Deutsche: "We Are Almost At The Point Beyond Which There Will Be No More Bubbles"

Whereas many Wall Street strategists enjoy simplifying their stream of consciousness when conveying their thoughts to their increasingly ADHD-afflicted audience, the same can not be said for Deutsche Bank"s Aleksandar Kocic, who has a troubling habit of requiring a background and competency in grad level post-modernist literature as a prerequisite for his articles among the handful of readers who don"t already speak exclusively in binary. Here is an example of Kocic"s "unique" narrative style:

Volatility is a consequence of speed and speed is the result of fear. Acceleration of movement is a defensive maneuver, a tool of retreat -- high speed and high volatility represent sophistication of flight (flight to quality is an example of the speed event). However, absence of volatility is not necessarily synonymous with absence of fear. Volatility is low not only when things become predictable, but also if the distribution of risks causes paralysis, when the state of no change, regardless how uncomfortable it might be, becomes the least undesirable of all alternatives.

While a passage like that is far more likely to have been taken from a book by Lacan, Derrida, Deleuze and Guattari, Foucault or any other prominent POMO-ists, in this case it comes from Kocic" year end outlook which encapsulates many of the themes we have covered recently, most notably his recent take on the interplay between volatility and leverage, a topic which anyone who has read Minsky is quite familiar with, yet which Kocic decided to give it his unique post-modernist spin with the following "spiraling leverage" chart from one month ago...

... which he described as follows: "spiraling leverage cannot continue indefinitely. At some point, the bubble becomes too big and cannot be subsumed by a bigger bubble – the damage of its burst would become irreparable. Therefore, when that moment comes -- and we believe that moment is now – the market is facing a following dilemma."

• Permanent state of exception: We continue to operate in a regulated environment. Leverage is limited, but care is taken not to overconfine the system so we avoid the Japanese scenario. While this appears as a prudent approach to reality, it implies giving up all the ideas of unlimited growth, something that made US economy look better than the rest of the world. Compared to what we have seen before, this means settling for much less than this country is used to aspiring. Although a reasonable proposition, it is emotionally a difficult choice that is and will remain subject to substantial political manipulation. It is unlikely that populist narrative will not continue to challenge this choice [ZH: hey, one can just blame the Russians, right?]


• Flirting with high tail risk : Deregulation and deficit spending could result exactly due to abandoning the first path, as its direct challenge, under political pressure that American economy can restore its old status and resume its pace of the previous decades. This is a serious tail risk as it is playing against the backdrop of considerable overhang of the post-2008 one-side positioning. Central banks are massively short convexity in this scenario. Any inflationary maneuver, or anything that would be a bear steepener of the curve, could force disorderly unwind of the bond trade and reinforce the trend thus creating another crisis from which there could be no way out.


• Forced deleveraging: An overly hawkish Fed forces rates higher and triggers a disorderly unwind of the bond trade, thus forcing the system to deleverage. This is the policy mistake.

The Deutsche Banker"s conclusion was stark and certainly dramatic:

"The tension created by these three choices is in the center of both economic and political discourse. It will shape the market dynamics in the future, beyond the near term. Taper tantrum and the US presidential elections were the two most recent episodes that have highlighted the risk distribution opened by these choices. Policy mistake appears less likely at this point. The financial conditions are as loose as they have ever been. Fed hikes are only going to tone this down, but it is very difficult to see how they can create overly tight financial conditions and cause economic slowdown. Nevertheless, negative convexity of the central banks in the bear steepening or generally high rates scenarios are making risk of volatile deleveraging alive."

Of course, Kocic could (far simply) have said that it takes more and more debt to kick the can, and keep the world"s biggest asset bubble ever created - with the explicit backing of central banks - from bursting. This is precisely what Bank of America"s Barnaby Martin did in far less words one month ago:

"the irony in today"s world is that central banks are maintaining loose monetary policies to generate inflation…in order to ease the pain of a debt "supercycle"…that itself was partly a result of too easy (and predictable) monetary policies in prior times."

* * *

In any case, fast forward one month later when Kocic picks up where he left off on his favorite "spiraling leverage" diagram, and decides to once again paraphrase Minsky"s conclusion that "stability is destabilizing" using just a few hundred extra words than is necessary, although since he does so in a "cool", Pomoist way, here is the paraphrase:

Persistent low volatility is like a sirens’ song. Low uncertainty engenders high leverage which leads to compression of risk premia and further buildup of risk, which, in the long run, destabilizes the system causing ultimately volatile deleveraging. This is generally harmful for the economy and requires stimulus injection in order to create an economic turnaround leading to subsequent decline in volatility and gradual releveraging as the system recovers. When described in terms of leverage and volatility, economic trajectories exhibit quasi-periodic pattern. These dynamic are shown in the Figure as trajectories in the vol-leverage plain across several “cycles”.

 

Starting with the internet bubble in 1999, we reach the 2001 recession and subsequent recovery on the back of the real estate boom (2003-2007). The figure suggests that after each volatile deleveraging (e.g. 2000 and 2007), subsequent sweep leads to a bigger bubble. After each sweep, amplitudes grow bigger and the damage more substantial, requiring a heavier hand in terms of policy response as crises they create become deeper and recoveries longer and more difficult.

Kocic then reuses the same chart he showed back in November to indicate the four distinct endgames should the leverage cycle be pushed into one of four final states of "instability."

Where the narrative differs from last month, however, is in the slight but perceptible shift to Kocic" conclusion: he now appears resigned that the current twist of the vol spiral is also the last one, beyond which the current financial and monetary system will no longer exist, something his just as gloomy colleague Jim Reid concluded not too long ago and which we described in "This Is Where The Next Financial Crisis Will Come From."

Here is Kocic explaining why we may be approaching the end of financial history (at least as we know it):

It is clear that the spiraling trajectory cannot continue indefinitely; it has to stop at some point beyond which there will be no more bubbles. In many ways, it looks like the post-2008 represents the last lapse. A new game has to be reinvented for the old future to materialize, or a different paradigm altogether has to take over.

As to what happens next, after the two sweeps of the spiral, both of which culminated with crashes, Kocic reverts back to his forecasting self and writes that "we arrived at the juncture point (2017) from which four possible trajectories emerge, none of them are looking very attractive at this point." For those who may have forgotten the November report, here they are again:

• Throughout the post-crisis period, policy response has been designed around an attempt to avoid the lower left corner of low volatility and low leverage. It is safe to say that we have been able to stay clear of this outcome.


• At this point, with regulated financial sector and restricted leverage, we have found what appears to be a “reasonable” base case trajectory – a middle ground between Japanese style liquidity trap and repeat of the same mistake of the previous lapse -- with regulated markets, lower leverage, and subaverage growth (a.k.a. Permanent state of exception).


• Alternatives represent risk scenarios and correspond to volatile outcomes. The lower right corner is the policy mistake territory of forced deleveraging (without inflation) triggered possibly by overly aggressive Fed.


• The most acute risk is associated with the path leading to the upper right corner where possible deregulation and reckless fiscal spending could trigger rise in inflation leading to stagflationary outcome with potential currency decline and forced unwind of the bond trade. Both of these trajectories represent high risk alternatives to be avoided.

Unfortunately, as recent social events have demonstrated, the current "reasonable base case" of a "permanent state of exception" is becoming increasingly improbable because the forced surreal financial relationships are starting to tear apart the social fabric itself. Not only that, but the fact that the "stability" has only been bought thanks to some $15 trillion in central bank liquidity is lost on only the biggest fools, and socialists, pardon - MMTers - in finance. Here again is Kocic:

As much as the base case trajectory appears as “reasonable” and a worry-free choice, its biggest problem is its legitimation. Easy money provided by central banks to restore growth was easy for capital, but not for labor. Policy response to crisis added further to inequality by blowing up the financial sector and inviting speculative rather than productive investment. The Keynesian bond which ties profits of the rich to the wages of the poor seems to have been severed, cutting the fate of the elites loose from that of the masses and the well-being of the economy. 

Confused? You can thank Bernanke and Yellen for president Trump. Anyway, Kocic continues:

 With subaverage growth and highly skewed wealth distribution, the economy is converging towards what for a growing majority increasingly resembles a zero sum game. To the vast majority, that is saying that the best days are behind us. This is the most difficult aspect of the base case scenario: There has been no political system in modern history -- inclusive, exclusive, democratic or oppressive, all the same – that has promised anything but better future to its constituents. For any ideology the gradient between the present and the future has always had to be positive. It is difficult, if not impossible, to conceptualize any political narrative capable of making the reverse acceptable. And in a context where economic growth is a universal metric of progress, problems  with the base case become even more acute. The legitimation of the base case will continue to define the populist narrative as a voice of change. Politics will be shaped along the lines of looking to disrupt the status quo with quick short-term fixes, which could emerge as outright triggers of stagflationary trajectory.

Well, considering that years and decades of endless political lies that "the future is brighter" is the reason why the world finds itself on the edge of a social, political and financial catastrophe, and which has made a handful of people richer than their wildest dreams while pushing the vast majority of the population into considering that socialism - and even communism - may be a wise alternative to capitalism, perhaps it is not so bad that for once the truth will be told and someone will have the temerity to admit that no, the future will not be better, especially when one admits that after the next crash - and the wars that follows - the future, or as it will be known then, the present, will be the worst since the world wars.

And finally, for those who lament the disruptions to the status quo by populist elements promising "short-term fixes", well just look where said status quo got you: a world where the markets have to close their eyes and pretend they can exist forever in the artificial, central-bank created "permanent state of exception."

Which, thankfully, is impossible.

The Best And Worst Performing Assets In The First Half Of 2017

The first half of the year may have been forgettable for a majority of the smart money and hedge funds, with nearly 80% once again underperformingttheir benchmarks due to months of P&L crushing short squeezes, but it was a buoyant time for equity markets and virtually all asset classes, for one simple reason: a record central bank liquidity injection of over $1.5 trillion YTD. Of course, that central banks had to flood markets with so much liquidity as the global economy is allegedly recovering is the main reason why nobody actually believes in said "recovery", and neither do the central bankers.

They did succeed however in generating outsized returns for the first 6 months of 2017, and as Deutsche Bank"s Jim Reid writes, the first half of 2017 has been an overall positive half year for our sample of assets. Reid continues below:

Indeed with measures of volatility for a number of asset classes at historically low levels, 32 out of 39 assets in our sample have delivered a positive total return while 35 assets have done similar in USD terms. In summary, equity markets have led the way with 9 out of the top 10 positions in our leaderboard. The peripherals stand out the most with the Greek Athex (+40%), IBEX (+24%) and Portugal General (+22%) all delivering decent double digit returns. European Banks (+20%) have extended a rally which started this time a year ago following a torrid start to 2016. EM equities (+19%), Stoxx 600 (+17%) and the S&P 500 (+9%) have also seen a more than solid start to the year. For bonds, in USD terms returns sit in the +2% to +9% range with the peripherals outperforming.

It’s worth noting that given the Euro has rallied some +9% this year, in local currency terms European Bond markets are actually mostly flat to modestly down for the year. Meanwhile for credit, returns for European indices are +9% to +13% in USD terms (and 0% to +4% in local currency terms) while returns for US credit are +3% to +6%. Finally, similar to the below for June and Q2, Oil stands out for the biggest underperformer in H1 with Brent and WTI down -17% and -14% respectively with the market still questioning the effectiveness of the major producer supply curb.

In terms of the month of June itself, it has been a mixed one for our sample of assets. Markets have had a few themes to contend with. The first is the underperformance of Sterling assets in the wake of a surprise UK election result. The second was the sharp decline in the price of Oil and the third was the big spike in volatility – particularly for rates - in the last week of the month following a chorus of hawkish central bank speak. The end result was this for our sample: 20 of our 39 assets ended the month with a positive total return in local currency terms and 24 in USD hedged returns. It is however worth noting that the range of returns was relatively small. Indeed in USD terms, 29 of our 39 assets ended the month with a total return in the +2% to -2% range.

Looking at the movers and shakers this month, there isn’t much of a theme to note at the top of leaderboard. In fact it’s a fairly diverse mix with the top 5 performers this month being Wheat (+19%), Greek equities (+8%), Copper (+5%), Shanghai Comp (+4%) and European Banks (+3%) in USD terms. For equities, it was a fairly mixed month with some volatility into month end helping to create some divergence. The Micex (-3%) and Bovepsa (-2%) were the notable underperformers reflecting lower Oil and political turmoil, respectively. The FTSE 100 returned -1% (and -3% in local terms) while the Stoxx 600 was also  -1%. The S&P 500 finished up less than +1% while EM equities were +1%.

For bond markets returns were subdued but in the case of Europe, mostly positive despite the big rates re-pricing in the last week. BTPs (+2%), Spanish Bonds (+2%) and Bunds (+1%) all finished with low single digit returns while Treasuries ended the month flat. Much like equities, Gilts (-1% in USD and -2% local) saw negative total returns over the month on political concerns and higher inflation. There were similar returns for credit markets suggesting little evidence of much spread tightening over the month. Generally speaking EUR credit outperformed US when looking at USD hedged returns. EU HY, EU Fin Sub, EU Fin Sen and EU IG Non-Fin all returned between +1% and +2% while equivalent US indices finished in a 0% to +1% range.

At the bottom of the leaderboard the most notable standout was the -5% declines for WTI and Brent Oil. That includes a late bounce in the last week or so. Prior to that, Oil had been down as much as -12% at one stage during the month. Elsewhere Silver (-4%) also had a bit of a month to forget as did Gold (-2%).

These Are The Most Expensive (And Best) Cities Around The World

Every year Deutsche Bank releases its fascinating index of real-time prices around the world which looks at the cost of goods and services from a purchase-price parity basis, to determine the most expensive - and in this year"s edition, best - cities. As have done on several occasions in the past, we traditionally focus on one specific subindex: the cost of "cheap dates" in the world"s top cities.

The index consists of i) cab rides, ii) dinner/lunch for two at a pub or diner, iii) soft drinks, iv) two movie tickets and a v) couple of beers. Deutsche Bank"s advice to those in Zurich is either to marry young or choose your blind dates carefully as its "cheap date" index continues to see Zurich as the most expensive place for courtship. Tokyo climbs to second and Oslo, Copenhagen and Stockholm make up the top 5. Indeed these 5 cities are also the most expensive for a haircut so the pre-date investment costs are also high!

If you"re in the Philippines, Indonesia, Malaysia, India and Mexico a date is around a quarter of the cost of that in Zurich and a haircut about a tenth of the price. So if you"re young, free and single in Zurich, depending on how much you date it might be profitable to migrate to parts of Asia even after the salary sacrifice, the German bank suggests.

And while traditionally we end it here, focusing merely on the most (and least) expensive cities part of the study, this year it is worth expanding because what started off as a pet project for Jim Reid back in 2011 has turned into a purchase-price parity masterpiece, as well as a crowdsourced "quality of life" index, which ranks some 50 of the world"s top cities on par with any of the rankings seen in various other, more popular rankings such as that by Mercer. As the London-based banker writes, "We continue to add new cities, refine our methodology and while it’s impossible to exactly match products and services around the world we try to ensure as much uniformity as possible and then convert prices back to USD."

Some further details:

This year Deutsche has added a few new series. In particular average after-tax salaries, average 2-bed apartment rental costs and finally a quality-of-life index that is the most subjective measure in the report and will probably cause most arguments, debates and disagreements. A lot of the data in the report is crowdsourced (including this new quality-of-life index). Wellington, NZ comes out on top out of the 47 cities we cover based on purchasing power, crime, healthcare, cost of living, house prices, commuting time, pollution and climate. Edinburgh, Vienna, Melbourne, Zurich and Copenhagen are next. Of our 47 cities, the "mega cities" like Tokyo (rank 27), NYC (28), Paris (30), London (33), Shanghai (37) and Mumbai (45) rank very low mostly due to high living costs, crime, pollution and commuting time. Megacity dwellers may also forsake short-term quality of life for aspirational reasons with these cities providing more upside rewards from the average for those most successful.

Looking simply at most expensive cities, Reid finds that Zurich remains the most expensive place to do and buy a lot of things but does have the highest average salaries, followed by several US cities and then Sydney. London has slipped out of the top 10 post the Brexit-FX fall.  

Rents are highest in San Fran, HK, NYC, London and then Zurich. Of note: the difference for a 2 bedroom rental between the most expensive city, San Francisco, and India"s Bangalore, when indexed in USD is a whopping 12 times.

Zurich is home to the highest ‘disposable income after rents’ and at the top of the purchasing power index.

However it might depend on how many dates and haircuts you have in a month (see top chart) as to how wealthy you feel. At the other end of the scale if you"re in Jakarta, Manila, Rio, New Delhi and Istanbul and a job comes up in Zurich then you could potentially increase your salary by ten-fold. Mind the cost of living increases though.

Global brands continue to be relatively cheaper in the US than across its DM peers. The top 10 most expensive regions across goods and services remain dominated by European cities. Swiss and Nordic/Scandinavian cities in particular require a tolerant bank manager to enable consumption. If you find yourself on holiday in Turkey, Brazil, Russia or Greece try to avoid the Apple store as iPhones are  25-50% more expensive than in the US - still the cheapest place to buy. Japan, Hong Kong, Malaysia and Canada only see a small premium over US prices.

The "weekend getaway" index reflects the general cost of living around the world but is perhaps biased by hotel costs.

Milan is the new number-one (very expensive hotels), followed by Copenhagen, Zurich, London, Stockholm, Vienna and NYC. Much lower hotel costs in Asia continue to keep these cities as attractive holiday destinations.

The "bad habits" index of cigarettes and beers is most costly in Australia, NZ and Singapore. At the opposite end of the spectrum it’s very cheap to indulge in such habits in the Czech Republic and South Africa.

If you relocate to Singapore, Copenhagen or Oslo consider a bike rather than a new car as duties etc. make the cost very prohibitive.

Avoid car rentals in Amsterdam and try not to get thirsty in Oslo (beer or coke)...

... and refrain from buying jeans and trainers in Copenhagen.

Petrol costs most in HK and public transport most in London.

Zurich also tops the rankings for most expensive movie tickets, while those who want to stay in shape will spend the most in Tokyo (with Zurich 2nd).

Hungry? A basic dinner will set up back some $73.70 in Zurich, while a full course dinner for two is most expensive in Oslo and costs just about $130.

Finally, new to this year’s study is a quality-of-life index of the 47 major cities DB collected prices for across the rest of this document. Figure 1 shows the overall index level plus the ranks for the individual components. The data has been collected by www.numbeo.com - a large crowd-sourced information database on global prices, quality of living etc. The data is based on the following 8 variables; purchasing power, safety, healthcare, cost of living, house prices/income, commuting time, pollution and climate.

In First Week Of ECB "Taper", Draghi Ramps Up Purchases Of Corporate Bonds

In previewing today"s newsflows, Deutsche Bank"s Jim Reid this morning said that "perhaps the most interesting stat today will be the ECB CSPP number which will include 3 days worth (out of 5) of settled secondary purchases under the new tapering regime. A big debate has been as to whether they taper CSPP in line with the PSPP or leave it running at a similar pace. Obviously the latter would be very good for credit technicals."

Reid said that "for choice I think they do taper CSPP" and added that "we won"t know for sure today but we"ll perhaps get some clues in the size of the purchases. The last two weeks have seen daily numbers of EU335m and 308m respectively down from the average of 365m since the program started so there"s a little clue here that they have been scaling back a touch. We also have to adjust for the slightly below 20% of primary in the number which due to longer settlement periods won"t be under the new regime in today"s number. So an interesting release to follow this afternoon."

Moments ago the ECB disclosed its "anticipated" first stub week of bond purchases under the tapered regime, when it disclosed that it as of April 7 it held €77.87BN in corporate bonds.

So it may come as a surprise to Jim, and other ECB watchers, that contrary to expectations, not only did the ECB not trim its corporate purchases for the week, but appears to have ramped bond buys, as its holdings rose from €75.46 to €77.87, a €2.41BN increase, or about €482MM per day, roughly a 40% increase from the recent "scaled back" run-rate of €308MM, and also above the daily CSPP program average of €365MM.  To be sure, as Reid also noted, the number has to be adjusted for the slightly below 20% of primary in the number which due to longer settlement periods won"t be under the new regime in today"s number, although even revising for that, it appears that the ECB has aggressively ramped up its purchases in the first week of the tapered program.

As a reminder, the ECB has provided a strong bid for Euro credit since its announcement of CSPP in Mar-16. iBoxx EUR IG and HY corporate credit spreads have tightened by 40bps and 197bps respectively since announcement. Corporate purchases began on 08- Jun-16, with a weekly average purchase of ~€1.8bn and total corporate bond holdings to date of €75.45bn (as of 31-Mar-17), or roughly €7.8bn a month. The ECB purchases aggregated a total return of -0.46% in Mar"17 vs 1.06% in Feb"17. Bonds purchased under CSPP have performed worse than the broad index (iBoxx EUR IG Non-fin Senior index) which returned -0.30% in March. Utilities sector with highest exposure by amount outstanding returned -0.06%.

So what did the ECB buy in the latest week? According to a Bloomberg the ECB purchased at least 11 corporate bonds under the CSPP program, which lifts the number of securities held to 894.

• As of Friday, the ECB now holds €77.87 Billion, or ~12.39%  ofthe €628.34 billion in European corporate bonds outstanding.


• The ECB bought bonds issued by BMW Finance, Daimler, DIA, EDF, Engie, HeidelbergCement, Italgas, Kering, Suez and Telecom Italia;


• Of note: 148, or 16.6% of the 894 securities are negative yielding. Utilities remain the largest industry group with 237 securities.

Finally, since the first week of the month may have some "noise" in the ECB"s purchases, we suggest waiting until next Monday for the definitive answer if the ECB has ignored tapering when it comes to corporate bonds, before rushing to buy even more Euopean corporates in hopes of frontrunning the ECB.

Gundlach: Ignore Stocks, "There Is A Stealth Flight To Safety Going On"

Not only is the Trump rally over, but stocks are the last to get the memo. That"s the current market summary according to DoubleLine"s Jeff Gundlach who told Reuters that "there is a stealth flight to safety going on."

Among key indicators, Gundlach pointed to German Bunds and especially Schatz (2Yr), noting that "German bond yields are leading the way down," adding that "Gold is rising." He also warned that "speculators remain massively short bonds and the market is going to squeeze them out."

As we showed last Friday, the yield on German Schatz plunged to a record -0.96%. Earlier that day, Deutsche Bank"s Jim Reid said "I"ve no idea why Bunds are rallying so hard at the moment."

That said, a simple reason for the collapse in German yields may have little to do with political risk or fear of the upcoming European elections, and everything to do with the ECB running out of eligible securities to monetize. As Citi"s Jamie Searle calculated last week, the ECB needs to buy around EU80b in 1y-6y German paper by year-end, and as a result traders are merely frontrunning the ECB. As a result, Citi expects that not only will the 2Y tumble below 1% but the 10Y Bund yield will plunge again, dropping as low as -0.10%.

Back in the US, US yields have given up much of their "Trumflation", post-election gains, and on Friday, the 10-year traded at 2.32%, compared with 2.388% late on Thursday. Yields fell as low as 2.313 percent, the lowest since November.

Gundlach, who oversees $101 billion, first introduced his view on the 10-year yield"s bottom in January. He then said on an investor webcast: "I think the 10-year Treasury will go below 2.25 percent ... not below 2 percent" before edging up again. As of this moment, we are just 7 basis point away from Gundlach being proven correct again.

As a result of the latest inflation trade unwind, Gundlach said the U.S. Treasury should consider issuing ultra-long-term obligations. "I’d issue the longest maturity Treasuries that the market accepts," Gundlach said. "Start with 40-year, then keep extending if the market allows it. Do 100 if you can get there. The timing is good right now." Of course, the mere hint that the US would so dramatically change its issuance calendar would very likely result in another steep selloff on concerns about duration realignment, and the sudden "unpredictable" shift in the world"s deepest and most liquid bond market.

Meanwhile, touching on stocks which soared in the last minute - literally - of trading to close at yet another all time high, Gundlach noted that "stocks are out of sync with the stealth flight to safety. Lots of hope built in."

Bond mkt is flashing warning signal on Trump reflation trade. Dow hit fresh record while 10y ylds at multimonth lows https://t.co/UNxyN6hyRT pic.twitter.com/VCH45KCqAC

— Holger Zschaepitz (@Schuldensuehner) February 26, 2017

Back in December, Gundlach said that "the bar was so low on Trump to the point people were expecting markets will go down 80 percent and global depression - and now this guy is the Wizard of Oz and so expectations are high. There"s no magic here." So far the magic remains, even if it is on the back of retail investors rushing into ETFs , even as the smart money is selling.

Despite the historical accuracy of Gundlach forecasts, DoubleLine"s flagship Total Return Fund (with $54.7 billion in assets) has trailed its peer category so far this year, posting year-to-date returns of 0.70% lagging 73% of its peer category. However, if the like of Goldman are correct, and volatility returns to stocks in the coming days, leading to a wholesale flight to safety into fixed income, we are confident that DoubleLine will fade the gap with his competitors on very short notice.

What A Trump Victory Really Means For The Market

Just like with Brexit, the so-called Wall Street experts scrambled to paint a picture of doom and gloom, warning traders, and markets, that the end of the world is imminent should Trump win, and that stocks could drop by 5%, 10% or more should Donald Trump get elected president. And again, just like in the case of Brexit, they convinced the algos and the momentum chasing traders. Briefly. Because after futures hit the 5% down limit shortly after the market realized it was dead wrong about the presidential election, they have since soared nearly 80 points of the overnight lows and are well above the Friday, pre-Comey close, level.

How come?

Simple: as we have repeatedly said, a Trump victory, coupled with lower taxes, a spike in infrastructure spending, and a surge in debt is precisely what the economy - and a normalized market, one not manipulated daily by central banks - wanted and needed, as it not only will prompt yields to rise, but it will assure even more QE in the near future as foreign buyers of US debt disappear (assuming Trump does not do away with the Fed entirely, which for a man running a real estate empire, he won"t do as he ultimately needs lower rates).

As Trump said overnight, in a far less combative speech than pundits had expected, "We"re going to rebuild our infrastructure...we"re going to put millions of people to work as we rebuild." A tax-cutting and big-budget extravaganza means Treasuries will have a hard time staying higher, it also means a steepener yield curve, just the thing banks need and explains the jump in bank stocks this morning.

It also means much more fiscal stimulus, as various pundits discovered overnight.

“Fiscal stimulus seems to be the most logical explanation, with Trump and a Republican Congress expected to deliver higher deficits,” Gennadiy Goldberg, an interest-rate strategist in New York at TD Securities told Bloomberg.

A good comprehensive summary of what Trump"s victory really means came from DB"s Jim Reid who said that a Trump win is likely to be viewed negatively across a wide range of assets in the short-term but the range of medium-term outcomes are much wider.

It increases the chance of higher fiscal spending but it will also reinforce the backlash against globalisation and associated forces of which migration policy and trade are obviously likely to be heavily scrutinised.

So as the trend is already pointing to, expect lower risk assets at first, lower bond yields on a flight to quality but then higher yields once his spending plans are digested and an equity market that might at some point benefit from reflationary policies but with greater risks (lower trade and global openness) and higher volatility.

First Brexit, now Trump and the 2016 anti-establishment triumvirate could be formed in less than 4 weeks by a "No" in the Italian constitutional reform referendum. The political world is changing and the consequences are likely huge over the years ahead. As we discussed as the main theme in our long-term study in September (An Ever Changing World), the 35-year super cycle in assets, politics, policy and globalisation has likely turned.

Furthermore the sharp rebound in December rate hike odds suggests that the market is certainly not worried that Trump will crush the economy overnight, and that Yellen may well go ahead with a December rate hike after all (even if it means pushing the US into a recession, then cutting rates and launching the much desired QE4).

There is also more good news for coal and other energy companies, who are certain to benefit as Trump moves the US away from the progressive "clean" agenda.

Not everyone will benefit: now that Republicans have swept the US government for the first time since 1928, it means Obamacare is over - just a matter of time - and Affordable Care Act-vulnerable stocks such as Universal Health Services, AmSurg and Mednax will likely plunge; on the other hand pure pharma stocks like MCK and ABC will benefit as rhetoric on drug pricing will diminish significantly, leading to more stable earnings if/when changes in drug pricing become more stable.

And while we will have much more to say about this in the coming days, here is a good "first take" from Bank of America"s Michael Hartnet.

Result: Trump wins

US election + BREXIT = populist repudiation of era of inequality, globalization, wage deflation; cements BofAML themes of peak Liquidity, Inequality, Globalization + Main St over Wall St. Electoral trends could mark secular low in long-term bond yields (Chart 1).

Tactics: credit spread to determine entry point

Gold surges toward $1400/oz, S&P 500 tumbles to 2000, 10-year Treasury yield to 1.5%; if credit spreads don’t crack (e.g. IBOXHYSE<500bps) and Mexico peso finds quick low = entry point for risk-takers (especially if Trump protectionist fears allayed); until then best Trump trades = long gold, short EU banks, long US small-cap, short EM.

Macro & policy: inflation and stagflation expectations rise

Uncertainty shock = lower US GDP estimates; markets will price in EU fragmentation; Fed likely passes Dec; but ultimate global growth impact of Trump will depend on whether protectionism or Keynesianism triumphs; either way inflation/stagflation = destination as policies focus on ending wage deflation via immigration controls, trade protectionism, fiscal spending. In our view, Republican sweep boosts probability of more meaningful fiscal stimulus to combat inequality.

Asset allocation: small returns, big rotation

No change in BofAML asset allocation: overweight commodities, real estate, stocks and underweight bonds. Rotation towards assets, sectors, markets that benefit from higher inflation and steeper yield curve may take longer to play out but destination is clear. The risk is protectionist policies could lead to rising expectations of stagflation. Note 1970s “stagflation” was positive small-cap, value and energy stocks, commodities and real estate, negative large-cap, growth, tech and utilities stocks

* * *

Trump Q&A: the Presidential Inflection

Here"s a quick take on the impact of Donald Trump"s victory in the US Presidential election on the macro and the markets.

1. What does the Trump victory signify?

Victory for populism, another vote against inequality, raises risk of stagflation, likely will provide one of the last great opportunities to reduce exposure to bonds. US election + BREXIT = populist repudiation of era of inequality, globalization and wage deflation; cements BofAML themes of peak Liquidity, Inequality, Globalization, Main St assets over Wall St. Last time electorates shifted in this manner was 1980 when electorate said “end inflation.” Bond yields peaked. Today electorates seem to be saying end wage deflation via immigration controls, trade protectionism, fiscal spending (Chart 1).

2. Does US election result change our asset allocation views?

No. We are currently overweight commodities, real estate, stocks and underweight bonds. Trump victory will cause short-term risk-off and preference for Developed Markets over Emerging Markets. Rotation towards assets, sectors, markets that benefit from higher inflation and steeper yield curve may take longer to play out but destination is clear.

We believe peak liquidity, peak inequality, peak globalization = peak returns for stocks and bonds in coming years. Given the starting level of global interest rates for the next US president (5,000-year lows!) total returns likely to be exceedingly low in the coming years. Same for positioning: asset allocation of BofAML GWIM clients January 2009 Obama inauguration: Equity 42%, Debt 32%, Cash 19%, Other 6%. Today, GWIM asset allocation: Equity 57%, Debt 25%, Cash 12%, Other 5% (Chart 2).

3. Does the US election result change our views on the macro and policy?

Yes, at least initially. Economists are likely to lower growth estimates due to "policy uncertainty". The election takes place amidst an improving global economy with global earnings revision ratios at 5.5-year highs, global PMI’s at their highest levels since early- 2014, Asian exports at 12-month highs and US wage growth at 7-year highs. Trump’s victory could temporarily derail stronger growth, higher rates narrative by raising expectations of a) protectionism, b) the Italian referendum following Brexit and US election as repudiation of elites and c) the Fed keeping rates on hold in December.

The Fed will likely be on hold in December. Trump’s criticism of Fed Chair Yellen is likely to unsettle global Treasury investors. On fiscal policy, he will likely push for tax cuts for individuals and businesses and a bipartisan deal to repatriate $2tn in foreign earnings at lower tax rates to fund federal infrastructure spending.

Uncertainty shock = lower US GDP estimates; markets will price in EU fragmentation; Fed likely to pass in Dec; ultimate growth impact of Trump will depend on whether his protectionism or Keynesianism triumphs; either way Trump will boost inflation/stagflation expectations as electorates say end wage deflation via immigration controls, trade protectionism, fiscal spending. 1970s “stagflation” was positive smallcap, value and energy stocks, commodities and real estate, negative large-cap, growth, tech and utilities stocks (Chart 3).

4. What is the trade?

Gold surges toward $1400/oz, S&P 500 tumbles toward 2000, 10-year Treasury yield to 1.5%; key is that credit spreads do not crack (e.g. IBOXHYSE<500bps – Table 1) and Mexico peso finds quick low = entry point for risk-takers (especially if Trump protectionist fears allayed); until then best Trump trades = long gold, short EU banks, long US small-cap, short EM.

These Were The Best And Worst Performing Assets In October And YTD

October was a month most investors will wish to quickly forget. As DB"s Jim Reid writes, for the most part October will likely be remembered as the month where ‘Hard Brexit’ concerns well and truly jumped into the spotlight and Sterling related assets suffered as a result. Politics was a fairly consistent theme during the month however with the US Presidential Election campaign also attracting plenty of attention. Earnings season has provided another distraction for markets while we’ve also had the usual focus on central banks including a number of speculative ECB stories. Add to that the ongoing OPEC related news and it’s certainly made for a busy October.

As DB adds, it was sterling assets which really stand out. Unsurprisingly the negative news flow had a big impact on the currency with Sterling dropping -6% during the month from around $1.30 to the low $1.20’s. Negative sentiment also hurt Gilts which in local currency terms dropped -4% however in USD hedged terms plummeted -10% and the most amongst the assets in the asset sample. It was a similar story for UK equities which were up 1% in local terms but -5% in USD terms. Given the moves for Gilts, Sterling credit also had a poor total return month despite the BoE purchasing scheme impressing with the initial pace of purchases in October. Indeed GBP corps, non-fins and fins were -8% to -9% in USD total return terms (and -2-4% in local currency terms) although GBP HY (0% local and -6% USD terms) did outperform.

It wasn’t just Gilts which suffered in bond markets however. With markets also reassessing inflation expectations, in USD terms BTP’s (-5%), EU Sovereigns (-4%), Bunds (-4%) and Spanish Bonds (-4%) all suffered. BTPs being also hit as the polls leaned slightly towards a rejection of the senate reform referendum in early December. Treasuries (-1%) outperformed but were still weaker during the month. Those moves had another obvious knock on in credit markets too although performance was reasonably resilient despite the rates selloff. US credit outperformed with indices finishing flat to -1% during the month while European indices were broadly -1% to -3% with ECB purchases still evidently having a positive impact and helping out-perform rates. Interestingly EUR higher beta HY and sub-fins outperformed more.

Speaking of financials, banks had a decent month. European Banks were +9% in local terms and +6% in USD terms no doubt supported by better than expected earnings to some degree, and also the positive correlation to the move higher for bond yields. Other equity markets were more mixed however. The FTSE MIB, Nikkei and IBEX were all +2% in USD terms while the DAX (-1%), S&P 500 (-2%) and Stoxx 600 (-3%) were more disappointing. It was a similar story for EM equities too which were little changed during the month, although the Bovespa (+14%) did top the table for the month. The other asset class to highlight is commodities. Oil traded around OPEC headlines and had looked on to course to end the month flatish before yesterday’s sharp plunge saw WTI and Brent finish -3% and -4% for the month respectively. It was the softs which outperformed with Corn (+5%) and Wheat (+4%) continuing the strong performance from the end of September, while Gold (-3%) and Silver (-7%) were down as Fed rate hike expectations for December crept above 70%. All in all, in local currency terms 17 of the 39 assets finished with a positive return while just 12 assets did in USD terms.

A quick refresher where we are YTD now. It’s the usual culprits which head the top of the leaderboard in local currency terms with the Bovespa (+50%), Silver (+29%), WTI (+27%) and Gold (+20%) leading while Russian equities (+18%) round out the top five. Sterling (-17%) takes up the bottom place while Italian equities (-17%) and European Banks (-13%) are still languishing. It’s worth noting however that these assets have bounced back from heavier losses earlier in the year.

Elsewhere the S&P 500 (+6%) has had a reasonable YTD while the Stoxx 600 (-4%) has struggled. Bond markets outside of Gilts are in the 1-5% return range while credit markets have had a strong year. European indices are up anywhere from 4-8% while USD IG indices are up 5-9%. US HY is leading the way however, returning +14% YTD.

Source: DB