Wednesday, August 3, 2016

5 Things To Focus On

Via Fasanara Capital's Francesco Filia,
Oil failed to conquer and retain 50$ and is now falling off visibly again: both Brent and WTI lost ~20% since mid-June highs. This is in stark contrast to the price action in Base Metals, as they push through new ytd highs despite weakness in the global economy. We also keep a close look to the USD, which has historically been well correlated to Oil prices. We continue to expect Oil to move erratically, alongside a downward trend, which will eventually take it into new lows. We also expect Base Metals to eventually give in too and remain at levels in line with a depressed economy entangled in structural deflationary trends.
BRENT is currently playing with 200days moving average
During the last 5 years, at times Brent prices cut through 50d, 100d and 200d MAs, a sudden drop followed.

OIL and BASE METALS decoupling, again, while moving in opposite directions
Base metals have closed their underperformance gap vs Oil, which opened up in May, as they moved higher in absolute terms while Oil fell. All this happened despite red-flashing signs of slowdown in the global economy.

Brent (inverted) vs USD Index
Historically, the USD has been nicely correlated to Oil prices. Lower levels for Oil normally coincided with higher level of USD (alongside various fundamental drivers). This is not the case at present, as markets assess the case for Oil to drop more violently from here. The dollar may experience a leg up if Brent prices keep falling.

US Earnings and US Sales confirm their downward trend: behind the smoke and mirrors of headlines beats on skilfully lowered guidance - a trend we got accustomed to in recent past, US earnings’ and Sales keep deteriorating, having been in a downward trend for the last 5 quarters. Valuations are over-stretched as a consequence of (i) lower bond yields distorting equity vs bonds valuations, and (ii) generous 2017 earnings’ upgrade expectations. Equity markets' consensus for 2017 seems then to entail that (i) bonds are wrong in factoring in a depressed economy (although that is the reason for the permanent Central Bank monetary expansion itself), and(ii) escape velocity of GDP is just around the corner. We expect such expectations to be misplaced (see May 2016 Investment Outlook), complacency to gradually fade (see Article: S&P the last castle to fall). We expect extreme valuations to give in, and cheaper US equities. To us, it is more a question of 'when', rather than 'if'.
US Earnings and avg. Sales are trending lower
Earnings/Sales moving lower but the market simply postpones the robust recovery to come, by expanding multiples to historically-silly levels. Just minor delays on the loose schedule of a strong US economy, or markets in denial?

S&P implied volatility moved to new historical lows in recent pastlower implied volatility can only exacerbate the virulence of any downside movements, as and when they occur, for it seduces weak-hands bond-type investors into equity markets, whose mandate is not drafted for stomaching equity-type volatility bouts, resulting in hot money flows at such inflection points when the market heads lower. Low historical volatility also entices Risk Parity strategies, algorithms / CTAs, and more leverage, ready to evaporate quickly once that low volatility gives in. Low volatility is a value trap: it is not so much a reason for an equity sell-off, but rather it may affect its shape and tempo, should a sell-off occur, as we expect.
US Banks have decoupled from US rates: while EU and Japanese banks have closely followed the path of interest rates / the slope of the yield curve, US Banks have decoupled markedly from them. We expect this divergence to correct in the following weeks, as US Banks move lower more than rates, or move higher less than rates. Our case for the EU Banking sector to hit new lows in the near future (see Article) - on grounds of profitability more than solvency - can be extended to US banks too. We look at this as a top value opportunity for the months to come.
US Banks have decoupled from US yields
The three following charts shows US, EU and Japanese Banks against their respective government bond yields. Comparing bank equities to the slope of the yield curve leads into similar conclusions.
While EU and JPN banks have closely followed the rates, US banks diverged from the level of interest rates. We may expect this to correct in the following weeks

Japanese yields experienced their largest 4-days sell-off since 2003the 10yr JBG yield rose ~23 bps since the BoJ meeting’s disappointment of last Thursday, where Kuroda ruled out the possibility of additional rate cuts. We follow closely the moves on JGBs, to see if they may lead to a 2015-type Bunds riot or 2013 l-type Taper Tantrum moment, while only temporarily so.
10yr JGB’s yield experience its largest 4 days rise since 2003
This is a trend to be closely followed, since it may lead to a larger sell-offs in US Treasuries and EU Bonds, although temporarily, as it was the case in April/May 2015.

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