Thoughts through the cycle: W4 June ’20

Share on facebook
Share on twitter
Share on linkedin

Like a market – only different, from the RWC Diversified Return Investment team

  • The pandemic lockdown has forced many into performing unusual roles. From mask-making by grannies on their sewing machines to parents having to home-school their children while working from home, few have been unaffected by recent events. Things have gone further in Spain where an over-zealous furniture restorer has ‘re-worked’ a painting of The Conception by baroque master Murillo (‘Experts call for regulation after latest botched art restoration in Spain’, The Guardian, 23/06/2020). The striking results can be seen below, with the virgin Mary’s face reduced to a collection of features that are included in a face rather any normal resemblance. While a somewhat abstruse comparison, one might ask the question whether recent central bank hyperactivity has done a similar thing to financial markets in terms of distorting them beyond recognition, especially if one considers ‘what a recession normally looks like’. It kind of looks like a market, but is it really functioning as one?

Financial markets, pre-pandemic, and then following central bank interventions?

Source: The Guardian

  • While it is comforting in an argument to start with a proposition or axiom and to build from there, when addressing the market one often gets a clearer understanding of what is happening simply by looking at how it behaves, rather than adopting a pre-existing conception of how it should behave and proceeding on that basis. For example, one might think the stock market overvalued, but clearly the recent rally means someone has to think it offers upside, otherwise it would not be so resilient. Dismissing current buyers as dumb retail, price-insensitive systematic algos, or passive pension allocations answers nothing. Why the market trades as it does is what the question at hand. The distortion lies in the eye of the beholder.
  • Sometimes a brief episode in market activity can reveal (like a well-painted face) much of what is really at stake in the world, economically, financially and politically. Such a vignette occurred on the 22nd-23rd June, and is worth exploring in some depth as it reveals almost perfectly all the market’s combined hopes and fears.
  • The immediate backdrop has been the growing tension between the US and China. Whether or not this is truly a ‘Thucydides trap’ of the up-and-coming global contender challenging the existing super-power, it has been clear through the Sino-US trade war of 2018-9 that there may well be a new cold war brewing. Accusations that China was slow to tell the world about Covid-19 have only intensified the problem. China has been increasingly aggressive to its neighbours, with June seeing an unpleasant spat with India in the Himalayas, military flyovers of Taiwan, accusations of cyber-attacks by Australia, and moves in Hong Kong to subvert judicial independence and the basic law.
  • It was against this backdrop that Peter Navarro, director of the US Office of Trade and author of the book ‘Death by China’, said in an interview on Fox News (22nd June 2020) that the Sino-US trade deal was ‘over’, adding that, “It was at a time when they had already sent hundreds of thousands of people to this country to spread that virus, and it was just minutes after wheels up when that plane took off that we began to hear about this pandemic,”. The graph of the e-mini S&P 500 future below shows the immediate effect this had on risk sentiment. It also shows the effectiveness of the desperate efforts from the White House to row-back on the comments (immediate tweeting from President Trump, denials by director of the National Economic Council Kudlow, claims by Navarro himself that his comments were ‘taken out of context’).

Source: Bloomberg, 23rd June 2020

  • This explosive sell-off and equally explosive rally is very revealing. It shows the full extent of the White House’s paranoia about stock prices. It reveals too the market’s underlying fear of the growing cold war between China and the US. It shows how in an increasingly systematic, algo-driven, passive investing world, statements by politicians are generally taken as true so long as they are congruent with a risk-on sentiment, lower volatility, and mean-reversion in that context. Language-focused algos clearly cannot compute the political notion of being ‘economic with the truth’.
  • The White House claims that Phase 1 of the trade deal is being implemented and is going well – they do this on an almost daily basis, which is a little worrying itself. Soya bean sales to China are a key part of this narrative, as they fit into Trump’s re-election bid with respect to how well he is doing for the farming community. Data from Bloomberg suggests Chinese soybean imports are up 6.8% in 2020 to 33.9mm tonnes, with imports from Brazil surging in May by 60% year-on-year probably because the Brazilian Real has weakened so these beans are cheaper (‘China’s soybean imports surged in May on buying from Brazil’, Bloomberg, 08/06/2020). Imports from the US are therefore lagging, despite periodic ‘must-try-harder’ headlines about China honouring its commitments as well as constant claims by the White House that China is implementing the deal terms in full.
  • Unsurprisingly, bond yields fell on the Navarro headlines, with 10yr US Treasury yields briefly dropping 3 bps to 0.68%. This is not a big move – perhaps bonds have done their thing. More interestingly was the immediate weakness in the yuan and general strengthening of the dollar. The graph below shows a sharp spike in the yuan before Trump’s soothing tweet allayed the market’s fears. The U.S. Dollar Index (DYX) also spiked from 97 to 97.25 on the headlines. A key element of the market’s reflation theme is the desire for (or possibly need for) dollar weakness to confirm the recovery. That it spikes so sharply in risk-off situations perhaps reveals that reflation is more posture than actuality, and that there may well still be an overall shortage of dollars, especially in the offshore euro-dollar market. The paramount question of the yuan peg to the dollar and China’s closed capital account clearly form part of subconscious concerns within the market’s ongoing recovery narrative.

Source: Bloomberg, 23rd June 2020

  • Most interesting of all was that despite the spike in the dollar, the immediate move in gold was higher not lower. This is entirely at odds with recent positive correlation between equities and gold (note how gold, despite being the ultimate safe haven, was not spared in February and March’s crash). The graph below shows gold spiking up to the very top of its post 2011 trading range.
  • It is a bit of a mystery why gold has been flat-lining for much of May and June despite aggressive ongoing central bank quantitative measures and governments indicating more clearly that their fiscal intervention will be prolonged as V-shaped recovery hopes give way to swooshes, Us, Ws and other less-enticing recovery patterns. The move shown below perhaps shows that a breakout in gold is nearing – deep in the Sino-US conflict is the issue of the dollar and its apparent weaponisation by the Trump regime. Gold is often touted as a possible alternative for a China-centric sphere of influence with its own currency. If gold is also going to see a tail-wind from ongoing money creation by central banks, then the reasons for owning the metal seem to be strengthening.

Source: Bloomberg, 23rd June 2020

  • This short burst of market volatility was just that – very short. A tweet by President Trump was enough for the equity market to trade back exactly where it was before. This above all things shows that the overwhelming sentiment in the market is still that despite the fears in geopolitics or the real economy (not least catastrophic unemployment levels), governments and central banks are still in control.
  • For markets though, this normality does feel strained – this is not just the fear of what lies beneath. Data below from JP Morgan’s cross-asset desk shows how correlation has a 20yr high as central banks have flooded financial markets with liquidity. This is very much an everything rally (except for the US dollar that is), even when experience suggests that certain asset classes (credit and equities in particular) ought to be struggling given the ongoing recession. For now, at least, buyers do not appear especially discerning.

Source: J.P. Morgan, as at June 2020

  • One way of reconciling this is by seeing official action as keeping the market in stasis while the economy tries to recover from a once-in-a-century shock. The question is how long this stasis can be maintained without the money system itself starting to show real signs of strain, either in terms of inflation expectations, real bond yields, or foreign-exchange levels. The greater the effort to keep things the same, the stranger the picture that financial markets offers will be, especially if the recovery in the real economy fails to keep up with breath-taking pace set by global equity and credit markets.

Unless otherwise stated, all opinions within this document are those of the RWC Diversified Return Investment Team, as at 29th June 2020.

The term “RWC” may include any one or more RWC branded entities including RWC Partners Limited and RWC Asset Management LLP, each of which is authorised and regulated by the UK Financial Conduct Authority and, in the case of RWC Asset Management LLP, the US Securities and Exchange Commission; RWC Asset Advisors (US) LLC, which is registered with the US Securities and Exchange Commission; and RWC Singapore (Pte) Limited, which is licensed as a Licensed Fund Management Company by the Monetary Authority of Singapore.

RWC may act as investment manager or adviser, or otherwise provide services, to more than one product pursuing a similar investment strategy or focus to the product detailed in this document. RWC seeks to minimise any conflicts of interest, and endeavours to act at all times in accordance with its legal and regulatory obligations as well as its own policies and codes of conduct.

This document is directed only at professional, institutional, wholesale or qualified investors. The services provided by RWC are available only to such persons. It is not intended for distribution to and should not be relied on by any person who would qualify as a retail or individual investor in any jurisdiction or for distribution to, or use by, any person or entity in any jurisdiction where such distribution or use would be contrary to local law or regulation.

This document has been prepared for general information purposes only and has not been delivered for registration in any jurisdiction nor has its content been reviewed or approved by any regulatory authority in any jurisdiction. The information contained herein does not constitute: (i) a binding legal agreement; (ii) legal, regulatory, tax, accounting or other advice; (iii) an offer, recommendation or solicitation to buy or sell shares in any fund, security, commodity, financial instrument or derivative linked to, or otherwise included in a portfolio managed or advised by RWC; or (iv) an offer to enter into any other transaction whatsoever (each a “Transaction”). No representations and/or warranties are made that the information contained herein is either up to date and/or accurate and is not intended to be used or relied upon by any counterparty, investor or any other third party.

RWC uses information from third party vendors, such as statistical and other data, that it believes to be reliable. However, the accuracy of this data, which may be used to calculate results or otherwise compile data that finds its way over time into RWC research data stored on its systems, is not guaranteed. If such information is not accurate, some of the conclusions reached or statements made may be adversely affected. RWC bears no responsibility for your investment research and/or investment decisions and you should consult your own lawyer, accountant, tax adviser or other professional adviser before entering into any Transaction. Any opinion expressed herein, which may be subjective in nature, may not be shared by all directors, officers, employees, or representatives of RWC and may be subject to change without notice. RWC is not liable for any decisions made or actions or inactions taken by you or others based on the contents of this document and neither RWC nor any of its directors, officers, employees, or representatives (including affiliates) accepts any liability whatsoever for any errors and/or omissions or for any direct, indirect, special, incidental, or consequential loss, damages, or expenses of any kind howsoever arising from the use of, or reliance on, any information contained herein.

Information contained in this document should not be viewed as indicative of future results. Past performance of any Transaction is not indicative of future results. The value of investments can go down as well as up. Certain assumptions and forward looking statements may have been made either for modelling purposes, to simplify the presentation and/or calculation of any projections or estimates contained herein and RWC does not represent that that any such assumptions or statements will reflect actual future events or that all assumptions have been considered or stated. Forward-looking statements are inherently uncertain, and changing factors such as those affecting the markets generally, or those affecting particular industries or issuers, may cause results to differ from those discussed. Accordingly, there can be no assurance that estimated returns or projections will be realised or that actual returns or performance results will not materially differ from those estimated herein. Some of the information contained in this document may be aggregated data of Transactions executed by RWC that has been compiled so as not to identify the underlying Transactions of any particular customer.

The information transmitted is intended only for the person or entity to which it has been given and may contain confidential and/or privileged material. In accepting receipt of the information transmitted you agree that you and/or your affiliates, partners, directors, officers and employees, as applicable, will keep all information strictly confidential. Any review, retransmission, dissemination or other use of, or taking of any action in reliance upon, this information is prohibited. The information contained herein is confidential and is intended for the exclusive use of the intended recipient(s) to which this document has been provided. Any distribution or reproduction of this document is not authorised and is prohibited without the express written consent of RWC or any of its affiliates.

Changes in rates of exchange may cause the value of such investments to fluctuate. An investor may not be able to get back the amount invested and the loss on realisation may be very high and could result in a substantial or complete loss of the investment. In addition, an investor who realises their investment in a RWC-managed fund after a short period may not realise the amount originally invested as a result of charges made on the issue and/or redemption of such investment. The value of such interests for the purposes of purchases may differ from their value for the purpose of redemptions. No representations or warranties of any kind are intended or should be inferred with respect to the economic return from, or the tax consequences of, an investment in a RWC-managed fund. Current tax levels and reliefs may change. Depending on individual circumstances, this may affect investment returns. Nothing in this document constitutes advice on the merits of buying or selling a particular investment. This document expresses no views as to the suitability or appropriateness of the fund or any other investments described herein to the individual circumstances of any recipient.

AIFMD and Distribution in the European Economic Area (“EEA”)

The Alternative Fund Managers Directive (Directive 2011/61/EU) (“AIFMD”) is a regulatory regime which came into full effect in the EEA on 22 July 2014. RWC Asset Management LLP is an Alternative Investment Fund Manager (an “AIFM”) to certain funds managed by it (each an “AIF”). The AIFM is required to make available to investors certain prescribed information prior to their investment in an AIF. The majority of the prescribed information is contained in the latest Offering Document of the AIF. The remainder of the prescribed information is contained in the relevant AIF’s annual report and accounts. All of the information is provided in accordance with the AIFMD.

In relation to each member state of the EEA (each a “Member State”), this document may only be distributed and shares in a RWC fund (“Shares”) may only be offered and placed to the extent that (a) the relevant RWC fund is permitted to be marketed to professional investors in accordance with the AIFMD (as implemented into the local law/regulation of the relevant Member State); or (b) this document may otherwise be lawfully distributed and the Shares may lawfully offered or placed in that Member State (including at the initiative of the investor).

Information Required for Distribution of Foreign Collective Investment Schemes to Qualified Investors in Switzerland

The representative and paying agent of the RWC-managed funds in Switzerland (the “Representative in Switzerland”) is Société Générale, Paris, Zurich Branch, Talacker 50,

P.O. Box 5070, CH-8021 Zurich. In respect of the units of the RWC-managed funds distributed in Switzerland, the place of performance and jurisdiction is at the registered office of the Representative in Switzerland.

Explore more

Thoughts through the cycle: W3 June ’20

In theory at least, in the world of Newtonian physics, if the position, direction and mass of every object in universe is known, then the future can effectively be predicted…

INVESTOR TYPE SELECTOR

Please confirm your investor type

Professional

Non-professional

By clicking Submit, you agree that you have read and accepted the terms and conditions detailed in the DISCLAIMER

This website uses cookies. A cookie is a small data file placed on your computer which captures information about your choices which allows us to improve your experience of the website, for example, by remembering your country of residence. By continuing to access this website, you agree to be bound by our Cookie Policy. You can accept and/or block at any time by changing your browser settings.

SELECT YOUR REGION

Where are you located?

Europe

Asia-Pacific

Rest of world

By clicking Submit, you agree that you have read and accepted the terms and conditions detailed in the DISCLAIMER

INVESTOR TYPE SELECTOR

What type of investor are you?

Professional

Non-professional

By clicking Submit, you agree that you have read and accepted the terms and conditions detailed in the DISCLAIMER