Risk-Adjusted Return Monitor Summary & Views

a global macro investment newsletter by Neil Azous

Morning Edition | October 29, 2018

Risk-Adjusted Return Monitor

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Summary & Views Contents

If Markets Fade The Keyboard Warrior, Retreat Fast Summary & Views Top Observations . Update – S&P 500 Tracking Portfolio . Help Me, Obi-Wan Kenobi. You’re My Only Hope Economic Data . Two Negative Headlines Ignored Last Friday

. Regime Shift Takes One Step Forward On The Charts . Tracking Portfolio – Performance – October 26, 2018 COB: WTD +0.93%, MTD +2.19%, +6.21% YTD net Tracking Portfolio

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Update – S&P 500

Over the weekend, the “keyboard warriors” were out in full force. Anyone who writes for a living, but does not manage money, are strongly advocating for a bounce in risk assets. Anecdotally, the decibel level was so high that earplugs were required.

Two other supporting catalysts, both worthy of respect, are receiving airplay.

After a 20-30% drawdown in cloud stocks, the news flow that IBM is set to acquire Red Hat for a +60% premium is welcome. At the same time, the idea that Google will be the biggest loser in that deal because it solidifies them as the #4 player will keep i-Bankers busy. Considering that type of money is pocket change for Google, if they let that happen without a fight or another purchase that will expose their lack of growth plans or commitment to the space. Worded differently, this space just became off-limits from the short-side.

The next section is on buybacks. It is self-explanatory.

The high of 2947.00 in S&P 500 futures (ESZ8) was made September 21st. The low-to-date was last Friday at 2627.25. The 23.6% Fibonacci level is 2702.75. A break of that resistance, especially on a closing basis, opens the move up to 2736.44, the 55-week moving average, or the level that crystalized the medium-term trend change.

Traders will continue to trade Fibonacci aggressively because it has been the best technical during this correction and the last one in February. However, we sense that investors have little desire to be involved between the 55- week MAVG and last Friday’s low. There are just too many catalysts to handicap between today and November 9th.

Help Me, Obi-Wan Kenobi. You’re My Only Hope

Like last February, the market is hoping that corporate stock buybacks will be the catalyst for a recovery in share prices. Below are various illustrations for corporate buybacks from Deutsche Bank, UBS, and Jefferies. They all point to an acceleration over the next week to peak repurchases in mid-November. All we are doing is aggregating the information.

See the left chart below from Deutsche Bank that shows Google search trends for the buyback blackout. We find it concerning that Main Street is searching for “buyback blackout” to this degree. Said differently, retail investors are just as “hopeful” as Wall Street that they will be bailed out.

According to UBS, buybacks don’t typically peak until around mid-November. They see rebalancing as providing key support combined with ~$170bn of buybacks + dividends over the next month (vs. $47bn last 4wks).

According to Jefferies, based on current stock price and Daily Allowable Limit within 10b5-1, buybacks can represent up to $32.7bn of notional buying power per day if no company is in a blackout period. Right now, $13.2bn or 40% of the daily notional buying power is blacked out. $7.5bn of notional buyback re-enters the market by the end of next week (11/2) and an additional $2.7bn by 11/9. The top 10 largest company’s in terms of daily notional buyback re-enter the market before 11/9. As a reminder, 384 companies in the S&P 500 have an approved buyback of $1.2T in aggregate.

Two Negative Headlines Ignored Last Friday

Throughout October, in some shape or form, the market received positive news flow that President Trump and President Xi would meet at the G20 Buenos Aires Summit on November 30th. Despite that event being far away, market participants viewed the meeting as an incremental positive step.

Last Friday, the market largely ignored news flow that the US is considering removing trade from the Trump-Xi meeting agenda. A Bloomberg story cited the White House saying:

G-20 meeting is still in planning stages; but White House is considering excluding trade from the agenda of a meeting between President Donald Trump and China’s Xi Jinping but likely won’t cancel it altogether, said 2 sources.

Secondly, last Tuesday, the Chairman of the House Ways and Means Committee, Rep. Kevin Brady, said the committee would be working with President Trump and his team on the design of the next round of tax cuts.

Despite that a 10% cut for the middle class needing to go through the legislative process, the market understood the reduction in the capital gains tax as only requiring an executing order. Meaning, that is something President Trump could initiate before the Mid-Term Elections to give his party a boost.

Last Friday, on CNBC, Brady said:

“We expect to advance this in the new session of Congress if Republicans maintain control of the House and the Senate,”

In so doing, Rep Brady acknowledged that it is unlikely to be on the agenda for the post-election lame duck session, even if President Trump has signaled otherwise. (Source: Roll Call, Article)

Regime Shift Takes One Step Forward On The Charts

Two large structural positions – Amazon Inc. (AMZN) and US fixed income flattener – closed offsides on a weekly basis last Friday.

We view these structural positions as the same trade. Value has a very high positive correlation to the yield curve, and momentum a high negative correlation. As the yield curve steepens, value relative to momentum should outperform. This relationship took a step forward on the charts last Friday.

AMZN closed below its 200-day moving average and 23.6% Fibonacci retracement level for the first time since early 2016. Put another way, this is the first time a chartist could link a technical observation to AMZN since they became the most important company in the world.

The 5/30yr US Treasury yield curve closed above 40 bps last Friday, a pivotal level throughout 2018.

More specifically, the 5/30yr US Treasury yield curve is “bull steepening.” Meaning, the 5yr is rallying the most on the curve in a sign the Fed is “done” raising interest rates.

The best way to see this is to look at the US Treasury 2-5-30 year butterfly (the “fly”).

The “fly” has fallen ~35 bps from its peak in May, indicative of the 2-5yr part of the curve flattening and the 5-30yr part of the curve steepening. For example, the 2-5yr part of the curve – a direct linkage to future rate hikes – closed within 0.5 bps of a cycle low on Friday. This degree of outperformance by the 5-year to the “wings” near the end of a tightening cycle is indicative of the market pricing the Fed being done raising interest rates in the very near term. Note, back in 2006, the same observation was made, and the Fed was done raising interest rates within three months.

Another way of observing this shift is the 3m-10y Treasury spread (not shown), which closed at ~75 bps on Friday, roughly equivalent to the end of August when it closed at 72 bps, the prior low, which caused all the angst about the yield curve. This is the Fed’s “preferred measure” of recession risk and is trading the same “policy error.”

If the Fed is “done” in the near term, there is plenty more room for the 5yr to outperform and drive further technology/momentum/growth underperformance.

[Back to top]

Top Observations

Markit Tidbits

. Good Question: What if the domestic credit market reaction to CNY weakness tightens Chinese financial conditions less than everyone thinks and the US equity market reaction to US tariffs that counter CNY weakness tightens US financial conditions more than everyone thinks? (Source: Karthik Sankaran)

o S&P500 vs. China A-shares: Is this the part where we say "no one wins a trade war"? (Source: Callum Thomas)

. Great Line: “The only way we find a bottom is if the FOMC signals they may tactically pause and reassess the economy in the first half of 2019, after the December move, and if Trump and Xi come to a comprehensive agreement in principal at G20 when they meet at the end of November,” said Barry Bannister, head of institutional sales strategy at Stifel Nicolaus in Baltimore. “If so, that’s a Santa Claus rally, but until then, it’s Halloween every day for investors.”

. After Japan’s stock market close, Fanuc (6954 JP) Posts Revenue Drop on China Weakness

o Posted its lowest quarterly revenue in 1.5 years; cut its sales forecast for the fiscal year, as orders for machine tools from China weakened amid trade tensions with the U.S. o Sales dropped 9.5% from the year-earlier quarter to 162 billion yen ($1.4 billion) in the three months ended Sept. 30

o Sales of robomachines, which include robotic drills used to machine the metal casing for Apple Inc.’s iPhones and injection molding equipment, dropped 41 percent o China’s share of the revenue in the segment shrunk to 31%, from more than half the previous quarter o Total orders from Chinese manufacturers plunged 49% from a year earlier o Fanuc cut its full-year sales outlook 1.8% and lowered the operating profit target 5.3%

. ISM Peak This Week?: US ISM Manufacturing data is released Thursday. Deutsche Bank asks if MMM’s poor performance following last week’s earnings release is a harbinger.

. Tighter Consumer Credit: Two of the biggest credit- card issuers are tightening lending standards, an unusual move in a strong economy that may signal longer-term concerns about consumers’ financial health. Capital One Financial Corp. and Discover Financial Services said last week they have become more cautious in how they’re handling credit limits. The two lenders said they don’t currently see signs of deterioration in consumers’ ability to pay their debts but do question how much longer the economic recovery will last. (Source: WSJ, LINK)

. Capex - Weakening:

o Left Chart: Manufactures New Orders & Shipments for non-defense capital goods ex-aircrafts. (Source: Deutsche Bank)

o Right Chart: Capex plans in freefall (NY, Philly, Richmond, KC average, equal-weighted) (Source: Bespoke)

US Mid-Term Elections

. Midterm Election Survey Results (Standard Chartered, Englander):

o Scenario 1: Market participants expect the Democrats to win a small majority in the House. This is expected to generate a small drop in equities, bonds yields and DXY and a small gain in CNY.

o Scenario 2: A somewhat larger Democratic win would extend downward pressure on yields, equities and bond yields, and lead to further CNY appreciation. Were the Republicans to surprise and squeak through with a narrow win, equities, DXY and yields are expected rise and CNY would fall. Few expect a big blue Democratic wave.

o Scenario 3: The US midterm elections may be a catalyst for more volatility in the equity and interest rate markets. Oddsmakers expect the Democrats to take the House and for the Republicans to hold the Senate. The “tail” event for the market is a Democratic sweep of both chambers. If that happens, most investors believe the stock market will react negatively and bond yields will fall.

Central Banks

. BOJ: It's All About Flexibility (Source: TD Securities)

o We expect no changes at the October Bank of Japan meeting. The policy rate will be unchanged at -0.10% and forward guidance will remain intact. No additional flexibility in yield curve control (YCC) will be announced at this time.

o Nonetheless, YCC flexibility will be an ongoing theme going forward. A window of opportunity to conduct an additional tweak could emerge in H1-2019 and we look to this meeting to provide clues.

o While risks (notably related to China) remain, a constructive tone should still prevail. With the market now challenging Fed leadership following the equity rout, we think the JPY remains biased to trade on its front foot.

. BOJ to Discuss Ways to Make JGB Trading More Active: The Bank of Japan will discuss measures to make trading of Japanese government bonds more active at its policy meeting to be held Oct. 30-31, the Asahi newspaper reported on Saturday, without citing anyone. The move will follow the bank’s decision on July 31 to take steps to reduce the side effects of its massive monetary stimulus program, as the current policy is causing JGB trades to shrink, the paper said. The bank will consider delaying purchases of long-term JGBs until two business days after the Ministry of Finance’s auctions, the paper said. The BOJ will also discuss reducing the frequency of mid- and long-term bond purchases, it said. (Source Bloomberg, Aya Takada)

. Fed’s Balance Sheet Normalization: "I remain highly confident that the FOMC’s framework for the normalization of the stance of monetary policy—both in the overnight market and the balance sheet—will continue to proceed smoothly, without unnecessary surprise, disruption, or volatility in financial markets." (Source: Simon Potter, Head of The Markets Group, New York Fed in speech titled U.S. Monetary Policy Normalization is Proceeding Smoothly delivered October 26th at the China Finance 40 Forum - Euro 50 Group - Banque de France, Paris, France)

. General: We do not see recent financial market volatility as sufficient cause for the Fed to engineer a pause. Another rate hike in December remains our base case.

Stimulus is providing solid momentum in the US, but further moderation in business investment suggests such momentum is likely to be transitory. Chinese authorities continue to implement measures to support growth, but data since mid-year point to lack of policy transmission. A decelerating US and China is something the global economy may need to digest next year. We see risk the ECB revises outlook lower in December. (Barclays)

. Bank of Korea: Various downward pressures on the economy exist, although the current economic trend is likely to be sustained next year. it’s true that the current downward pressures on economy seem "a bit big" and BOK’s rate decision will be made after taking into account all aspects. A rate hike will only come on the premise that it won’t put significant "burden" on growth and inflation. (Source: Bank of Korea Governor Lee Ju-yeol, parliamentary audit)

o Monetary policy needs to be accommodative at current situation, and the central bank has continued to maintain such stance. A single rate increase does not mean BOK will start monetary tightening, rather it would mean BOK is heading into monetary normalization o Note that South Korean 10-year yield fell by ~9 bps last night.

Cross Asset

. 1-2 bps from Repeat? Graphs depicting requisite ED curve flatness combined with SPX weakness presaging prior Fed pauses. Since '87, Fed either hiked just once more or paused each time ED5-6 & ED5-9 were 0/neg & SPX was -2.5% or lower over prior month. 1/2bp from repeat. (Source: Glarus Trading, Jack Rodeghier)

. Cross-Asset Futures Positioning (Source: Deutsche Bank)

Equities

. US 3Q Earnings Season – Good Point: The important distinction that needs to be determined over the next few months is whether it is earnings themselves have peaked or just the growth rate of earnings. This is a very important distinction. (Source: BAML)

. European 3Q earnings season: Has continued to be fairly weak with more EPS misses than beats for the first time since 4Q14. Sales have beaten expectations, with margins and cost inflation a large source of weakness. EPS revisions are at a 2.5Y low, while price reaction to results has been very poor. (Source: Morgan Stanley)

. Weekly Coppock Curve: has a bearish bias for 33 of the 37 non-US markets we monitor. And a bearish bias for all 11 S&P sectors. No bottom in sight. (Source: Walter Murphy)

. Start of the Bear Market Analogue: The S&P 500 is down 20 of the last 26 days. The only other time that's happened since 1997 was 4 days in October, 2000. (Source: Conor Sen)

. Buying the Dip: Buying the S&P 500 after a week of negative returns had been a profitable strategy from 2005 through 2017, but that no longer seems to be the case, as "buying the dip" in 2018 has resulted in an average daily loss of around 5bps. (Source: Morgan Stanley)

. Medium-Term Trend Change – Bloomberg Cumulative Advance-Decline Line for NYSE Securities (TRADCANY): Closed below the 55-week MAVG last Friday.

. S&P 500 – 55/200 week moving average set up: A weekly close below the 55 week moving average would have to make us more cautious. (Source: Citigroup, Technicals, dated 10/24/18, confirmed 10/26/18)

o Regular readers will know that this set up when it occurs is one our favorite indicators when:

. Price has been above the 55 week moving average on a weekly close basis for an extended period(close to 3 years but at least for 2 years). Price has been above the 55 week moving average on a weekly close basis for 2 years and 9 months. . Price becomes elevated to the 55 week moving average at the highs and a wide gap opens up between the 55 and 200 week moving averages due to the momentum of the move. Both these criteria have also been fulfilled. . We get a weekly close below the 55 week moving average (we stress a close below not a trade below) suggesting a danger to move all the way to the 200 week moving average. The 55 week moving average is at 2,733 while the 200 week moving average stands at 2,323. . Such a close, IF seen, would have to be concerning and would leave little in terms of major support until the Feb-April 2018 lows at 2,554 and 2,533 respectively.

. S&P 500 – Other:

o SPX fell 10% in February this year. It's down 10% since its all-time high (ATH) in September. Two falls of 10% from an ATH in one year has only happened once since 1960, in 1990. (Source: Josh Brown)

o When SPX has been in an uptrend (defined as above the 12-month ma), SPX has fallen more than 9% in one month two times in one year only 3 other times: in 1980, 1990 and 2000. There was a recession and a bear market within a year each time (Source: Steve Deppe).

o Weekly momentum (RSI) over the past 5 weeks fell to under 14. In the past 40 years, this has only happened during bear markets: 1981, 1987, 1990, 2001-02 and 2008. None of these happened within 5

weeks of an all-time high, which is the case this time. SPX subsequently continued lower each time, although in 1981 and twice in 2001, SPX jumped 11%, 12% and 19% within two months (Source: Troy Bombardia).

o Stock have fallen 15 days in October, the highest proportion since 1970 (Source: Ryan Detrick)

. There have been 7 other years since 1950 that were positive going into October and then lost all those gains during the month. November and December were positive in 6 of the 7 instances with an average gain of 4%

o Seasonality typically turns positive into the mid-term elections, but this month is the worst mid-term October since 1978 and the second worst since 1930. In the 22 mid-term Octobers since 1930, SPX has closed higher than a loss of 3% in 91% of all instances. This year is in the small minority. If you are looking for a silver lining, after October 1978, SPX rose 9 of the next 11 months by 17%. (Source: Urban Carmel)

o The Fear & Greed index closed at 6 on Thursday. In the past 20 years, SPX has subsequently gained 86% of the time over the next month by a median of about 4%.

o The DSI for SPX dropped to 10 this week. That was followed by 8% and 6% rallies in the next month after similar DSI levels in February and April, respectively. (Source: Tom Thornton)

. Nasdaq index corrections from All Time Intra-day Highs: Since 1970, last time we had 3 corrections in the same year was back in 2000, and before that in 1999. (Source: @paststat)

. Three -2% Months In One-Year Analog: If October 2018 does close down at least -2%, it will be the 3rd calendar month this year that has done so. Here's every year since 1999 with at least three -2% months before November and how SPX did for the entire year. Middle column is number of -2% months before November. (Source: Odd Stats)

. Elevated CBI And New SPX Low Carry Bullish Implications: The Quantifiable Edges Capitulative Breadth Index (CBI) finished at 10, which is a level I have long considered bullish. The combination of a 10+ CBI and a 50-day closing low is something I have shown in the past to be bullish for both the short and intermediate-term. These are very appealing results, from Day 1 right through day 20. And 20 days out there was just one loser and it only lost 0.2%. Meanwhile, the average gain of the other 18 instances was a sizable 5.7%. The CBI is suggesting we are in a bottoming process right now, and that the market is likely to move higher in the coming days and weeks. (Source: Quantifiable Edges)

. Weekly S&P500 Chart Storm - 28 Oct 2018 - Oversold Examples (Source: Callum Thomas, LINK)

o Almost 80% of global stock markets have seen a "death cross"

o S&P 500: Bullish Divergence: lower low on price vs higher low on the RSI.

. Similar pattern seen in the average RSI for S&P500 stocks - textbook oversold conditions (nb. oversold can go more oversold)

. Another angle on oversold conditions: 52wk NH-NL at 2015/16 levels -- more meaningful washout now...

o VIX vs VXV (VIX futures curve) indicator also indicating oversold conditions for SPX

o Leveraged ETF volumes: ratio long vs short -- another indicator of oversold conditions

o Fear & Greed Index still in panic mode

. Positioning – Equity Futures: The last 3 weeks of CFTC data have shown Asset Managers selling $78 billion in US Equity Index futures (S&P, NASDAQ, Russell, MidCap, and Dow) – that is 13% of total open interest. That is the most we have seen Asset Mangers sell in a consecutive 3-week period (in terms of # of contracts, % of open interest, or USD notional) since the CFTC started breaking out Asset Manager and Leveraged Fund positioning in June 2006. The buy-side’s net long position in US Equity Index futures is now ~$47 billion notional and – outside of the week ended May 29th, 2018 – the smallest it has been since December 2016. From their peak net long position on January 30th, 2018, the buy-side has sold a total of $104 billion notional of US Index futures; since October 2nd, 2018, the buy- side has sold $56 billion notional. (Source: Morgan Stanley)

. What’s priced in? A severe slowing: economic stagnation with an ISM at 50 (versus the 58-60 range over the last year); zero earnings growth (versus 25%headline and 15% ex tax cut). (Source: Deutsche Bank, Asset Allocation & Delta-1 Strategy, Investor Positioning & Flows, 10/26/18)

o The S&P 500 relative to its 200dma (to adjust for the trend), has historically been strongly correlated with macro and earnings growth. The S&P 500 is currently pricing in an ISM of 50 or economic stagnation and similarly earnings growth of zero. We do expect earnings growth to slow next year, but to 10%, close to the underlying growth rate of 12% which has prevailed since early 2017. Current market pricing implies a faster and more severe slowdown in macro and earnings growth than after the US dollar shock which saw the dollar rise 25% in 9 months and a collapse in oil prices. Such sharp declines in growth have historically only happened around recessions.

. Why We Could See A Huge Rally Over The Next 3 Days (Source: Jesse Stine)

Foreign Exchange

. Trading: We expect a risk rebound which could be FEDERAL RESERVE SOMA DAY catalysed by China stabilising the CNY, European Daily Impact Par Monthly political risks moderating somewhat or signs of a slower on US BBDXY (%) SPX (%) Value Cap US economy. EUR, GBP, NOK, SEK and BRL should Liquidity perform best this week. (Source: Morgan Stanley) 2017-10-31 8.7 -6.0 6.0 0.09% 0.09% 2017-11-15 11.0 -3.5 6.0 -0.06% -0.55% . Trading: If the end of the week sees another solid job 2017-11-30 7.9 -2.5 6.0 0.01% 0.82% gain in the US, accompanied by a move in average 2017-12-31 17.5 -6.0 6.0 -0.52% 0.83% hourly earnings to 3% per annum, foundations of the risk 2018-01-31 27.6 -12.0 12.0 -0.17% 0.05% sell-off will have been reinforced. EURUSD will probably 2018-02-15 16.6 -4.1 12.0 -0.46% 1.21% still be in its 1.13-1.18 range though downside is in danger 2018-02-28 32.0 -7.9 12.0 0.20% -1.11% at some point now, but the US dollar is likely to remain 2018-03-31 31.2 -12.0 12.0 0.06% -2.23% well supported, AUD and NZD remain vulnerable, and 2018-04-30 30.4 -18.0 18.0 0.31% -0.82% the yen should continue to find support. It has been the 2018-05-15 26.2 -8.6 18.0 0.60% -0.68% pick of the G10 currencies in October and should be for 2018-05-31 28.5 -9.4 18.0 0.07% -0.69% Q4 as a whole. (Source: Societé Generale) 2018-06-30 30.5 -18.0 18.0 0.45% 0.31% 2018-07-31 28.5 -24.0 24.0 0.15% 0.49% . Australia – AUD: While AUD/USD has fallen close to 2018-08-15 23.1 -12.6 24.0 0.18% -0.76% AMP Capital’s target of 0.70, it still has more downside 2018-08-31 20.9 -11.4 24.0 0.35% 0.01% into 0.60. The gap between RBA’s cash rate and the 2018-09-30 19.0 -19.0 24.0 0.02% 0.00% U.S. fed funds rate pushes further into negative territory 2018-10-31 22.9 -22.9 30.0 TBD TBD as the U.S. economy booms relative to Australia. Being 2018-11-15 34.3 -17.4 30.0 TBD TBD short AUD remains a good hedge against things going 2018-11-30 24.9 -12.6 30.0 TBD TBD wrong in the global economy. (Source: AMP Capital, 2018-12-31 18.2 -18.2 30.0 TBD TBD head of investment strategy and chief economist Shane Average Last 9 SOMA Days 0.24% -0.55% Oliver) *Source: Rareview Macro LLC, Bloomberg, Federal Reserve

. Month End – Buy Dollars – Second Largest Liquidity Drain To Date: Month-End includes the Federal Reserve draining its balance sheet. So far, the stronger dollar theme remains intact.

. Month End – Buy Dollars: The month-end FX hedge rebalancing model sends a strong signal to buy USD and sell all other currencies at the October month-end WMR fix. The average signal strength measures around 2 historical standard deviations, making it the strongest USD buy-signal since the Global Financial Crisis of 2008. (Source: Citigroup)

. Month End – Buy Dollars: Signal Summary of weighted month end model signals: (Source: Nomura)

o Strong Buy USD vs EUR, JPY, GBP, CAD, AUD, NZD, SEK, NOK, CHF o Strong Buy EUR vs CAD, AUD, NZD o Strong Sell NOK/SEK o Medium Sell AUD/JPY

. Month End – Buy Dollars (Source: Credit Agricole):

. Month-end rebalancing also USD-positive (REBA- days): Month-end rebalancing flows will though also likely be relatively USD supportive, at least against the EUR and Scandis. In our month-end rebalancing model (based on monthly proxied market value changes of bonds and equities since 1989), the monthly negative market value change in USD assets is close to a 2 standard-deviation event (for the first time in roughly ten years), while it is less extreme looking at the EUR-proxy, due to a positive mark to market from German bond markets. (Source: Nordea)

. Monday is a HIA day - good news for the dollar: Is the US tax reform is prompting US firms to repatriate cash on specific days? If a company wishes to convert spot EUR into USD no before the end of October, it needs to do so no later than October 29 (T-2). We call these days “HIA days”, as the effect may stem from Trump’s tax reform, which in turn resembles the Homeland Investment Act of 2004. While such days showed no pattern whatsoever in 2017, the dollar does show a strengthening pattern on such days in 2018. For instance, EUR/USD has weakened by an average of 0.3% (on a close-to-close basis) and done so eight out of nine times this year (a hit ratio of 89%). Other G10 pairs also show negative averages and hit rates of between 67% (JPY, AUD, NZD) and 89% (SEK). In short, if history repeats - or rhymes - the dollar will perform nicely on Monday October 29. (Source: Nordea)

. Equity Weakness Impact on FX – CAD, COP, ILS, MXN Most Exposed to US Demand (Source: Goldman Sachs)

. Positioning & EUR: CFTC data show that at the start of last week, the market was still building a (large-ish) short euro bet, was buying a bit of its sterling short back, and the net dollar position remains long, substantial rather than huge, and steady. Value and positioning both support the euro, but what it needs to recover is higher Bund yields, in absolute terms as much as in spread terms against other bonds. 35bp doesn't hack it, even if the euro gets some relief this morning from a 10bp drop in BTP yields in respond to the lifting of any S&P uncertainty. A week ago, the post-Moody's relief rally was short-lived, to say the least. (Source: Societé Generale)

. Positioning (Source: Nordea)

. IMM POSITIONING for the Week Ended October 23rd saw a decline of USD longs: Noncommercial futures traders reduced USD net long positioning by roughly $1bn in the week ending October 23, prior to the equity volatility later in the week. The largest move occurred against JPY as traders—primarily leveraged funds—cut net shorts. However, speculative traders also reduced net shorts in currencies with positive beta to risk, such as GBP, CAD, NZD, and AUD. Meanwhile, both asset managers and leveraged funds were more bearish EUR on the week, but speculative traders as a whole were relatively neutral. Noncommercial traders also reduced net longs in MXN, likely ahead of the public consultation on the Mexico City Airport project. (Source: Goldman Sachs)

Fixed Income

. We maintain our forecasts for 3.5% 10s at year-end 2018 and a cyclical peak at 3.8% in Q3 2019. Recent equity weakness has been insufficient to materially change the Fed’s rate path. Our colleagues in economics estimate that a sticky decline in the S&P500 to 2450 would be necessary to exert the same drag on the economy through financial conditions as a 25 bp hike. (Source: Deutsche Bank, US Fixed Income Weekly, Tighter By Design)

. Why is Libor widening? Citigroup goes through the calculations...Lower Equities seem to crimp Security Lenders Business... As in the equities they "lend" out are worth less....

. What Share of Bond Markets Do Central Banks Own? (Source: Deutsche Bank, Torsten Slok)

. Weekly Net Supply - Negative: There will be a significant amount of negative net government bond supply this week with only one bond auction in Australia and Japan, none in the US, and heavy redemptions in Europe.

Commodities

. WTI Crude Oil: Still a bit away, but oil closes the month below $63.60, it will have outside reversed the last 5 MONTHS.

. Bearish Crude Oil: Short term momentum sellers have entered the picture as the complex sets new 20 day lows. Trend followers are flipping from long to short as the key moving average crossovers turn lower. RBOB – the weakest market of late–saw the key 10d moving average move below the100d on a roll adjusted basis this week. We suspect the rest of the complex is not far behind. On top of momentum and trend followers turning sellers–the curve structure collapsed this week. The positive roll yield long-term investors have been accustomed to for most of the year has all but disappeared. With systematic traders adding shorts and fundamental traders liquidating positions –we see little to stop the downward momentum for the immediate future. (Source: Rabobank)

o Looking forward: Looking forward we expect the oil markets to stay under pressure. Systematic traders have liquidated long positions and are now building shorts. Fundamental discretionary traders have been caught wrong-footed on this move and are likely being forced out of positions. The fundamentals are simply not compelling enough to stand in the way of the herd.

th o The base case is for Brent to trade down to the low 70s before finding value. The December 6 OPEC meeting will come into focus in the coming weeks and could provide some support to the market. A US- China trade agreement remains the biggest potential upside catalyst in our view, however this is very unlikely in the near term. Perhaps this too will come into focus once we are past the US mid-term elections in early November.

. Positioning – Energy Futures: For the 2nd week in a row, Managed Money sold notable amounts of hydrocarbon futures (totaling $8.3 billion notional across WTI, Brent, Heating Oil, RBOB Gasoline, and Gas Oil futures). Over the past 2 weeks, Managed Money have sold more hydrocarbon futures (as a % of total open interest) than over any 2-week period since June 2017. Managed Money’s selling was most significant in WTI futures and Brent futures, where it was driven by long liquidation. (Source: Morgan Stanley)

o WTI futures: since the ~4-year high in price on October 3rd, Managed Money have sold 130k contracts ($8.6 billion notional). Managed Money’s net long position is now right near its average since 2006; Managed Money are the least net long WTI futures that they have been since September 12, 2017.

o Brent futures: Over the past 2 weeks, Managed Money have sold 105k contracts ($8.1 billion notional). This is the most that Managed Money have sold over a 2-week period (as a % of total open interest) since May 2, 2017. Even with the selling, Managed Money remain 0.8 z-scores more net long Brent futures than on average since 2011.

. Positioning – Softs: For the 3rd week in a row, Managed Money bought > 3 z-score amounts of Coffee futures and Sugar futures, driven by covering shorts. (Source: Morgan Stanley)

o Coffee futures: since the end of September, Managed Money have bought over 76k contracts ($3.5 billion notional) – the most over any 4-week period since these data were reported in 2006. Managed Money remain 0.9 z-scores more net short Coffee futures than on average since 2006, but are the least net short that they have been since October 3, 2017.

o Sugar futures: over the past 3 weeks, Managed Money have bought 172k contracts ($2.7 billion notional) – the most over any 3-week period since these data were reported in 2006. Managed Money are now slightly (0.2 z-scores) more net long Sugar futures than on average since 2006, and the longest they have been since March 2017.

. Iron Ore: Chinese-traded iron ore rose 5% last week, the most this year. Higher Chinese steel prices are in response to production cuts slated in northern China for the heating season. (Source: CBA)

Emerging Markets

. Brazil - Long, then Short BRL: Far-right populist Jair Bolsonaro is widely expected to defeat his left-wing opponent Fernando Haddad in the nation’s final presidential vote on Sunday. Bolsonaro’s win will lead to a nice bounce, and which will be nice entry point to short BRL. Bolsonaro’s honeymoon period won’t last long – he’s political unsavvy, congress remains very fragmented, and Brazil faces considerable fiscal headwinds. This will ultimately lead to downward pressure on the BRL and Brazilian equities (Source: (Brazilian Macro Manager, h/t Chris S.)

. Brazil – Near-term optimism to prevail: The election of Jair Bolsonaro should boost investor sentiment and add material upside to local assets, amid market-friendly policy announcements over the next few weeks. We expect market optimism to be tested late in 1Q 2019, when doubts about Bolsonaro’s ability to approve unpopular reforms should intensify. (Source: ING)

o The USD/BRL should consolidate below 3.7 in the nearer-term, likely reaching 3.5, but we continue to see 3.7 as closer to “equilibrium” for the currency. In particular, doubts over the new administration’s ability to approve unpopular fiscal austerity initiatives are bound to intensify, sooner or later, and weigh down local assets.

. Brazil: The right-wing candidate for Brazil's presidential election has secured victory. This was the outcome markets had expected. The composition of the economic team during the transition will be monitored. Markets would probably appreciate signs of economic continuity. (Source: UBS)

China

. Must Watch - The World’s First Digital Totalitarian State by 2020: The Chinese government has created an extensive social-credit system using its citizens' data (Source: The Economist, Video Link)

. Equities: Consumer-driven Kweichow Moutai fell by the 10% limit after only delivering a 3% profit growth in the 3Q. This led to all industry groups on the CSI 300 falling under very heavy volume.

. Research Calls:

o Alibaba Target Cut To $202 From $224 At Nomura, Remains Buy

o Bernstein downgraded the recommendation on China Life Insurance Co. Ltd.'s American depository receipts to market perform. (9th largest name in FXI at 3.2%)

. Currency – 7.10 Year End: Recent negative growth surprises and the proximity of 7.00 in USDCNY have focused the market back on China. We expect further growth deterioration, as monetary and fiscal policy responses have incremented in urgency over the past two months. We see negative data surprises, particularly in trade data, as a catalyst for further sharp CNY weakness via stoking expectations for nominal and real effective $CNY easing. We continue to see 7.10 in $USDCNY by year-end, and weakness into the new year for the renminbi, as the PBoC manages the pace of depreciation, but defends no level outright. (Source: TD Securities)

. New Stimulus: NDRC to Propose 50% Cut to Car Purchase Tax; suggest tax cut to 5% from 10% on cars with engines up to 1./.6 litres – accounting for 70% of vehicles sold last year.

. Further Economic Weakness: A gauge of sentiment around SME businesses fell to its third lowest reading in the last 10 years. (Source: Standard Chartered)

o Sales turned sluggish on slowing domestic demand and increasing export uncertainty, according to our survey results. Production activity moderated in October as a result, and the outlook turned gloomier. Investment and hiring lost steam, pointing to softening business sentiment over the longer term. Profit margins narrowed on the back of slower price gains and weaker demand.

. Liquidity Contraction: Following a 460bn net yuan injection of liquidity into the banking system last week, the PBOC drained 120bn on Monday, the biggest net withdrawal of liquidity since after the holidays in August.

. Credit Overhang: Some 48.9 billion yuan ($7 billion) of perpetual notes will have first call dates this quarter, which means they either have to repay the debt or be forced to increase interest rates by as much as 500 basis points. While state-owned firms, which make up a big portion of these issuers, are widely expected to redeem on call dates this quarter, all eyes are on whether the private companies that are struggling to raise funds can pay.

. Recent Stimulus (Source: Barclays, dated 10/15/18)

Sell Side Strategy & Calls Of Note

. Understanding the downside for risk assets – Fundamentally we think we have entered a “third” regime. (Source: Deutsche Bank, Global Market Strategy, 10/26/18)

o The first was Fed normalization beginnings when term premium continued to fall but the risk neutral rate was rising. Both of these contributed directly to strong risk asset performance. Mild bear and a strong flattening trend is consistent with very positive risk asset performance.

o The second regime has been one of more caution around very low term premium and the risk that if it rises risk assets would suffer. This regime allowed one to be long risk assets but required curve caps to hedge for the rise in term premium. o The third new regime we think is to structurally wind down long risk asset positions and lift hedges accordingly until it becomes clear that the recovery extension is assured. Our House view is very much that the Fed avoids a recession. We suspect it will take the markets more time to be convinced and hence we expect accordingly ongoing volatility with further downside risks.

. Looking For Buybacks & Rebalancing To Offset Potential Further Selling: After a 3pp decline in the equity vs. bond allocation, we see rebalancing as providing a key support combined with ~$170bn of buybacks+ dividends over the next month (vs. $47bn last 4wks). Valuations are pricing a '15-16 type slowdown and a data disappointment cycle but US economic momentum remains solid as risks remain. The selloff has exceeded the 5%+ type pullback we thought was likely, but we still see the balance of risks as supporting equities into year end. (Source: UBS, Strategist, Keith Parker)

. Primary Trend Down; Margins at Risk for 2019: Rallies should be sold until the liquidity picture improves, valuations compress further or 2019 earnings estimates are reduced. Companies acknowledging margin risk. (Source: Morgan Stanley, Strategist, Michael Wilson)

o The Rolling Bear Market continues to make progress and there is growing evidence that it is morphing into a proper cyclical bear market in the context of a secular bull. o Our primary concern remains liquidity. o Growth Matrix Shows Why Earnings Growth Is Likely To Disappoint Next Year o Good Earnings Growth Not Good Enough. Earnings are on track to grow 22.5% y/y with sales growth of 7.4%, but reactions to prints seem to be more about the market looking to future rather than reacting to 3Q results

. Cuts U.S. Stocks Again as Global Bear Market Deepens (Source: Ned Davis, Chief global investment strategist, Tim Hayes, 10/25/18)

o S&P 500 slump is evidence that no countries will be spared o Recommends equalweight all regions, upgrades U.K. equities o For the second time this month, reduce holdings in U.S. stocks, saying the global bear market is worsening. o Advise investors to trim their exposure to 55% from 59%. o The reduction, which followed a cut earlier this month from 64%, effectively lowered the rating on U.S. stocks to market weight from overweight. o “We’re in the midst of a global bear market with increased downside participation from the overvalued U.S. market and technology sector that helped the U.S. outperform,” Hayes wrote in a note late Thursday. “Bear markets tend to lack safe havens among regions.” o “Conditions are likely to get far worse before they get better,” he said. “Our current advice is to use rallying to get more defensive, with a sustainable global recovery unlikely before 2019.”

. Overweight Miners, a Good Hedge Against inflation: Miners will stabilize as China, EM FX and metal prices are not deteriorating further (Source: JPMorgan, Equity Strategist, Mislav Matejkawrite)

o miners have the second highest positive correlation to inflation forwards, making them a good hedge against rising inflation o banks and insurance are also positively correlated, but JPM has a bearish view on banks o Reiterates overweight miners on positive risk-reward, strong relative EPS momentum, dollar peaking and stabilization of Chinese activity on policy easing o Sees EPS upgrades of 10% for 2019 and 20% for 2020, if underlying metal prices stay at current levels; balance sheets and free cash flow generation stronger than in 2015

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Economic Data

China

Event Period Surv(M) Actual Prior Revised Industrial Profits YoY Sep -- 4.1% 9.2% --

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