Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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The disconnect between equities and macro grows wider
Peter Garnry
Chief Investment Strategist
Summary: Japan's leading indicators in August fell to the worst momentum levels since the 2008 financial crisis highlighting that the global economy is likely headed into a recession. However, global equities remain at high levels with low realised volatility levels reflecting a strong believe of recent weakness only being temporary. It's a dangerous game for equity investors to be playing but maybe the negative yielding bonds are creating perverse behaviour nobody could think of just 10 years ago. Today's equity update also discuss HSBC's decision to cut 10,000 jobs and the prospects for the banking industry.
Overnight Japan released its leading indicators for August, and they are down 8% compared to last year showing the worst momentum since the 2008 financial crisis. Japan’s leading indicators are telling investors that the third largest economy in the world is most likely entering a recession soon following Sweden and Germany. Global equities have remained bid all indicators suggesting the slowdown is worsening and that global profits will fall. As we have said before we believe there is a massive disconnect between macro reality and equities likely made worse by policy action forcing rates deep into negative territory.
Tomorrow, OECD releases their global leading indicators for August, and we expect another decline extending it to a 19-month straight decline and further evidence that the global economy is likely headed into a recession. There are some indications about a stabilization measured on the real-time GDP tracker on the Eurozone economy called the Eurocoin Growth Indicator, but the stabilization is fragile. Worse than expected earnings from the upcoming Q3 earnings season is all it takes for sentiment to crumble.
On Thursday the US-China trade talks resume in Washington and according to the media China has firmly narrowed the scope of a trade deal refusing to cave into Trump’s demand of a grand deal. Specifically, the Chinese government will not allow changes to China’s industrial policy or government subsidies be part of the trade negotiations. This could be interpreted as China perceiving to have a stronger hand going with Donald Trump facing an impeachment with a second whistleblower emerging and apparently a person much closer to the actual content of the phone call between the US and Ukraine presidents.
While both the US and Chinese macro numbers have deteriorated, they also both face political issues ranging from impeachment to demonstrations, but the scoreboard in financial markets is still declaring the US as the winner judging by our trade war basket (see chart). US equity markets are not bad enough for Trump to waver in the US-China trade talks. We still see a low probability of even a narrower trade deal.
HSBC is out today announcing that it’s cutting 10,000 jobs to reduce costs and improve profitability. The endless exercise for banks failing to deliver the same returns for shareholders as before the financial crisis. In the first half of 2019 the 12-month trailing return on equity (ROE) stood at 8.4% down from the average of 16% pre-financial crisis of 2008. While HSBC has recently increased its ROE the bank still faces issues structural issues in North America and Europe. In the first half of this year HSBC generated 80% of its pre-tax profit from the Asia region. As we discuss in today’s Market Call podcast negative rates and general banking regulation are weighing on banks making it a difficult industry to invest in. Our view is still underweight banks but if we observe a policy change in the coming year with more focus on fiscal policy and a path away from negative yields then banks are clearly an overweight sector driven by low valuations.
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