FT : Why the fate of European stocks lies with China

Why the fate of European stocks lies with China
Fiscal rules and still-loose monetary policy mean the region has to look elsewhere for stimulus

We are a long way from Mario Draghi’s “whatever it takes” reassurances for the eurozone. While the fury of the region’s debt crisis has passed, the eurozone is beset by slowing growth prospects, Italy’s budget fight with Brussels and wounded leaders at the helm of Germany and France. Hardly helping matters is Albion, with Brexit and the risk of a badly managed UK exit in March, or perhaps even a no deal.

This week marked the end of an era in monetary policy as the European Central Bank formally halted its €2.6tn bond-buying programme. While a historic moment, the fact that the ECB also tempered its outlook for growth and inflation for 2019 should be of greater interest to investors.

Almost four years have passed since the ECB announced its plan for quantitative easing in early 2015 and, when you look at where the economy and markets are today, the unavoidable question is what has really changed?

The bottom line is that inflation is falling, and signs of a sustainable recovery remain elusive. With Europe restricted by budget rules and interest rates still negative, there is little wriggle room should the economy weaken from here.

Less an engine of the global economy, Europe and its exporters rely on foreign demand to help offset poor demographics. At the same time, it continues to struggle with a one size fits all monetary policy. 

A meaningful ceasefire in US-Sino trade tensions will undoubtedly register for Europe, as would any sign of China’s economy picking up speed. Both are possible outcomes in 2019, but neither can be relied on. Alleviating some of the region’s economic pain this year has been a weaker euro, but once the Federal Reserve pauses monetary tightening and focus switches to the rising US budget deficit, plenty believe that trend of euro weakness will be on borrowed time.

The importance of a weaker single currency is clear looking at corporate earnings expectations for next year. CFRA note that analysts still see earnings growth rising for the S&P Euro 350 to 8.5 per cent in 2019 from 7.1 per cent in 2018, thanks mainly to a weaker euro boosting the value of revenues generated outside Europe. This rosy outlook is one that the market clearly disagrees with given the index currently trades at a 6 per cent discount to its long-term average price-to-earnings ratio.

“As the economic environment continues to slow, earnings growth will be at risk,’’ Lindsey Bell at CFRA cautions. “Political uncertainty and a lack of structural reform for countries such as Italy and France will probably continue to fuel weakness across the euro zone.’’

Indeed, France’s 10-year bond yield this week rose to its highest level over the German Bund since May 2017, as president Emmanuel Macron announced a U-turn on fuel taxes and new spending measures that are estimated to push the country’s budget deficit beyond the EU cap of 3 per cent of GDP next year.

For those mining for value, European shares hold some surface appeal. But they are cheap for a very good reason. As this year has shown, Europe is vulnerable to a protracted trade war, weakening global growth and, as we enter 2019, any signs that confirm the US economy is slowing.

One important component of eurozone equities is financials. With a drop of 25 per cent, it is competing with carmakers as this year’s worst performing group in the Stoxx 600. But if you are looking for a sign of a sustainable bounce in equities, financials need to reverse course. This is an important leadership group for many equity markets, particularly in Europe. While eurozone banks certainly look cheap in price to book terms, they really need a level of economic growth that prompts the ECB to raise interest rates. The bond market, however, has been leaning towards no tightening of ECB rate policy until 2020.

Unless we see financials turn round soon, the broader market will stay under pressure and mired in correction territory.

In the case of Germany’s Dax, it already sits in a bear market for 2018, after a drop of more than a fifth since it peaked in January. The 10-year German Bund yield has loitered around 0.25 per cent, its lowest level since the summer of 2017, as the eurozone’s most important economy suffers from China’s focus on excessive leverage and trade protectionism.

With the ECB’s having already fired its monetary bullets, the answer for the region is a combination of fiscal stimulus and economic reforms, which in France now appear to be on borrowed time. Alas, a fractured EU means there is little hope of greater leeway on spending as Germany demands fiscal discipline.

Ethan Harris at Bank of America Merrill Lynch says there is one bright aspect: “China seems ready, willing and able to reverse its growth slowdown with a steady diet of stimulus.’’

That leaves the case for buying European equities dependent upon the news cycle and decisions made in Beijing, Washington and London.

FT : Investment chiefs fret over high debt and liquidity crunch

Investment chiefs fret over high debt and liquidity crunch
CIOs overseeing $21tn expect volatility, protectionism and Brexit to pose big risks

Investment bosses at fund managers controlling $21tn of assets warn that high levels of corporate debt and tighter liquidity pose a risk to the global economy in 2019.

The executives predict that volatility will be an overriding feature of markets next year, while this year’s dominant events — Brexit, US-China trade tension and hardening monetary policy — will still influence their decisions.

Investors should strap in for a “wild and bumpy ride”, said Kristina Hooper, chief global market strategist at Invesco, the $1tn US manager.

She identified the three biggest risks for 2019 as protectionism, monetary policy shifts and high levels of debt. “Any one of these is significant. Together they represent a perfect storm, with the potential to negatively affect economic growth and roil markets,” she said.

Other investment bosses who singled out corporate debt as a significant risk included Pascal Blanqué, chief investment officer at Amundi, the $1.7tn French manager; Anton Eser, CIO at Legal & General Investment Management, the $1.3tn UK business; and Andrew Balls, global CIO for global fixed income at Pimco, the $1.7tn US bond specialist.

“Unlike the banking crisis of 2007-08, this downturn may be driven by over-levered corporates unprepared for slowing economic growth and sweeping technological change,” said Mr Eser. “Be wary of catching a falling knife — valuations are cheapening but we should wait for governments to support the corporate sector before relying on a sustained recovery.”

Mr Balls added that Pimco would be paying close attention to debt markets and liquidity should investors move out of fixed income. “It makes sense for us to be very cautious in terms of our overall corporate credit exposure, and see non-agency mortgages as offering a defensive alternative,” he said.

A trade war between China and the US has preoccupied market analysts this year, and several investment chiefs believe it will be a dominant global risk in 2019.

Stefan Kreuzkamp, CIO of DWS, the $780bn German fund manager, said trade tension edged out Brexit and Italy’s budget negotiations with the EU as the biggest risk for investors.

“The further erosion or potential dismantling of the world’s rule-based global trading order, and with it international supply chains, is a risk of a different order of magnitude to corporate earnings, investment and productivity growth,” he said. “This could drag down growth for the world as a whole for many years to come.”

However, Akiyoshi Nagashima, CIO of Sumitomo Mitsui Trust Asset Management, the $570bn Japanese investment company, was optimistic following recent talks between US president Donald Trump and Chinese president Xi Jinping.

“The biggest opportunity could be the potential de-escalation of tension between the US and China,” he said. “This will improve market sentiment and will undoubtedly be an opportunity for investors.”

Most investment heads contacted by FTfm said they were warning clients to prepare for volatility. Yet Suni Harford, head of investments at UBS Asset Management, the $800bn Swiss group, said there was a possible upside to giddy markets. “Higher volatility means plenty of opportunity for skilled stock pickers,” she said.

“The road ahead is likely to be bumpy but, on a selective basis, valuations feel out of kilter with fundamentals.”

WSJ : Investors Turn Focus to Fed’s 2019 Rate Path

Investors Turn Focus to Fed’s 2019 Rate Path
After a volatile streak in markets and more dovish comments from Fed officials, investors are looking for a gradual course of rate increases

The Federal Reserve will conclude its final policy meeting of the year Wednesday. With traders widely expecting the central bank to raise short-term interest rates, many say the focus will be on Fed officials’ comments on the economy. Volatile markets and mixed inflation data have amplified investors’ doubts about how many times the Fed can raise rates next year. Also fueling the hesitation are remarks by Chairman Jerome Powell, who said in November that rates looked like they were “just below” neutral, a level that would neither speed nor hamper economic growth.

The result: Many traders have begun pricing in a more gradual course of rate increases for 2019.


The winding down of rate expectations has coincided with a sharp drop in oil prices. While higher oil prices can lead to higher inflation, pushing the Fed to move faster with its rate increases, weak commodities markets can do the opposite.

In another sign investors are pricing in less inflation ahead, funds focused on Treasury inflation-protected securities—essentially a safeguard against rising prices—have suffered outflows. That marks a reversal from the start of 2018.
Not all parts of the markets have lost ground this quarter. Doubts about the trajectory of the U.S. economy and monetary policy have helped drive fresh money into utilities shares, whose dividend payouts look more attractive to investors when they are less optimistic about growth.
Home buyers have also gotten a bit of a reprieve as mortgage rates, which hit their highest level in more than seven years in October, have fallen with Treasury yields. That is good news for economists who have worried that the housing sector will face increasing pressure as rates rise.
Still, many investors say that, even with the possibility of a more gradual rate path, they remain cautious heading into 2019. The yield curve, the gap between two- and 10-year Treasury yields, has continued to flatten in the fourth quarter. Historically, that has signaled trouble ahead for the U.S. economy.

WSJ : Top Deputy Exits Aurelius Capital Amid Its Recent Stumbles

Top Deputy Exits Aurelius Capital Amid Its Recent Stumbles
Dan Gropper, a lieutenant of founder Mark Brodsky, recently left the hedge fund, people familiar with the matter say

Aurelius Capital Management LP, a hedge fund that made its name winning a yearslong debt battle against Argentina, has lost one of its top lieutenants.

Dan Gropper, the right-hand man to founder Mark Brodsky, recently left the firm, according to people familiar with the matter.

Mr. Gropper’s departure comes as some investors have fled after the firm’s recent stumbles, according to one of the people familiar with the matter.

Aurelius and Mr. Gropper declined to comment.

The firm led by Mr. Brodsky, a former bankruptcy lawyer, and Mr. Gropper have been involved in many of the biggest battles with distressed companies and governments struggling to pay their debts over the past decade.

Like many in the hedge fund industry, Aurelius’s performance has faltered over the past two years. Hedge funds that focus on distressed debt—corporate and government bonds trading at deep discounts to their face value—have, in general, fared poorly because there have been few big bankruptcy cases.

One of the firm’s more prominent recent bets on Puerto Rico remains in the red. Even after prices of the U.S. territory’s debt surged in recent months, they haven’t recovered to levels reached when Puerto Rico filed for bankruptcy in 2017.

This summer Aurelius suffered a legal setback when a federal judge ruled against its effort to have Puerto Rico’s bankruptcy case thrown out. The firm has appealed the decision in a higher court.

A recent $1.2 billion investment in bankrupt Brazilian telecom company Oi SA also hasn’t performed well.

The value of the Aurelius Capital Partners LP fund is down about 39% over the past two years, according to government filings by Aetos Capital Distressed Investment Strategies Fund LLC, a fund invested in several distressed debt-focused hedge funds.

Hedge funds in general, including equity-focused funds, have struggled recently. In October long-short equity hedge funds had one of their worst days in seven years, Goldman Sachs told its clients.

>>> US Close Dow -2.02% S&P -1.91% Nasdaq -2.26% Russell -1.53%


Closing Market Summary: Stocks Fall on Continued Global Growth Concerns

The S&P 500 fell 1.9% on Friday to extend its monthly loss to 5.8%. Friday's sell-off was a function of poor sentiment driven by global growth concerns and a continuation of weak price action. 

The Dow Jones Industrial Average lost 2.0%, the Nasdaq Composite lost 2.3%, and the Russell 2000 lost 1.5%. For the month, the respective indices are down 5.6%, 5.7%, and 8.0%.

The selling started overseas when China, the second-largest economy in the world, reported some weaker-than-expected industrial production and retail sales data. In addition, some weaker-than-expected preliminary manufacturing PMI readings out of the eurozone helped feed into concerns over economic growth and corporate earnings prospects.

A solid November Retail Sales report out of the U.S. didn't change the selling bias either.  Instead, the good news on that front was drowned out by the concern that weakness abroad will eventually lead to a slower pace of growth in the U.S.

Selling picked up after the close of the European markets (11:30 a.m. ET) and would continue in an orderly manner throughout the day, culminating in the S&P 500 closing just below 2600.

Within the S&P 500, the health care (-3.4%), information technology (-2.5%), and energy (-2.4%) sectors led the broad-based retreat.

The negative bias within the health care and tech groups was driven by some corporate news, while energy fell in tandem with oil prices.

Johnson & Johnson (JNJ 132.80, -14.84) dropped 10.0% after a Reuters report alleged that JNJ "knew for decades that asbestos lurked in its baby Powder." The company's litigation counsel rejected the report as "false and misleading."

Within tech, Apple (AAPL 165.48, -5.47, -3.2%) fell after an influential analyst from TF International Securities cut his first quarter 2019 iPhone shipment estimate by 20%, according to CNBC; Adobe Systems (ADBE 230.00, -18.08, -7.3%) fell after failing to overly impress investors with its fiscal fourth quarter results and outlook; and Cisco (CSCO 45.82, -1.65, -3.5%) fell after being downgraded to 'Neutral' from 'Buy' at Nomura.

In other corporate news, Costco (COST 207.06, -19.45) fell 8.6% after reporting its fiscal Q1 results, which included revenues that were slightly below consensus. Margin weakness, attributed to higher merchandising costs, also weighed on the stock.

There was little room to hide in the stock market, though the defensive-oriented real estate (-0.2%) and utility (-0.3%) sectors suffered only modest losses.

Investors sought safety in U.S. Treasuries, pushing yields lower across the curve. The 2-yr yield lost three basis points to 2.73%, and the 10-yr yield lost two basis points to 2.89%. Also, the U.S. Dollar Index rose 0.4% to 97.45, nearing a yearly high.

Reviewing Friday's economic data, which included Retail Sales for November, Industrial Production and Capacity Utilization for November, and Business Inventories for October:

  • Total retail sales increased 0.2% in November, as expected, while retail sales, excluding autos, jumped 0.2% (consensus +0.3%).
    • The key takeaway from the Retail Sales report is that core retail sales, which exclude auto, gasoline station, building materials, and food services and drinking places sales, increased 0.9%. That's important because core retail sales are used in the computation of the goods component for personal consumption expenditures in the GDP report.
  • Industrial production increased 0.6% in November (consensus 0.3%) after declining a downwardly revised 0.1% (from +0.2%) in October. The capacity utilization rate was 78.5% ( consensus 78.6%) following a downwardly revised 78.1% (from 78.4%) in October.
    • The key takeaway from the report is that manufacturing output was flat on the heels of a 0.1% decline in October. That indication runs counter to the solid uptick seen in the November ISM Manufacturing Index.
  • Total business inventories increased 0.6% in October, in-line with the consensus estimate, after increasing an upwardly revised 0.5% (from 0.3%) in September. Total business sales increased 0.3% after increasing a downwardly revised 0.3% (from 0.4%) in September.
    • The key takeaway from the report is that business sales rose at a slower pace than inventories. That distinction, if it persists, will diminish pricing power.

Looking ahead, investors will receive the NAHB Housing Market Index for December, the Empire State Manufacturing Survey for December, and Net Long-Term TIC Flows for October on Monday.

  • Nasdaq Composite +0.1% YTD
  • Dow Jones Industrial Average -2.5% YTD
  • S&P 500 -2.8% YTD
  • Russell 2000 -8.1% YTD