RESEARCH REPORT - athenabest.com Department/Research/R… · RESEARCH REPORT For July 2018 . For Professional Use Only 3 On the back of the relieved worries over trade disputes, global

RESEARCH REPORT

For July 2018

For Professional Use Only 3

On the back of the relieved worries over trade disputes, global equities rebounded gracefully. Overall, despite the tariffs impositions of the U.S. and China, the investment climate has improved in July, especially as the market looked forward to the Juncker-Trump trade agreement.

For now, American equities continued to see an apparent advantage over most other regions. Within, the intact uptrend has been constantly supported by the robust economy and profound corporate earnings.

Although there were earnings that came under expectations in the technology sector which pulled NASDAQ’s performance back, the negative sentiment appeared to be short-lived and the market rally very soon recovered.

Mainly, we believe that the correction was the result of their high valuations which were vulnerable to negative sentimental factors.

Most other developed markets also presented nice returns within the month whereas South Korea and Hong Kong stocks saw sell-offs, the latter of which was primarily affected by Chinese A-stocks. Meanwhile, several emerging stock markets like Brazil lifted intensely.

3.05%4.71%

2.15%3.53%

4.06%1.46%1.38%

1.12%1.68%

1.10%8.88%

1.02%6.16%

-0.46%2.37%

6.66%5.48%

0.36%2.04%

1.56%

-1.29%

-1.33%

-4% -2% 0% 2% 4% 6% 8% 10%

MSCI WorldDow Jones

NasdaqFrance

GermanyUK

AustraliaJapan

MSCI EMRussiaBrazil

ShanghaiIndia

VietnamIndonesiaThailandMalaysia

MSCI ASIATaiwan

SingaporeHong Kong

South Korea

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Softened Oil Market Brought Correction

In mid-July, the striking news that previously-

shut oil terminals in the eastern Libya would resume operation smacked the oil market and put oil price under massive pressure. This led a slump of over 8% in the next few days. After that, crudes went sideways at around WTI $70 till the month closed and hardly had any chance to bring up the price again.

Ahead, a firmer greenback and the escalating tariff tit-for-tat between the two influential economies shall continue to press on oil and other commodities in August but the recent sudden drop in Iranian oil exports might tighten the oil market and give a slim boost to oil prices.

Presumably, the firm dollar is also partly responsible for the continued weakness in gold and other precious metals. However, the overall downtrend for gold has lasted for months, which is still barely justified.

Meanwhile, wheat prices soared singularly in July. The fact that weather has been

persistently hot and dry was one major reason for falling crops. We believe that the 10% growth was a result of the downwardly revised wheat crops expectations in the EU and Russia. Apart from driving wheat prices up in late July, this also initiated an increase in expectation that export countries would likely see a significant inventory reduction.

American Equities Will Likely Rule Over

Technically speaking, some emerging markets such as Indian stocks have rebounded for some certain months already. Given that not all EMs’ fundamentals are competent for growth, their rebound might not last into the end of 2018 so easily. Besides, EMs still bear substantial short-term burden under the Fed’s rate hikes compounded with the growing trade tensions.

Nonetheless, the longer-run equity and currency outlook for EMs is closer to neutral as their extensive current account surplus and the anticipation that intra-EM trade agreements might be made to combat the trade war’s impact are yet to foresee derailment in the fundamentals.

Within the developed markets, our preference for American equities continues to stand out. Basically, the market has presented a strong case in the upside momentum. In the meantime, the European stocks are more prone to consolidating shortly as the growth parameters and the upside momentum saw slowdown.

-2.32%

-7.27%

-1.69%

-5.22%

10.47%

-12%

-8%

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12%

Gold Crude Oil Platinum Copper Wheat

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What is Ahead of Us? -----------

The main theme now is definitely the non-stop tariff tit-for-tat between the U.S. and the

rest of the world, mainly China. Under such disturbances, American equity markets have

still continued to renewing their record highs. It looks like the U.S. stock investors are

taking most part of the trade war merely as sentimental drivers rather than tangible

threats to the economy.

Of course, the U.S. has an apparently strong

economic backdrop and profound corporate

earnings to back up both its equities and currency.

Now that the European Union took side to stand by

the U.S. in the upfront, the U.S. gained even more

advantage in the battle.

In fact, shall either side not hole such lofty ego,

the trade war might never have been bred all the

way from the war of words to actual tariff

impositions at this point. Even so, taking in all the

facts, we could basically justify who the game

winner would most likely be.

But the Weaker Hesitates to Give In…

As discussed before, it has been general consensus

that the Chinese economy is comparatively prone

to the trade war impact. And the anticipation

didn’t come from nowhere.

Over the past few months, China has been

aggressive clamping down its risk-off balance

sheet, thus such tightening moves drove up credit

risks and corporate defaults which in turn derailed

China’s economic growth and brought weaker

market resistance to shock.

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Because of that, China has already slowed down its deleveraging efforts and shifted its policy focus back to economy enhancement. Besides, China still keeps its solitude in the battle and lately PBoC reiterated that the Bank would not use weak Renminbi as a tool in the trade war.

Up till now, we learnt a few things. First, Trump is much engaged in capitalizing protectionism which shall extend the trade war duration. Second, Europe allied with the U.S. which set a sample for other developed counterparts and that’d easily direct the threat to China.

If you ever wonder why the U.S. is more defiant to the trade war impact, it sounds as if its solid economic backdrop is one big support. In fact, ever since the 2008 Financial Crisis, the U.S. has explicitly shown a moderately stable growth.

It goes without saying that this 9-year recovery has provided rich grounds for protection in the trade battle as American equities still soared around 4% in the past 3 months while Chinese stocks have already accumulated over 13% of

decline. Judging from the prior peak, the stock market actually entered the bear market with over 20% of decline.

Less Tariffs might not be the Best Solution

As said, Europe’s role is crucial in this battle. Meanwhile, they are working on the bilateral trade agreement TTIP, the Transatlantic Trade Investment Partnership. If this proposal passes, it would cover half of the world’s GDP as well as 800 million of the wealthier population!

However, setting up such a colossal free trade area might only benefit the U.S. and Europe. Simply, if the two add trades in between them, they would trade less with the others and free trade at the global level would be weakened, particularly settling the burden on the EMs.

Furthermore, the U.S. might even take advantage of the global trade inequality as tightened trade relations apparently have barely any effect on the country’s market.

For now, China is taking more of a cautious stance, basically not taking a move in hope not to bring too much harm to its economy. For the record, Yuan’s 4% year-to-date decline is actually lower than that of the other emerging markets like Argentina, Turkey and Brazil whose currencies are down by over 10% year-to-date. That would mean, even if China would use Yuan as a weapon, it’d only have a slender effect.

Our principle view on the trade war remains unchanged. For now, both sides would give in,

thus we believe the uncertainties would continue into 2018 H2. Further, the U.S.’s tense

nerves with other EMs might even lead to massive chaos such as a currency war. Of course,

what the war points to remains unclear but we shall be prepared to brace for the worst.

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European Economies Under Dovish ECB & Risk-Off Sentiment Although the Euro Area’s economy has been growing solidly under the dovish central bank’s

policies, the underlying inflation outlook remains flat for now. We believe, as long as the

Bank’s balance sheet is still expansionary and inflation is well below target, rate hikes

would only be possible in the second half of 2019.

July’s consumer prices were slightly up from the

previous 2% to 2.1%, mainly supported by the core inflation rate and falling oil prices kept inflationary pressures soft. Meanwhile, the core inflation rate continued to build up, with a flash estimate of 1.1% last month.

Notwithstanding the external pressures, trade tensions and rising prices, the industrial sector still presented a nice PMI level that confirmed at 55.1. However, the output expansion fell to the second weakest since November 2016.

Overall, the economy’s growth eased in the second quarter of 2018. The GDP growth on year rose 2.1% in the last quarter, compared to 2.5% in 2018 Q1 and 2.8% in 2017 Q4 and the market expectation of 2.2%.

To sum up, above figures were indicative in suggesting a constant but moderating growth in the Euro Area. As the data continues to disappoint, the growth shall await the central bank to unfold any change of direction. Besides, protectionism remains a growing risk for now and we may watch out for more possible impact.

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2012 2013 2014 2015 2016 2017

Ann. InflationAnn. Core Inflation

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ServiceIndustrial

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GDP QoQ (Left)GDP YoY (Right)

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The Euro went sideways throughout July at around 1.17 paired with USD as the month saw

no sign of recovery from the depreciation since the year began. Even more, the common

currency plummeted along with worries that the Turkey-U.S. relationship got edgy.

For the record, the Euro has already been weak before any news in Turkey struck the market. In the EURUSD pair, we saw a crossover between the 50 and 200-day moving averages, i.e. the shorter-term moving average fell below the longer-term which usually assumes for a downside outlook ahead.

Meanwhile, the European stocks are also facing consolidation in the near future as the STOXX index momentum parameter touched zero. We believe the worries on Turkey would shed more pressure on the markets.

The Crisis in Turkey

It shocked half of the world markets when U.S. President Trump announced another new tariff on Turkish imports. Market believed that was a state of manner to show fury against the earlier detention of an American pastor in Turkey. Coupled with the tariff impact, the relation between the two countries edged up quickly.

This round of turmoil not only once dragged Turkish Lira down by over 15% in a day which recently struck the lowest below 7 in its USD pair, led sell-offs in Turkish stocks and bonds, but affected the overall European markets too. We believe the crisis would also bring potential threats to the European banks.

As said, we wouldn’t know when and where this tariff game would end, so we could only assume that under USD’s strength, there would be more difficulties. Perhaps, this will mark the start of consolidation in the European equities.

1.1

1.14

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1.26

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1.26

Jan 2018 Mar 2018 May 2018 Jul 2018

EURUSD SMAVG (50)SMAVG (200)

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MSCI EM (L)USDTRY (R)

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The United States Economy Solid Economy Growth Shields from Trade War

Broadly speaking, most growth measures satisfied but the industry equity sector revealed

some impact from the ongoing trade disputes with China. More details follow.

In July, the U.S. manufacturing PMI stood at 55.3, slightly down from 55.4 in the previous month but still presented a fast expansion in the industry, showing that the trade tightening isn’t revealing any considerable impact on the U.S. economy. After all, the U.S. was barely the one that suffered in all rounds of trade disputes.

In the labor market, the month created 157K new jobs as reflected in the non-farm payrolls. This is to compare with the market expectation of 190K and an upwardly revised 248K in June.

Meanwhile, the annualized unemployment rate fell back to the second all-time low of 3.9% in July, in line with the market consensus. Besides, the average hourly rates rose 2.7% in the private sector which indicated a steady growth in the jobs market, implying for soft inflationary pressure.

Noteworthy, the annual inflation rate stayed at the years-high of 2.9% in July, mainly a result of the still fluctuating oil and gasoline prices. Meanwhile, the core inflation rate beat the market expectation and previous of 2.3% to have ended at 2.4%.

All in all, the U.S. economy is still robust to shield the country from trade war stress.

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2015 2016 2017 2018

Industrial Service

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NFP (L) Ann. Jobless Rate (R)Avg Hrly Rates (R)

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2012 2013 2014 2015 2016 2017

Ann. Core InflationAnn. Inflation

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For now, American stocks are on track to mark more new peaks where S&P are closing in to January’s high and Nasdaq already renewed its all-time high despite that the minor correction in July after the lower-than-expected earnings were released.

The intact uptrend is largely attributed to the solid growth in the country’s economy, the lately passed tax reform legislation and the still accommodative policy of the Fed.

Therefore, we recommend staying invested in American stocks which have explicitly shown an obvious advantage over most other regions. Particularly, after the tariff imposition on Turkey, most other developed and developing nations have endured great stress.

Total Return (June 2012 - July 2018)

Top 3 Info Tech 195.2%

Consumer Cyclical 179.4% Financials 165.4%

Bottom 3 Real Estate 45.4% Telecoms 38.9% Oil & Gas 33.5%

Sector-wise speaking, the info tech is no doubt a long-term outperformer with a total return of 195% over the past 6 years but there’s one interesting fact. When we look into the fund flows, the worst sector, oil & gas, actually received the highest inflows.

Naturally, we believe that when it comes to the long-term peak, money would rapidly flow into the technology assets. Therefore, it’s possible that the tech sector hasn’t reached its long-term peak yet and we might expect the tech stocks to go on to lead American stocks in the year.

90

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Dec 2017 Mar 2018 Jun 2018

S&P Nasdaq Dows

-2

0

2S&P Momentum

Signal Line

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Chinese Economy Continuously Under the Shadow of Tariffs

Under trade tensions with the U.S. and the transforming economic structure of the country itself, the economy is expected to continue to suffer in the near term.

In July, Caixin China manufacturing PMI dropped further from the previous 51 to 50.8. Though the ease in growth was trivial but it could be a sign of the start of a continuous easing which could be a result of growing protectionism risks among world trades.

In details, Chinese trades reflected more impact from the earlier tariff impositions. Last month, the trade balance shrunk to $28.05 billion, well below the previous $42 billion. The fluctuation over trade balance figures might point to a tighter market in the country’s exports.

Nonetheless, the country’s extensive foreign exchange reserve might provide cushion for further shock. The reserve continued to be holding the level above $3 trillion.

Meanwhile, the inflation momentum was increasing as the annualized CPI rose to a 4-month high of 2.1% in July, compared with the market expectation and previous 1.9%. Still, the warmth is far lower than the official target of 3%. More importantly, the producer price index rose 4.6% on year, lower than the previous 4.7% but beat the market consensus of 4.4%.

After all, we believe the tightened trade setting would bring impact to the economy shortly despite the still fine data now.

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2015 2016 2017 2018

Industrial Service

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$2.90T

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$B$10B$20B$30B$40B$50B$60B$70B

2012 2013 2014 2015 2016 2017Trade Balance (Left) FX Reserve (Right)

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2012 2013 2014 2015 2016 2017

Ann. PPI (Left)Ann. Inflation (Right)

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This month, Renminbi fell nearly 3% which continued its weakness since February of the year while Shanghai Composite kept a relatively soft growth of 1%. Even though the People’s Bank of China (PBoC) reiterated a few times that they wouldn’t use the weak Renminbi as a tool in the trade war, the Bank apparently didn’t do anything to help boost the currency’s strength. Meanwhile, PBoC fixed the USDCNY pair at the highest since last May as the USD’s clear strength pushed Renminbi further lower.

In the equity market, from the graph below, we could see that Hang Sang Chinese Enterprise Index had in general a way higher implied volatility than Asia and S&P indices. This suggests for a bearish outlook in Chinese stock outlook and we believe the index will continue to decline over time.

Lately, we also saw more defensive modes in Hong Kong as the Hong Kong Monetary Authority (HKMA) intervened to defend its currency to the USD for another three times within 24 hours after three months of inactivity as HKD fell to the weak end of its trading band against the USD. In total, the Authority bought HKD 12 billion and brought the total banking system reserve down to under HKD 100 billion.

In the meantime as we worry about the slowdown in China’s credit growth, China might actually end up to be the inadvertent winner from Trump’s aluminum tariffs to Turkey. Of course, it is probably not what Trump intended for when he approved the tariff imposition on Turkish imports but as Chinese steel and aluminum producers could be the easy substitutes to the increase in Turkish import tax, China might turn out to benefit a little in it.

End of the Wave of Rebound of EMs

Even so, we might very well expect an end to this wave of rebound in the emerging stock markets as the Turkey Crisis could be a major turning point, we would discuss in more details later in this report.

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29 Dec 2017 29 Mar 2018 29 Jun 2018

MSCI EM (L) MSCI South Asia (R)

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From Lira to the World ---------------

Following the dramatic declines in Turkish Lira (TRY), the country’s equities and bonds led

some sharp sell-offs as well. There, we saw over 20% of TRY slump in merely 3 trading days!

One might wonder, what does this have to to do with us or the rest of the world for the

U.S. to punish a developing nation? And why has such a single tragedy over in Turkey

casued such unease at the global level?

Now, no matter what Turkey does, even if President Erdogan threatened to boycott American electronics, the impact is still largely on her flaccid economy instead of the U.S.

Well, for the record, Turkey was indeed once the hope of the emerging nations as her president Erdogan initiated much membership talks with the European Union on economic liberalization and so.

However, over the past few years, the post-coup Supreme Leader turned 180 degrees to become

increasingly autocratic; some even question the independence of the central bank (CBRT).

Although the new Finance Minister, son-in-law of Erdogan assured of CBRT’s independence, the Bank has done little to help Lira which has indeed been weak since the year started but the Bank has been reluctant to raise rates despite the warming inflation.

But now, the right timing has passed. Even if the Bank pledges to provide liquidity now, Lira could hardly get out of the selling pressure.

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If Turkey Can’t Repay its Heavy Debts…

Under the continued weakness of Lira, the country’s debt ratio has risen from 28% to 58% of GDP by the end of March. Within, 122 billion worth are short-term borrowings from the European banks.

In this case, the Lehman Brothers effect could easily kick in if any one of the banks cancels their credit lines and that could be catastrophic to all the European bank lenders who would have to bear the burden to write off at least some of the loans.

Even worse, it doesn’t matter which European bank is the biggest lender because the European financial sector is tightly networked, even the U.S. and Asian banks might need to brace for the aftershock. Now, that’s why we have all been so concerned.

Nonetheless, we believe the risk is yet to reveal now. Consider that, both the European Central Bank and the European banks shall have sufficient experience to handle financial crises, thus they could at least provide some support in the initial impact, the stress shall be controlled.

The Emerging Markets Suffer as a Whole

However, the fate wouldn’t be the same for the emerging markets. The USD’s clear strength coupled with the growing trade tensions not only pressed on Turkey to have led to such crisis, but have caused substantial stress on the emerging markets as a whole.

Besides, even if some emerging nations have their good faith in the fundamentals, investors would hardly differentiate them with Turkey and would be prone to selling off their EM assets. So, the loss would be unavoidable.

For now, as the volatility struck up again since last year, we shall watch closely the movements of the USD as well as development in the trade war.

Still, both are yet to see any sign of corrections but as we presumably believe that U.S. President Trump would barely get off hold of the trade war which has helped gain him higher popularity, the trade war shall last in the medium term.

For now, even if there’s yet to see a large financial crisis, investors would still need the attention for several risk factors, especially on the EMs’ reactions to the strong USD. In the near future, we recommend underweight EM and financials and avoid bottom fishing.

Disclaimer ____________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________________

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guide to future performance. Investors may not get back the full amount invested, as prices of shares

and the income from them may fall as well as rise. Performance shown on this document is for

reference only. Actual performance may differ depending on the actual investment date and charge of

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differ.