‘Performance in 2016 will hinge on whether USD/commodity/EM trends persist (consensus) or to varying degrees reverse (my view). On a CAPE basis, global value is at its cheapest versus growth since 2000 and cyclicals are at their lowest relative valuation since the crisis and we should see a mean reversion rally. Local currency EM debt, Euro, JPY, EM equities, US HY credit, copper, oil, AUD, and CAD all look attractive…’ Dec 15th 2015 Asset Allocation Note
Those macro views are suddenly becoming fashionable, but certainly weren’t at the turn of the year versus what we termed a ‘lazy consensus’. The overwhelming view from Wall Street analysts was that the dollar rally would be sustained through 2016, energy/materials equities and credit remained an obvious short and emerging markets would flirt with disaster.
The RMB devaluation ‘running out of FX reserves’ hysteria in January marked a climax for that popular bearish narrative. Hedge fund sentiment and positioning has shifted radically since then, from oil futures to resource stocks – the yen has now replaced the dollar as the biggest bullish currency bet, a prospect that would have been greeted with disbelief a year ago.
Investment bank FX strategists have had a disastrous few months, having missed the potential for euro and yen strength, as well as the dramatic EM currency rally. If you believed consensus wisdom, the euro should now be sub parity versus the USD and the yen well over 130 by now. They missed the importance of the dramatic current account improvements across many EM economies last year, as well as that in Japan.
Alongside already very cheap currencies on a trend real effective basis as calculated by the BIS, that made a high probability macro backdrop to the ‘surprise’ rally we’ve seen, with the recent ECB/BOJ action merely a catalyst. Fundamentally, global cyclical momentum is now turning higher, from factory new orders to Chinese cement and steel rebar prices anticipating a rebound in fixed investment activity.
Oil demand growth continues to be upgraded, notably from India (seeing demand growth of about 600k bpd this year) while US gasoline demand this year will almost certainly reach a record high on rising average mileage/SUV fleet share. So far supply destruction from the crash in global energy capex has been modest but remains critical to rebalancing the market. Our Brent crude target back in December for end 2016 was $50-60/bl and remains so.
Equity net earnings revision ratios remain negative across nearly all markets, but the second derivative is turning as the pace of analyst downgrades slows, particularly in Asia. We retain the overweight stance on deep cyclicals, materials and energy as well as EM with a focus on North Asia. Japanese exporters, many of which have seen 20-30% declines YTD on record foreign investor net outflows.
That panic selling has taken global funds slightly underweight versus benchmark. High global beta stocks exposed to EM demand now look a very attractive anomaly as the consumer and investment demand cycle turns higher from China to Indonesia, offsetting yen strength as an earnings drag. It’s paid to be contrarian this year, and that’s unlikely to change just yet…