Please Share:: 
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Macro Backdrop: March Higher
The risk rally continues: S&P 500 futures are marching higher in a tight upward sloping channel (Slide 2,
LHS) as our GRAMI signals better risk appetite (Slide 2, RHS). As we have highlighted before, we think
there are four key factors behind this rally:
1. Easy money: global Central Bank policy is easy and likely to get even easier. Take-up at this week’s
second ECB 3y LTRO was higher than expected, resulting in a net increase in liquidity of EUR
313bn1. Meanwhile, Bernanke’s testimony to congress presented no new information in our view.
Although not mentioning QE explicitly, he re-iterated that easy policy from the Fed is also likely here
to stay. In the EM world, too, some Central Banks are starting to ease
2. Reduction of systemic fears: related to easier monetary policy, systemic fears have receded since
the onset of 2012. Money market rates such as 3m Euribor traded through ECB policy for the first
time since 2010 this week, causing the Euribor-OIS spread to further contract (Slide 3, LHS) and
several EMU bond spreads also continue to narrow (Slide 3, RHS)
3. Growth prospects: Citi’s ESIs remain positive and near their highs. Furthermore, having anticipated
the re-pricing of growth expectations late last year, our updated Leading Indicators for Consensus
Forecasts for February signal consensus growth expectations need to be ratcheted higher. Note that
our LIs are more or less directly comparable with 2012 growth expectations at this juncture2. In the
US, our LI stands at 2.45%, a positive gap to consensus of 47bp (Slide 4, LHS); and in the
Eurozone, our LI at 0.03% suggests consensus expectations are 56bp too low (Slide 4, RHS).
4. Positioning: several positioning indicators hint at relatively low investor participation in the risk rally.
The latest credit investor survey showed longs increased to 12m highs, but was offset by large cash
inflows (Slide 5, top LHS). The beta of equity long/short funds remains low (Slide 5, top RHS),
supported by Citi’s prime finance data which shows net positioning has lagged the pick-up in gross
positioning3 (Slide 5, bottom RHS). Below average volumes in equities also signal a reluctant rally
(Slide 5, bottom LHS). Finally, the still steep term structure of implied equity vols also indicates that
investors are not complacent (see equity section)
So what could de-rail the rally? Of course there are always tail risks lurking around the corner, and at the
current juncture there is no shortage of them for sure. However, with respect to the above key drivers, we
think commodity price shocks pose a big risk to continued Central Bank liquidity injections and consensus
growth expectations. Here we focus on two sources of such shocks: energy and food prices.
On the former, apart from the threat to inflation (Slide 6, LHS), sharply higher oil prices could de-rail the US
recovery, as we have been saying for several weeks. Our commodity strategy colleagues have estimated
the impact of oil price shocks on US GDP4: they find that from a sudden 10% increase in the real price of oil,
US GDP contracts by 70bp. They also note that the dynamic of such shocks can be nonlinear and
asymmetric: for example, their results show that for a sudden 50% oil price increase, economic growth could
drop by 4.3% (Slide 6, RHS). This then implies that an oil price increase of 30%+ (of which some has
already occurred) could wipe out Citi’s 2% US growth forecast for 2012. For investors with a pro-risk
portfolio, an upside hedge in oil should be considered, in our view.
In terms of food prices, given large weights in EM CPI baskets (Slide 7, LHS), food price inflation is an
important factor for the EM policy outlook. Although food prices have increased in recent weeks, these
increases remain small and, furthermore, favourable base effects also point to low food price inflation in the
coming months (Slide 7, RHS). This should give EM Central Banks room to ease, adding further liquidity
support. The starting point of nominal EM interest rates is much higher, and the scope and willingness to cut
thus substantially greater than DM. In terms of our macro portfolio, this is one of the reasons we like
expressing our bullish bias through a long in EM equities (see equity section).
Rates
Core G10 bond yields have continued to be range-bound. As we highlighted in our last Weekly, what is
going on is effectively a battle between higher nominal/real growth expectations vs. some combination of
portfolio balance effects and the idea that major central banks are keeping short rates anchored for a long
period of time.
Even if growth expectations will improve, carry-and-roll strategies become very tempting if policy rates are
going to be near zero until, e.g., late 2014 in the US. Moreover, as our Rates Strategy colleagues have
pointed out, carry and roll adjusted for (realized) volatility is still very high. Realised volatility is unlikely to
pick up significantly unless the market starts to (a) price in earlier rate hikes by the Fed or (b) inflation risk
premiums trend higher and become more volatile.5
As for (a), it will likely take continued improvements in the activity and labour market data, as well as sticky
inflation, to get a big move in the forwards. Regardless, we think cross-market US-Europe trades are still
attractive. In our macro portfolio we are paying 3y3y USD swaps vs. receiving in EUR (alternatively, we also
like short EDZ4 vs. long ERZ4).
As for (b), it’s true that inflation breakevens have trended higher, but there is ample room for further
increases. While the bond market experience of the 1970s is probably not a good template for today’s
environment of private/public sector deleveraging, we cannot completely ignore some of the lessons of that
period. The combination of large oil supply shocks and the Fed over-estimating the degree of slack in the
economy meant the Fed effectively ran a very inflationary policy, at least with hindsight.
The oil shocks were much bigger back in the 70s then what we believe could likely happen today, but the
increased probability of energy price spikes given the current situation in Middle East politics, combined with
the recognition that there is considerable uncertainty over the degree of slack in the US economy, indicates
that forward inflation breakevens could rise further.6 After all, even if the Fed’s 2% inflation target is credible,
30y TIPS breakeven rates currently at 2.39% (Slide 8, LHS) imply an inflation risk premium of less than
40bp. This is not particularly high compared to a standard deviation of 288bp in CPI inflation (yoy) since
1955 (Slide 8, RHS).
Then there is the fact that real interest rates on TIPS are at extraordinarily low levels compared to current
(Slide 9) and expected real GDP growth rates. The chart also shows the average real GDP growth rate
between 2012-14 projected by the FOMC committee.7 Needless to say, it would be extraordinary for real
term rates to stay this low if growth turns out meet the Fed’s forecasts. Furthermore, real “risk-free” rates are
even more negative once a credit risk premium is subtracted from TIPS yields.
Ultimately, given their low starting point, term yields can drift higher even if neither (a) nor (b) above
materialises to a great extent in the short run. In fact, the 10y UST yield is about 20bp off its lows in early
February. Thus, we stay short via UST Long Bond futures with a stop at 146-16.8
Elsewhere in rates we have:
• 10s30s UST BE steepener
• Receive 5y EUR vs. short 5y Bobl
• Receive 2y2y ZAR
• Receive 2y INR
FX
Given our risk-on view, continued easy money and stabilising growth expectations, the outlook appears to
be skewed towards further USD weakness in the coming weeks. As we have shown many times, the riskon/
risk-off dynamic with the USD is well defined (Slide 10, RHS) and only very strong or very weak growth
scenarios (neither apply currently) benefit the USD (Slide 10, LHS).
In reality, however, as witnessed by our rather slim FX portfolio, we are not inclined to sell USD vs. its major
DM counterparts at this juncture, given these other central banks are also easing policy. Recent EUR/USD
price action bears out our concern. As the LHS of Slide 11 shows, EUR/USD came under some intraday
pressure after the ECB’s LTRO tender added further liquidity, a risk positive development. A few hours later,
a bout of risk aversion following Bernanke’s speech also depressed EUR/USD. The EUR remains torn
between an easier ECB and risk appetite in other words.
Our EUR FV model tries to capture these effects and is still signalling upside with fair value near 1.40 (Slide
11, RHS). Instead of chasing EUR, we prefer to be positioned for USD weakness via higher beta European
FX, where fundamentals also remain supportive. We have held a 7.05/6.60 USD/SEK risk reversal, but
since inception in late January, the 7.05 call we sold has lost most of its value and by buying it back now, we
can guarantee a profit on the overall risk reversal.9 We continue to hold the 6.60 USD/SEK put.
If risk assets remain bid, we think most DM currencies (in particular USD, EUR, JPY, CHF and GBP) will
likely be used as funding currencies to hold high beta/high growth/carry/EM currencies. In terms of such
trades, as regular readers will know, we view the high beta crosses within G10, in particular AUD, as
overvalued, and hence prefer EM FX to trade this theme.
Having recently taken profits on our long TRY trade, we are assessing opportunities elsewhere in EM. We
think the best chances for FX strength are in Poland, Mexico, India and Indonesia. Apart from Mexico, which
shares tight links with the US, all are mostly domestically driven economies and hence more comfortable
with stronger currencies and most have also recently intervened to strengthen FX (Slide 12).
Equities
As mentioned in the introduction, two key elements of our bullish risk view have been easy money and
improving growth expectations. What is the relative importance of each of these two factors on equity
prices? This question took on greater prominence this week in the light of the market response to
Bernanke’s testimony to Congress on Wednesday.
Following the release of Bernanke’s testimony, stocks fell, the USD rallied and gold prices dropped sharply
– see Slide 13. Perhaps some investors were looking for hints of QE3 (which weren’t there) or the Fed
Chairman’s testimony was perceived as being more hawkish overall than his comments following the last
FOMC meeting. Frankly, we think Bernanke’s comments were fairly neutral. Moreover, it should not have
been a surprise to hear Bernanke use the word “conditional” when discussing the outlook given the more
transparent “conditionality” of the Fed’s new communications framework, something we have emphasised in
recent Weeklies.
Nonetheless, the market response to Bernanke’s comments provides some evidence that easy money has
played a role in supporting risk assets. In the first instance, easy money could be seen as having a bigger
impact on valuations. Lower Treasury yields reduce discount rates and dovish central bank policies may
also reduce risk premiums. By contrast, growth expectations may affect earnings expectations more.10 The
former is about the “P/E”, the latter is about “E”.
Much of the rally in equities since December has arguably been driven by a re-rating instead of an increase
in earnings expectations. This is difficult to prove, of course. From a bottom-up perspective, earnings
revisions have been negative even as markets have rallied, which supports the re-rating hypothesis.
However, we think that consensus growth expectations have been much more pessimistic than bottom-up
analyst numbers, so part of the rally in risk assets may also have been driven by stabilization in investors’
views on earnings. In any case, if our Leading Indicators discussed above are accurate, consensus growth
expectations should rise a bit further and revisions to earnings estimates could turn positive (Slide 14),
which in turn could help fortify a move higher in equities.
Furthermore, equity valuations overall are not stretched yet, so we think most markets are unlikely to de-rate
in the short run. In fact, forward P/E and price-to-book ratios on EM stocks are currently -0.2 and -1.0
standard deviations below latest cyclical averages, so there is still room for multiple expansion in these
markets. This is one reason we recently chose to go long EM stocks as a way to add beta to our portfolio.
Otherwise, as mentioned in the introduction, we think investor positioning is still sending a bullish signal for
stocks. In particular, as our colleagues in Equity Trading Strategy have noted,11 the very steep term
structure of implied volatility (Slide 15) indicates that investors have not become complacent. Indeed, we
think it makes sense that future implied vols should be elevated given the downside risks still present
surrounding the EMU crisis, China slowdown, etc, even if we have a positive directional view. For this
reason, we continue to hold our long VIX futures/long CDX HY trade in our macro portfolio.
Credit
We maintain our view that spread tightening is likely to continue. Clearly valuations are not as attractive as
they have been during most of the past few months, with CDS index spreads, for example, not far off their
lows since last August. Nevertheless, more stable growth expectations and supportive monetary policies
keep us positive.
Furthermore, as Citi’s Credit Strategy team points out, the technical picture in corporate cash markets is
very favourable.12 One consequence of the ECB’s LTROs is that EUR-denominated net issuance by
Financials is set to be even more negative this year (Slide 16, lower LHS). So while net issuance by Non-
Financials should remain healthy (estimated at $262bn in the US market and €30bn in Europe), the global
IG bond market is set to shrink for the first time in years (Slide 16, top LHS). Combined with the increase in
flows into credit funds (Slide 16, RHS), demand-supply dynamics have definitely turned more bullish.
But with yields at very low levels, especially in IG (Slide 17, LHS), the upside in the cash market from a total
return perspective could be rather limited if we get a backup in US Treasury yields, even if spreads tighten
during a Treasury market sell-off as we expect they would. From this perspective, high yield or lower-rated
IG cash credit is more appealing as spreads would probably tighten more in beta-adjusted terms, and in any
case offer higher carry. For instance, Citi’s US high grade strategist, Jason Shoup13, prefers short-dated
BBB-rated credits over longer-dated A-rated ones (see yield chart by rating and maturity, Slide 17 RHS).
In terms of our macro portfolio, in addition to being long CDX HY vs. long VIX futures, we continue to be
long US Large Banks vs. short iTraxx Senior Financials in CDS. So far, we are slightly in the red on the
trade as European financial credit has done well on the back of the LTROs. Frankly, as long as the risk rally
continues, this trade is unlikely to move much either way. However, we still believe that spreads should
widen (much) more on the European leg in a risk-off scenario, and hence this trade can also be seen as a
partial hedge to our generally pro-risk portfolio, and in particular our short EUR 5y ASW spreads trade.
Commodities
Gold came under heavy selling pressure following Bernanke’s testimony to congress, falling over 5%
intraday on Wednesday. As we have highlighted previously, we think gold is driven by reflationary
expectations at this juncture and not by safe-haven flows. Hence, the lack of “QE3 talk” caused investors to
pare back exposures in the precious metal complex.
In that respect, we think it is striking that other “reflationary trades” did not experience similar moves. For
example, US inflation breakevens have been broadly trending higher together with Gold since 2009 and
have been particularly correlated since late last year (Slide 18, LHS). Yet, US BEs hardly moved this week,
suggesting the fall in Gold might be overdone. For what its worth, CFTC positioning as of 21Feb2012, i.e.
before BB’s speech, did not seem particularly extended either (Slide 18, RHS).
All in all, in an environment where Central Banks will continue to be easy, we still think fiat currency
substitutes should be well supported. As such, we view the recent price action as a buying opportunity and
continue to hold our long in Gold and Palladium (via a 50:50 basket14).
Elsewhere in the asset class, we still hold our long in Aluminium, as base metals in general are still lagging
risk appetite in our view. As the LHS of Slide 19 shows, the base metals complex has severely
underperformed the S&P 500 and is furthermore lagging the improvement in risk appetite suggested by our
GRAMI and the better growth expectations predicted by our Leading Indicator for Consensus Forecasts
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Macro Backdrop: March Higher
The risk rally continues: S&P 500 futures are marching higher in a tight upward sloping channel (Slide 2,
LHS) as our GRAMI signals better risk appetite (Slide 2, RHS). As we have highlighted before, we think
there are four key factors behind this rally:
1. Easy money: global Central Bank policy is easy and likely to get even easier. Take-up at this week’s
second ECB 3y LTRO was higher than expected, resulting in a net increase in liquidity of EUR
313bn1. Meanwhile, Bernanke’s testimony to congress presented no new information in our view.
Although not mentioning QE explicitly, he re-iterated that easy policy from the Fed is also likely here
to stay. In the EM world, too, some Central Banks are starting to ease
2. Reduction of systemic fears: related to easier monetary policy, systemic fears have receded since
the onset of 2012. Money market rates such as 3m Euribor traded through ECB policy for the first
time since 2010 this week, causing the Euribor-OIS spread to further contract (Slide 3, LHS) and
several EMU bond spreads also continue to narrow (Slide 3, RHS)
3. Growth prospects: Citi’s ESIs remain positive and near their highs. Furthermore, having anticipated
the re-pricing of growth expectations late last year, our updated Leading Indicators for Consensus
Forecasts for February signal consensus growth expectations need to be ratcheted higher. Note that
our LIs are more or less directly comparable with 2012 growth expectations at this juncture2. In the
US, our LI stands at 2.45%, a positive gap to consensus of 47bp (Slide 4, LHS); and in the
Eurozone, our LI at 0.03% suggests consensus expectations are 56bp too low (Slide 4, RHS).
4. Positioning: several positioning indicators hint at relatively low investor participation in the risk rally.
The latest credit investor survey showed longs increased to 12m highs, but was offset by large cash
inflows (Slide 5, top LHS). The beta of equity long/short funds remains low (Slide 5, top RHS),
supported by Citi’s prime finance data which shows net positioning has lagged the pick-up in gross
positioning3 (Slide 5, bottom RHS). Below average volumes in equities also signal a reluctant rally
(Slide 5, bottom LHS). Finally, the still steep term structure of implied equity vols also indicates that
investors are not complacent (see equity section)
So what could de-rail the rally? Of course there are always tail risks lurking around the corner, and at the
current juncture there is no shortage of them for sure. However, with respect to the above key drivers, we
think commodity price shocks pose a big risk to continued Central Bank liquidity injections and consensus
growth expectations. Here we focus on two sources of such shocks: energy and food prices.
On the former, apart from the threat to inflation (Slide 6, LHS), sharply higher oil prices could de-rail the US
recovery, as we have been saying for several weeks. Our commodity strategy colleagues have estimated
the impact of oil price shocks on US GDP4: they find that from a sudden 10% increase in the real price of oil,
US GDP contracts by 70bp. They also note that the dynamic of such shocks can be nonlinear and
asymmetric: for example, their results show that for a sudden 50% oil price increase, economic growth could
drop by 4.3% (Slide 6, RHS). This then implies that an oil price increase of 30%+ (of which some has
already occurred) could wipe out Citi’s 2% US growth forecast for 2012. For investors with a pro-risk
portfolio, an upside hedge in oil should be considered, in our view.
In terms of food prices, given large weights in EM CPI baskets (Slide 7, LHS), food price inflation is an
important factor for the EM policy outlook. Although food prices have increased in recent weeks, these
increases remain small and, furthermore, favourable base effects also point to low food price inflation in the
coming months (Slide 7, RHS). This should give EM Central Banks room to ease, adding further liquidity
support. The starting point of nominal EM interest rates is much higher, and the scope and willingness to cut
thus substantially greater than DM. In terms of our macro portfolio, this is one of the reasons we like
expressing our bullish bias through a long in EM equities (see equity section).
Rates
Core G10 bond yields have continued to be range-bound. As we highlighted in our last Weekly, what is
going on is effectively a battle between higher nominal/real growth expectations vs. some combination of
portfolio balance effects and the idea that major central banks are keeping short rates anchored for a long
period of time.
Even if growth expectations will improve, carry-and-roll strategies become very tempting if policy rates are
going to be near zero until, e.g., late 2014 in the US. Moreover, as our Rates Strategy colleagues have
pointed out, carry and roll adjusted for (realized) volatility is still very high. Realised volatility is unlikely to
pick up significantly unless the market starts to (a) price in earlier rate hikes by the Fed or (b) inflation risk
premiums trend higher and become more volatile.5
As for (a), it will likely take continued improvements in the activity and labour market data, as well as sticky
inflation, to get a big move in the forwards. Regardless, we think cross-market US-Europe trades are still
attractive. In our macro portfolio we are paying 3y3y USD swaps vs. receiving in EUR (alternatively, we also
like short EDZ4 vs. long ERZ4).
As for (b), it’s true that inflation breakevens have trended higher, but there is ample room for further
increases. While the bond market experience of the 1970s is probably not a good template for today’s
environment of private/public sector deleveraging, we cannot completely ignore some of the lessons of that
period. The combination of large oil supply shocks and the Fed over-estimating the degree of slack in the
economy meant the Fed effectively ran a very inflationary policy, at least with hindsight.
The oil shocks were much bigger back in the 70s then what we believe could likely happen today, but the
increased probability of energy price spikes given the current situation in Middle East politics, combined with
the recognition that there is considerable uncertainty over the degree of slack in the US economy, indicates
that forward inflation breakevens could rise further.6 After all, even if the Fed’s 2% inflation target is credible,
30y TIPS breakeven rates currently at 2.39% (Slide 8, LHS) imply an inflation risk premium of less than
40bp. This is not particularly high compared to a standard deviation of 288bp in CPI inflation (yoy) since
1955 (Slide 8, RHS).
Then there is the fact that real interest rates on TIPS are at extraordinarily low levels compared to current
(Slide 9) and expected real GDP growth rates. The chart also shows the average real GDP growth rate
between 2012-14 projected by the FOMC committee.7 Needless to say, it would be extraordinary for real
term rates to stay this low if growth turns out meet the Fed’s forecasts. Furthermore, real “risk-free” rates are
even more negative once a credit risk premium is subtracted from TIPS yields.
Ultimately, given their low starting point, term yields can drift higher even if neither (a) nor (b) above
materialises to a great extent in the short run. In fact, the 10y UST yield is about 20bp off its lows in early
February. Thus, we stay short via UST Long Bond futures with a stop at 146-16.8
Elsewhere in rates we have:
• 10s30s UST BE steepener
• Receive 5y EUR vs. short 5y Bobl
• Receive 2y2y ZAR
• Receive 2y INR
FX
Given our risk-on view, continued easy money and stabilising growth expectations, the outlook appears to
be skewed towards further USD weakness in the coming weeks. As we have shown many times, the riskon/
risk-off dynamic with the USD is well defined (Slide 10, RHS) and only very strong or very weak growth
scenarios (neither apply currently) benefit the USD (Slide 10, LHS).
In reality, however, as witnessed by our rather slim FX portfolio, we are not inclined to sell USD vs. its major
DM counterparts at this juncture, given these other central banks are also easing policy. Recent EUR/USD
price action bears out our concern. As the LHS of Slide 11 shows, EUR/USD came under some intraday
pressure after the ECB’s LTRO tender added further liquidity, a risk positive development. A few hours later,
a bout of risk aversion following Bernanke’s speech also depressed EUR/USD. The EUR remains torn
between an easier ECB and risk appetite in other words.
Our EUR FV model tries to capture these effects and is still signalling upside with fair value near 1.40 (Slide
11, RHS). Instead of chasing EUR, we prefer to be positioned for USD weakness via higher beta European
FX, where fundamentals also remain supportive. We have held a 7.05/6.60 USD/SEK risk reversal, but
since inception in late January, the 7.05 call we sold has lost most of its value and by buying it back now, we
can guarantee a profit on the overall risk reversal.9 We continue to hold the 6.60 USD/SEK put.
If risk assets remain bid, we think most DM currencies (in particular USD, EUR, JPY, CHF and GBP) will
likely be used as funding currencies to hold high beta/high growth/carry/EM currencies. In terms of such
trades, as regular readers will know, we view the high beta crosses within G10, in particular AUD, as
overvalued, and hence prefer EM FX to trade this theme.
Having recently taken profits on our long TRY trade, we are assessing opportunities elsewhere in EM. We
think the best chances for FX strength are in Poland, Mexico, India and Indonesia. Apart from Mexico, which
shares tight links with the US, all are mostly domestically driven economies and hence more comfortable
with stronger currencies and most have also recently intervened to strengthen FX (Slide 12).
Equities
As mentioned in the introduction, two key elements of our bullish risk view have been easy money and
improving growth expectations. What is the relative importance of each of these two factors on equity
prices? This question took on greater prominence this week in the light of the market response to
Bernanke’s testimony to Congress on Wednesday.
Following the release of Bernanke’s testimony, stocks fell, the USD rallied and gold prices dropped sharply
– see Slide 13. Perhaps some investors were looking for hints of QE3 (which weren’t there) or the Fed
Chairman’s testimony was perceived as being more hawkish overall than his comments following the last
FOMC meeting. Frankly, we think Bernanke’s comments were fairly neutral. Moreover, it should not have
been a surprise to hear Bernanke use the word “conditional” when discussing the outlook given the more
transparent “conditionality” of the Fed’s new communications framework, something we have emphasised in
recent Weeklies.
Nonetheless, the market response to Bernanke’s comments provides some evidence that easy money has
played a role in supporting risk assets. In the first instance, easy money could be seen as having a bigger
impact on valuations. Lower Treasury yields reduce discount rates and dovish central bank policies may
also reduce risk premiums. By contrast, growth expectations may affect earnings expectations more.10 The
former is about the “P/E”, the latter is about “E”.
Much of the rally in equities since December has arguably been driven by a re-rating instead of an increase
in earnings expectations. This is difficult to prove, of course. From a bottom-up perspective, earnings
revisions have been negative even as markets have rallied, which supports the re-rating hypothesis.
However, we think that consensus growth expectations have been much more pessimistic than bottom-up
analyst numbers, so part of the rally in risk assets may also have been driven by stabilization in investors’
views on earnings. In any case, if our Leading Indicators discussed above are accurate, consensus growth
expectations should rise a bit further and revisions to earnings estimates could turn positive (Slide 14),
which in turn could help fortify a move higher in equities.
Furthermore, equity valuations overall are not stretched yet, so we think most markets are unlikely to de-rate
in the short run. In fact, forward P/E and price-to-book ratios on EM stocks are currently -0.2 and -1.0
standard deviations below latest cyclical averages, so there is still room for multiple expansion in these
markets. This is one reason we recently chose to go long EM stocks as a way to add beta to our portfolio.
Otherwise, as mentioned in the introduction, we think investor positioning is still sending a bullish signal for
stocks. In particular, as our colleagues in Equity Trading Strategy have noted,11 the very steep term
structure of implied volatility (Slide 15) indicates that investors have not become complacent. Indeed, we
think it makes sense that future implied vols should be elevated given the downside risks still present
surrounding the EMU crisis, China slowdown, etc, even if we have a positive directional view. For this
reason, we continue to hold our long VIX futures/long CDX HY trade in our macro portfolio.
Credit
We maintain our view that spread tightening is likely to continue. Clearly valuations are not as attractive as
they have been during most of the past few months, with CDS index spreads, for example, not far off their
lows since last August. Nevertheless, more stable growth expectations and supportive monetary policies
keep us positive.
Furthermore, as Citi’s Credit Strategy team points out, the technical picture in corporate cash markets is
very favourable.12 One consequence of the ECB’s LTROs is that EUR-denominated net issuance by
Financials is set to be even more negative this year (Slide 16, lower LHS). So while net issuance by Non-
Financials should remain healthy (estimated at $262bn in the US market and €30bn in Europe), the global
IG bond market is set to shrink for the first time in years (Slide 16, top LHS). Combined with the increase in
flows into credit funds (Slide 16, RHS), demand-supply dynamics have definitely turned more bullish.
But with yields at very low levels, especially in IG (Slide 17, LHS), the upside in the cash market from a total
return perspective could be rather limited if we get a backup in US Treasury yields, even if spreads tighten
during a Treasury market sell-off as we expect they would. From this perspective, high yield or lower-rated
IG cash credit is more appealing as spreads would probably tighten more in beta-adjusted terms, and in any
case offer higher carry. For instance, Citi’s US high grade strategist, Jason Shoup13, prefers short-dated
BBB-rated credits over longer-dated A-rated ones (see yield chart by rating and maturity, Slide 17 RHS).
In terms of our macro portfolio, in addition to being long CDX HY vs. long VIX futures, we continue to be
long US Large Banks vs. short iTraxx Senior Financials in CDS. So far, we are slightly in the red on the
trade as European financial credit has done well on the back of the LTROs. Frankly, as long as the risk rally
continues, this trade is unlikely to move much either way. However, we still believe that spreads should
widen (much) more on the European leg in a risk-off scenario, and hence this trade can also be seen as a
partial hedge to our generally pro-risk portfolio, and in particular our short EUR 5y ASW spreads trade.
Commodities
Gold came under heavy selling pressure following Bernanke’s testimony to congress, falling over 5%
intraday on Wednesday. As we have highlighted previously, we think gold is driven by reflationary
expectations at this juncture and not by safe-haven flows. Hence, the lack of “QE3 talk” caused investors to
pare back exposures in the precious metal complex.
In that respect, we think it is striking that other “reflationary trades” did not experience similar moves. For
example, US inflation breakevens have been broadly trending higher together with Gold since 2009 and
have been particularly correlated since late last year (Slide 18, LHS). Yet, US BEs hardly moved this week,
suggesting the fall in Gold might be overdone. For what its worth, CFTC positioning as of 21Feb2012, i.e.
before BB’s speech, did not seem particularly extended either (Slide 18, RHS).
All in all, in an environment where Central Banks will continue to be easy, we still think fiat currency
substitutes should be well supported. As such, we view the recent price action as a buying opportunity and
continue to hold our long in Gold and Palladium (via a 50:50 basket14).
Elsewhere in the asset class, we still hold our long in Aluminium, as base metals in general are still lagging
risk appetite in our view. As the LHS of Slide 19 shows, the base metals complex has severely
underperformed the S&P 500 and is furthermore lagging the improvement in risk appetite suggested by our
GRAMI and the better growth expectations predicted by our Leading Indicator for Consensus Forecasts
No comments:
Post a Comment