Financial Outlook June 2019

I′ve been sharing my viewpoint regarding the business cycle and the credit cycle for 6 months now. Anyone can check the "Financial Outlooks" of past months to review some of the things that I think it makes no sense to keep repeating.

Some details about the credit cycle on March financial outlook.

Where are we on the cycle, from a value perspective on May financial outlook.

As the saying goes: "risk is perceived slowly at first, then it happens all at once"

The values reached by this bear-rally in early May were fueled by an alleged recovery in V of the economy and an "imminent" trade agreement between China and the US. Two narratives with little foundation in reality.

The "commercial agreement" does not deserve analysis. To all who invest based on the current government twits I wish them luck. Do not waste more time reading these lines.

On the recovery in V, I choose not to mention the GDP, because I already put some words last month, and because in its calculation a deflator was used well below the reported CPI which, if used, would have reduced the GDP by half. Instead, let me talk about profits growth in the companies that conform the S&P500.

The graph shows the peak of 24% between the 2nd and 3rd quarters of 2018, followed by a drop to 12% in the last quarter. In the first quarter of this year the number is a barely positive (1.4%).The magic recovery should come in the current quarter, where we would have to return to the number of the last quarter of last year (12%). Instead we will most likely find ourselves with a negative number. To add insult to injury, the year over year comparison of this possible negative number will be the peak of 24%, against which it’ll look like a free fall. Recovery in L, if the horizontal line of the L had negative slope.

The bond market told the truth during all this time, and is shouting Risk-Off since yields peaked in October / November last year. Two others signals that are worrisome, and historically have had a high predictive value for the global economy: Copper and Kospi, both almost at the beginning of the year lows.

Back to bonds, the US10Y is at 2.26%, if you think that this is too low a number to buy bonds, compare it with the UK10Y that is below 1%, or better yet, with those that have negative yields such as Swiss, German or Japanese bonds.

Who buys bonds with negative returns? Central banks to force investors to move their capital to riskier investments, and investors who see in the stock indices an even lower prospective than those bonds and are expecting a rate cut.

Today we accumulate a record signals for the end of an expansive economic cycle in the US market:

• Inverted bond yield curve (across the curve and in several countries)
• Index of economic activity (PMI) in free fall and close to contraction
• Copper and Kospi discredit the current rally
• Global economic deceleration (Brazil's GDP: negative, Italy's GDP: negative, South Korean and Japanese industrial production: negative, China's manufacturing PMI: negative)
• Indexes in record high values

And a couple of peak signals that are mistakenly perceived as positive

• Recording consumer confidence
• Record unemployment index

The potential scares for the coming times:

1. China's interbank financing market is beginning to freeze. Scenario similar to what happened with the Eurodollar complex before the 2008 crisis.
2. The impact that the deterioration of the financial markets may have on corporate debt, where the downgrade of one of the big names could trigger a new shutdown of the credit window.

For June 2019:

• Metals: maintain exposure to precious metals or mining companies
• We continue with a bullish outlook for metals and mining companies, which are behaving reasonably well despite the strength of the dollar.
• US Indices: we increased our short positions for the Russell 2000, the S&P500 and the Nasdaq, in that order. About sectors, we prefer (long) Utilities and Reits as proxies for bond yields, and Financial and Technological to go short.
• Bonds: we increased our position in US bonds throughout the curve.