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While the playbook for the year is naturally diverse (2016 has been all about doing the opposite of what feels right), there are two key market thematics which I feel take pride of place on the radar and, in my opinion, hold a significantly higher probability than a flat market for the remainder of the year.
Firstly, the prospect of a sizeable correction in markets is increasing, although the exact cause is obviously not yet known, but one suspects it will come from a USD rally causing instability in China and Asia more broadly. Central banks have shown a certain camaraderie since mid-February and markets have responded in kind, but there seems to be a diminishing impact on markets from monetary easing, so I question how long can this go on for. It won’t be long before we start talking about an implementation to so-called ‘Helicopter Money’, especially as the debate in the market has turned from one of controversy to how it should be used.*
Importantly, after a three month period of markets rejoicing about China stimulus, a number of key Chinese officials (including President Xi) have used the state-owned press to refocus the market on financial stability and supply-side reforms. There is a strong bid to drive efficiencies and greater productivity, which is clearly needed, but will there be unintended consequences and will they get it right?
At the time of writing it seems aggressive to express an outright bearish view with any real conviction. As a guide, the technical set of equities indices are hardly bearish, credit spreads are not giving clear sell signals to equity investors and the market is not pricing in a full rate hike from the Federal Reserve until mid-2017. However, in the case where traders are faced with a rapid rise in the USD and a sharp pick-up in volatility being short the EEM (iShare MSCI emerging market ETF) would be one of the preferred ideas.
On the absolute opposite side of the correction idea is positioning for a move into trades that benefit from a longer-term reflationary cycle. Central bank policy is (rightly) accommodative, notably with the real ‘neutral’ federal funds rate sitting at -1.6% and both the European Central Bank and Bank of Japan incentivising the supply of credit into the economy through the banking channels. The real kicker here though will come from a genuine rotation by global Mutual Funds and Asset Managers out of a fairly concentrated holding in technology and healthcare stocks into energy, industrials and US financials. Of course, price will display any rotation front and centre, while investment bank flow data will confirm this. Twitter is a really good place to find this information.
Despite this view being very much out-of-consensus, the platform is set. We are also seeing a massive increase in corporates issuing debt in the US and Europe, which is bullish and shows real confidence in the financial landscape. Corporate buy-backs will stay robust through the US and European summer and should keep equity markets supported, although for this trade to really come to fruition it would be great to see corporates use their excessive cash hoards to invest in growth and CAPEX. Oil prices, at the time of writing, look bullish and again this should lead to higher nominal inflation expectations if price can push into $50 and sustain this level.
Names I like in this environment are JP Morgan and Bank of America, where reflation should promote a steeper yield curve, which will greatly improve margins at a time when current valuations suggest minimal longer-term earnings growth. On the energy side, BP, Chevron and Woodside Petroleum look attractive if the reflation theme kicks in, although each appeals to an individual’s risk tolerance to the sector.
* For traders who want to understand more about ‘Helicopter Money’ reach out on firstname.lastname@example.org.