Iron Ore Price Rises On China Steel Demand Opti... |VERIFIED|
But Murphy says Brazil's weak performance is not the only factor; despite pandemic lockdowns in early 2020, China is on track to produce record volumes of steel once again this year, and that means iron ore demand is strong.
Iron ore price rises on China steel demand opti...
Welcome and thank you for joining this year's second-half Shark Tank event with myself, Noel Dixen, alongside my fellow colleagues, Anthi Tsouvali and Tim Graf. Today we'll present our best trading ideas with the hope of earning your vote, which we'll ask you to cast by the end of today's session. I'll kick things off by going over what I believe is the best-in-breed in the commodity FX space. I then will hand it over to Anthi to express her views on European equities. Then we'll close things out with Tim, who will give his thoughts on sterling yen. With that said, let's get started. First and foremost, I think it's important to give some context. Commodity FX performance year-to-date has certainly not kept up with the overall commodity index. If you were to grasp the BCOM index against a basket of commodity currencies year-over-year, you will see that there is a significant divergence. Aside from idiosyncratic factors, one of the major reasons for this divergence is that the rally and the commodity index has not been broad based. What is true is that commodities are up close to a six-year high; roughly thirty per cent plus. However if you were to exclude or take out energy, the index is actually only up about roughly twelve per cent. What this tells us is that the performance in the commodity index has been largely skewed by the energy sector. This is consistent with the performance in the commodity currencies. The top best performers have been the NOK and have been the CAD, which makes sense because they are the top biggest exporters of oil among their peers. The worst performers have been the Aussie and have been the Kiwi. Moving forward as we think about the commodity complex, we actually think that the divergence is going to start to normalise. As I take a step back and I think about what's going to be the best opportunity in the next six-to-twelve months from a risk reward standpoint, for me it's clearly the Aussie. I think it's fair to say that a lot of the bad news has been priced into the Aussie. I think it really sets the stage for the green shoots that are going to start emerging to really start to come across. One of the major challenges that Australia has faced is that they were behind the curve in vaccinating its citizens. What this has translated into is severe lockdowns. For example, Melbourne just underwent the longest lockdown in the world, with a duration of two-hundred and sixty-two days. This is largely to blame for the poor jobs mess that we've just experienced about a week ago. The silver lining, however, is that since then a lot of these headwinds have since abated. The restrictions are starting to get eased. They currently have achieved a seventy per cent vaccination rate. If you delve into the last employment print, the participation rate actually picked up after a three-month decline. There's evidence of significant pent-up consumer demand that is yet to be unleashed. What is more is that despite this tough environment, their exports have actually held up quite well. Despite their dispute with China and a drop in iron ore prices, that's been replaced by an increase in exports to places such as India, and an increase in thermal coal prices and liquified natural gas that has helped to offset some of the drop in iron ore. What that has equated to is a term of trade print that has been pretty solid from a historical context. When we think about China, it appears that they're off to a soft versus a hard landing. What is important to point out is that at this stage, their corporate bonds and their mortgage loans are continuing to hold up quite nicely. Then you add on to that the signalling to expand government debt issuance. So overall that will lead to a pick-up in aggregate total financing by the end of the year and beyond. We know any pick-up in credit impulse tends to lead the Aussie by about three-to-six months. This factor, alongside some of the inflationary pressures, we believe is going to cause the RBA down the road to get even more of a rethink than they already have done. For instance, as we know in the last meeting, they've just abandoned their yield curve control policy. They just moved their 2024 central rate case up to 2023. We think that that's just the beginning and that they're likely to do more going forward. When we look at one-year forward rates, what we see is that among their peers they have the least amount of rate hikes priced in. So all else equal, from a relative basis the Aussie should be more susceptible to any move in interest rate, a change in interest rate forecast from the RBA moving forward. The pressures are clear. If we look at our PriceStats indicator it shows that inflation is likely to be persistent in, say, the coming months. When we look at house prices, they still remain pretty elevated on a year-over-year basis. This is the highest it's been, going back to about 2003. Now, aside from that, as we stated earlier, the RBA, these datapoints, it's going to be difficult for them to ignore. From a broader macro view, when we take a look from a fiscal and monetary standpoint there's still plenty of support. From the monetary side for instance, the Fed is going to remain with about an $8 trillion plus balance sheet in the end. We believe that the Fed is going to remain lower for longer as they seek to achieve maximum employment. From the fiscal side when we think of Biden's infrastructure investment and Jobs Act, according to the American Iron and Steel Institute, for every $100 billion that's going to get spent on infrastructure, that's going to equal about $4 million to $6 million tonnes of steel demand, which on the margins should be helpful for iron ore. Collectively, both this fiscal and monetary support should be good for a risk on backdrop. As we know, in that environment high beta currencies such as the Aussie tend to outperform in that environment. To augment that point, when we look at behavioural sentiment, our BRS - our behavioural risk scorecard - currently has about a plus ten print, which is a quite solid reading. But what is important to point out is that we've just experienced about three-hundred consecutive days above the negative forward threshold, which implies that there is certainly conviction and momentum for this risk appetite moving forward. Finally, I think it's important to point out that the Aussie is undervalued, so right now the Aussie is undervalued by about seven per cent from a PPP perspective. Real Money seems to understand this concept as they continue to buy aggressively. We're in about the ninety-fifth percentile or so. When we put this all together - the significant green shoots that are on the horizon, as I mentioned earlier; the persistent inflation we think is going to help to drive the RBA even further; there's still plenty of policy both fiscal and monetary to support a risk on backdrop; as I've just mentioned, the Aussie is undervalued - all of that compels me to have a target of about eighty, which from here is about a nine per cent return from current levels, which is a pretty decent gain by anyone's standard. I'll leave it there. Hopefully I've convinced you to buy the Aussie. I really thank you for your time. Now I'm going to hand it over to Anthi to go over her views. Thanks.Thank you very much, Noel. I do share your optimism about the market. However I think that the best way to play here is through equities, and more specifically European equities. As you all know, the equity market had a very good year; it went up about twenty per cent so far this year. I'm sure all of you wonder, can it still go up? The short answer is yes it can, because we have a winning combination right now. Earnings continue to be very strong and we heard that during the last earning reporting season. We have a very accommodative economic environment. So far, the central banks have not said anything that will change the low rates for longer. Finally, we still see very positive behavioural support. As Noel mentioned earlier, you can see in this graph, you can see that there is still strong demand for risky assets. I think that the most important is the light blue line here that shows you holdings of risky assets. Despite the strong buying recently, we see that holdings are not elevated, so that trend could continue. That also tells us that probably investors are not complacent in their views, so we can see more buying of risk. I think that most of the optimism is coming from strong earnings. We recently had the third-quarter earnings reporting season. What we saw there is that more than sixty-five per cent of companies were able to bid on earnings and sale forecasts. I think that the most important part, though, is that analysts in the market were able to upgrade their views on already fairly high earnings expectations. What we heard very loud and clear from companies is that they still see strong demand. That demand is outpacing supply. Still, the global economy has not recovered fully from COVID. Most of the markets are actually growing right now. In that case, in that type of environment of course we're going to see inflation. But we don't think that this is going to put a stop in the market. I think that my favourite chart, that shows me that we shouldn't be scared of inflation, is this one right here. It shows profit margins and the expectations of how they are going to do over time. As you can see, there is going to be a small drop in the short term, but in the long term we see increasing improving profit margins. Especially driven by cyclical sectors - and those are industrial and commodity sectors mainly. I think the reason why it's happening and companies are able to pass on most of their input cost increases that we're recently seeing, is because the pandemic has been very, very unique. It's been very unique in the sense that we're coming out of a very difficult environment, with consumer being stronger, and companies having much more stronger balance sheets and a lot of cash that they can spend. Of course if they need even more cash, cash is available - and it is very cheap. In certain environments I think that one of the best regions to invest in is Europe ex-UK. In the recent reporting earning season, as I said, it had very good earnings. Expectations have been fairly high and they were able to beat those expectations. They are twenty per centage points higher compared to their historical average. Analysts are upgrading those expectations. This is mainly driven by financial, consumer discretionary and earnings that have had a particularly large proportion of companies beating expectations. They should continue to do so. I think a lot of the optimism is stemming from the fact, as you can see, the sector composition within European equities. As you can see in the first two bars, you see that Europe lacks the exposure to information technology. Historically that had been a big issue and that's why US did much better than Europe. That would actually serve Europe well. I think industrials, energy commodities, those reopening trades should do much better moving forward compared to IT. Europe has this exposure to those cyclical sectors. Most importantly, these sectors are the ones that are talking a lot about increasing capex spending. During the earning reporting season, we heard companies talk about investing more in the future. I know a lot of you are probably listening to me and saying, 'Oh, we've heard that before!' That's true, but I think that what is different this time, other than the fact that they have a lot of available cash, is that there are few trends that are transpiring from the pandemic. One is the fact that we saw that it's more important than ever to shorten supply chains, and the second one is green technology. These are things that are going to play out over multiple years. We are talking about multiple years of spending into future growth. I think that that's very promising. If you look here, if we look at capex spending over the last two years, you can see on the left chart that Europe ex-UK is actually bridging the gap of spending between the world market, the global market. That has actually started to pay off. As you can see next, profitability, we're already talked about margins improving, but we see that the quality of earnings is improving as well. The way we measure is as return of equity. I think that the most important graph for me right now is that, for the last year or so, we are all talking about Europe. There is still strong buying of European equities, but it doesn't look like all the good news is priced in. You can see that the Europe ex-UK has underperformed over the last decade. Now despite a good year, that's only just a small blip in the long-term graph. If we look at the light blue line and holdings, we see there that despite the strong inflows into European equities, then investors in the last year or so, they just managed to create, to close their underweight position and be neutral in European stock. So I don't think that the prices reflect the better earnings outlook in European equities. Just to recap, the reason to vote for me today is because I do expect global equities will go back, will continue to go up. As I said, Europe is the ultimate cyclical play because earnings are improving, capex is picking up. Fundamentals are improving, and still Europe is neither crowded nor expensive. With that, I'll pass you to Tim to talk about his shorting sterling yen idea.Thanks very much, Anthi. Thanks, to all of you who are listening, for your attendance and your interest in what we're doing. I'm going to finish the Shark Tank discussion today with something that's a bit of a contrarian view actually, at least for the colleagues of mine you've just heard from, who still see further upside for equities or upside for riskier currencies in the New Year. It's a bit funny. By nature I'm more of an optimist, but that optimism I have is tempered I think for the year ahead in suggesting something of a risk of hedge in selling sterling yen. No matter what your outlook is for next year, it's almost certain to be another year of change. I think that change, the primary change we have to deal with, comes via the response of policymakers to inflation and also how markets meet the challenges of a policy environment that's no longer geared full time towards reflation. I've summarised the backdrop and motivations for my trade idea here, but let me walk you through the details below. As with so many of the thoughts you'll be hearing from institutions like ours at this time of year, we have to begin with inflation. Simply, inflation as we capture it through the lens of online prices presented through our partnership with PriceStats, really shows no sign of slowing down. Now, inflation is thought by most of the major central banks to still be transitory - and really that may well pan out to be true by the middle of next year. But that doesn't really escape the fact that inflation is persisting at a higher level than we previously envisaged, for a lot longer than we anticipated. In fact as we can see here, it still looks as though we have yet to see a peak. This is really important because markets have started to price for a policy response already across most of the developed economies. The two-year forward rate expectations for central bank rates are now higher than at any point since the immediate aftermath of the global financial crisis about ten, twelve years ago. Some of these central banks have actually already started to deliver. It seems unlikely that we're going to have a repeat of that experience, when markets got very excited about pricing for central bank rate normalisation only to be proven wrong pretty much across the board in the subsequent years of, say, 2010, 2011 and 2012. Now, the inflation dynamics we currently see, those alone would suggest we're not going to have a repeat of that episode. However there's one similarity to ten years ago in that the Japanese yen has lost a lot of ground as markets have priced for rate normalisation - just as happened about ten years ago. I think this performance of the yen is potentially poised to change. Now, I am not for a moment suggesting that the BoJ is all of a sudden going to turn hawkish, and markets will start to price for rate hikes. I'm not completely crazy! Instead I think that other factors could take over and start to support the yen a little bit more. First and most obviously in this chart, I think some central banks are likely priced to hike more than they actually will. The Bank of England strikes me as a perfect example. After the run of strong data we've seen this week, a hike next month does now look pretty likely. But I would think that the one hundred basis points that are priced in over the next year is a bit more of a stretch given the challenges that the UK economy faces, some of which I'll continue to detail below. Central bank disappointment elsewhere could stand the yen in better stead given there is nothing priced for the BoJ. That's not likely to change, but aside from rates, risk conditions also look a little less comfortable for me for riskier currencies. It puts safe havens like the yen in a better light. You've already seen the flow component of our behavioural risk scorecard for Noel and Anthi. This chart now shows the aggregate risk preference of real money investors captured by the breadth of their holdings, or their positions. Now, over the last year, aggregate risk positions have built to a consensus overweight. This overweight is not yet at historic extremes that might signify a turning point, but it's really heading in that direction. Investible cash balances have already fallen quite a lot. The number of extreme overweights in risky assets is already at a three-year high. Likewise, other measures that we look at of risk, such as our measures of price unusualness in FX markets, also hint at some caution. This chart shows our FX turbulence index as well as a measure of implied FX volatility. If you recall, turbulence is one of our price-based measures that captures volatility and correlation unusualness in the G10 currencies. We use it to pinpoint periods where market pricing might be either too complacent or maybe even too panicked. We see such a deviation at the moment. FX turbulence has been elevated and very, very choppy for months and yet FX implied volatility has barely moved. You're only just recently seeing it start to rise. The value of FX volatility that this deviation currently implies I think highlights the potential risk reward of currencies that often act as volatility proxies, such as the yen. On that note, it's worth highlighting just how much the yen still does act as a safe haven. It maintains those strong external balances that are characteristic of safe havens, such as what you see on the right-hand side of this scatter plot, while also maintaining a persistent negative long-term correlation to risky assets, as you see on the Y axis. So the safe havens here sit in the bottom-right quadrant. The riskier currencies sit in the top left. It's no coincidence that my choice of a funding currency - sterling - plays on this desire for a hedge. It has a positive correlation to equities. We're in one of the worst current account positions of the major economies. Sterling also has room to suffer when you consider just how elevated expectations remain for the UK economy. Now, most economies are forecasted to see slower growth next year; the UK is not unique among that - and that's not really a surprise. It's really hard for economies to continue to gr