JP Capital Perspective is everything January 6, 2016

Data announcements

Jan 6: ISM manufacturing Jan 6: FOMC December meeting minutes

Jan 6: Euro Zone PPI Jan 7: Euro Zone retail sales

Jan 8: U.S employment report Eurozone PMI rose to 54.3, rising at the fastest rate in recent months. Germany, France,

Italy, Spain and Ireland led the charge, boosting confidence in the Euro project

Market roundup

Source: Bloomberg, Spot returns. All data as of last Friday’s close. Past performance is no guarantee of future returns

EquitiesTotal Return in USD (%)

Level WTD MTD YTD

DJIA 17,425.0 -0.7 -1.5 0.2Nasdaq 5,007.4 -0.8 -1.9 7.0S&P 500 2,043.9 -0.8 -1.6 1.4MSCI World 1,662.8 -0.6 -1.8 -0.9Fixed Income

Total Return in USD (%)Yield WTD MTD YTD

U.S. 10- Year Treasury 2.27 -0.2 -0.3 0.9U.S. Corporate Master 3.68 -0.2 -0.9 -0.6ML High Yield 8.76 0.4 -2.6 -4.6Commodities & Currencies

Total Return in USD (%)Level WTD MTD YTD

Gold Spot 1,061 -1.4 -0.3 -10.4WTI Crude $/Barrel 37.0 -2.8 -11.1 -30.5

Current Prior Week End Prior Month End 2014 Year End EUR/USD 1.07 -0.92 2.81 -10.22USD/JPY 120.2 -0.2 -2.3 0.4

2 lorem ipsum :: [Date]

EQUITIES

2016, picture the scene

2016 will be a year of divergence. China kicked off the year in a highly unstable fashion, posing the same old questions of 2015. With the Yuan weakening further, this will add further pressure on the ASEAN region. If 2015 was a bad dream, EM are now waking up to a worsening reality that looks set to stay for the medium term. We are bullish on EM over the long term, no surprises there, but not for the next 12 months. There is too much uncertainty and although the old adage of ‘be greedy when others are fearful’ is true, EM has further to go in our view.

The U.S Federal reserve gave the markets their rate rise and with the minutes out this week, we should get an insight into the trajectory of future rate rises in the famous dot plot.

Turning closer to home, the Euro area has been quietly performing well under the radar. With all the attention in the back half of 2015 on China and the United States, the Eurozone has been posting some solid figures. However, inflation remains low giving the ECB an argument for further stimulus, however as we have said all along, further lowering of rates will not solve the Eurozone puzzle (10-yr bund at 50bps). That said the latest manufacturing data showed solid signs of improvement, with Germany and France at the core leading the way. The question then becomes, at least from an investment point of view, will the Stoxx 600 post further gains in 2016? We feel the answer to that is a resounding yes. Valuations in the U.S are toppy, yet with a tightening environment pending.

Next- FX update: Draghi’s dilemma

Exhibit 1: Eurozone PMI remains robust

Source: Markit

The Eurozone has less toppy valuations, but has an accommodative environment. The Stoxx 600 rose roughly 10% in 2015, albeit with some immense volatility, particularly in August when China sent shockwaves throughout financial markets. One has to bear in mind that the weakening Euro would have erased some of those gains but performance was reasonable nonetheless. We feel European equities have further upside alongside Japan and the UK to a lesser extent (purely from a low interest view from the BoE).

Markets haven’t bolted from the gates in the New Year after some clarity from the Fed in Q4. So far we’ve seen the exact opposite, with the focus immediately on to China, irrespective of key solid corporate fundamentals. Equities look a decent proposition, but if one can’t stomach large volatility, cash looks a good play, especially if the U.S sells off more, optionality will be premium.

Source: Markit

3 lorem ipsum :: [Date]

FOREIGN EXCHANGE

Nice Yaun!

Next- Commodities update: Oil heads lower

Exhibit 2: Renminbi rates diverge in 4 standard deviation move

Yuan- No you are reading it right, this is the New Year issue! Unfortunately we are taking the same characters as last year, and we are just re-writing stories about them! So what is going with China, well we haven’t got enough space, and you probably not enough time to read all about it, but effectively a lot of stuff. Here am just going to concentrate on the Yuan, and on something, which is very interesting, the onshore and offshore spread. The Yuan sank to a five-year low after China’s central bank signalled that it is becoming more tolerant of a depreciating currency as intervention costs rise and economic growth slows. I think we could have told them that, before they started the intervention, we are very much to the view that the markets should be left alone and let them adjust to the economic situations. We can see the government intervention and how it is affecting the “real” price of the Yuan (please note when I say “real” price I am not talking about the price without inflation). Indeed, this can be easily seen by the spread between the onshore and offshore price of the currency! The onshore price being higher as the government has more control over the currency, effectively the offshore investors are plummeting the price of the Yuan, they are driving it down big time! What this is doing is that it is affecting the “correct/real” price of the Yuan, the Yuan should be a lot (and I mean a lot) lower than it should be, the market cannot correctly adjust itself when there is such a divergence between the two prices. The offshore Yuan dropped beyond 6.70 per dollar for the first time since September 2010, about two months after trading was first permitted in Hong Kong, while the onshore rate was 6.5560 as of 5:05 p.m. in Shanghai. That is just too large of a spread (table below puts it in perspective better).

Source: Bloomberg

4 lorem ipsum :: [Date]

COMMODITIES

Next- Bond update: What hike?

Source: Bloomberg

Oil- Just like China with the currencies, oil is just not letting go of the front-page news. So, we all know by now supply is outrageously large in comparison with its actual demand. So, why suddenly the price is at the lowest since 2004? The thing is we were given a bit of hope on Monday morning. Indeed, basically, there has been a break in the friendly relationship between Saudi Arabia and Iran, so that led to an increase in the prices, Brent went up to $39. However, investors then decided to think a little and realised that if there is a rift between the two most powerful countries which are part of OPEC, they will unlikely find a “terrain d’entente” regarding the supply issue, and so production will likely continue as it is, if not increase (yes they could actually do that). In fact, Saudi Arabia has shown no signs of being prepared to lower output to make room for Iran, and let’s not forget that Iran plans to increase production and exports when sanctions related to its nuclear programme are lifted. That could happen by the end of the first quarter! This is what we are saying, oil will not increase for a while, in other words, it probably won’t go over $40 a barrel by the end of the first quarter, and it could go lower if the relationship between the two OPEC countries does not improve. Without making any predictions, there are a few things to look out for in the commodities market this year. First of all, oil, this has to be the prime commodity to lookout for, mainly because a lot of investors will base the health of economies and production depending on oil prices. Secondly, gold, with an appreciating dollar, gold should depreciate, however, with stock markets becoming more and more unstable, gold will have it’s role to play, and this can lead to another safe haven period for gold! Lastly, copper, this is regarded as the commodity that determines the global economic health, and with China being in trouble, it is likely to stay low for a while.

Exhibit 3: Brent hits 11 year low on supply glut

Brent slide continues

5 lorem ipsum :: [Date]

FIXED INCOME

FX traders find fixed income dull. Jon holds this view too. The way I normally defend bonds as an asset class is they are longer-term barometers of confidence. A bond in isolation is not particularly useful, but the spreads on certain types of bonds allow investors to gauge confidence or fear, long before the equity market takes a hit. The chart above shows the spread of junk bonds (CCC rated) and slightly better rated bonds (BB) has widened considerably over the last 12 months (the line rising indicates a flight to safer havens, in this case, to BB rated debt). The HY space has around 25% of its weight in energy and wider commodities so it’s no surprise with the oil price at mid 30’s a barrel and copper and iron ore at low levels, the debt service payments for producers are not guaranteed. My view on fixed income is similar to clothes shopping. If I want something that will last, I go to a slightly more expensive place. If it costs more, it will likely have had more research and technology gone into it, thus the selling price is higher. You pay for quality. The opposite end of the spectrum is the t-shirt from Primark. I’m not concerned about it if it gets marked on from my dog.

Exhibit 4: High yield takes a battering return

Secular stagnation

Source: Morgan Stanley

Fixed income works much the same way. If you want quality, you go for government bonds that will last the test of time. If you want something more short term but with slightly higher return, high yield is your market. HY is impacted much the same way as equities, so I view the HY market as the way I look at stocks. Coupon payments over the long term have outperformed dividend payments and are guaranteed. But the question becomes, are bonds an attractive place to invest now? Many do not hold my yes view. I feel rates will stay low (U.S treasuries to sit around 2.5% for at least 2 years). Reason being, inflation is non existent (secular stagnation theme) and with rates so low in Europe and Japan, money will flow into the U.S, capping further rises in yields. HY I feel will take a further hit as China looks to steamroller everything in its path, not batting an eyelid at the consequences on the rest of the world. Sit sight for some low action.

6 lorem ipsum :: [Date]

JP Capital Perspective is everything

Jonathan Taubert FX and Commodities

Pete McCarthy Equities and Fixed Income

JP Capital Team

Going forward Happy New Year to our JPC readers. We appreciate your reading and continued feedback. The market expects the Fed to raise rates twice this year, with the Fed itself forecasting four. They stated they are looking for ‘actual expected progress on their goals’. Goal number 1: inflation. With oil prices falling further, inflation looks to be cool for now. The New York Fed conducts a survey asking people what they expect inflation to be in 12 months time. That chart has been falling since September, which begs the question: are we likely to get a rate cut over a rate rise? Seems unthinkable right? Well, no one thought rates would be at 0.5% 8 years after Lehman went bang. No one though yields would be lower at the end of 2014. No one thought the Chinese Yuan would have such a detrimental impact on Asia. 2016 will be the year of surprises. We feel the central banks which are pegged in some loose or rigid way to the Euro will unpeg or remove such floors, just as the Swiss National Bank did this time last year. We shall close on one final point. Equity markets have been in a bull market since the crisis due to central bank policy, not blockbuster economic growth. Valuations have therefore become detached from fundamentals meaning the chances of a validation are fairly low. Equity market returns have been brought forward due to QE and low rates so we feel 2016 is about paying back some of that return. Borrowing money for consumption now means sacrificing future consumption. Bonds should therefore benefit in addition to a risk off sentiment from geo politics.