setting, technology theft, financial power, and infrastructure investment for advantage”. Sound familiar? Nationalism and protectionism are on the rise and global growth will suffer in all this. Stocks are not pricing this by some margin. As Larry Summers has argued, Covid-19 looks to be a hinge moment in history. This is not so much because it is changing trends, but rather because it is accelerating them. It is reasonable to bet that the world which emerges on the other side of the pandemic will be far less co-operative and open than the one that entered it. The world economy is far more integrated than ever before and so the costs of deglobalisation must be correspondingly greater and yet despite the global economy sliding into a debt-bust depression, the NDX is within kissing distance of new all-time highs. Hmmm

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Strategy:

Macro:.

Short AUD @ .6550. Stop @ .6685.

Short GBP @ 1.2260.. Stop at 1.2350 Stopped out in NY session.

Short GBPJPY @ 131.95 Stop at 133.20

Brought to you by Maurice Pomery, Strategic Alpha Limited.

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