DON the HELMETS by Steen Jakobsen

By #SAXOSTRATS

DON THE HELMETS By Steen Jakobsen

The breakdown of the social contract could send Trump to victory and exacerbate volatility throughout markets. Yet, from extreme disruption comes change and the need for a clear out of the current false premises underpinning the system is massive

We enter the fourth quarter with extreme low volatility, term position on dollar possibly sending EURUSD interest rates, inlation and growth, combined with high towards a test of 1.00 and some stabilisation of USDJPY anxiety and social inequality. Q4 can and must be about around 100.00, and more against our core long-term the US Presidential election which looks tighter and view, we’re short gold and silver. tighter but it is also a time of the year which seasonally is weak for risk-on as well when governments typically Another reason for this end-of-year belief in a higher become evasive on how little money they will spend on dollar lies with the credit market. The TED spread, which the budget. In other words ‘It’s show time!’ traditionally illustrates credit stress, has risen 40 basis points during the year, and likewise the related LIBOR, I remained convinced the world can’t survive on a which relates to the price of money between banks. stronger US dollar, but despite this, we at Saxo Bank have been laser-focused the past few months on how The Federal Reserve is yet to deliver a rate hike this the ‘cost of capital’ has risen for non-government and year, but the market has done not one, but two hikes how funding in dollar has been slowly but surely drying for the small amount of money which trades freely up. This has led us to a positive short- and medium- without government intervention. It’s also highly likely

www.saxobank.ae · Saxo Bank A/S · Philip Heymans Allé 15 · 2900 Hellerup · Denmark · Telephone: +45 39 77 40 00, E-mail: [email protected] Dubai, Currency House, 1st Floor, DIFC, P.O. Box:506830, Dubai, United Arab Emirates, Phone: +971 4 381 6000, Fax: +971 4 325 9209, E-mail: [email protected] Abu Dhabi, Etihad Towers, Tower no. 3, Unit 1401, P.O. Box: 43082, Abu Dhabi, United Arab Emirates, Phone: +971 2 408 8000, Fax: +971 2 658 3400, E-mail: [email protected] 1 By #SAXOSTRATS

that post the US election, the Fed will move one more in motion what I have been calling for, for years – the time with a 25-bps hike in December at a 60% chance. need for change.

The Fed still wants to hike, while counterparts the Republican candidate Donald Trump may or may not European Central Bank, the Bank of England and the win the US election but his voters and support cannot Bank of Japan are running out of options meaning the be ignored. The social contract remains broken and the support or Put for the market is weakening. We have implications abound. seen recently that even the policy makers indirectly For the record, I think Trump will be the next US acknowledge that not only is quantitative easing and President, not because of what he stands for and QQE not working, it could feed bubbles in the housing certainly not for what says, but because he is so anti- sector and markets. It’s inally establishment. If Trump takes dawning on them that something the White House, it will not be else is needed. because of him but because of the deep unpopularity of his But what is the something Democratic opponent Hillary else? Clinton who represents 100% THE WORLD IS ONCE more of the same, a course Well the new is the old – don’t which has left many Americans lose me here – as the world is AGAIN DREAMING OF poorer. once again dreaming of a iscal A FISCAL EXPANSION expansion to save the world. TO SAVE THE WORLD Don’t forget that the social This is the very remedy which contract through the centuries was used back in 2009 when this has been built on the trust that most unusual business cycle was kicked into gear, both the ruler and ruled would beneit, not through this but there is one caveat we have to make. cycle of pretend-and-extend. The ruled have lost jobs, disposable income and their belief in the future. Fiscal deicits sit with the politicians and most governments are on a diet when it comes to spending, Anyone running for oice anywhere in the world on an especially the major economies in the West. The anti-establishment platform will be elected I will argue. US, France and Germany are all going into election. This again is neither on merit nor ideas, but merely Typically, nothing happens during an election and in the because this world can no longer deal with more of the ensuing 100 days, so while the rest of 2016 will see talk same. More of the same means a world where we have about one day getting more iscal stimulus and about the highest inequality ever, lowest productivity, steering how we should invest more infrastructure, the political rates and inlation, coupled with all-time low volatility calendar will straitjacket action essentially postponing and maximum complacency. policy until...this time next year! I think Q4 will bring the irst sign of change to the Already, 2017 has the look of another lost year for political process and hence will bring about higher growth, but I get the feeling that 2017 will create volatility in markets. Initially, the market will be shocked enough disruption, noise and marginal change, to set to ind that their portfolio is so correlated that hiding in

WHILE THE REST OF 2016 WILL SEE TALK ABOUT ONE DAY GETTING MORE FISCAL STIMULUS AND ABOUT HOW WE SHOULD INVEST MORE INFRASTRUCTURE, THE POLITICAL CALENDAR WILL STRAITJACKET ACTION

bonds, or gold does not work. The inal warning we have is the fact that we today have cross-asset correlations in the high 60s% meaning there is no hedge to be had as all assets are moving in the same direction. In other words, we have come full circle having not moved anywhere in eight long years. Exhaustion with turning the wheel is at maximum and there’s no-one left who wants to send it spinning again.

All macro changes in history originate from political mistakes. Trump becoming president may be a big mistake, but it will set in motion the disruption which the world needs.

We are headed for a bumpy ride and we’d advise helmets. But, this is also a ride which will clear out a lot of the false premises on which this market has been built.

GREEN BUT GUARDED By Ole Hansen Commodities remain on track to record their irst year of positive returns since 2010. But with the Bloomberg Commodity index up by less than 10%, it could all Commodities are still on track to still change before year-end. While the energy sector continues to stabilise following a two-year sellof, it has post their irst overall green year primarily been the precious metals sector with its 29% since 2010, but concerns remain on gain that has helped stop the commodity rout.

multiple fronts. Crude oil and gold Global commodity demand has yet to recover as in particular face a variety of risk continued questions about global growth are being asked. Instead, most of the gains – apart from those events that could send prices lower seen in precious metals – have been due to the supply before the start of 2017. side adjusting, either through cutting production (oil and industrial metals) or through involuntary disruptions caused by weather (softs).

Oil lower for longer

From the vantage point of early 2016, the year’s inal quarter was widely expected to deliver a irm recovery for oil prices. Prolonged price weakness, it was thought, DURING THE FINAL would ultimately trigger strong demand growth while reducing high-cost production enough to balance the QUARTER WE EXPECT market. Instead, the oil market remains locked in a $45 THE $45 TO LOW to $50/barrel range from which it will struggle to escape from into year-end. 50S RANGE TO BE MAINTAINED Rising Opec supply (both from new production and reduced supply disruptions), together with Russian FOR BRENT CRUDE production hitting new record levels, has once again delayed the rebalancing process. In addition, the past quarter showed emerging resilience among US high- cost producers which are once again adding rigs amid stabilising oil output. Hedge funds provided most of the volatility during the third quarter as the rangebound nature created US producers have been taking advantage of hedging several false signals in both directions. These signals in opportunities in 2017 and 2018. Central banks’ turn supported the rapid ebb and low in speculative experiments with negative yields, meanwhile, have positioning, which helped create a great deal of ensured that plenty of investors have been prepared to volatility. Heading into the inal quarter, funds remain lend money to the sector. overall bullish but the net-long has been reduced by 40% compared the peaks witnessed during April and On top of all this, we still need higher oil prices in the August of this year. future in order to attract the investments required to ensure stable supplies. Opec producers, led by Saudi Arabia, have shown increased willingness to support the price as the slump has now have lasted much longer and been far more painful than was originally expected. Crude oil Upside Downside During the inal quarter we expect the $45 to low 50s range to be maintained for Brent crude oil. A deal among Opec producers and potentially Russia to freeze Opec and Russia agree to Global demand growth led cut production by China and India stalls or even cut production is unlikely to have a major positive impact on prices at this stage. It will, however, reduce the time it takes to bring down the global excess Low prices postpone a Resilience among high- supply overhang of both crude oil and products. much-needed increase in cost producers triggers Capex spending towards renewed production future production growth The lasting impact of such action is not likely to be felt until 2017 on the assumption that global demand growth continues to rise. In a recent Geopolitical instability The rapid accumulation report, the International Energy Agency said that oil increases in key exporting of gold triggers a deeper- countries than-expected correction demand growth from China and India was slowing at a faster pace than initially predicted as underlying macroeconomic conditions remained uncertain.

The one factor that stands out among the key drivers of the impressive rally seen in gold and silver has been the continued tumble in global bond yields. It has reduced or in some cases even removed the opportunity costs THE ONE FACTOR THAT of holding gold compared to low- or negative- yielding secure government bonds. STANDS OUT AMONG THE KEY DRIVERS OF THE GOLD Other drivers which continue to attract attention have been the market’s obsession with the future direction of AND SILVER RALLY HAS BEEN US short-term interest rates, the dollar, and the general THE CONTINUED TUMBLE IN price trends for the commodity sector as a whole.

GLOBAL BOND YIELDS We believe that gold’s longer-term direction is higher but the market behaviour during the past few months could indicate that the yellow metal may need a longer period of consolidation during which a test of key support below $1,300/oz could be seen. Precious metals face a volatile quarter From a technical perspective, gold’s post-Brexit rally ran A US election that remains too close to call, a December out of steam at $1,375/oz, a level that coincides with rate hike, the direction of the dollar, global bonds, and a both a trendline from the 2012 peak and a 38.2% rising concerns about the negative rate experiment correction of the sellof seen up until last December. from several central banks... An eventual break of this level could see gold initially These are just a few of the themes that gold traders will target an extension to $1,485/oz. have to deal with during the coming months. Until such time, we view the downside risk being the Gold spent most of the third quarter locked in the range greatest over the coming months. We would view a established following the Brexit vote on June 23. As the potential break below $1,300 as a positive development yellow metal continued to trade within a diminishing as it would force the market to react and show its hand. range (initially between $1,300 and $1,375/oz), the demand from investors began to fade. Total holdings in It is often during times of weakness that the true exchange-traded products rose by 38% during the irst strength of a market can be gauged and following a half of the year but have been almost lat since then. 25% year-to-date rally, gold may now be in need of such Hedge funds have held an unchanged but still elevated a test. bullish bet for the past three months. With our raised concerns that the dollar may regain More than physical demand, investment demand has some strength during the coming months, we look to been the main driver behind the price surge witnessed gold priced in other currencies for upside momentum. earlier this year. While total holdings through ETPs and According to our forex outlook and intro from Saxo money managers’ positions in futures have reached a Bank chief economist Steen Jacobsen, some of these level just 13% below the 2012 peak, the nominal value alternative currencies could be euro, kiwi, and of this position remains some 35% below. Canadian dollar.

Gold (precious metals) Upside Downside

FOMC commits to a dovish rate hike US dollar enters a period of strength (reducing number of future hikes)

Other central banks keep monetary Central banks begin to show signs of policies super loose => negative bond moving away from negative interest yields => rising allocation from real policies money investors

The rapid accumulation of gold Sluggish global growth and renewed triggers a deeper than expected equity market turmoil correction

Event risks such as the US presidential election

Source: Saxo Bank

QUEASY AND UNEASY By John J Hardy

The gradual transition towards appreciated the implications of September’s key central bank meetings. At the September 8 European Central iscal-led policy from the Bank meeting, for example, the ECB, amid expectations central-bank orthodoxy is for a policy overhaul, was loudly silent and didn’t even extend the horizon of its purchase programme. The inevitable and the reach-for-yield reasons are that its asset purchases are too large for theme could come a cropper in Q4. the European bond market to absorb beyond the established horizon out to March of next year and clearly aren’t boosting economic growth or inlation meaningfully in the irst place. In many ways, Q3 felt like a collective holding-of-the breath in markets as asset markets and currency Then, on September 21, the Bank of Japan delivered volatility largely died down during the quarter, even a bombshell that wasn’t fully appreciated for what it after the Brexit vote rocked the inancial world near the was: a de facto QE taper. The BoJ policy announcement end of Q2. abandoned a set asset purchase target and instead announced a focus on managing the yield curve. The lion’s share of the reaction to the Brexit vote was absorbed in the initial 24 hours and volatility faded The BoJ was clearly running out of bonds to buy and for much of the quarter, even if we did see a steep didn’t like that it was brutally lattening the yield curve devaluation in sterling. Elsewhere, the eerie quiet that and therefore crushing Japanese bank’s ability to eke asserted itself in Q3 was actually an extension of the out proits in a traditional borrow-short, lend-long massive return of risk appetite and the “reach for yield” banking model. The new focus was a very clever one- regime that developed in the wake of the crisis at the two, however, as the bank prevented an avalanche beginning of this year. of yen buying as the move also had longer-term implications. To recap, the meltdown in inancial markets in January forced the Federal Reserve to retreat from its rate- Yes, for the short term it allows the BoJ to taper hike intentions and veered China away from its yuan purchases if necessary when the BoJ has trouble inding devaluation that had been the chief driver of market bonds to buy at reasonable yields while hiding under volatility, but had also been brought about by the the cover of a yield focus. But for the longer term, it yuan’s linkage to a painfully strong US dollar (based also leaves the door open to massive future expansion again on Fed hawkishness). In Q3, the Brexit vote and in QE without having to declare a new purchase target. subsequent Bank of England easing underlined the idea That buying might be needed the day the Shinzo Abe that central banks will never do anything to upset the government commits to a larger iscal stimulus than we market and encouraged a fresh extension of risk taking. have seen thus far.

But the market has overplayed the reach-for-yield This new framework could keep a loor under USDJPY in theme as we head into Q4 and has not suiciently Q4 eventually.

QE to ininity yields to unease

So the ECB and BoJ have stepped of the QE train, showing not only evidence of losing faith that QE acts as intended, but also quite simply bumping up against BUT THE GAME IS UP: practical limits because of the overwhelming size of their programmes, which vastly outstrip government’s MONETARY POLICY ACTING net issuance needs. Market observers might counter ALONE SIMPLY DOES NOT that the Fed could head back into a QE regime if markets destabilize or the US economy shows signs of WORK – AND THE FED’S slipping into recession. LACK OF RECOGNITION IN

After all, Janet Yellen weakly proclaimed at her damp THE COMPLETE LOSS OF ITS squib of a Jackson Hole, Wyoming speech this August CREDIBILITY IN THE MARKET that fresh easing would take the form of more QE, if PLACE IS DISQUIETING, aimed at an expanded palette of assets, and forceful forward guidance. TO SAY THE LEAST

But the game is up: monetary policy acting alone simply does not work – and the Fed’s lack of recognition in the complete loss of its credibility in the market place is disquieting, to say the least. The policy impetus from here is switching to iscal, if with various leads and lags, just as central banks were remarkably out of synch in implementing QE in the 2009-15 timeframe.

But as of this writing, it doesn’t appear that markets fully share our impression of what is going on or appreciate the implications if we are headed into a long period of uncertainty in which markets both lose faith in QE and risk a long wait until iscal stimulus comes in suicient size to move the needle. Our expectation, therefore, is a rise in volatility in Q4 that we thought would be well under way already in Q3.

Our chief trading theme for Q4, therefore, is that with the waning faith in and impact of QE, we expect the large QE currencies will perform well against most other currencies, especially those that beneitted the most this year from the reach for yield theme, like commodity and emerging market currencies.

Chart: Carry adjusted performance of G3 versus commodity dollars (Source: Bloomberg)

Indexed to 100 on January 1, 2007, the chart shows the carry-adjusted OUR CHIEF return of a long basket of USD, EUR and JPY versus a basket of AUD, CAD and NZD. If markets are losing faith in QE pushing currencies from here, TRADING the traditional QE currencies, the G3 of USD, EUR and JPY could rise sharply THEME FOR Q4, against the commodity dollars, where structural headwinds from large private debt bubbles could inally start to come into play in Q4 and have the THEREFORE, IS market actually predicting further rate cuts and even the eventual arrival of THAT WITH THE bailouts, QE and so on. WANING FAITH IN AND IMPACT OF QE, WE EXPECT THE LARGE QE CURRENCIES WILL PERFORM WELL AGAINST MOST OTHER CURRENCIES

Questions for currencies in Q4

Trump or Clinton? Alone, the uncertainty of whether Donald Trump or Hillary Clinton will be the next president will occupy considerable bandwidth in Q4. The supposed no brainer is that a Trump victory would mean greater uncertainty and a greater risk of an asset market correction with supposed lack of faith in the US dollar and liquidation of US treasuries. A focus on the iscal implications of some of his spending and tax cut proposals is also cited as a USD negative.

But the USD might just as well strengthen under Trump as well. Two reasons: markets might position for a massive corporate proit repatriation down the road and more fewer risks to the US economy than elsewhere. As well, new Trump iscal outlays will only arrive with a long lag, and the Fed may be reluctant to play ball with Trump, who would inevitably politicize Fed policymaking.

We’ve not seen political antagonism around the Fed Can any of the G10 smalls stand tall? policy in a generation, not since Reagan-Volcker. The only 100% guarantee with a Trump presidency will be The lay of the land among the G10 smalls (the three that Yellen is no longer Fed Chair when her term runs commodity dollars AUD, CAD and NZD plus the out in early February 2018. Any replacement is hardly Scandies SEK and NOK) is actually quite varied, though likely to be of the Yellen/Bernanke mold and what use is they do mostly share the structural risk from having forward guidance from a Fed with an unknown leader in inlated remarkable private debt bubbles. In Q4, the just over a year? cracks may begin to show in some of these bubbles, particularly in housing in Australia and Canada. Longer USD, EUR or JPY? term, the inevitable response will be enormous bailouts that leverage up the public balance sheet to bail out The USD is our still our favourite safe haven in times of the private sector. QE comes to the small economies, in volatility, though Q4 could be a rough ride. The yen is a other words, even as it is largely losing steam in the G3. diicult call, as the near-term implications of what was We’ve played this scene before – this will mean lower a de facto BoJ taper this September are JPY positive, real rates and weaker currencies. but Japan will likely be the irst major currency to look at iscal stimulus, which will drive real rates lower. The As a basket, the G10 smalls may perform weakly against euro may prove relatively resilient as well on the ECB’s the G3 in Q4. Among these ive currencies, the kiwi stepping away from QE, but a new political crisis over stands out as the most egregiously overvalued, SEK the future of the EU and the ongoing challenges to is rapidly becoming the cheapest, and the others sit Europe’s banks could force Europe more quickly toward somewhere in the middle. We would expect AUD to a massive new easing with iscal support that could see outperform NZD. the euro sharply weaker versus the US dollar. CAD is a bit of a wildcard on the risk of a Trump victory, How low can sterling go? but may get too cheap versus the others commodity currencies if the market overreacts, but NZDCAD may We would expect sterling to ind a low point some fall nonetheless. SEK has gotten too cheap, while NOK is time in Q4, though there could be a risk of weakness getting more fairly priced but is still probably too cheap, stretching into Q1, until the maximum moment of even though it ofers the G10’s most negative real uncertainty when Article 50 is invoked. Sterling is interest rates. getting very cheap, but we may need to see signs of the developed world’s largest current account deicit Is the yuan devaluation going to remain on hold? turning before the currency can stabilize and possibly rally. Sterling could turn the corner irst against a likely The Chinese regime’s intentions on currency policy troubled euro in 2017. are inscrutable, but with the obvious and very scary build up in its credit bubble and the inevitable non- performing loans this bubble has created, one of the safety valves available to relieve the pressure is a further currency devaluation. China will likely keep the rate very stable until at least the other side of the US presidential election.

All bond classes have performed admirably so far in 2016. Quantitative easing and low inlation have been CARRY the driving forces, but also at play was a revaluation of the refashioned emerging market bonds which – as we ME had predicted – outperformed in the third quarter. We also foresaw quite an upbeat scenario following Brexit and a dilution of fear stemming from HOME overexposed risk factors like Chinese growth, low-priced By Simon Fasdal oil and general EM worries. What we did not foresee is the still elusive global inlation and a rather sluggish growth pattern. This resulted in core yields remaining low for most of Q3 with no outlook to a higher path anytime soon.

The transformation towards a less Does this mean that we have an even bigger bond bubble ready to burst in Q4? Not really. In fact, one of inlationary global economy will give the major issues is the lack of global inlation, which is carry trades another magic moment not only dragged down by lower commodity prices but also by an overall lag of global growth. Admittedly, the in Q4. engine is running, and some regions are seeing higher growth levels, but the overall sentiment is that global growth surprises to the downside.

This is not necessary bad for bonds, because it prevents – or at least delays – central banks turning from dovish to hawkish, starting with the Fed. It also keeps the QE doors open in one form or another for the European Central Bank and the Bank of Japan. WE’RE STILL VERY CAUTIOUS

So as long as we have a status quo on growth and ON MOST CORE BOND inlation, there exists a very fertile environment for spread MARKETS, ESPECIALLY over products, and this explains why we have seen some of the riskier bond classes perform well in Q3. EUROPEAN GOVERNMENT BONDS The big question, of course, is where we should focus our attention in Q4. expectations. In turn, this could spur the hawkish camp of Fed members into action and force ECB chief Mario Core bonds Draghi to pull the carpet from under QE letting the “whatever it takes” determination disappear into thin We’re still very cautious on most core bond markets, air. And should we see a substantial spike in oil not only especially European government bonds in longer would core bonds feel the impact, a wave of turbulence maturities, and related products. The risk of being hit would hit all inancial markets too. by the irst wave of inlationary fears would be felt most strongly here. Despite the fact that events are unlikely to pan out like this, the sensitivity of inancial markets to one single The risk of this is slight, but imagine a sudden and commodity is huge and worrying, and is certainly sharp increase in the price of oil propelling inlation something to keep in mind.

Due to ECB QE and overall demand for higher rated bonds, most of the investment grade bonds ofer little or no value. With some parts of the segment carrying negative yields we do not see much value at all here unless you, as investor, are obliged to hold a considerable stake in it.

The European high yield segment is also afected by the contraction of European ixed income, but we have not seen the same contraction as in investment grade, and we believe that the current credit spreads justify (i) The overall low yield environment and (ii) The gradual improvement in European sentiment. That said, a major risk for the European credit market remains – the banking sector troubles that could spill over into other areas.

European corporate bonds However, for corporates and sectors that will beneit from the overall stimulus in Europe, low oil, the weaker As virtually everyone has now lost faith in European euro, QE and a gradual improvement of European corporate bonds, we think it’s time to question if this sentiment, as well as the chances of looser iscal policy, really is a “no-go” area of the bond market. the present level still ofers some value.

Emerging market bonds

EM bonds have seen a tremendous rally throughout 2016, even though some market participants warned against the segment as far back as the New Year. The EM COULD TRADE MORE ROBUSTLY overall rally stemmed from a combination of stabilising EM FX, the overall low inlation sentiment globally, a THAN OTHER BOND CLASSES IN A hesitant Fed and accommodative policies from the HIGHER INFLATION SCENARIO ECB and the BoJ along with dovish statements after the equity sellof early in the year. that EM would be the most vulnerable class in the One can argue that emerging markets are at risk of event of sudden spikes in global yields. Instead, it a setback if we see a trend towards higher global would be core bonds that would take the irst hits inlation, hence higher global yields. Should we see a as we expect an improved outlook for the global big shift in sentiment all bond classes would be at risk, economy would have a positive impact on overall including emerging markets, but our observations show credit risk premiums. that EM could trade more robustly than other bond classes in a higher inlation scenario. To sum up

The reasons for this are: Even in a worst-case scenario with spikes in global core yields, we do not envisage a huge global sellof in riskier • Increasing global yields would be a sign of health for bond classes. Again, moderations in maturities must the world economy that would imply opportunities be taken into account. If we continue the present trend for most emerging markets. of gentle upturns in global growth, continued sluggish • The rally of 2016 has been more a question of inlation and some turbulence in a sideways equity catching up with other bond classes, as shown by market, then every oasis of yield will continue to be a the overall cheapness of EM compared to other haven for global investors, who in our view will continue bond classes (political and structural risk factors to upscale allocations in markets that can still yield factored in). something. This would support emerging market bonds • The correlation patterns we expect do not indicate in the process. The carry trade is here to stay in 2016.

MARATHON BULL RUN By Peter Garnry

The ongoing bull market in stocks has proven incredibly resilient, but can it survive a Fed rate hike and the US election?

This bull market spanning 91 months is almost like a Theories of relativity parasite – we can’t seem to get rid of it. No matter what is thrown at it (Brexit, China slowdown, negative rates, Albert Einstein once said that it’s all relative. Although banking crisis in Europe, emerging market crisis, weak an old quote, it its well with the current narrative in oil prices, geopolitical conlicts…), it always seems to inancial markets. Given the extant prolonged bull relentlessly grind to new all-time-highs. With a hugely market in equities and undoubtedly high valuations interesting US presidential election in November and – The MSCI World index is valued at 22.6 times a likely Fed rate hike around the corner, global equity trailing earnings – unprecedented accommodative markets ind themselves entering another unknown monetary policies seem to have broken down historical battleground. relationships in inancial markets.

Will the bull market survive again?

What in isolation seems like a high valuation is nothing compared to the immense bubble present in government bond markets, with the average G7 10-year yield sitting around 53 basis points. Viewed in that light, global equities (yielding 2.6%) seem like a bargain. Our asset allocation models AS GOVERNMENTS are still long most equity markets and in our view, equities –together with real estate – seem to ofer the best risk-reward ratio on a global basis. The HAVE INCREASED biggest risk deinitely lies in bond markets. THEIR LEVERAGE Ready for higher TO OFFSET WEAK PRIVATE SECTOR Every action has its reaction. The bubble in government bonds produced by central banks does not exist in isolation. As governments have increased DEMAND, THE their leverage to ofset weak private sector demand, the corporate and CORPORATE AND household sectors have engaged in a multi-year long deleveraging process HOUSEHOLD which has ended in the US but continues in Europe.

SECTORS As the below chart on net-debt-to-EBITDA among MSCI World companies HAVE ENGAGED shows, the deleveraging wrapped up in the global corporate sector around the end of 2014. Today, leverage ratios among companies are lower than IN A MULTI- the period from 1995 to 2011 that saw the pinnacle of corporate leverage YEAR LONG reached.

DELEVERAGING The probability of a Fed rate hike in December stands at 59% as of PROCESS WHICH September 23, 2016. Despite the fact that the Fed wants more evidence HAS ENDED IN before hiking rates, the world is ready. US inlation is above 2% (except when measured on PCE core) and the economy close to full employment. THE US BUT At the same time, Europe’s unemployment rate is ticking down and its CONTINUES companies are the least leveraged in two decades. A small rate hike will not derail the corporate sector. IN EUROPE

The value of the vote signal. But one thing seems certain: whether we get Clinton or Trump, the health care sector is in for a November 8, 2016 could become a turning point in rough ride with increased scrutiny over drug prices American politics if Donald Trump wins the election, and the runaway inlation in health care expenses that setting a new course for the Republican Party and the US has experienced over the past three decades. If changing the status quo. The equity market may initially Trump wins, inancials are likely to sell of while a Clinton be spooked, but could come roaring back if Trump victory will likely lead to a more positive reaction simply unleashes a big iscal stimulus programme to kick-start because she represents the establishment. economic growth. If Hillary Clinton wins, we will get more of the same and equity markets will cheer, not Earnings have to stage a comeback because it is necessarily better long-term but simply because equity markets like low risk. With global equity markets in an earnings recession (two earnings seasons with negative earnings growth) The US presidential election, no matter what the investors want to see a change for the better. Equity outcome, will hopefully lead to a new agenda with analysts have steep forecasts with global EPS set to bigger impulse from the iscal side, something that rise by 35% over the next 12 months as oil prices are is desperately needed as the world battles low no longer a drag and the trade-weighted USD has productivity growth and weak demand. stabilised.

There exists no conclusive evidence from history that Among S&P 500 companies, the expectation for EPS equity markets behave diferently depending on who growth over the next 12 months is more muted at 17%. wins the White House. It’s all noise and there is no

MSCI World earnings per share are down almost 20% Our strategic long positions in Amazon (AMZN:xnas) from their peak in late 2014, before the meltdown in and Facebook (FB:xnas) are maintained as we believe oil. While most of the decline can be explained by lower both companies will continue to surprise against oil prices and a stronger USD, it has also helped inlate expectations. equity valuations. In the short term this is not a worry, but we need to see a bounce back in global earnings Twitter (TWTR:xnys) has long been a lost case, but a in Q3 and again in Q4 or else we face a fundamentally nascent turnaround is beginning to deliver results with driven decline in valuation multiples across global equity the recent NFL live feeds being a particular and notable markets. success. The irm’s fundamentals have drastically improved and we are betting that the company will How to trade equities in Q4? eventually be bought at a steep premium.

We enter the fourth quarter on a cautious note but China’s manufacturing activity has improved signiicantly acknowledge that our trend-following model lashes since September 2015 as measured by the Li Keqiang long signals in most key equity markets except the S&P/ Index tracking annual growth rates in outstanding bank ASX 200 Index. Given the events on the horizon, traders loans, electricity production, and rail freight volume. cannot be lax. We recommend being net long equities in Q4, but investors should be prepared to be lexible. The index’s annual growth rates have improved to 9% y/y in August 2016 from 1.2% y/y in September 2015. Based on recent changes in communication from the This has led to a comeback in emerging market equities, European Central Bank and Bank of Japan, we are mining companies, and lately in the Baltic Dry Index. betting heavily on European insurers as the downward pressure and lattening of the yield curve may be over We are playing the Chinese growth story through our for now. long positions in Glencore (GLEN:xlon) and Golden Ocean Group (GOGL:xosl). Our main bets are long Aegon (AGN:xmas) and Generali (GASI:xmil). SaxoStrats Equity Portfolio (as of September 23rd)

Source: Saxo Bank

THE NEW

MANTRA THE CONTEXT IS ACTUALLY By Christopher Dembik VERY FAVOURABLE FOR HIGHER PUBLIC SPENDING Commodities are still on track to post their irst overall green year Once in a lifetime opportunity since 2010, but concerns remain on multiple fronts. Crude oil and gold The context is actually very favourable for higher public spending. Economic liberalism, that has exerted in particular face a variety of risk an overwhelming inluence on policymaking over the events that could send prices lower last thirty years, has been discredited by the emergence before the start of 2017. of the global inancial crisis. There is no dominant economic ideology anymore. Moreover, the role of rating agencies, which have acted as the guardians of Over the past three months, several global central iscal orthodoxy, is now much less important banks have stressed that monetary policy can only buy for investors. time but other actions are also needed. In its previous quarterly bulletin, the Bank of England strikingly However, the real incentive to make public spending is demonstrated that the money multiplier, which justiies linked to historically low borrowing rates on inancial the intervention of central banks, does not work. markets. Global credit conditions are close to the loosest they have ever been with the average yield In those circumstances, the ball is in the governments’ on global government bonds (all maturities included) court. In a dramatic turnaround, all the international hovering around 0.9% which is well below the 10-year organisations, especially the International Monetary average of 2.30%. In some cases, the situation is Fund and the G20, have called for more public spending even more unusual, such as in Germany where more to push economic growth close to its pre-crisis level. than 80% of the sovereign bond market is carrying There is no doubt that this quarter, iscal spending will negative rates. top the agenda for investors all around the world. China and Japan are leading the way

In terms of iscal stimulus, Asia is leading the way. Investment by publically-owned companies has increased by 24% since the beginning of the year in China in a move to ofset the deceleration of private FISCAL SPENDING investment. The aim is to avoid an abrupt downturn of the economy WILL TOP GLOBAL but it also accentuates industrial overcapacity and the INVESTORS’ AGENDA delationary spiral (which has, however, slowed down since the start of the summer due to higher global THIS QUARTER commodities prices). To limit the negative efects,

promising measures have recently been decided including granting equal access to private investors in education and medical care, sending out inspections teams to make sure projects are carried out on the ground and investing in infrastructure in rural areas, where it is really needed. If implemented, these decisions could certainly help ix the economy.

A similar impact can be hardly expected from the stimulus package worth about 28 trillion yen (though direct spending only represents 7.5 trillion yen) that was approved last August by Japan. Compared to previous packages, it is not really impressive. It will probably lead to a temporary burst in industrial production but the efect will quickly vanish once again due to the delationary mind-set of companies and households. There is no easy trigger to switch this mind-set. Until now, nothing has worked. A similar situation occurred in the USA in the 1930s and, actually, only war solved it.

The last Japanese iscal package worth 28 trillion yen mostly consists in infrastructure spending and cash handouts to poor families.

Europe: The end of austerity and of the 3% rule

Unlike Japan, the risk of delation is not the main issue in Europe. Despite very weak underlying inlationary pressures, there is no change in household and corporate behaviour resulting from low inlation for a prolonged period of time. In this context, iscal policy can still be efective.

Europe hasn’t waited for the green light of the IMF to push for iscal stimulus. In April 2015, the Juncker plan got underway. It is on the right course since 20.4 billion euros worth of projects (one quarter of this amount for the beneit of small business and start-ups) have been approved on

a three-year target of 60 billion euros by the EFSI Investment Committee. However, it does not fulil its initial promises in terms of growth.

Therefore, to speed up the process, more than one third of the EU countries have recently launched or plan to launch some sort of iscal stimulus in the coming weeks (e.g. UK and Hungary). Yet, only three countries have suiciently strong public inances to do so: Germany, Sweden and Austria.

The elections and referendums that will take place in the coming months in Italy, Spain and Austria and in France in April 2017 will inevitably favour the spur of populism and weaken appetite for austerity (or iscal consolidation). For the moment, Keynesian-style stimulus programs have not been embraced, with the exception of the UK that may opt for a strategy of infrastructure spending to overcome uncertainty in the aftermath of the Brexit vote.

In most cases, the measures mostly consist in lower corporate tax to prevent delocalisation to Ireland and to stimulate investment. Britain’s vote has also been a strong near-term catalyst for iscal cuts in many countries. However, signiicant tax cuts or tax credits for households, to ofset the important increase that has happened over the past years and, why not, direct cash handouts to poor families like in Japan could occur more frequently close to the election date.

The comeback of expansionary iscal policy put a deinitive end to the 3% deicit rule. As the saying goes, promises only bind those who believe in them. Italy, whose GDP at constant prices has not increased one iota over the past 15 years, as well as Spain and Portugal are expected to miss their deicit reduction target in 2016 and 2017.

In the case of France, considering the economic programme of the main presidential candidates from the right and the left, the election outcome will be, in any case, the break of the 3% deicit pledge, as happened before in the early 2000s. Due to the absence of a coordinated European iscal policy, it is the reign of “every man for himself” that prevails.

Considering its primary surplus, Germany is the largest European country to be able to engage in iscal stimulus. It will eventually be forced to do so to integrate the migrants it welcomed.

The US government frozen by key election Traditionally, the debate is about big government versus small In this debate about public spending, the noticeable absentee is the United government but this opposition States. The honourable performance of the US economy and the upcoming does not make any sense in presidential election do not militate for iscal stimulus. However, we can a globalised world where the easily anticipate that if Hillary Clinton wins, she would not hesitate to use the state needs to further regulate iscal lever when signs of economic slowdown appear. She may be inspired inance and faces the challenge of by the Bill Clinton stimulus package of 1993 that put US growth back on the climate change. We should better right track. talk about smart government: a government that relies on new However, it is more diicult to assess the decisions that Donald Trump technologies to reduce operating could take in these circumstances. His economic programme contains costs, that tackles the issue of interesting measures, such as lowering corporate tax to 15%, but also declining productivity and that absurd and dangerous proposals like ripping up existing trade agreements develops a real industrial policy, and imposing heavy taxes on imports. which have never been done in the past 25 years in most of the rich This quarter will be the opportunity to discuss (again) the role of the state countries. in the economy. Unfortunately, it is a debate that is systematically lawed because it is inluenced by ideology whereas pragmatism should prevail. My message to governments: at all costs, stay away from old-fashioned Public spending is neither bad nor good, and it is certainly not a miracle protectionism and understand that solution, as shown by the example of Japan. Its efectiveness depends on it is a waste of money and time to the economic diagnosis and on its implementation. However, it is quite good support industries that are doomed news that governments will inally step in and that monetary policy does not to decline. Those strategies have substitute for iscal policy anymore, which has been the case since 2008. zero chance of success.

BEFORE

THE ISSUE, AS ALWAYS, IS FALSE TIMING… ARE WE TALKING THE NEXT THREE MONTHS, OR THE GODS NEXT THREE YEARS? By Kay van Petersen

We’ve seen the third consecutive disappointment from We remain in the shadow of the the Bank of Japan’s attempts to ease policy further still largest monetary policy experiment (January 29, July 29, and September 21), consistent rallying of the domestic currencies despite rate cuts/ of all time, and markets are swollen, dovish stances by central banks (witness the EUR, NZD, distorted, and fragile. That said, and the AUD going into their respective central bank while the day of reckoning may well meetings) and of course we saw September 9, where seemingly out of the blue the VIX closed up 40% and be coming, that doesn’t mean it’s the S&P fell 2.5% after close to two months of sub-1.0% coming this quarter. moves in either direction.

What happened right before that? Well, the European The big-picture global macro backdrop is roughly Central Bank met on September 8 and declined to unchanged. We are still in the midst of the largest come out with any more “easing” for the party – not monetary policy experiment of all time, bubbles even an extension of the quantitative easing window. populate the world, and they all share one thing in The market, of course, did not like that one bit. German common: they are a construct of the record low-yield, bunds went from below minus 10 basis points to plus easy money-printing environment by which we remain ive within 24 hours, dragging US and Japanese 10-year surrounded. yields with them and sparking a risk-of environment where everything seemed to have a correlation of one. The sailing into uncharted waters continues, yet hundreds of years of rhyming historical precedents – As I said to clients the following Monday, it reminded loose monetary policy, inancial repression, conidence me of 2008. “There were only two things up on Friday,” I deicits, elevated valuations – do not bode well for the commented; “volatility and the USD – even ‘safe-haven’ future. assets such as gold/silver the yen and the Swiss franc were clobbered.” We are nearing the end-game of the “false gods era” (read: central bankers) and we are seeing lashes of These are lashes of things to come. The issue, as fatigue and doubt appearing over and over again. Just always, is timing… are we talking the next three months, as lightning strikes before the mother of all thunder or the next three years? I am honestly still not sure, but storms, the eventual fallout from all of this will make the we are getting closer and closer. crisis of 2008 look like a minor squall. You can run from global macro for a while, but you can’t It will not be a tight-and-tidy spill linked to the US hide. housing market, but something more like a widespread global cancer. On the lip side of the coin, and just to play “contrarian

Charlie” for a moment, everyone is sitting at record cash and a few things are starting to look very compelling, while waiting for the other shoe to drop and thinking such as USDMXN at 19.90. At close to the 20.00 level, that this is all unsustainable. To my eyes, this suggests long peso/short dollar may be a beach trade for 2017 that the pain trade is up. with the same theme playing out across MXN bonds (short the CDS, long equities etc.). And that’s most likely what we are still going to get, because when everyone is waiting for the inevitable, There are always opportunities – do the work on MXN guess what? The inevitable does not happen. So if you and Mexico. are waiting for a 10% pullback in the S&P 500, well, good luck because there will be an avalanche of cash on The tactical book: Positioning into year-end the side looking to buy any dips. Remember how I said (and really believe) that Brexit was a game-changer? We have incredible event risks going into year-end with That it could potentially be the shock that takes us to a the US presidential election on November 8, the Italian much-needed washout and ultimately a return to the referendum on December 4, a potential Federal reserve business cycle? Well, it didn’t even last a week – the rate hike (November 2 or December 14), the European excess liquidity just absorbed it and the markets treated banking sector – the list goes on. Brexit like a drop in the ocean. With the Fed having missed the opportunity to move The big picture: structural positioning on September 21, and with November 2 considered a wash given the election, the next “real” Fed meeting is The “old-school macro” positions stand: long gold and on December 14 – light years away in this market. At the other precious metals, with the majority of the exposure same time, the BoJ (November 1 and December 20) is constructed through miners in both underlying and not likely to move anytime soon after its recent fumble, long-dated calls. We should see higher highs in the likes and the ECB (October 20 and December 8) will keep its of gold, silver, and other precious metals; the miners powder dry until the Italians vote on the constitution. are still lagging the moves in the underlying and it will be interesting to see whether the reporting season that Net-net, I believe we could be entering the longest kicks of in October starts to feed through to some well- regime of USD weakness/liquidation that we have deserved re-rates. had so far this year. Expect us to break out of the range-trading environments that we’ve been stuck Look at long, positive-yielding government debt with in for months, i.e. across currencies, commodities, the likes of the US and Australia, as well as solid, “real- and equities. This is quite a signiicant call, as the asset” companies with positive- yielding cash lows. successes achieved in these markets have gone to the There are quite a few blue-chip companies yielding range-traders and it’s been hard for macro, CTAs, and 5-10% dividend yield without the gimmicks of inancial trend-followers in general to do well in this choppy engineering (i.e. BP over IBM). I continue to think other environment. alternatives sharing the characteristic of a denominator that cannot be debased – i.e. there is a inite supply – Expect new year-to-date highs in a lot of the yield- deserve some looking into. heavy crosses like NZDUSD (with a move from 0.7274 to 0.7600 possible as the pair takes out new levels) Whether you’re a private individual with access to AUDUSD (0.7669 to 0.79 ), USDINR (66.6125 to 66.30), cryptocurrencies such as Bitcoin or a Family oice with and USDRUB (63.9663 to62.5000). access to German RE/PE investments and the like, some diversiication from traditional “liquid asset markets” is In gold, we can see the metal moving up to will take prudent. out the year-to-date high at $1,384/oz, with a $1,400/ oz breach being very feasible. Cofee, which presently I am also starting to look around the corner into 2017 trades around 153.55, is seeing some very strong

positive price action and market positioning could see signiicant upside with the 180 level being challenged. It will be risk-on (new highs in US equities), and that’s the pain trade given the levels of cash on the sidelines YOU CAN RUN and the fact that everyone has been waiting for the other shoe to drop for the last few years… FROM GLOBAL MACRO FOR A WHILE, The key risk to this USD liquidation/multi-asset range- breaking thesis is if we start to make new highs in G3 BUT YOU CAN’T HIDE bond yields (lower lows in bond prices) once again. In such a case, the very thing that took equities up (lower and lower yields) will unravel equities and lead to an outbreak of risk-of sentiment.

I don’t expect it to happen, but there are deinitely some bears out there watching.

Go kiwi go! We could continue to new ytd highs taking out 0.7600 from the current 0.7274 levels:

Expect new lows in USDINR and USDRUB as the rupee and rouble strengthen to greater ytd levels:

s that a cup and handle brewing in cofee? In my view, 180 is doable from the 150 levels…

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