31.12.2018

International stocks witnessed an exceptionally volatile end of year with intraday movements unseen since the mid-eighties. These developments were mainly driven by US markets undergoing brutal adjustments attributed to panic selling and subsequent rebalancing that reflected shifts out of bonds into stocks from pension funds (and secondarily from likely interventions of the working group on financial markets). We ought to give the recent gains the benefit of the doubt and acknowledge receipt of recent tweets of D. Trump inviting us to grab equity markets as he witnesses great progress in Sino/US trade deal negotiations. Following a recent phone call with President XI, President Trump tweeted “…Deal is moving along very well. If made, it will be very comprehensive, covering all subjects, areas and points of dispute.” Still, many of those tweets are mere variations of other bipolar ones that led investors by the nose and into the dust repetitively and for months throughout 2018. There will be great and fantastic progress in soybeans, soja and even pork bellies but the rest is not going to be about agreement, more about outright war for technological leadership and for years to come. We have to believe that gains of the past few days will be more than a fragile recovery but evidence also point at a slowing world economy that will ill afford a further normalisation in monetary policy. This is a near term positive for investors who continued to express their expectations for a late Christmas squeezy rally (or swift new year recovery) by building an unusually large amount of “non-linear” long exposure on major indices via the purchase of calls at the same time as their appetite for puts dwindled (leading to a sharp increase in the call open interest and a concomitant decline in the put open interest, see chart below).

This reflects a continued “fear of missing out”, a familiar and nearly decade long driver of equity market bullishness, next to the sugar high of tax cuts, the associated soaring of share buy-backs volumes and gradually fading central bank asset purchase programs. We lifted some hedges in between two gulps of our soup last week but we will start the year with the needle right in the middle in terms of our expectations for a continuation of this equity rally early next year. One thing we agree on is about the need of buying options to limit the downside on any of our short-term views. Expectations were also buoyed last week by D. Trump relieving the pressure on Fed Chair J. Powell as one of his aides suggested J. Powell’s job was “safe”. Needless to say these pressures will return if the Fed tightens (as little as) one more time next year… but for now all market based expectations thereof have disappeared. The President also criticized the QT program that essentially at this stage takes away most of the powder of share buybacks… We also expect this balance sheet normalization to be further questioned and to come to an end in 2019, which might help prolonging the credit cycle. Next to everything else, this context leaves us with some question marks for next year on the dollar outlook. US financing needs are set to increase significantly amidst a diminishing appetite for dollars, judging from the latest IMF data which suggested a continuation of the recent trend towards a regularly and slowly eroding share of the USD in international reserves. The de facto US foreign policy of “management by sanctions” will have slow but perennial consequences on the use of the USD in international trade in the coming years and therefore on foreign appetite for US debt financing over the long term (even assuming that the current US policy progressively resolves the need to finance what should lead to a dwindling US current account deficit). The appetite for US “higher yielding” Treasuries will likely remain constrained by their unattractiveness to European and Japanese investors on a currency hedged basis. As regards the ECB, the plan is to halt the asset purchase program by the end of this year which will take out further liquidity from the system but expectations are now for any rate hike to be postponed to 2020 which should help in some ways mitigate the need for more reflationary fiscal policies in Europe. The European outlook suggests growth will be closer to 1% than 2% next year which is not quite a rosy scenario either. “Expectations” therefore remain for the euro to face more difficulties in 2019, a consensus view which we do not share at the present time, simply because the European currency is owned in international portfolios in proportions three times less (20% vs. 64%) than the USD that will likely face the headwind highlighted above. In this context, Bitcoins and their likes will continue to be no safe haven . They were treated no differently than all previous bubbles in 2018 but the job remains incomplete. Most of them will converge towards their intrinsic value which is closer to zero than their current value over the next year or so, in our view. Running yields might be more approachable in EM currencies that suffered disproportionately last year, now that the fear of Fed tightening has all but dissipated. We’ll have to buy our time for the moment when 10-year Bund yields will offer anything more normal than a 25bps yield. In the meantime, Italian bonds might be just fine, even as Texan hedge funds keep crying wolf before getting squeezed. There will be lots of money at stake in the next bond bear market but the time has likely not come just yet. For those investors seeking hedging and diversification, our view remains that they will likely be better served owning (physical) gold and silver next year, especially as sentiment remains fairly muted in the precious metals complex.

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