August review and EM debt outlook Geopolitical headline risk remains high and we had expected a fair degree of volatility as we entered this holiday period with impaired liquidity and low volumes. However, following an initial correction, the markets almost sleep-walked through the Ukraine, Middle East and European headlines with ‘risk’ rallying to record levels and the S&P 500 marking its best August for 14 years. It is hard to explain why markets that are already at stretched valuations should rally still further on news that may dramatically affect future growth other than that the effects of Central Bank balance sheet expansion are still playing out, not least the assumption of further market intervention if required. Bad news brought an expected bid to government bonds which would normally be a signal for risk-off but seemed instead to further fuel asset price inflation. The credit markets were driven from August’s lows by the seasonal lack of supply, lack of Russia/CIS issuance and the desperate reach for yield as spreads widened with stronger government bonds. The structural and sanctions inspired slowdown in European growth saw Signore Draghi threaten stronger measures to ward off deflation which helped offset fears of Fed tightening, weakening the Euro into the bargain. US assets also benefitted from a safe-haven effect. Amongst Emerging Market credits Russia/CIS (where we have negligible risk) was a clear underperformer with investors forced to look elsewhere such as Brazil, where polls suggest Rousseff will be defeated at the upcoming election. Broadly, our Latam exposure contributed nicely to performance although the exception was our Argentina GDP warrant position. The country has often confounded in the past and once again, with several positive solutions to the hold-out problem within its grasp, the country stumbled as President Kirchner followed the populist route and proposed a swap into local debt to circumvent court rulings. In time, we sense that the economy will weaken enough to force the government into a market-friendly outcome. In the meantime, our Greek GDP warrants behaved more in line with risk and were better on the month for a small gain. Our Stock picks were broadly flat but the S&P 500, where we were long of OTM puts, outperformed, becoming even more expensive outright and against other markets. In time, we see relative stimulus, valuations and a lower level of share buy-backs in the US as allowing EM indices, where growth remains above that of Western economies, to outperform once more. However, our main concern remains the overall level of risk and whether current trends can continue. Firstly, expectations of ECB action and its efficacy we believe are overdone since QE cannot easily be extended to public bond markets and the amount of private debt available is limited. In the meantime, the impact of TLTRO may be muted if, as happened in the UK, the programme is used by banks to assist deleveraging by replacing existing lending arrangements. In the US, whilst recent data is supportive, income growth is subdued and consumption is once again being largely fuelled by debt accumulation in the form of auto loans and student loans. Wealth distribution is hugely skewed to the ‘haves’ as witnessed by the housing market. We are therefore reluctant to call a big turn in the US Treasury market and whilst this may itself support risk assets, we see a greater chance for some sort of correction in risk. Given the trend in stocks, a catalyst for a correction remains elusive but valuations and geopolitical risks suggest we may be close. However, in credit we are happy to further pare positions ahead of what we believe will be a strong calendar of supply in the next few weeks as markets return from vacation. Last but not least, in commodities we have initiated a long in Coffee futures based on supply dynamics which we see as supportive. Disclaimer This document has been prepared by BT Finance S.A., which has used all reasonable care to ensure that it is fair, accurate, and complete. BT Finance S.A. makes no representation or warranty, either express or implied, as to the accuracy, completeness, or fitness for any purpose or use of such information whatsoever. Nothing contained in this document shall be construed as constituting specific investment, legal, tax, or other advice. The information or opinions contained therein have no relevance to the specific investment objectives, financial situation, or particular needs of any individual recipient of said information. You are advised to obtain specific, personal, and appropriate professional advice before making any investment decision. The information and opinions contained in the document are provided for personal and informational purposes only and are subject to change without notice. The value of investments in any securities, derivative products, shares, or mutual funds may go down as well as up, and, as a result, the investor may not get back the amount originally invested. Past performance is no guarantee of future performance.
Posted on: Thu, 04 Sep 2014 18:54:48 +0000