THE WEEK IN REVIEW 17 Nov 2018

The year-end rally is about to start

Since 1950, the S&P has rallied in December 75 % of the time, according to the Stock Traders Almanac. The benchmark index has gained an average of 1.6 percent for December, traditionally the best month of the year.

After an October that saw the S&P 500 slump nearly 7 percent, and most markets losing 11 % of their value, world equity markets started to find their footing last week.

Markets are up 0.7 percent so far in November even if last week was negative and China bucked the trend with a 3 % positive performance.

Markets have been struggling with uncertainty over U.S. congressional midterm elections, the path of interest rate hikes by the Federal Reserve, tariffs, the trade war and the possibility corporate earnings have already peaked.

But the conditions are falling in place for the unfolding of a strong year-end rally that should spill over into the first quarter of 2018.

Equity markets have now digested the likelihood of another interest rate increase in the US in December, the US dollar is turning as we expected, The US – China Trade war is easing as meetings are going on between Steve Mnuchin and Liu He, Brexit negotiations will be put to the test this week with the vote of the British parliament and China is preparing for a global tax cut.

Finally, the 25 % collapse in oil prices will keep a lid on inflation for the time being.

Technically, most equity markets recorded higher lows last week from extremely oversold levels.

Of all factors, the American consumer could be one of the key drivers next week alongside news on the Trade War.

Investors will get a glimpse of US consumer health next week as the holiday shopping season gets under way with Black Friday sales, and a solid start could help equities steady after several tumultuous weeks.

The day after Thanksgiving has been regarded as the traditional start of the holiday buying season, although deals and bargains are being unveiled earlier this year.

Data released on Thursday showed that U.S. retail sales rebounded sharply in October, boosted by purchases of motor vehicles and building materials, but the prior two months were revised lower and the trend indicated slower consumer spending, which accounts for more than two-thirds of economic activity in the country.

Same store sales for the fourth quarter are expected to come in at a healthy 3 percent, according to Refinitiv data.

In China, Chinese e-commerce giant Alibaba Group Holding Ltd cashed a record 213.5 billion yuan ($30.7 billion) in sales last Sunday during its 24-hour online retail frenzy Singles’ Day, but the event’s annual growth dropped to its slowest rate.

Shoppers in China and across the world snapped up hot items including iPhones, furniture and milk powder starting pre-dawn, with Alibaba recording roughly $10 billion in sales in the first hour after midnight.

Singles’ Day, also called “Double 11”, is the world’s biggest online sales event, outstripping the sales of U.S. shopping holidays Black Friday and Cyber Monday combined.

This year, the company surpassed last year’s full-day sales record of 168 billion yuan in just under sixteen hours.

The annual sales growth rate fell from 39 percent to 27 percent, the slowest rate in the event’s 10-year history, However, considering the fact that the absolute number is now exceeding te GDP of entire nations in one sigle day, expecting the same rates of growth in the future is idealistic.

27 % growth to 30 Billions still a massive increase.

The world economy is still humming and monetary policies are not restrictive yet. Now that the corporate earnings season is out of the way, and that the speculative froth has been eliminated, investors will put cash back at work hoping for a positive ending for the year

In sum, we expect equity markets to start their year-end rally next week or the week after.

China and Asia will outperform strongly their US counterparts but the entire year-end rally should be seen as a bear market rally that will probably top-out in the first quarter of 2019 without making new all-time highs.

We expect emerging markets to re-trace 50 % of the 2018 bear phase, meaning that the potential for a 20 % rally from now till the year-end is high.

China’s Outperformance

The most striking feature of last week was the strong outperformance of Chinese equities last week. Chinese Domestic indexes delivered positive performances of 2.8 to 3 % at a time where US equities fell by 2 % , Japan by 3 % and Europe by 1.5 % on average.

Asian markets were also mixed with Hong Kong and Indonesia delivering strong positive performances.

Relative strength is always an indicator of where action is going to take place next and China is bound to deliver superior performances in the weeks to come.

Chinese equities have been sold to levels of undervaluation not seen for decades and local and foreign hedge funds are still significantly short the markets.

The Yuan is turning and Xi Jing Pin’s administration is determined to use monetary and budgetary policies to contain the structural slowdown.

A number of strong signals have been sent to the markets.

China should cut corporate and personal income taxes to support the slowing economy amid a trade dispute with the United States, former Chinese finance minister Lou Jiwei said on Sunday.

Facing the nation’s weakest economic growth since the global financial crisis, Chinese policymakers are fast-tracking road and rail projects, pushing banks to increase lending, and cutting taxes to ease strains on businesses.

“There is room for cutting both corporate and personal income taxes,” Lou, now chairman of the National Council for Social Security Fund (NCSSF), told a finance forum in Beijing.

In October, China already raised the threshold for collecting individual income tax to 5,000 yuan ($720) per month from 3,500 yuan, hoping to boost consumption.

The government has also been cutting value-added taxes and fees for companies, but it has yet to lower the corporate income tax rate of 25 percent.

China should not launch another round of large-scale infrastructure investment to spur growth given that such a move could worsen the country’s debt risks, Lou said.

Local governments in China are already burdened by heavy debt, he said, and the government should instead use its fiscal tools to help defuse debt risks at financial institutions.

Finally, the push to open China’s financial markets to foreign corporations is in full swing.

Last month, Chinese President Xi Jinping confirmed in a speech that the country was “steadily widening the opening up” of its financial industry.

Almost exactly a year after the country announced historic plans to ease local ownership rules and entry barriers to what’s now a $45 trillion industry, the pace of change has been slow but real.

While Xi signaled that China’s opening remains on track despite the country’s trade war with America, he also made it clear that policy makers will move deliberately.

The most important changes announced a year ago allow foreign companies to take majority stakes in local securities firms, mutual fund managers, banks and insurers.

So far, most of the action has taken place in the securities industry. UBS Group AG, JPMorgan Chase & Co.and Nomura Holdings Inc. have all submitted applications for majority stakes in their Chinese joint ventures, according to regulatory filings, and Morgan Stanley and Credit Suisse Group AG are expected to apply.

While Beijing has yet to sign off on a foreign-controlled business under the recently completed rules, the first approval could come soon.

It’s not hard to understand China’s appeal to global investment banks. At $5.6 trillion and $11 trillion, respectively, the country’s equity and debt markets are the world’s third largest. And their importance will only grow as policy makers move to reduce the economy’s reliance on bank lending. For global securities firms, that means plenty of opportunities for brokerage, advisory and underwriting fees.

On the macro-economic front, a number of indicators came out stronger than expected by the markets last week. Amongst them, Consumer confidence, disposable income, real estate prices and industrial production were al stronger than expected and are painting a less dire picture of the Chinese economy than usually projected by analysts.

China’s economy showed tentative signs of stabilization in October with infrastructure investment and industrial production picking up.

Industrial production gained a better-than-expected 5.9 percent from a year earlier, and fixed-asset investment rose 5.7 percent in the 10 months through October, exceeding an estimate of 5.5 percent.

Those readings signal that government stimulus aimed at spurring infrastructure investment is finally passing through into the real economy.

An easing of trade sanctions and a confirmation that the Yuan has bottomed out would send equity indexes rallying through their 2018 downtrend, forcing short-covering on a significant scale.

The USD is turning

Interestingly enough, the US dollar made an important turn last week. As our readers know, we had correctly predicted the 10 % rise in the US dollar back in March and recommended investors to sell Dollars at 1.13 two weeks ago.

Last week, the greenback closed at 1.14 against the EUR in what amounts to a significant bearish reversal.

This is coming at a time where the economic data for Japan and Europe showed a significant contraction in the third quarter of 2018.

One-off factors were largely to blame — weather in Japan
and cars in Germany. and mounting trade wars.

Both the Japanese and German economies are forecast to rebound this quarter after shrinking an annualized 1.2 percent and 0.2 percent on a quarterly basis respectively.

Japan’s economy was bound to take a hit from a string of natural disasters and in Germany, Services output came out unusually weak, but data quality is lower for that sector at this stage. This creates room for an upward revision in future estimates of the third quarter.

But there is no doubt that underlying momentum in the export-heavy nations is being undermined by the U.S.’s antagonistic tone on trade.

Reports that President Donald Trump will hold off for now on imposing levies on imported Japanese cars and auto parts keeps one of the biggest threats to Japan’s economy at bay for the time being.

Germany is benefiting from a truce between the EU and the U.S., though European Commission President Jean- Claude Juncker signaled that this might only last until year-end.

As we have argued all along, the main factor that is destabilizing the world economies and the financial markets at large is the US induced Trade War.

Now that the mid-term elections are behind us and that equity markets have clearly sent loud warning signals, the incentive for Donald Trump to maintain his aggressive stance is getting much lower.

America needs a strong Chinese economy and sanctions on Chinese imports will affect US corporations significantly if their are to pass in January.

We clearly expect a change of tone on the US trade war in the coming two weeks and that will provide a global relief to investors sentiment.

At the same time, the sharp volatility in equity markets is bound to dent consumer sentiment in the USa and the 18 % fall in oil prices will both keep a lid on inflationnary pressures going forward.

As such investors are less likely to bid the US currency higher and any improvement in the data coming out of Europe and Japan has the potential to send the EUR higher.

The Australian and New Zealand Dollars have already turned as have several emerging markets currencies.

Next week the US will publish building permits and housing starts, existing home sales, durable goods orders and flash Markit PMIs.

Other important releases include: ECB and RBA meeting minutes; UK CBI factory orders; Eurozone flash Markit PMIs; and Japan inflation and trade balance.

Crypto-currencies are collapsing

Last week was a litmus test for what remains of the crypto-currency space.

After having traded for almost nine month above the US$ 6’000 level, Bitcoins fell through and slumped 13.85 % in the week alone

The battle for the control of Bitcoin Cash is what triggered the slump.

The fourth-largest cryptocurrency began attracting mainstream attention this week when two competing software-development teams failed to agree on how to best update the code and ended up splitting the network.

The fight was cited Wednesday for contributing to the biggest drop in eight months for Bitcoin, which Bitcoin Cash had split off from last year.

Both factions have been ramping up the amount of computing power they own to support their software version to win a race called Nakamoto Consensus, under which whoever has the most computing support wins.

The groups, known as ABC and SV, are losing about $700,000 a day on expenses like electricity to run so-called mining rigs that compete to process transactions, according to BitMex Research. That’s on top of another $1 million a day in lost opportunity cost from not having their computers mine Bitcoin, according to Jimmy Song, a Bitcoin core developer.

Each has pledged to keep going to win the so-called Hash War, where “hash” denotes computing power dedicated to the effort. While ABC is currently ahead, according to tracker Coin Dance, the balance of power could still shift.

The ABC faction is headed by Chinese crypto mining powerhouse Bitmain and investor Roger Ver, who is referred to as Bitcoin Jesus for his early advocacy of the original coin.

The SV, or Satoshi’s Vision, group is led by billionaire Calvin Ayre and Craig Wright, the self-proclaimed Satoshi Nakamoto, the anonymous creator of Bitcoin. Wright’s claim has long been doubted in the crypto community.

In the meantime, the fight has been costly for investors, who have already seen Bitcoin Cash lose $2.75 billion in market value in the last week.

The truth of the matter is that the battle confirms that Crypto-currencies are nowhere reaching the stage of fulfilling any of the feature of safe and reliable means of payments and that they only represent speculative bits of code that have no real demand for them.

And the crypto-currencies drama is probably just starting.

According to Bloomberg Intelligence, the price could fall to $1,500, which would indicate another drop of more than 70 percent from current levels.

The digital token has lost more than 60 percent of its value so far this year.

Many of Bitcoin’s closest peers, including XRP, the cryptocurrency also known as Ripple, fell in tandem last week.

As our readers know, we have been short Bitcoins since December 19th 2017, the day the Future market started trading in Chicago and we still are !

The End of the Oil Era Theme

A quick snapshot that says it all :

Too much Oil and not enough demand !

Oil is oversold for now and OPEC is moving fast to reduce production, but the long-term dynamics are in place of a significant fall in oil prices later in 2019.

Mohamad Bin Salman, Donald Trump and Wladimir Putin are certainly calling the market shots. But he Saudi prince may struggle to defend output cuts against a hostile Trump and indifferent Putin.

Saudi Arabia needs Oil prices at US$ 73.3 to balance the Kingdom’s budget but MBS’s political stance has been seriously eroded with the killing of Khashooggi in Turkey and with the jump in America’s production capabilities, OPEC is slowly but surely losing its grip on oil prices.