admin@hottinger.co.uk, Author at The Hottinger Group

Chart of the Week: The China Syndrome

Posted on August 25, 2023September 25, 2023 by admin@hottinger.co.uk

Author: Tim Sharp

Researcher: Jack Williams

Published: August 25, 2023

Economic woes in China are proving to be worse than initially feared. As we entered the year, many investors were optimistic, expecting to see the economy boom as the country relaxed its Zero Covid lockdowns and rules. As disappointment shrouded the region’s markets, China bulls became expectant, hoping dismal data would force the hands of government officials towards the stimulus lever, which on numerous occasions over the past couple of decades has resulted in an uplift in not just China GDP, but global growth as well.

Figure 1 – CNY/USD (Bloomberg Data/Bloomberg.com)

But how far will the CCP (Chinese Communist Party) have to go to create a meaningful impact, especially since the PBOC (Peoples bank of China) cut rates last Tuesday by 15bps, a move swiftly shrugged off by most. Over the past month or so, we have seen Central Banks such as Peru and Brazil cut rates, each of which were met by a positive response in the markets (although these rate cuts were widely expected).

Prior to the event, 93% of Bloomberg economists surveyed said they did not expect any change in the PBOC bank rate, with just a single economist expecting a cut. The country is currently grappling with a worsening property sector, weak consumer confidence and spending along with mortifying economic data, all of which this latest policy shift has not provided any respite to.

As shown above, China’s biggest bruise is the one on its currency. The Yuan now sits at a similar level to before covid restrictions began to lift and close to a 14-year low marked in 2007 prior to the Lehman collapse. In the last 24 hours, China’s central bank has asked domestic lenders to scale back outward bond investment aimed at limiting the supply of Yuan offshore, its latest attempt to shore up the currency.

Furthermore, the main metrics of economic activity in the region are all flashing red with industrial production, property investment, and retail sales all at their lowest levels since turn of the millennium.

Shown below is a range of metrics (Industrial Production, Property Investment, Fixed Asset Investment such as infrastructure and Retail Sales) shown via a 6-month moving average.

Figure 2-6M Moving Average of YoY Growth Metrics (Bloomberg Data/Bloomberg.com)

All these metrics are at, or near two-decade lows, with property investment falling off a cliff, industrial production readings falling short of expectations and retail sales plummeting at a gradient that would surely be a black run if found on a ski resort. Only fixed income investment is off its lows, but in recent months even this metric has begun falling again.

The PBOC cut rates on its medium-term lending facility last week by 15 bps to 2.5%, marking its second cut since June and the highest cut since 2020. Immediately following the cut, reactions suggested little excitement was generated from investors with any gains on indices being quickly absorbed as investors digested the surprise move.

The Hang Seng Index is down 9.6% from the start of the year, down 6.3% on the month and flat on the week. It Is clear further stimulus would be needed to raise China’s economy, but Xi Jinping has of yet resisted plans for further additions of stimulus into the economy particularly around the property sector, of which numerous red flags are re-emerging.

Figure 4-PBOC 1Y Loan Rates (PBOC/Bloomberg)

Figure 3-Hang Seng Index (Refinitiv Data)

While the property sector continues to give flashbacks to the Evergrande calamity in the back end of 2021. In recent weeks developers such as Country Garden have missed coupon payments on their USD based bonds. Over the past two years calamities within the property sector have wiped out a whopping $87 billion dollars from the industry.

At the time of writing China announces plans to cut stamp duty on domestic stock trading by as much as 50% in a bid to rescue their equity markets. Whether this will work, only time will tell, although it does feel lacklustre compared to the number of issues the region faces.

Earnings within China have been mixed as of late, although tech behemoths such as Apple, Bite Dance (Private Co.), Alibaba, Tencent and to some extent JD.com all reported improvements in China based sales while Shanghai Disneyland saw record high revenue, operating income and margins through the quarter, narrative echoed by Universal Studios Beijing which enjoyed its most profitable quarter since opening.

This paints a picture of bifurcation amidst China’s economy, with huge swathes struggling, whilst others seemingly enjoy similar trends such as increased prioritisation of experiences and entertainment which we have seen since earlier reopening following the pandemic in developed markets. Looking forward it will be vital for China to capitalise on those parts of the economy doing well (Leisure, Entertainment, Food, Technology) whilst introducing confidence back into markets and consumers to address these severe areas of weakness alike property and general retail.

Cheng, E. (2023). What China’s big earnings say about the consumer. [online] CNBC. Available at: https://www.cnbc.com/2023/08/18/what-chinas-big-earnings-say-about-the-consumer.html

Liu, P. (2023). Country Garden Leaves Investors in Dark on Exact Default Deadline. Bloomberg.com. [online] 22 Aug. Available at: https://www.bloomberg.com/news/articles/2023-08-22/country-garden-default-deadline-becomes-guesswork-for-creditors.

Trading Economics (2019). China Loan Prime Rate. [online] Tradingeconomics.com. Available at: https://tradingeconomics.com/china/interest-rate.

Hancock, T. (2023). China’s Consumer Sentiment Starting to Improve, Surveys Show. Bloomberg.com. [online] 24 Aug. Available at: https://www.bloomberg.com/news/articles/2023-08-24/china-s-consumer-sentiment-starting-to-improve-surveys-show.https://www.theguardian.com/business/2023/aug/23/china-economic-model-property-crisis

News, B. (2023). How China’s Faltering Growth Threatens to Derail Commodities Markets. Bloomberg.com. [online] 22 Aug. Available at: https://www.bloomberg.com/news/articles/2023-08-22/how-china-s-faltering-economic-growth-threatens-to-derail-commodities-markets.

Lehner, U.C. (2023). Debating the size of China’s economic rough patch. [online] Asia Times. Available at: https://asiatimes.com/2023/08/debating-the-size-of-chinas-economic-rough-patch/.

August Strategy Meeting 2023 – Inflation’s Grip is Loosening

Posted on August 24, 2023September 25, 2023 by admin@hottinger.co.uk

Author: Tim Sharp

Researcher: Jack Williams

Published: August 24, 2023

It has been an eventful month with markets, surprising the bears once again.

Asia ex-Japan was the best performing region, the Hang Seng rose 6.1% during this period as market participants overlook weak factory and services data, choosing instead to concentrate on Beijing’s latest measures to stimulate consumption and kickstart what has so far been a lacklustre covid recovery.

We remain somewhat sceptical of China as an investable market with geopolitical tensions, slowing growth (albeit still at a higher rate than the majority of nations) and the commercial property downturn continuing.

As of writing this publication, stories of Country Garden (2007.HK) another real estate behemoth in China missing interest payments and scrapping plans to inject cash into the business emerge, sparking renewed fears of a smaller scale Evergrande calamity or economic downturn in the region as the government struggles to regain confidence.

As a team we are very intrigued by the landscape of LATAM equities currently as we seek to benefit from the downturn in rates and a potential rotation back into equities following a period of elevated rates in the region. The Brazilian Bovespa index gained 3.3% in July following the BCB’s first rate cut of 50bps, Chile too cut rates the week before with their central bank moving to cut by 100bps and minutes from their July meeting suggesting another 75-100bps could be cut in August.

Global fixed income was flat to marginally weak with credit and emerging market bond index spreads falling slightly more, in line with a risk on environment. Listed infrastructure and real estate recovered 4% during the month, although this was mixed at a subsector level and could well be perceived as bargain hunting at these discounted levels. At the time of writing news is emerging of Buffet moving Berkshire into the housebuilding sector, accumulating stakes worth over $814mm in three US names, Dr Horton (6mn Shares), Lennar (152,572 Shares) and NVR (11,112 Shares).

To our relief, and somewhat in-line with our own expectations, the vice-like grip of inflation eased across markets with EU, UK and US readings all surprising to the downside, U.K headline reached 7.9% while core hit 6.9%.

While still extremely data dependant, it is encouraging to see inflation heading in the right direction and adds weight to the argument that within developed markets we could be close to terminal rates and a pause by central banks (excluding Japan) is likely from here while they seek to assess the stickiness of their remaining inflation. Until recently the soft-landing argument was sneered at by many market participants, however this is now being priced as the most likely outcome.

The BoJ continues to run very loose monetary policy stimulating inflation, although this has been favourable for Japanese equity markets with investors looking for value and positive earnings momentum. We continue to find ourselves attracted to Japanese equities due to the favourable mix found within markets. Japan offers attractive valuations on companies engaged in some of the most pioneering industries to which globally we could be at the inflection point of mass adoption, think Robotics, Technology, AI, Automation, Japan has had a foot in this camp for many years now and this could well be a very interesting period for the region. We see the opportunity mix alongside valuations as a big reason for the Nikkei making 33-year highs back in May.

While the committee kept S.A.A unchanged we took this moment to re-visit some of our inflation beneficiaries including an overview of the food retail sector. We reviewed the razor-sharp margin nature of the businesses, increased governmental and societal pressure for lower food prices and valuation extensions on equities within the space to P/E’s in excess of 30x. . Falling inflation and persistently tight labour markets also present a significant challenge for these businesses. In summary we see better value and opportunity elsewhere in areas such as UK Pharma.

We have also noticed a growing concern amongst market participants and economists that the ECB could be drastically close to a policy misstep. Many believe the economic picture within the Eurozone economy is not as rosy as it is currently being painted by the central bank, combine this with their aggressive tightening regime and could yield a hefty blow to businesses, individuals and equity markets within the region.

A.S.R (Absolute Strategy Research) undertook a comparison of the global financial crisis and the economy post pandemic; it would seem several of the mistakes witnessed amidst the GFC have not been repeated. Post GFC compared to post pandemic saw a major difference, whereas stimulus in the GFC was removed to be replaced by years of austerity leading household incomes and assets to shrink, following the pandemic fiscal stimulus has remained looser for longer replacing what was a long-term deflationary threat with this new inflationary environment. ASR expect a slower pace rate of cuts than expected, weaker growth and higher for longer interest rates which could spell volatility for investors given current market expectations.

ASR see the current forecast of rates falling while the economy slows as overly optimistic, siding with central bankers. We see the yield curve inversion being solved by principally falling short term rates. Long dated bonds are also pricing in continued falling inflation, however, if inflation surprises by staying higher for longer (it wouldn’t be the first time sticky inflation has caught investors off guard) then there could be a case to be made for long term yields to remain elevated over a longer term, meaning the unwinding of the curves inversion may unfold in a different manner to that of the general consensus. Long term yields are also likely to remain elevated in the presence of high budget deficits which will require funding through an increase in the issuance of coupon securities.

Advancements in technology along with a strong consumer are two clear reasons the market has performed well this year, however as a team we question the underlying statistics leading many to this outcome. The excess savings figure we see as highly subjective and continue to advocate for the study of credit flows to assess strengths and weaknesses within consumer behaviours.

Despite strong returns year to date, earnings on a forward basis are flat, leaving P/E ratios vulnerable. ASR believe any significant upside in the SPX from these current levels would need EPS growth in excess of 15% or forward P/E’s of 20X, which would see equity indices looking stretched to say the least. Now investors can achieve 5.5% on 3-month cash rates and the trailing earnings yield of the SPX is at 4.16%, we question whether investors are being fairly compensated for the any risk taken when risk free options seem so attractive in these times. When compared to bonds ASR state Global Equity Risk Premium is the lowest since 2007 and US ERP is at a 19-year low. Even with the optimism being created by investors, equities look expensive on a relative basis and are generally priced for perfection in our view. This creates an awkward dilemma for any companies trading on elevated multiples that cannot live up to the image valuations have painted. Any disappointments in earnings or guidance would likely be met with a fierce market reaction.

In aggregate we remain underweight equities, overweight short-dated fixed income and overweight alternative strategies.

Chart of the Week: Keeping Up with The Corporations – A Disappointing Earnings Season for Beats and Misses

Posted on August 9, 2023September 25, 2023 by admin@hottinger.co.uk

Author: Tim Sharp

Researcher: Jack Williams

Published: August 9, 2023

In the past, companies were often rewarded for meeting or exceeding analyst projections, and investors would respond positively to earnings reports. However, recent earnings periods have been far from the norm, characterized by exacerbated moves in both the up and downside as shifts in market themes and uncertain macro backdrops collide, leading to increased volatility. This is particularly evident in the current earnings season, where companies missing expectations or issuing lacklustre guidance are being heavily punished by the market.

Earnings Reactions:

The chart in Figure 1 illustrates the stark contrast between companies beating estimates and underachievers in the market. The average one-day percentage change as a reaction to earnings over the last ten years has been negligible at -0.01%. However, in the current earnings season, this figure has dropped to -0.8%, indicating a significant difference from the historical average.

Figure 1 – Reactions (% Change) on Earnings Day vs L10y Avrg
Source: Bespoke Investment Group

Moreover, the average reaction to Earnings-Per-Share beats in the past was a positive 1.58%, leading to an increase in share prices. In contrast, the current earnings season has shown an average reaction of only +0.27%, considerably lower than the historical average. Companies missing EPS revisions also saw slightly worse reactions this earnings season, with an average drop of -3.54%, compared to -3.35% over the last ten years. Companies meeting expectations are also experiencing more negative reactions, with an average decline of -2.89%, reflecting investors’ preference for outperforming businesses amidst the current uncertain macro environment.

Real Estate has struggled due to a weak macro backdrop for housing, even for those companies beating EPS, with an average decline of -0.45%. Technology also faced challenges as heightened expectations during earnings season, driven by the tech/AI-led rally in US stocks, pushed valuations to previously high pandemic territory once again. This resulted in an average reaction of -0.79% to a positive EPS beat within the sector. Communication Services also struggled in this earnings season, affected by weaker business sentiment, lower consumer confidence, and market stories such as lead cable contamination, which led to shares, such as AT&T, hitting 30-year lows.

Short Interest Effect:

Figure 2 – Russell 3000 Earnings Reactions By Short Interest Group
Source: Goldman Sachs

Data from Russell 3000 earnings suggests that short interest may be playing a significant role in earnings reactions. Stocks with short interest as a percentage of free float at over 7.5% posted earnings day returns of at least 1.5% on average, with 7.5%-10% being the sweet spot, producing +1.6% returns on earnings day compared to negative average returns for stocks with less than 7.5% short interest as a percentage of free float.

Conclusion:

The recent earnings season has been marked by increased volatility, with companies facing heightened scrutiny for their performances. Market themes and macroeconomic uncertainties have played a significant role in shaping investors’ reactions to earnings reports. Sector-specific challenges have also impacted reactions, with the Real Estate, Technology, and Communication Services sectors facing difficulties.

While this can be confusing and perhaps points to potential weakness around future earnings periods during times of uncertainty and macro inconsistence, this may not be the case. As nerves reemerge following a monster rally in the US year to date and the first 1% drop in the US Blue Chip Index in over two months, data from similar situations points the opposite direction as the typical outcome.

The chart below shows US500 performance after the first 1% drop in more than two months, which on average yields investor returns of 14.8% one year later. Obviously, nothing is guaranteed, but as the old saying goes, history tends to repeat itself, which I’m sure in this case, should it happen, would be warmly welcomed by many investors.

Figure 3-SPX Performance after first 1% Decline After More Than Two Months Without One
Source:Carson Investment Research

Sources:

Investment Group, B. (n.d.). Bespoke Daily 📊 – No Love for Beats. [online] us11.campaign-archive.com. Available at: https://mailchi.mp/bespokepremium/bespokes-morning-lineup-553274?e=33d57ea167.

Detrick, R. (2023). Volatility Is The Toll We Pay. [online] Carson Group. Available at: https://www.carsongroup.com/insights/blog/volatility-is-the-toll-we-pay/

Anon, (n.d.). S&P 500 Stocks – Average Earnings Day Moves – ISABELNET. [online] Available at: https://www.isabelnet.com/sp-500-stocks-average-earnings-day-moves/

The Market Ear. (2023). The Market Ear | Live news, analysis and commentary on what moves markets and trading. [online] Available at: https://themarketear.com/newsfeed

THE SHORT AND LONG OF RECENT VOLATILITY. (n.d.). Available at: https://www.goldmansachs.com/intelligence/pages/gs-research/the-short-and-long-of-recent-volatility-f/report.pdf

July Investment Review: Possibility of a soft landing?

Posted on August 2, 2023 by admin@hottinger.co.uk

by Haith Nori

July saw global markets deliver positive returns. The encouraging news of inflation reducing in the US, Eurozone and the UK has rippled through global equity markets leaving a progressive outcome. Despite the good news, Central Banks have continued to increase interest rates, factoring the latest data into their plans, with the exception being the Bank of Japan who have maintained their stance on ultra-low interest rates. Half-way through the year, second quarter earnings have so far been encouraging and fears of a recession are slowly fading with the idea of a soft landing seeming to be more plausible. Ukraine has, for the time being, not been allowed to join NATO while the war is still active. The trade war between the US and China is levelling up once more and Russia has pulled out of the UN Grain Deal brokered by Turkey last year in retaliation to what they believed to be an attack from Ukraine.

At the beginning of July, China announced that from August they would impose export restrictions on gallium and geranium to US, which are crucial elements for semiconductors and computer chips used in electric vehicles and military equipment. The news came just before Independence Day. China’s decision was ‘widely seen as retaliation for U.S. curbs on sales of technologies to China’[i]. The US announced that they would stop sales to China of high-tech micro-chips in July, as they feel these should not be used by Chinese Military. The retaliation from China could be the beginning of increased tensions between the two countries. Janet Yellen, US Secretary of the Treasury, travelled to China to meet with Premier Li Qiang, in an attempt to repair economic relations between the two countries, stating China had unfair economic practices but China wanted her to meet them in the middle with the development of trade ties. However, whilst Yellen achieved some success talking with some of China’s main economic policymakers, no trade, investment or technology matters have been agreed.

Russia pulled out of UN Grain deal brokered last year by Turkey called “The Black Sea Grain Deal” set up last year after blasts to the Russian bridge connecting to the occupied Crimean Peninsula by what Russia thought to be Ukrainian Seaborn drones. Their decision ‘raised concern primarily in Africa and Asia of rising food prices and hunger’[ii]. Russia has retaliated by targeting grain infrastructure striking the Ukraine grain port of Odesa.

A NATO summit was held in Vilnius, Lithuania on 11-12^th July where the idea of Ukraine joining the NATO was raised. Whilst the thirty-one members of NATO are supportive of Ukraine being part of the alliance, the US has posed strong opinions that they will not ‘let a warring country into NATO and give too firm a timeline commitment’[iii]. It was indicated that Ukraine would be able to join NATO once the war was over. The leaders of NATO have also declared that the future of Ukraine laid in the hands of NATO’s military relationship. Neither Zelenskyy nor Putin were happy with the outcome.

On 12^th July US CPI data was released for the 12 months ending in June of 3% beating expectations of 3.1%. This has come a long way since its level of 9.1% in June 2022! On Wednesday 19^th June UK CPI data was released for the 12 months ending in June was 7.9%, beating expectations of 8.2% and marking a steady reduction. The positive news gave a boost to UK Equities, with housebuilders benefiting the most as market participants believe that upward pressures on interest rates (and thus mortgages) could be abating. In the Eurozone CPI figures were 5.5% for the 12 months ending in June, down from 6.1% in May. Whilst these figures have been promising, Central Banks are still attempting to control inflation.

On 26^th July the US Federal Reserve made the decision to hike interest rates by 0.25% (as expected) to 5.25%-5.50%, the eleventh time in the last 12 meetings. The last time the Federal Reserve had raised rates this high was in 2007 when there was a housing market crash. Jerome Powell has suggested that this is perhaps not the end and will review if rates are to be raised again in September stating ‘We’ll be comfortable cutting rates when we’re comfortable cutting rates, and that won’t be this year’[iv]. Powell still believes there is a pathway towards a soft landing, which is where inflation falls without a recession being caused as a result. On 27^th July the European Central Bank continued their path by increasing interest rates by 0.25% to 3.75%, this being the ninth consecutive hike in a row and has taken them to twenty-three-year highs.

On 28^th July the Bank of Japan’s Governor Kazuo Ueda decided not to change their ultra-low interest rate policy, maintaining overnight interest rates at -0.1%. He also made the choice to marginally loosen their yield curve control (YCC) by buying 10-year Japanese Government Bonds at a rate of 1.0% in fixed-rate operations, rather than the previous 0.5% rate, shocking markets. By promising more flexibility in the YCC, this is their method for controlling long-term interest rates as ‘This effectively expands its tolerance by a further 50 basis points, signalling the BOJ would let the 10-year yield rise to as much as 1.0%.’ [v] The next meeting for the Bank of England will be at the beginning of August where markets are expecting a 25 basis point hike.

Overall, July saw a positive performance across asset classes. Brent Crude, after starting the month at levels of c.$74 per barrel, increased to over c.85 during the month. UK 2year Gilts have reached a yield of over 5%, with the 10-year yield reaching highs of c.4.65% and US 10-year Treasury note c.4.048%. During July Sterling continued to hit its highest levels over this past year, reaching over c.1.31 against the US Dollar. Gold also regained some of its lost value in June.

[i] https://www.reuters.com/markets/commodities/chinas-rare-earths-dominance-focus-after-mineral-export-curbs-2023-07-05/

[ii] https://www.reuters.com/world/europe/russia-carries-out-air-strikes-second-night-ukraines-odesa-port-governor-2023-07-18/

[iii] https://www.cnbc.com/2023/07/14/zelenskyy-absurd-comment-how-nato-pressured-ukraine-to-show-more-gratitude.html

[iv] https://www.reuters.com/markets/rates-bonds/fed-poised-hike-rates-markets-anticipate-inflation-endgame-2023-07-26/

[v] https://www.cnbc.com/2023/07/31/strategist-boj-should-move-to-new-normal-sooner-current-policy-is-very-harmful.html

Chart of the Week – Latin American Equities

Posted on July 28, 2023September 25, 2023 by admin@hottinger.co.uk

Primed for a New Bull Market After Breaking 15+Year Trendline?

Author: Tim Sharp

Researcher: Jack Williams

Published: July 28, 2023

Developed economies have recently surprised on the upside following a long streak of losses causing Latin America to fall off the radar for many investors. However, these markets may be at a pivotal point and could be headed for brighter days ahead. The MSCI Emerging Markets Latin America ETF chart above depicts a sustained fall in price since its peak in 2008, declining from over $5200. Each candlestick in the chart represents one month’s worth of price action.

Figure 1-MSCI EM Latin America ETF Monthly Candles

The blue trendline illustrates the “slow puncture” effect witnessed in these markets over the past 15+ years, as capital gradually withdraws from the region. We believe Latin American Equities may be at a significant turning point, as future catalysts, current conditions, and our global outlook aligns, creating what some investors may describe as the perfect storm for Latin America. This month, bulls have broken through the long-term negative trend, turning heads investors heads as the case for LatAM builds.

In this article, we delve into a few interesting reasons why particular attention is being paid to this region as of late.

Figure 2-MSCI EM LatAM ETF Daily Candles 2008-Current

Inflation:

Inflation is a critical factor that cannot be ignored. Latin American countries have more experience in dealing with high and sticky inflation compared to most developed markets in recent history, having tackled numerous bouts of high level inflation. Learning from past experiences, central banks in the region took proactive measures to counteract its effects, aggressively hiking rates at a rapid pace. Brazil’s base rate rose from 2% in 2020 to the current level of 13.75%, which has been maintained for the seventh consecutive meeting (June 2023).

The chart above illustrates the easing of headline inflation while monetary policy has tightened across emerging market nations. The dark blue bar represents the current level of inflation, with the green dot showing peak inflation over the past 12 months. The cyan-coloured dash indicates the current level of monetary policy (e.g., Brazil at 13.75%), while the red triangle represents the target level of inflation. Additionally, a purple line shows monetary policy twelve months ago, revealing a push upwards and rapid decline in inflation well below peak levels for LatAM nations and in a much better place to cut rates sooner than most developed markets. At the current time of writing, Chile is expected to cut rates by 75bps following a 9 month hold at a rate of 11.25%, other nations are expected to follow suit in the coming months.

Figure 4-Brazil Central Bank Rate (TradingEconomics Data)

The US Dollar has shown notable weakness in recent months, as depicted in the sterling USD pairing chart below, showing that since October’s mini-budget debacle, sterling has outpaced the greenback.

A similar story can be observed when looking at Latin American currencies, such as the Brazilian Real, charted against the MSCI Latin America Index. The USD/Real chart shows that as the USD peaked, the Brazilian Real’s strength took over, leading to an upward march in the MSCI Latin America Index.

Figure 6-USD/REAL (White) MSCI LATAM ETF (Blue) Rebased to Par.

Onshoring:

Onshoring or reshoring is a relatively new concept that has gained traction due to global tensions. It involves moving key components, materials, manufacturing hubs, and business infrastructure closer to home for businesses. The move towards onshoring has been driven by growing tensions with manufacturing nations like China, as well as uncertainties about Taiwan, further exacerbated by the COVID supply chain disruptions and the Russia-Ukraine war.

Countries like Mexico are poised to be major beneficiaries of this onshoring trend, potentially leading to increased GDP growth. Developments of factories, infrastructure, and higher-paying jobs may follow as states look to secure supply and manufacturing of crucial industries, such as semiconductors, closer to home.

In conclusion, Latin American equities appear to be at a turning point, with favourable conditions and global trends aligning in their favour. The region’s experience in managing inflation, the weakening US Dollar, and the added element of onshoring could potentially contribute to brighter horizons ahead for Latin American Equities

Sources:

Benedito, L.M. and Burin, G. (2023). Brazil central bank to keep rates steady on June 21, cuts coming soon. Reuters. [online] 16 Jun. Available at: https://www.reuters.com/markets/rates-bonds/brazil-cbank-keep-rates-steady-june-21-cuts-coming-soon-2023-06-16/

Uddin, R. and McDougall, M. (2023). Latin America’s bonds and currencies lure yield-hungry investors. Financial Times. [online] 6 Jul. Available at: https://www.ft.com/content/c04c3a04-8c36-4822-813b-28f25e2ba067

Cambero, F. (2023). Chile to start rate cuts, signaling more across the region. Reuters. [online] 27 Jul. Available at: https://www.reuters.com/markets/rates-bonds/chile-start-rate-cuts-signaling-more-across-region-2023-07-27/

Nair, D. (2023). US dollar weakness expected to continue as inflation cools. [online] The National. Available at: https://www.thenationalnews.com/business/money/2023/07/13/us-dollar-weakness-expected-to-continue-as-inflation-cools/#:~:text=The%20currency%20slumps%20to%20a

Goodkind, N. (2023). Why the Fed paused its rate hikes: It’s tired of playing a giant guessing game | CNN Business. [online] CNN. Available at: https://edition.cnn.com/2023/06/16/investing/premarket-stocks-trading/index.html#:~:text=After%2010%20consecutive%20interest%20rate

For Swaps Traders, Latin America’s Rate-Cut Cycle Comes Too Late. (2023). Bloomberg.com. [online] 27 Jul. Available at: https://www.bloomberg.com/news/articles/2023-07-27/for-swaps-traders-latin-america-s-rate-cut-cycle-comes-too-late

US Says It Must Work With Latin America More on Key Minerals. (2023). Bloomberg.com. [online] 26 Jul. Available at: https://www.bloomberg.com/news/articles/2023-07-26/us-must-step-up-latam-work-on-critical-minerals-state-aide-says

GLOBAL INSIGHT Q3 2023

Posted on July 14, 2023 by admin@hottinger.co.uk

June Investment Review: Federal Reserve takes a pause

Posted on July 3, 2023 by admin@hottinger.co.uk

by Haith Nori

June saw global markets deliver mixed performances, albeit generally reacting positively to the US Debt ceiling issue being resolved at the end of May. A key aspect during this month has been central banks taking their next steps to control inflation. Japanese equities have reached their highest point since August 1990, up c.29% since the start of 2023 with Warren Buffet spotting value in the country and increasing the size of his existing positions in several of Japan’s largest firms. Back in the US, Apple has now reached a market capitalisation of over $3 trillion for the first time ever, assisting with the continued technology rally since the beginning of the year.

On 13^th June US CPI data was released for the 12 months ending in May of 4%, 0.9% lower than that of April, still on the downward trend since June 2022 (9.1%). US. Federal Reserve Chair Jerome Powell is still fixated on achieving a 2% inflation target. On 16^th June Eurozone CPI data was released for the 12 months ending in May of 6.1%, a reduction from April’s 7.0%. On 21^st June UK CPI data was released for the 12 months ending in May remained at 8.7%, unchanged from April, missing expectations of 8.4%.

On 14^th June the US Federal Reserve made the decision to keep interest rates unchanged at 5.00%-5.25% following ten consecutive meeting hikes. Global markets reacted positively to the news with many participants believing a pause was a sensible idea given the huge increase in base rates over the past year. On 15^th June the European Central Bank also continued on its path, increasing interest rates by 0.25% to 3.5% (this being their eighth straight hike in a row). ECB president Christine Lagarde suggests further hikes are likely in July’s meeting. This is the highest level of interest rates in 22 years for the European Central Bank. Following suit, on 22nd June the Bank of England also made the decision to increase interest rates by 0.5% to 5% from 4.5% being the 13^th time in a row that the Bank of England has increased interest rates. This was higher than the expected rise of 0.25% and is the largest rate increase since February. The Bank of Japan kept their ultra-low interest rates unchanged. At the European Central Bank Forum on Central Banking in Sintra, Portugal (26^th-28^th June), policy makers were keen to stress that market participants should not anticipate any interest rate cuts for at least a period of one to two years.

US Secretary of State Antony Blinken made the long-awaited trip to China on 19^th June to meet with President Xi Jinping in Beijing’s Great Hall of People (which is usually reserved for meetings with heads of state). The purpose of the trip was to attempt to ease tensions between the two countries. The initial meeting was planned for February but delayed after the US shooting of the suspected Chinese spy drone. During the meeting ‘China and the United States agreed on Monday to stabilize their intense rivalry so it does not veer into conflict, but failed to produce any major breakthrough’[i]. Both leaders of the two countries, US President Joe Biden and China’s President Xi Jinping cited the meeting as progress as concerns were able to be raised and channels of dialogue were opened. Whilst at this time, no firm plans have been put into action, the face-to-face meeting with US Secretary of State has begun a journey for the two countries to communicate further.

On 21^st June, US Federal Reserve Chair Jerome Powell testified before the House of Financial Services Committee to deliver his semi-annual report to both Chambers of Congress. The next day he appeared in front of the Senate Banking Committee. After US markets had benefited from the Federal Reserve keeping interest rates unchanged, Powell ‘hinted at the likelihood of further interest rate hikes’[ii] leading to further sell offs in US equity markets.

On 22^nd June, the Prime Minister of India, Narendra Modi, made his first official state visit to Washington D.C. to meet with President Joe Biden. The purpose of the meeting for Modi was to raise the status of India and strengthen ties with the US and ‘the two countries announced agreements on semiconductors, critical minerals, technology, space cooperation and defence cooperation and sales’[iii]. One deal that has already been signed off is with General Electric to produce jet engines in India for their military aircrafts with an agreement with Hindustan Aeronautics. Further deals are being planned between the two nations and no doubt will be a boost for the economy in India.

On the weekend of 24^th June, Yevgeny Prigozhin, the boss of private mercenary army Wagner, led an ultimately brief rebellion starting in the city of Rostov-on-Don, Russia, moving north towards Voronezh following the path towards Moscow. ‘Wagner fighters have taken control of all military facilities in the city of Veronezh, about 500km (300 miles) south of Moscow’[iv] with which Putin made an announcement accusing Wagner fighters of “treason”. After the initial ambush Prigozhin ordered his army that was advancing on Moscow to stand down to avoid any further casualties. Whilst this has been short lived the act made a large impact calling for countries to prepare a quick response if the situation was to escalate further and ending with a tougher response from Russia on its attack on Ukraine. Mr. Prigozhin was exiled to Belarus in exchange for the criminal case being dropped against the Wagner Group.

Overall, June saw mixed performance across asset classes. Brent Crude, after starting the month at levels of c.$74 per barrel, remained at a similar level throughout the month. Japanese equities have reached a 33-year high and UK 2 year Gilt yields reaching a level of over 5%.UK 10 year Gilt yields reached highs of 4.49% and US 10 year Treasury yields 3.839%. During June Sterling also hit its highest level at c.1.28 against the US Dollar over the past year and gold slightly fell in value.

[i] https://www.reuters.com/world/china/blinken-wrap-up-rare-visit-china-may-meet-xi-jinping-2023-06-18/

[ii] https://www.reuters.com/markets/us/futures-muted-ahead-powells-congressional-testimony-2023-06-21/

[iii] https://www.reuters.com/world/biden-modi-strengthen-ties-with-defense-trade-agreements-2023-06-22/

[iv] https://www.reuters.com/world/europe/how-mercenary-revolt-has-gathered-pace-russia-2023-06-24/

Chart of the Week: Convergence of Returns Amongst Cash, Bonds, and US Equities

Posted on June 27, 2023September 25, 2023 by admin@hottinger.co.uk

Author: Tim Sharp

Researcher: Jack Williams

Published: June 27, 2023

In a notable turn of events, the recent market rally in the United States has led to the erasure of the premium traditionally associated with owning shares in US companies. This phenomenon is particularly evident in the convergence of yields between cash, bonds, and equities. Currently, three-month Treasury bills offer a yield of 5.3% following a brief pause in interest rate hikes by the Federal Reserve, which has maintained the interest rate in the range of 5-5.25%. Although the central bank has hinted at a potential double increase in rates towards the end of the year, it remains uncertain.

This convergence of yields across different asset classes is unprecedented in history. As depicted in the accompanying chart, the earnings yield of the US500 (S&P 500) now matches that of cash and bond yields. This is a significant departure from the situation less than six months ago, when the US500’s earnings yield exceeded 6%. The recent surge in US markets, primarily driven by the technology sector and semiconductor industry, has contributed to this decline in the earnings yield.

Comparisons between the price-to-earnings (P/E) ratios of the US500 index and its European counterparts have raised concerns amongst investors.

The US500 currently boasts a P/E ratio of 23 times earnings, 56% higher than the Stoxx 600’s valuation of 13 times earnings in Europe.

One explanation for this disparity lies in the differing sector composition between the two regions.

Europe has fewer companies operating in the technology and semiconductor sectors, which have been key drivers of the recent market rally. However, some asset managers, including Christian Kopf of Union Investment, argue that bonds offer US investors better risk-adjusted returns compared to the current state of the markets.

On the other hand, Pictet, another asset manager, is seeking alternative sources of alpha and identifies European and Asian equities as potentially outperforming their US counterparts in the latter half of the year.

Figure 2- US500 P/E Ratio 1928 – 2023 (Refinitv/Hottinger Investment Management)

Figure 3- Nikkei225/Stoxx600 P/E Ratio (Refinitv/Hottinger Investment Management)

This convergence of returns is not limited to equities and three-month treasuries; it also extends to investment-grade bonds and cash yields. According to a recent survey by Bank of America, investment-grade bonds are experiencing the highest overweight positioning since 2008, with a net allocation of +10% in this space.

In conclusion, the recent market rally in the United States has resulted with matched yields among cash, bonds, and equities, which is an unprecedented occurrence in history. The decline in the earnings yield of the US500 reflects the strong performance of US markets, driven by the technology sector and semiconductors, which has not been seen in the Eurozone area to the same extent. The disparity in P/E ratios between the US500 and European indices can be attributed to differences in sector composition to some extent, however, there has been a long-standing valuation gap between US markets and the EU and UK markets which many are wondering whether this could be a reason for such gap to narrow or close, however, that is yet to be seen.

Referencing

Bloomberg Data, Bloomberg Data. “Bloomberg – Asia Pacific Stocks.” Www.bloomberg.com, Bloomberg Financial Data, 21 June 2023, www.bloomberg.com/news/articles/2023-04-18/investors-turn-most-underweight-stocks-versus-bonds-since-2009#xj4y7vzkg. Accessed 21 June 2023.

Mosolova, Daria, and Mary McDougall. “Rate Rises Erode Investors’ Incentive to Hold US Companies’ Shares.” Financial Times, 18 June 2023, www.ft.com/content/79b7775a-fe35-4591-ae4a-cc31eea1c81c. Accessed 21 June 2023.

Research, Siblis . “P/E & CAPE Ratio of Nikkei 225 & Japanese Stock Market.” Siblis Research, 20. 2023, www.siblisresearch.com/data/japan-nikkei-pe-cape/. Accessed 21 June 2023.

Research Service, MacroTrends. “S&P 500 PE Ratio – 90 Year Historical Chart.” Www.macrotrends.net, 21 June 2023, www.macrotrends.net/2577/sp-500-pe-ratio-price-to-earnings-chart.

Reddy, Sam Moore, Rohan. “Global X 1-3 Month T-Bill ETF (CLIP).” Global X ETFs, 21 June 2023, www.globalxetfs.com/introducing-the-global-x-1-3-month-t-bill-etf-clip/. Accessed 21 June 2023.

Chart of the Week: Unprecedented Concentration in Equity Markets Raises Concerns – Will History Repeat Itself?

Posted on June 14, 2023September 25, 2023 by admin@hottinger.co.uk

Author: Tim Sharp

Researcher: Jack Williams

Published: June 14, 2023

The year of 2023 has been an anomaly for many reasons, perhaps the main one being the extreme concentration within equity markets, especially within recent months. Defined here as the concentration of top 10 leaders to the three-month performance of the US500, is above the 99^th percentile over the past 30 years.

Shown below in figure one, you can see in light blue the weighting of the top ten leaders within the US500, and in dark blue the contribution of those top ten leaders.

Figure 1-Refinitiv Data / Barclays Research

Stock	Weighting	YTD Performance	PE Ratio
Apple (AAPL)	7.50	+46.57%	31.14
Microsoft (MSFT)	6.7	+39.53%	36.23
Amazon (AMZN)	3.1	+47.59%	307.09
Nvidia (NVDA)	2.6	+186.57%	213.19
Alphabet (GOOGL) A	2.203	+38.95%	27.96
Tesla (TSLA)	1.846	+139.32%	76.17
Alphabet (GOOG) C	1.7737	+38.72%	28.09
Meta Platforms	1.658	+117.51%	34.63
Berkshire Hathaway (BRK.B)	1.651	+8.54%	N/A
United Health Group	1.26904	-5.27%	22.47

Since the mid 1990’s there has only been two instances with comparable levels of concentration, the first being the 2000 dot com bubble, and the second being the 2020 Covid rebound, both opposites in terms of outcomes for the market.

Figure 4 – 2020 Covid Rebound (Refinitiv Data)

Figure 5 – Dot-Com Market Low (Refinitiv Data)

During the 2020 Covid Rebound, the market ripped higher by +20% while the top ten underperformed the US500 remaining flat for the first 9 months. Following this nine month period, the US500 rallied further instead being led by the top 10 stocks. 10 Leaders rallied +33% while the US500 ripped higher by 15%, highlighting the dramatic outperformance in this period by the top 10 names.

Market participants are currently weighing up which scenario, 2020 rebound or dot com era misery will prevail. With the debate amongst institutions continuing, recently several houses have been making their views known as to whether they view the latest rally as worth participating in.

Barclays equity strategists commentary has been increasing in positivity recently regarding the US main market. Within a research note issued by Barclays on the 13^th of June entitled “Equity Options Not Pricing for Any Surprises”, strategists issued the firms belief the current situation is closer to that seen in the Covid rebound, with the main reasoning being the dramatic difference in valuation multiples seen in the Dot Com period compared to the current market, which although higher than where a bull market typically starts are still a long way from the lofty multiples being touted in the 2000’s period.

Figure 2 – Refinitiv / Bloomberg / Barclays Research

It is worth however noting that a bear market historically has not bottomed at multiples seen currently in these markets. The most expensive bear market low to date was the US500 following the dot-com bust, in which US500 PE’s stood at 13.5 times. The second most expensive bear marker bottom was the covid rebound in 2020 where earninsg stood at 13.5 times earnings.

Figure 3 – Refinitiv / Hottinger Investment Management

Morgan Stanley, on the other hand, are much more bearish in their forecast. With the US500 rally now crossing the 20% threshold, many are declaring the bear market officially over. Morgan Stanley are not in this camp, quite the opposite infact. M.S are predicting a V shaped earnings recession/recovery within their forecasts.

Over 70% of the US500’s industry groups grew forward earnings expectations by 20% above pre covid levels. Morgan Stanley’s forecast of earnings stand well below current consensus. Even being so far below consensus would still put their figures 10% above the long term earnings trend line.

Figure 6 – M.S Earning Model Suggest Earning Recession Is Not Over (FactSet / Morgan Stanley)

While their forecast was lower than consensus even 6 months ago, the spread between MS and consensus has widened further while the street and buy side have raised their consensus for earnings over recent months.

Figure 7 – Spread Between Morgan Stanley Model & Consensus Rarely Been Wider (FactSet / Morgan Stanley)

Rather than looking at similar rallies or period of concentration, M.S are looking at the variables that led us to our current situation and when similar variables such as Fed hiking cycles, sticky inflation and build up of savings occurred in the past.

Figure 8 – M.S Base Case EPS Estimate Still Above Long-Term Trend (FactSet / Morgan Stanley)

Perhaps the most notable period, and which Morgan Stanley have chosen to focus on is the post WWII period. This was similar in a way where excess savings were built up and unleashed into the economy during a supply constrained environment, where inflation surges as a result.

In this case asset prices surged to prior cycle highs at a historically rapid pace. The boom in inflation and earnings lef to the Fed tightening at the fastest rate in 40 years… Sound familiar?

The boom and fed reaction caught many investors off guard, with M.S expecting many to be surprised once again by the depth of their forecasted earninings recession with the sharp V shaped recovery they forecast in 2024.

Referencing:

Research, B., Gupta, A., Pascale, S., Kang, V. and Dass, R. (2023). “Equity options not priced for any surprises ahead of heavy macro week” .

Barclays Research, Barclays Research / Barclays Live: Barclays Research , pp.1–7.

‌www.macrotrends.net. (n.d.). S&P 500 PE Ratio – 90 Year Historical Chart. [online] Available at: https://www.macrotrends.net/2577/sp-500-pe-ratio-price-to-earnings-chart.

Ward, S. (2022). Why Stock Multiples Say the Market Could Continue to Drop. [online] Morningstar, Inc. Available at: https://www.morningstar.com/markets/why-stock-multiples-say-market-could-continue-drop.

Slickcharts (n.d.). S&P 500 Companies – S&P 500 Index Components by Market Cap. [online] www.slickcharts.com. Available at: https://www.slickcharts.com/sp500.

Wilson, M.J., Pauker, A.B., Weaver CFA, M.M., Ding PHD, D. and Lentini, N. (2023). Weekly Warm-Up: The Bear Is Still Alive Based on Our Boom/Bust Framework. Morgan Stanley Research: Morgan Stanley Research.

Statista. (2023). Europe: PE multiples technology & telecommunications 2022. [online] Available at: https://www.statista.com/statistics/1028379/price-earnings-in-the-technology-and-telecommunications-sector-in-europe/.

May Investment Review: Dancing on the Ceiling

Posted on June 1, 2023June 14, 2023 by admin@hottinger.co.uk

by Haith Nori

May saw a mixed performance across global markets. In equity markets across Europe, including the UK there was a slight decline in overall value. However, US technology stocks continued to increase, as did Japanese Equities. Elsewhere in the US equity market performance was more mixed. Yields increased on both UK 10-year Gilts and US 10-year Treasuries. The US Debt ceiling has been a key focus over the course of the month, with the House of Representatives finally passing the bill at the end of May. The US Dollar, after a weak start to the year, regained value over the month of May. Tayyip Erdogan has now been elected for 5 more years as the President of Turkey, having already been in power for 20 years. The G7 Meeting also took place in Japan where global leaders met face to face and Ukraine’s President Mr. Zelensky continued to request support from other developed countries around the world.

On 3^rd May 2023, the US Federal Reserve made the decision to increase interest rates by 0.25% from 5.00% to 5.25%, marking the highest level of interest rates reached in the past 16 years. On 5^th May the European Central Bank also raised interest rates by 0.25% to 3.25%, this being the seventh straight hike in a row and with the previous three rate hikes all being 0.50%. Following suit, on 11^th May the Bank of England also made the decision to increase interest rates by 0.25% to 4.5%, this being the 12^th time in a row that the Bank of England has increased interest rates. The UK bank rate is now the highest it has been since 2008. The next meetings for the Federal Reserve, the European Central Bank and the Bank of England will be in June 2023.

On 10^th May, US CPI data was released for the last 12 months ending in April. Headline inflation came in at 4.9%, 0.1% lower than that of March of 5%. Previous figures were 6.0% in February, 6.4% in January, 6.5% in December and 7.3% in November, highlighting inflation’s gradual decline since June 2022 (9.1%). On 17^th May, Eurozone CPI data was released for the last 12 months ending in April of 7%, slightly up from March’s 6.9%. On Wednesday 24^th May, UK CPI data was released for the last 12 months ending in April of 8.7% compared to 10.1% for March, 10.4% in February, 10.1% in January. This is down from its peak of 11.1% in October. Whilst this did not meet consensus expectations of 8.2%, it is the largest reduction in CPI data since the pandemic and has dropped below 10% for the first time in 8 months.

Ukraine’s President Volodymyr Zelensky has been requesting support across Europe before arriving in the UK on Monday 15^th May. The UK Prime Minister Rishi Sunak said ‘Britain would provide Ukraine with hundreds of air defence missiles and further unmanned ariel systems, including new long-range attack drones with a range of more than 200km’[i]. The delivery is expected in the following months and will be combined with Britain beginning training of Ukrainian pilots this summer. In addition to the UK, Germany has vowed to send up to $3 Billion worth of arms and France pledged to train and equip Ukrainian battalions with dozens of armoured vehicles.

The G7 meeting was held between 19-21^st May in Hiroshima, Japan where members stood united on various global issues including support for Ukraine, nuclear disarmament, China, clean energy economies, economic security, and climate change. US President Joe Biden has pledged $375 million in a military aid package with other G7 leaders pledging their continued support. Concerns over China were raised, including Beijing’s military activities against Taiwan and its use of economic coercion for its political gains. The G7 heads expressed their desire to work with China constructively but the existing issues needed to be addressed. However, ‘Beijing’s foreign ministry said it firmly opposed the statement by the G7’ and ‘said it had summoned Japan’s ambassador to China in a pointed protest to the summit host’[ii] highlighting the intensity of frustration and China’s newspaper the Global Times dubbing the G7 summit an “anti-China workshop”.

The US debt ceiling, which is the limit set by the US Congress on the amount of Government debt that can be accrued, has been in critical negotiations in May. Ever since the legislative cap was created in 1917, a majority vote is required by both the House of Representatives and the Senate. The vote raises the upper limit of how much the government can borrow. Since 1960, the debt ceiling has been raised 78 times but never reduced. The Democrats want the debt ceiling to be raised but the Republican leaders wish for spending cuts to be agreed first. President Biden is arguing that issues regarding government spending are separate from the issue of raising the debt ceiling. Currently, the nation’s debt ceiling is $31.4 trillion and a deal is needed to be struck as Treasury officials estimated that if they were to continue spending at the current rate the US could run out of money by Monday 5th June. Finally, on Wednesday 31^st May, The US House of Representatives passed a bill suspending the debt ceiling which will need to be signed by Joe Biden in order to be put into law. ‘The legislation suspends – in essence, temporarily removes – the federal government’s borrowing limit through Jan. 1, 2025’[iii] setting aside the issue until after the next US Presidential Election in November 2024.

Overall, May has seen mixed performance within asset classes. Brent Crude, after starting the month at levels of c.$80 per barrel, decreased over the course of the month ending at c.$73 per barrel. UK 10-year Bond yields and US 10-year treasury yields both continued to increase. Gold fell in value whilst the US Dollar rose.

[i] https://www.reuters.com/world/ukraines-zelenskiy-meet-british-pm-sunak-2023-05-15/

[ii] https://www.reuters.com/world/china/china-summons-japanese-ambassador-over-actions-g7-2023-05-22/

[iii] https://www.reuters.com/world/us/us-debt-ceiling-bill-faces-narrow-path-passage-house-2023-05-31/

Chart of the Week: Erdogan Elected Causes Financial Volatility, Will Anything Change This Time?

Posted on June 1, 2023September 25, 2023 by admin@hottinger.co.uk

Author: Tim Sharp

Researcher: Jack Williams

Published: June 1, 2023

After Turkish President Tayyip Erdogan’s re-election, Turkey’s financial markets once again experienced turbulence, as the Turkish Lira reached an all-time low against the US dollar, and the country’s sovereign bonds depreciated in value. Erdogan, who has been in office since August 2014, secured another five-year term, defeating opposition leader Kemal Kilicdaroglu, a Turkish economist, retired civil servant, and social democratic politician who was widely regarded as someone capable of addressing the problems that have arisen during Erdogan’s tenure. Since 2016, Turkey has faced strained relations with most European nations, a decline in media freedom, and, most significantly, an increase in the money supply during periods of high inflation, leading to further inflationary pressures.

Figure 1 – Turkish Inflation Rate (Statista)

Remarkably, Turkey’s inflation rate over the past 12 months has surpassed a 24-year high, soaring to over 85%. These price surges can be attributed to Erdogan’s unorthodox monetary policy, which contradicts the approach taken by other central banks and countries during this period of high inflation. Rather than raising interest rates, as most would expect, Erdogan has pursued a strategy of lowering rates, resulting in spiralling inflation that has negatively impacted the population. Unsurprisingly, this issue featured prominently in the election campaigns of both major parties in the recent election.

Investors have expressed concerns about this matter and have contemplated whether Erdogan might consider revising his monetary policy to restore financial prudence in the country. In recent weeks, an internal party team has hinted at the possibility of such a policy shift.

This renewed enthusiasm has sparked a rally in Turkish equities, particularly in the banking sector. Notably, the broader Turkish Index (BIST) has surged by 11.84%, while the banking-focused Turkish BIST BANKA index has experienced a remarkable rally of 14.94% in the past five trading days alone. Although Turkish Credit Default Swaps (CDS) have only marginally retreated from their elevated levels, decreasing from 624 to 622, the cost to insure against defaults has significantly risen since the beginning of the year. CDS swaps started the year at a rate of 513, representing an increase of 21.2% to their current levels.

Figure 2 – Turkish BIST Index (RefinitivData)

Figure 3 – Turkish BIST BANKA Index (RefinitvData)

Turkish investors undoubtedly hope for further declines in CDS rates as Erdogan announces his new cabinet, in the expectation that some positions will be filled by candidates who favour a more open-market approach. This would pave the way for the necessary changes to Turkey’s detrimental monetary policy, which both the country and international investors aspire to witness. Presently, Turkish 10-year bonds offer a yield of 9.705% and have performed poorly compared to other emerging market (EM) debt instruments, with a decline of -5.8% as opposed to the -1.6% decrease observed in the broader EM dollar bond space.

Figure 4 – Turkey CDS (WorldGovBond)

Sources:

Al Arabiya English. (2023). Turkey sovereign dollar bonds rise as markets await Erdogan’s economic team. [online] Available at: https://english.alarabiya.net/business/economy/2023/05/30/Turkey-sovereign-dollar-bonds-rise-as-markets-await-Erdogan-s-economic-team [Accessed 31 May 2023].

Karakaya, K. (2023). Turkish Lira Sinks, Stocks Gain as Investors Bet on Policy Shift. Bloomberg.com. [online] 30 May. Available at: https://www.bloomberg.com/news/articles/2023-05-30/turkish-lira-sinks-stocks-gain-as-investors-bet-on-policy-shift.

Parsons, A. (2023). As Kilicdaroglu takes on Erdogan – here’s why Turkey’s election may well be the most important in the world this year. [online] Sky News. Available at: https://news.sky.com/story/as-kilicdaroglu-takes-on-erdogan-heres-why-turkeys-election-may-well-be-the-most-important-in-the-world-this-year-12879032.

Statista. (n.d.). Turkey monthly inflation rate 2022. [online] Available at: https://www.statista.com/statistics/895080/turkey-inflation-rate/.

TradingEconomics (n.d.). Turkey Government Bond 10y – 2022 Data – 2010-2021 Historical – 2023 Forecast – Quote. [online] tradingeconomics.com. Available at: https://tradingeconomics.com/turkey/government-bond-yield.

Charts/Data – RefinitivData / Hottinger Investment Management / YCharts

Chart of the Week: 2023’s Debt Ceiling Issue Seems Eerily Similar to 2011’s

Posted on May 25, 2023September 25, 2023 by admin@hottinger.co.uk

Author: Tim Sharp

Researcher: Jack Williams

Published: May 25, 2023

The 2011 debt ceiling issue was a significant event that unfolded in the United States, casting a shadow of uncertainty over the country’s financial stability. The dispute, primarily between the Obama administration and the Republican-controlled Congress, revolved around raising the federal debt ceiling to avoid defaulting on the nation’s financial obligations.

The debt ceiling is a statutory limit set by the US Congress on the amount of national debt the government can accumulate, which has been a major story in recent weeks as the US default probability rises, and the country nears their resolution deadline.

In 2011, the United States approached its debt ceiling of $14.3 trillion, leading to a heated political debate. Republicans demanded significant spending cuts and fiscal reforms in exchange for raising the ceiling, while the Obama administration argued for a “clean” increase without any attached conditions.

As we near the 2023 ‘X’ date of the 15^th of June 23’ (the date interest payments on U.S debt are scheduled to be made, many institutions such as J.P Morgan, rather than looking forwards are looking backwards to 2011 to gain an idea of how the market might react should the U.S not come to a resolution in time.

Whilst many of the same names (JPM etc.) are cautiously optimistic that discussions between Biden and speaker McCarthy will produce at least a partial deal to either raise or suspend the debt ceiling, as we near the ‘X date’ the risk of default rises dramatically.

The chart below shows the probability of the U.S defaulting, and how the risk of default grows as the ‘X date’ nears. The blue line below shows the probability of default in 2011, as the U.S neared their X date a sharp uptick in risk of default appeared, rising to almost 6%.

The partial grey line follows the risk of a U.S default this year (2023) which has seen a sharp rise recently, similar to moves seen in 2011.

Figure 1 – J.P. Morgan Equity Macro Research, Bloomberg Finance L.P

Figure 2 – Bloomberg Data

Figure 2 below shows short term 1-month T-Bill yields, which as of recent have spiked, suggesting increasing default concerns, a stark contrast to the rallies seen amidst US indices in recent weeks.

In times such as these where volatility is expected, one might expect to see flows into treasuries as investors look to take some risk off the table, however T-Bill have surprisingly traded in the opposite direction, now trading at yields in excess of those seen amidst the 08’ financial crisis.

In 2011, prolonged and contentious negotiations over the debt ceiling caused uncertainty to flood into financial markets, particularly within the U.S as investors worries about the prospect of a default. This led to increased volatility and heightened risk which lasted for nearly three trading months.

In the weeks leading up to the 2011 August 2^nd deadline the market experienced significant swings. Throughout July 11’ all major US indices (DJIA, US500 and Nasdaq) witnessed substantial declines. The DJIA for example saw several days of triple digit losses, with the index shedding over two thousand points through a two-week period.

Figure 3 – J.P. Morgan / Bloomberg

During this time, the US 500 index declined by 17% with the brunt of the beating being felt by materials, financials, and energy, while defensive strategies excluding real estate outperformed.

Furthermore, to amplify market turmoil, ratings agency Standard and Poor’s downgraded the US sovereign credit rating from AAA to AA+, marking the first time in history the U.S lost its top tier credit rating.

Figure 4 – SP500 (2011) TradingView

While there are clear differences between the 2011 debt debacle and the current issue, perhaps the largest being the Rate of Inflation and Fed Funds Rate (both of which were dramatically lower in 2011 than today) many lessons have been learned regarding why negotiations must be conducted and concluded swiftly. That being said, one cannot ignore the risk however small of a US default and its potential impact on markets.

Figure 5 – Bloomberg Data

The U.S president Joe Biden has cancelled a planned visit to Australia and Papua New Guinea to focus on debt limit talks, with speaker McCarthy commenting that talks were productive in nature. It is true that the US has never defaulted on its payments before and the debt ceiling has been raised 78 times since 1960 under both republican and democrat presidents, although ex-president Trump is calling for a default as his preferred resolution.

On 26^thApril Republicans passed a bill in the house that would raise the debt ceiling by $1.5Tr but mandated $4.8Tr in spending cuts over a decade, although democrats have so far refused to negotiate spending cuts over the debt ceiling talks.

Negotiations are expected to resume Wednesday 24^th with Republicans looking for some kind of guarantee on spending/budget caps and investors hoping for news regarding some sort of resolution.

Sources:

Asset Management , J.P.M. (2023). How Does the Debt Ceiling Progress From Here? | J.P. Morgan. [online] www.jpmorgan.com. Available at: https://www.jpmorgan.com/wealth-management/wealth-partners/insights/how-does-the-debt-ceiling-progress-from-here#:~:text=With%201Y%20CDS%20at%20a.

Authers, J. (2023). On X+1 Day, We Won’t Be Going Back to Normal. com. [online] 24 May. Available at: https://www.bloomberg.com/opinion/articles/2023-05-24/debt-deal-before-x-1-day-the-us-crisis-will-have-already-begun?leadSource=uverify%20wall.

Aratani, L. (2023). What is the US debt ceiling and what will happen if it is not raised? The Guardian. [online] 17 May. Available at: http://www.theguardian.com/business/2023/may/16/what-is-debt-ceiling-limit-explainer.

BGR Group (2021). History of Debt Limit and Why It Matters | BGR Group. [online] BGR Group. Available at: https://bgrdc.com/history-of-debt-limit-and-why-it-matters/.

Palumbo, A. (2023). Stock Market Today: Dow Drops, Premarket Movers, Debt Ceiling Talks, Fed Minutes, Bitcoin Falls, Nvidia Earnings, China Covid-19. [online] www.barrons.com. Available at: https://www.barrons.com/livecoverage/stock-market-today-052423?mod=article_inline.

P. Morgan (n.d.). Debt ceiling drama: What you need to know. [online] www.jpmorgan.com. Available at: https://www.jpmorgan.com/wealth-management/wealth-partners/insights/debt-ceiling-drama-what-you-need-to-know#:~:text=Today%2C%20that%20limit%20stands%20at.

Chart of the Week: The Gold Vs Copper Conundrum

Posted on May 18, 2023September 25, 2023 by admin@hottinger.co.uk

Author: Tim Sharp

Researcher: Jack Williams

Published: May 18, 2023

In this week’s Chart of the Week, we examine the recent performance disparity between copper and gold, two key commodities, within the context of the current global economic environment. While the overall Goldman Sachs Commodity Index (GSCI) has experienced losses of approximately 30% over the past year, certain commodities within the index have demonstrated strong returns, fuelled by the prevailing high inflation and uncertainty. This study aims to elucidate the drivers behind the contrasting performance of copper and gold by delving into the factors that influence their respective prices.

Copper’s Underperformance

Despite the positive economic growth forecasts, particularly those for China, which exceed 5% in terms of economic expansion, copper’s performance has surprised many investors. Given copper’s extensive use in construction, electrical equipment, wiring, and manufacturing, its price movements are closely tied to global economic growth and investor sentiment. However, the present climate of heightened global uncertainty surrounding economic growth in the US, Eurozone, and UK does not bode well for copper. As a result, the anticipated rise in copper usage, which would tip the supply/demand balance in favour of investors, has not materialized. Consequently, copper has lagged gold in terms of returns.

Copper vs. Gold: The Role of Cyclical Stocks

The performance of copper and gold is intricately linked to cyclical stocks, exhibiting a correlation of 76%. Cyclical industries, such as manufacturing, construction, automotive, heavy machinery, and infrastructure development, are heavily influenced by the overall economic cycle. During periods of economic prosperity, these industries thrive, while economic downturns pose challenges for them. Copper, being closely associated with economic growth, is often used as a leading indicator of economic health. An increase in copper prices and demand signals optimism regarding future economic growth. Conversely, gold’s performance is driven by factors such as central bank policies, inflation and currency fluctuations (particularly in the context of a weak dollar), economic and political instability, and investor sentiment.

Gold’s Strengths

Gold, traditionally regarded as an inflation and war hedge amongst investors, has regained its appeal as such due to recent developments. Central banks, grappling with historically high and persistently sticky inflation, have raised interest rates to curb rising prices. Additionally, ongoing geopolitical tensions, including the war in Ukraine, escalating China-Taiwan tensions, and deteriorating relations with Western nations, have heightened economic and political instability to levels not witnessed in recent times. These factors have significantly favoured gold investors, as the precious metal is perceived as a ‘safe haven’ in times of uncertainty.

Summary

In brief conclusion, the substantial underperformance of copper compared to gold can be attributed to the global economic climate and the nature of the commodities themselves. Copper’s price movements are closely tied to economic growth and investor sentiment, making it susceptible to the prevailing uncertainties. On the other hand, gold’s performance is driven by a range of factors, including central bank policies, inflation, geopolitical tensions, and investor sentiment. Given the present economic landscape characterized by uncertainty, high inflation, and geopolitical risks, gold has outperformed copper and lived up to its status as an inflation and war hedge, at least for the time being. These findings highlight the importance of analysing the drivers behind commodity price movements and considering the broader economic and geopolitical context when making investment decisions.

Sources:

S&P GSCI Total Return Performance & Stats (ycharts.com)

https://ycharts.com/indicators/gold_price_london

RefinitvData/Hottinger (ABRDN Physical Gold x WisdomTree Copper x Wisdomtree Silver x Crude Spot Price)

RefinitivData/Hottinger Gold Spot Price – 5yr

S&P GSCI Total Return Performance & Stats (ycharts.com)

https://www.bullionbypost.co.uk/price-ratio/gold/silver/10year/

https://www.xe.com/currencyconverter/convert/?Amount=1&From=USD&To=GBP

LME Copper | London Metal Exchange

Chart of the Week: US Closes In On Debt Ceiling, Potential for Default Rises

Posted on May 16, 2023September 25, 2023 by admin@hottinger.co.uk

Author: Tim Sharp

Researcher: Jack Williams

Published: May 16, 2023

As anxiety spreads among investors, the cost of insuring against a possible U.S. credit default has surged to its highest level in more than ten years, surpassing levels observed in early 2009. This surge is a result of the United States coming closer to the brink of a potential default or breach of its debt ceiling.

Shown on the below chart, the United States has reached the level of its debt ceiling following a rapid rise in borrowing from 2017, partially worsened by the pandemic and knock on measures the country had to take to keep the economy alive such as their mass Stimulus Payments scheme.

Yesterday, US Sovereign CDS (Credit Default Swaps) rose again to 74 basis points according to Bloomberg Global Market Data, up from 73 points on the previous day’s close (+1.34%), and the highest level traded since March 2009.

A credit default occurs when a borrower is unable to meet its debt obligations, causing a default on its loans. In the case of the United States, a default would mean that the country would be unable to repay its debt, which would have severe consequences for the global financial system. Given that the United States is one of the largest borrowers in the world, a default could potentially trigger a major crisis, and could even lead to a sharp increase in borrowing costs, and a potential drop in the value of the U.S. dollar.

In order to protect themselves from the risks of a potential default, investors buy credit default swaps (CDS), which are financial instruments that act like insurance policies against default. A CDS pays out in the event of a default, providing investors with compensation for the losses they may incur.

The surge in the cost of CDS indicates that investors are becoming increasingly worried about the United States’ ability to meet its debt obligations. The cost of insuring against a potential default has risen significantly, suggesting that investors believe that the likelihood of a default is increasing, however it is worth noting that the overall probability of a US default is less than 6% over the next 5 years.

Substantial evidence of market stress linked to the tensions surrounding the debt ceiling have already begun to appear. Such has been seen recently by the significant increase in yields on Treasury bills that are set to mature around the X-date (Potential Default Date), resulting in higher borrowing costs for the government and consequently, for taxpayers as well. Figure 2, depicted below, clearly shows this trend. Since mid-April, there has been a near 1 percentage point increase in yields on short-term Treasury bills, which is nearly a 20% move from where yields previously stood. US Treasury Secretary Janet Yellen has been trying to raise the alarm, she says the potential default could happen as soon as June 1^st.

When asked to speak to the potential outcomes of a default on US debt, the White House points to the written piece on their default which includes a study on the risks of a protracted default. A simulation ran by the CEA showed an immediate, sharp recession to the magnitude not seen since the great recession (2007-2009). In 2023 Q3, the first full quarter following the simulated debt ceiling breach, the simulation showed a 45% drawdown in the stock market, while consumer and business confidence takes a substantial hit. Unemployment was modelled to increase by 5 percentage points as consumption cuts take place.

Moody’s recently undertook a similar study using their own model, which predicted under a clean debt ceiling breach job growth continues northbound adding 900,000 jobs. Although under a protracted default situation, the modelled job losses amount to almost 8 million, which would be even further unemployment than The White House is forecasting within their own.

https://www.whitehouse.gov/wp-content/uploads/2023/05/DL-Figure-1.3.png

https://www.whitehouse.gov/wp-content/uploads/2023/05/Debt-Limit-Blog_Figure2.png

Figure 1 – https://www.crfb.org/papers/qa-everything-you-should-know-about-debt-ceiling

Figure 2 – https://www.whitehouse.gov/cea/written-materials/2023/05/03/debt-ceiling-scenarios/#_ftn1

Figure 3 – https://www.whitehouse.gov/wp-content/uploads/2023/05/DL-Figure-1.3.png

Figure 4 – https://www.whitehouse.gov/wp-content/uploads/2023/05/Debt-Limit-Blog_Figure3.gif

Datapoints/charting – Bloomberg Global Market Data / Refintiv Data

April Investment Review: Light Relief

Posted on May 2, 2023 by admin@hottinger.co.uk

by Haith Nori

April delivered some light relief following the volatility witnessed over the first quarter of the year. There has been a flurry of Merger & Acquisition deals within the financial industry, including Rathbones buying the UK arm of Investec and Deutsche Bank agreeing to buy London based investment bank Numis. JP Morgan Chase have had their offer accepted on First Republic Bank after being in a bidding war in the final week of April following the Federal Deposit Insurance Corporation (FDIC) reaching out to big banks in the US.

On Tuesday 4^th April, the ‘US unveiled $2.6 billion worth of military assistance that includes three air surveillance radars, anti-tank rockets and fuel trucks, the Pentagon announced’[i]. Countries are still providing support to Ukraine as the war has still not reached a resolution. In the UK, Jeremy Hunt, Chancellor of the Exchequer, confirmed that an additional $500 million in guaranteed loans would be provided by the UK on 13^th April.

On 4^th April, Rathbones agreed to buy the UK Wealth arm of Investec in an ‘all-share deal that values the unit at 839 million pounds ($1.04 billion)’ [ii]. If the deal goes to plan, a very large wealth manager will be created with approximately 100 billion in assets under management. On the flip side, Investec will own 41.25% stake in the combined firm. The deal is still subject to the necessary regulatory approvals and is estimated to be completed in the final quarter of 2023.

On Friday 28^th April, Germany based Deutsche Bank announced that it ‘had agreed to buy Numis Corp (NUM.L), a London-based boutique investment bank, for about 410 million pounds ($511 million) as the German company continues to deepen its links with British corporate clients’[iii]. This is a cash consideration deal valuing Numis at 350 pence per share and is Deutsche Bank’s largest acquisition in more than a decade. The deal will provide Deutsche Bank with strong links to the UK and Ireland which it intends to combine its existing corporate finance business in these areas with Numis, a leading UK corporate broking and advisory house. The deal is again expected to be completed during the final quarter of 2023 subject to regulatory approval.

First Republic Bank, the third bank to fail since March after Silicon Valley Bank and Signature Bank, saw several bidders trying to capitalise on the bank’s demise. The bank had been seized by regulators and the Federal Deposit Insurance Corporation (FDIC) was subsequently appointed the bank’s receiver. In the last week of April, the FDIC had been reaching out to other big banks in the US to gauge interest in acquiring its assets. On Sunday 30^th April, the race had reduced to just four competitors after the FDIC informed potential investors to input their final bids by a deadline of noon. JP Morgan Chase were one of the bidders and had dedicated the task of due diligence on First Republic Bank to over 800 employees. The deal was later accepted by the FDIC and announced in the early hours of Monday morning, where ‘JP Morgan will pay $10.6 billion to the U.S. Federal Deposit Insurance Corp (FDIC) as part of the deal to take control of most of the San-Francisco-based bank’s assets and get access to First Republic’s coveted wealthy client base’[iv]. US President Joe Biden praised the deal, announcing his evaluation that JP Morgan was helping make the US banking system more secure. The deal has received all the necessary regulatory approvals and has since closed.

On 12^th April US CPI data was released for the 12 months ending in March of 5%, down from 6.0% in February, 6.4% in January, 6.5% in December 2022 and 7.3% in November 2022, continuing its gradual decline since June of last year at 9.1%! This is the largest decrease seen for a while, and lower than expectations which shows some positivity. On 19^th April UK CPI data released was 10.1% for the 12 months ending in March, compared to 10.4% in February and 10.1% in January. A decline has been seen but the headline rate remains above double digits and is now back to the levels achieved at the start of the year. There has been a 1% decrease since October’s 11.1% and there is still a long way to go if the Bank of England is to achieve their overall inflation target of 2%. The next meetings for the Federal Reserve, Bank of England and the European Central Bank will be held at the beginning of May where they will once again address the decision of whether to change interest rates.

In other asset classes the UK 10-year Bond yield started the month at c.3.429%, ending at c.3.718% showing an increase in yields, returning to levels last seen at the end of February and beginning of March. On the other hand, the US 10-year Treasury yield started the month at c.3.432% and ended at c.3.452% showing little gain (and unlike the UK 10-year bond has not returned to its levels at the beginning of March). The price of Gold, which increased in March, saw little movement during April remaining at high levels. GBP continued to gradually strengthen against the US Dollar over the course of April ending the month at its highest level since the beginning of the year. Global equity markets closed marginally higher in April. In the UK house prices have increased by 0.5% ‘following seven consecutive falls going back to last September’[v].

Overall, April has seen less volatility than has occurred since the beginning of the year within asset classes. Brent Crude, after starting the month back at levels of c.$85 per barrel, increased slightly over the course of April and subsequently fell, ending the month at c.$80 per barrel. UK 10-year Bond yields were higher than US 10-year treasury yields.

[i] https://www.reuters.com/world/us-pledges-another-26-billion-weapons-aid-kyiv-statement-2023-04-04/

[ii] https://www.reuters.com/markets/deals/rathbones-investecs-uk-wealth-arm-merge-deal-valued-839-mln-stg-2023-04-04/

[iii] https://www.reuters.com/markets/deals/deutsche-bank-buy-institutional-stockbroker-numis-511-mln-2023-04-28/

[iv] https://www.reuters.com/business/finance/california-financial-regulator-takes-possession-first-republic-bank-2023-05-01/

[v] UK house prices rise after seven months of falls; factory downturn deepens; eurozone inflation rises to 7% – business live (theguardian.com)

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