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Episode 8

Top charts for 2020

Published on: December 18, 2019 • Duration: 15 minutes

This week we highlight ten charts that matter for 2020 that everyone should have on their radar. Central banks, consumer confidence, commodities and inflation are in the spotlight. The market chatter looks at the outcome of the UK election and the opportunity for UK assets now that the Conservatives have won a huge majority. And the whisper looks at the latest attempts to grease the US repo market with additional liquidity for year-end.

  • [00:00:04] In this episode, I'm going to look at 10 charts for 2020. I'll use a few more than that, but I'm focussing on 10 main themes that I think will be important next year. What's more, many other charts could easily have made the cut. I think these 10 will be at the very heart of the market narrative forming part of the big conversation throughout the next 12 months.  

    [00:00:28] The first Chart is perhaps one of the most obvious ones, which is global central bank balance sheets and the S&P 500. And the central banks we're looking at here are the PBOC, China, the Bank of Japan, the ECB in Europe and obviously the US Federal Reserve. And I guess the big question is, can central banks continue to levitate markets even if or even as the economy slows down? We've seen throughout the last 10 years that as long as those collective balance sheets have been expanding, then the S&P has generally done pretty well. There are two occasions where that collective balance sheet started to tail off in terms of growth or actually contract. That was 2015 and 2018. And both those periods saw much higher equity market volatility. And a lot of people do say, is this cause and effect or is it coincident? And it's uncertain. But it does look like there is some influence. And I think most people would agree that central banks have been absolutely key. And I think if we can zoom in even on just the last few weeks, we can see that with the US Federal Reserve once again expanding its balance sheet since late September, it does look like the S&P has been following the gyrations of that balance sheet with a one week lag. So, with the Fed now set to potentially go into the new year to 2020 with its balance sheet expanding, I think this is still key one to watch and it certainly does look to be extremely influential. The second chart is, is consumer confidence. U.S. consumer confidence. And I picked this chart out because it could also be representative of things like the employment and unemployment data in the US as well. Consumer confidence is riding high and the consumer is a large part of the US economy. So, as long as the consumer is okay, the U.S. economy tends to be okay. The reason why this one's on the radar is because the the labour differential, which is jobs plentiful minus jobs hard to get. That indicator moved into negative territory in the last month. And it's done that five times in the last 30 years. It's meaningful that this thing is rolling over. But what's really important here is when we look at consumer confidence itself, consumer confidence, when it turns down, it drops off a cliff dramatically. And right here, right now, we are testing the sort of trend channel that has been in place for the last eight years, very similar to the last four where we saw a collapse. So, is that labour differential telling us that we're about to see a collapse in consumer confidence? Thirdly, the dollar and the dollar index the D X Y. Now we look at the dollar index, but maybe we shouldn't because it's 60 percent euro. And the dollar index over the last few days has been breaking down. But over the last two years, it's been remarkably well behaved, as we can see with EURUSD volatility pretty much at the multi-year lows. So, the dollar index has been well behaved and suggests that the FX world has been well contained. But I show this breaking down because it is meaningful if it breaks further. But behind the scenes, we've seen a lot of weakness in emerging market FX. They've been struggling versus the dollar and I've picked one here, which is the Brazilian Real. If we have global growth, then emerging market currencies tend to be high beta and should perform well. But we've been seeing is emerging market currencies doing remarkably poorly. And the Brazilian real itself is this cup and handle formation, a technical formation that suggests some upside of dollar versus Brazilian real. And when we look at the dollar, the dollar also then brings us on to commodities. Commodities tend to have an inverse relationship with the dollar. And the first one I'm going to be keeping an eye on next year is copper. Dr. Copper, which is the sort of the embodiment of the global economy. It tends to perform well when the economy is growing. Throughout 2019 it's been testing this this neckline of a head and shoulders formation. And I and many others thought it was going to break down dramatically. Instead, it broke down a little bit and has now recovered and over the last two or three weeks has actually shown some decent strength. Similarly, oil, WTI and WTI again is all pervading or at least crude oil prices are. The reason why I picked WTI is that it's important for the credit market. If you look at this chart of WTI versus the US high yield ETF, you can see the two periods of weak oil prices also coincided with weakness in the high yield ETF. So spreads were widening out. And that's because a large section of the US high yield market is energy high yield. So it's it's a significant impact. But we really care about this because as everyone knows, the stock of credit in the credit market has been exploding over the last 10 years and it's tended to be the lower ends of investment grades, triple B or the high yield sector, where we've seen the biggest growth and therefore the biggest risk. So not only is WTI an indicator of strength in the economy and important for inflation, but it's also an incredibly important input into what's going to happen in the credit market. Which brings me onto to inflation and we have a few charts on inflation. Firstly, China. China has changed in 2019. But one of the problems that they currently have is that Chinese pork prices, CPI has been very, very strong. We've had this problem with swine flu. Chinese inflation, when you look at producer prices, is very, very similar to the CRB, the commodity index priced in RMB., and that's been gyrating up and down for last 20 years and it's been relatively weak. So PPI and CRB have been weak together. Now, if China wants to do anything on the growth front, it needs to inject liquidity that needs to inject credit, but it won't want to do that when it's got a problem with inflation. So as long as this China pork price and CPI is going up, it limits the amount of opportunity that China has to inject credit to grow the economy because they will be scared about CPI inflation. Europe has an inflation problem, too, which is our seventh chart, but it's a one off disinflation or deflation. And on this chart is very similar to the chart in the US. This is the European five year, five year forward inflation expectations. The key point here is this is inflation expectations. When you look at CPI, particularly in the US, it's been relatively well-behaved, but people's concern has been about inflation five to 10 years forward. Inflation is a problem for Europe with inflation expectations. Which brings us on to the next chart, which is banks and banks are important because they are facing an existential threat. This is an endangered species. It looks like the eurozone banks in particular sitting on this 30 year support. If that support goes, we are talking about banks that will probably go under and that could happen in the next slowdown or recession. And you can see why this matters, because that chart of inflation I showed you has been defining where bond yields or German 10 year yields go and German 10 year yields are being followed, tracked by the European banking sector. When those bond yields fall, the European banking sector also falls too. Inflation, yields and banks are critically linked together. And we need those inflation expectations and bond yields to rise, but not so much that they then impact the balance sheets where everybody is holding long term debt in Europe, which obviously will fall if yields go up. Now, the final two charts are slightly different, but it kind of brings it all together, which is that those central banks have in some ways changed the outlook and the framework for the whole economy. We've seen this massive shift away from active towards passive and rules based funds. And when we look at the short, this record short in VIX futures, which are volatility futures, is that something which is reflecting an incredible risk that people are complacent? Or is that reflecting this incredible change in the complexion of the market? It's probably a little bit of both. Things changed in 2012 where people went from using volatility as a tail hedge to downside risk in the economy, to really using volatility as yield enhancement, as they went from being long to short. Which then brings me onto the final chart, which is S&P 500 earnings and the S&P itself. We've seen over the last five years an incredible period of zero earnings growth, of no profits growth, whilst we've seen a new record high after record high on the S&P. Now, in some ways it's similar to what we saw in 2000, but really that was this incredible bubble sentiment where equity prices just got ahead of themselves because everybody was bullish, even though earnings were not catching up. Today, the price action in the equity market is probably reflecting this changed framework. And if we move onto the final chart, which reflects this, is that throughout this period of S&P outperformance versus earnings, we've pretty much only seen outflows from ETF and mutual funds. So people been selling equities, but the market's been going up and up and up. And we know that that's mainly to do with corporate buybacks and it's to do with this increase in the rules base funds as opposed to passive. This is rules based funds, minimum volatility, risk parity. And that's why I think that this final chart is a fascinating one, because we expect the earnings and the performance of the S&P to reconvene, merge. But how long are we going to have to wait if his central bank liquidity in that first chart is the real influence here that could keep this going longer than most people expect?  

    [00:09:46] Back in early November, the British pound was implying that the Conservatives would win a working parliamentary majority. And it looks like the currency markets were pretty good at predicting the outcome once more. But now there's a lot of chatter about what to expect next. And did we get the expected move in U.K. assets in the first place? Well, firstly, the pound did move towards the level that we thought it might get to. When we talked about this. On the 5th of November, it hit 1.35 versus the US dollar shortly after the exit poll on the day of the election. We had anticipated a range of 1.35 to 1.40 if there was a victory for the conservatives and I would still expect a test of the upper end of that range. But up there, there are significant resistance levels. And although the stage is set for the Brexit to go ahead on January the 31s, this is only the first part of a much, much longer process. Sterling versus euro may actually be the more exciting trade, now that it's breaking out of what looks like a three year bottoming formation. Perhaps the biggest surprise given the strength in the pound was that the FTSE100 outperformed other European markets, when I'd expected it to underperform on that sort of sterling strength. But I think this may be that it's a relief across all UK assets that the Brexit process will now move on and that this government has a strong working majority to pass new legislation. And the FTSE100 itself remains relatively cheap as an equity market versus other global markets on a forward PE terms, but in a world dominated by passive funds valuation matters less and less. But the prospects for domestic UK companies looks great. We did see a 4 percent jump in UK real estate sector on the day and its ratio versus the FTSE100 looks like it has further to go. Recall the UK real estate sector has been in a state of paralysis this year with the UK construction PMI hitting recessionary territory around 43.3 earlier in the year. On the fiscal side, Boris Johnson has pledged to cut corporate taxes even further to 17 percent, continuing a trend that's been in place since the 1970s. In fact, foreign direct investment and domestic CapEx should now pick up, which will boost all UK domestic equities. One of the outliers that we had suggested in previous shows was this Conservative government has pledged to increase government spending, making a break from the austerity measures associated with previous conservative governments. The line on this chart of spending should actually start to tick up and this is all part of a global move towards increased fiscal expenditures from all governments. But the UK will be the first mover and this should help UK yields tighten towards US yields having diverged after the Brexit vote in 2016. And if that is the case, we should see a steeper UK yield curve. And if we couple that with lower corporate taxes, then UK banks at least those with Hong Kong risk, should outperform their European counterparts. And this they actually did. They had a very good day in the immediate aftermath of the election results. So in summary, the pound should test resistance levels around 1.40 versus the US dollar. Domestic equities will start to benefit from tax cuts and a re-ignition of foreign and domestic investment. And together that should also help boost the outlook for UK banks.  

    [00:13:01] In a very first whisper segment back in October, we talked about the issues in the repo market in the US and how the global systematically important banks were at the very centre of this problem. And you may recall it in September, overnight, US Treasury repo rates blew out to levels that could have destabilised the complex network of global collateral and therefore also the global banking clearing system. Now the U.S. Central Bank stepped in to ease those funding issues. And this in some ways was basically a problem of huge amounts of visible capital, but very little available capital as the bank's basically continued to hoard the highest quality bonds or cash. Now, although we haven't seen any new funding spikes, not big ones anyway, since then, the Fed has been very, very active, increasing amounts of overnight and term, which is about 14 day repo from 60 billion to 120 billion. But turn the funding - that's the funding over the year end - that's been creeping higher. And the fears of a year end crunch, the sort of crunch that could send risk assets into another tailspin, have been building momentum. Although we didn't get the easing of the G-SIB rules that we touched on in October (and that's the capital requirements of the global systematically important banks), last week, the Fed did outline plans for a significant injection of yet more capital over year end, including 150 billion of overnight repo for each of the 31st  December and the 2nd  of Jan, plus 75 billion for the 31st December, maturing on the 2nd January, plus 10 offerings of between 35 and 50 billion between the middle of December and the middle of January. And some estimates basically put this all together and say that's up to 500 billion of new injections over the next month. And that would take the Fed's balance sheet through its all time highs, even if that's only on a temporary basis. And so with the signing of the trade deal last week ahead of the 15th deadline, that has removed one of the short term banana skins from the market's path. Obviously, we can never say never, but additional short term liquidity and that postponement of the trade debate at least should have taken away two of the biggest stumbling blocks for the markets into year end.