Overview:

  • Relative performance of EM and cyclical based economies are not confirming a bottom in growth
  • EM currencies are not showing similar strength to the economic bottom in 2016
  • Copper, aluminum, steel, and auto PMIs are also not confirming the pick up in growth that equities are
  • Given these divergences, the probabilities of the dollar moving higher are greater than 60%

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Over the past few weeks, we have noticed a change in equity leadership on a global basis, which may provide some insight into the next leg for equities, growth, and the dollar. While Emerging markets led global equities lower for most of last year, they had solid relative performance from October 2018 to February 2019. The rebound led participants to increase their bullish view on EM, which is now apparent in positioning and sentiment (see BAML’s recent survey). The bullish EM view was further aided by 1) the Fed walking back rate hikes, which in turn should be dollar negative and 2) a large-scale stimulus effort out of China supporting EM. We think there are holes in this thesis.

Two weeks ago we put out a piece showing China’s current round of stimulus has not moved the needle, primarily due to the large increase in bill financing and lack of a pick-up in total credit creation YoY. To change our view here, we will need to see a continued pick up in Chinese M1, which had its first positive uptick Sunday– though aggregate credit creation was still quite weak at 703bn Yuan (estimates of 1.3T), with short term loans to households contracting 293bn Yuan (only the second time this has happened since 2009).

While we were bullish on EM towards the beginning of the year for similar reasons cited by the masses currently, we have not seen a follow through in China’s credit creation, which has resulted in us flipping our view for the time being.

We think the markets are starting to confirm this change of view, as EM is now trending lower on a relative basis, while the S&P regains some of its lost leadership. Interestingly, Japan – which is significantly tied to global manufacturing and China, has had the worst relative performance (bottom left chart). Japan is also not tied to the trade war, but is tied to global economics, which may be a tell. Note that Europe looks to be improving, which possibly is a sign that domestic policies are picking up steam. This is also not driven by Germany, which has the highest economic tie to China.

 

In addition, China stimulus 2.0 is also not being seen in EM currencies, as China’s largest trading partners have marginally strengthened or weakened from their lows versus significant strengthening in 2016. Technically, the dollar looks very bullish across all pairs here as well. We would need to see strength out of these currencies to be more supportive of a growth turnaround.

This week we also got some good intel from the global copper, aluminum, steel, and auto PMI’s. Note below that output declined sharply in February, with Asian users seeing the most marked downturn.

Asian steel users also saw the quickest drop in production, with new orders globally falling at the sharpest rate since 2009.

Aluminum with the same thing.

Turning to the charts, we can see that the current prints are not similar to past turnarounds. Note the rounding bottoms in the prior two upturns versus today.

And Aluminum

As well as copper

And Global Autos

While there have been some positives developments in Chinese PMIs, we still see the probabilities of a global upturn as being low given the information above. The most recent equity rally is looking more like an under-positioned bounce that led participants to chase, which was then further supported by talks of a trade deal and low vol strategies. Given this view, there is a meaningful probability that the dollar continues to appreciate over the next 2-6 months. There is also ample evidence that the USD will decline longer term (budget deficits, positioning, etc), but the risk is to the upside for the time being.

 

Teddy Vallee Uncategorized

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