Macro and market perspectives on Q2 2019

It is worth remaining in the 'don't touch it, it's toxic' camp. Afterall it has been a horrible Q4 2018 for risk assets fuelled by the US Federal Reserve's 'far from neutral' and Commodity Trading Advisors (CTAs) selling into a liquidity hole in December. The Fed panicked and CTAs were forced to buy their risk assets back and go long (luckily bonds stayed bid on the back of the Fed so they got away without too much damage).

US Real Yields haven’t failed to price in the renewed Fed’s dovishness:

Source: Ollari Consulting

We are now approaching the old highs in equities, and as expected CTAs are long everything:

Source: Ollari Consulting

Hedge funds in general have also been forced to chase the market higher:

Source: Ollari Consulting

Interestingly, real money has been selling equities and buying bonds:

Source: Ollari Consulting

It's oddly quiet - it grinds higher, it feels big. The problem with these markets is that they often collapse with little warning and very quickly. Once everyone has spent their money for the year, it's easy to see the markets retrace to the lows without much effort. Much more difficult is to guess when that might happen.

On the economy – there has been a bit of a bounce out of China with the much-expected follow-through in credit creation. Things were, unsurprisingly, good in Q1 as implied in Q4 (which suffered from Q3 acceleration of orders to avoid US tariffs). Chinese Industrial firms’ profits jumping 13.9% in March (YoY) is only displaying the same reality that has been conveyed by the trade balance or the Manufacturing PMI: essentially a sharp snapback offsetting the extreme weakness of the start of the year and prior to the Lunar New Year. However, that favourable comparison is now old news.

Source: Ollari Consulting

Also, we get ominous rumblings from the White House about Trade War 2.0 with Europe. The French and German governments are on course for some fiscal stimulus in Q2 2019, pushed by an attempt to shore up their electoral appeal. That might put a floor to the dismal reading on the economic growth front:

Source: Ollari Consulting

So rather than try to time it, our preference is to sit it out on equities, although a couple of retro comments on the possibility of a 'melt up' suggest we may not be too far from the denouement.

Briefly on credit: interest cover ratios. Given the sharp rise in non-financial corporate debt over the past decade, signs of margin pressure should be watched carefully. Current cover ratios are not as poor as they were in 2016, but are again deteriorating, and this despite low levels of yields and tight credit spreads, per se the vulnerability to even a modest rise in rates and/or spreads could prove very challenging, to say the least.

One thing that is clear is that market weakness will be met with more QE. This is economically dangerous - we still haven't paid the bill for the last bout of unconventional easing and the end of a long expansion seems a reckless place to do more. For that reason, we prefer commodities to bonds as this is textbook territory for inflation (I know, it doesn't feel inflationary but with the World's Central Banks competing to flood the market with their currency, it's got to come out somewhere).

It might not be a bad place to have a bit of long volatility in your back pocket given this year’s collapse in vol prices. Large speculators, mostly hedge funds, were net short about 178,000 VIX futures contracts on April 23, the largest such position on record, weekly CFTC data that dates back to 2004 show. Aggressive bets against the VIX are, depending on your worldview, evidence of either confidence or complacency. As the readers know, I am in the second camp.

Source: Ollari Consulting