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20, 25 Then 10...

US stocks were hit right out of the barn yesterday as the Chinese rally gave signs of petering out and after the Nikkei followed on the downside. After shedding more than 2% in the first hour, the S&P500 bottomed for the day, triggering hopes that it could end the day in the green… US stocks fell back in the last 15 minutes, leaving the S&P500 and the Nasdaq with losses of -0.6% and -0.3% respectively. With the S&P500 200dMa broken, the market is looking at the Nasdaq which closed just 0.8% above its own 200dMa. The energy sector suffered the biggest loss (-2.7%) after oil fell sharply. European stocks dropped, closing before the US market had an opportunity to rebound. Reflective of the broadening negative trend affecting global equity markets, only 33% of shares included in the MSCI world are still trading above their 200dMa (vs. 44% for the S&P500 and 22% for the MSCI Europe). “US earnings will probably produce a quarterly year-over-year growth rate of 20% for the recent three-month period, but the trajectory is lower after the first half of the year at 25 per cent growth rate. Next year the S&P is expected to trend towards a 10% quarterly earnings pace, good but no longer sufficient to justify lofty valuations, especially if we see wages, interest rates and other input costs pick up further from here”, the FT wrote. Volatility ebbed back yesterday after a brief spike. Poor equity market developments yesterday came from 3M which dropped -4% and CAT which shed -8% after the industrial sector warned on tariffs, rising prices and downside risks to the global outlook. L. Kudlow accused China late yesterday of doing nothing to defuse trade tensions. Concerns also mounted that China could engineer a drop in the renminbi to offset the impact of tariffs (although L. Kudlow opined that recent yuan weakness likely resulted from market forces). L. Kudlow also noted the risk of a “blue wave” in 2 weeks’ time that could overturn Trump’s policies. The recent equity market selloff might work against the interests of D. trump but the caravan with 5000 migrants heading towards the Southern border will be coming handy to serve his cause. D. Trump’s popularity remains high; he has achieved some results (including coercing Germany into building some gas terminals they do not need to buy US LNG); his level of energy in unwavering and our best guess at this stage is that Republicans will keep the White House and the two chambers... In Europe, the European Commission formerly rejected the Italian budget, requesting a new proposal within three weeks. This was expected but in a context of global risk aversion, Italian bonds underperformed driving the BTP/Bund spread higher by 13 bps. For what it is worth, out of the 35 or so procedures of excessive deficits launched by the Commission, not one led to fines and we do not expect the Italian case to be treated differently although the posturing and rhetoric issues of the Italian coalition (and in response of some members of the Commission) is making the dialogue more intense. Government bonds were well bid yesterday although not excessively so given the equity context. US 10y Treasury yield (snapshot) and 10y German Bund yield dropped 2bps. We cannot develop a bullish outlook for bonds for anything else than a few hours or days. Treasuries remain unattractive for foreigners on a currency hedged basis. The US fiscal deficit is USD780bn for the fiscal year just ended. Next year it will be USD1000bn and foreigners have not made net new purchases for three years which means it is up to US buyers and in particular pension funds (a USD6’000bn gorilla) at this stage to buy the new issuance which they have been doing as they shifted more equities into bonds. Once this shift will be done, it will be done. Risks on bonds in a tightening context, the lack of financial incentive (despite a high nominal yield) for foreigners to own treasuries, geopolitical tensions that are cutting off demand for Treasuries and therefore a potential inadequacy between US bond demand and supply make us very cautious on the US bond outlook and therefore also…on the USD despite its ongoing strength. This is making us fairly constructive on precious metals as speculators remain short of gold and as central banks are likely to remain constrained in their ability to normalize policy.

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