Golden Horse Daily Commentary

Asian

Market

Asian shares bolstered by strong U.S. jobs growth, banks

Asian equities were off to a positive start on Monday, driven by strong jobs growth and a possible regulatory rollback in the U.S.

Hong Kong’s Hang Seng Index HSI, +0.54%   was up 0.5%, Australia’s S&P/ASX 200 XJO, -0.11%  slipped 0.1% and Japan’s Nikkei NIK, +0.29%  was up 0.3%. Korea’s SEU, +0.14%  gained 0.1% and the Shanghai Composite Index SHCOMP, +0.29%  was up 0.2%.

Japanese stocks NIK, +0.29%  recovered after notching the biggest one-week decline in seven months last week. Japanese banks led gains in Tokyo, tracking gains in U.S. bank stocks.

Large U.S. banks rose as much as 4.6% on Friday, after U.S. President Donald Trump ordered a review of the Dodd-Frank Act. The legislation was passed in 2010 to tighten bank oversight following the global financial crisis.

Mitsubishi UFJ 8306, +3.66%  climbed 4.5%, Nomura 8604, +1.52%  gained 3.2% and Dai-ichi Life 8750, +1.19%  rose 2%.

The U.S. jobs report delivered Friday after Asian markets closed contained mixed data. U.S. employers added 227,000 workers in January, the biggest gain in a month since September. However, unemployment edged up to 4.8% as more people looked for work, and the pace of wage growth slowed.

The data are seen as just strong enough to be supportive of Asian stocks on Monday. “The U.S. economy was able to create more jobs than expected, without a commensurate rise in wages, [suggesting] that we’re further from ‘full employment’ than many bulls were hoping,” said Matt Weller, an analyst at Faraday Research.

However, the data also dimmed expectations for a near-term interest rate increases by the U.S. Federal Reserve, which weighed on the dollar on Monday.

The U.S. dollar USDJPY, -0.02%   was down 0.1% to ¥112.54 in early Tokyo trade. The WSJ Dollar Index BUXX, +0.03%  , a measure of the U.S. dollar against a basket of major currencies, was flat at 90.34.

In recent weeks, Japanese equities have been volatile because of economic and political factors, said Masayuki Kubota, chief of online brokerage Rakuten Securities in Tokyo.

There are indications that the U.S. economy is strengthening, which is positive for Japanese stocks, he said. However, worries that Trump could label Japan a currency manipulator is boosting the yen. A stronger yen hurts Japanese exporters and weighs on stocks.

“Economic situations are getting better while political situations are getting worse. So markets are uncertain about which way to go,” Kubota said.

Some investors remain focused on the Bank of Japan’s bond-buying moves, after it stepped into the market Friday, boosting its bond purchases by more than $6 billion following a sharp selloff in Japanese government bonds.

On Monday, the central bank said it offered to buy the same amount of bonds compared with previous tenders, including ¥450 billion of JGBs maturing in five to 10 years. Lead Japanese government-bond futures fell to 149.53 shortly after Tokyo markets opened but trimmed losses after the BOJ’s announcement. They were last down 0.12 at 149.64

JGB yields were broadly higher, with the newest 30-year tenor up 0.010 percentage point at 0.875% and the benchmark 10-year bond unchanged at 0.095%.

A raft of weak economic data from Australia and Japan failed to damp investors’ enthusiasm.

Australian retail sales dropped 0.1% in December from a month earlier, the government said Monday, compared with a 0.3% rise expected by economists. Fourth-quarter retail sales climbed by 0.9% from the third quarter.

Record low wages growth and evidence of weakness in the job market have taken some momentum away from retail sales in recent months. In December, household goods sales fell 2.3% from the previous month, the first decline since July.

In Japan, wages edged up 0.1% in December from a year earlier, slower than the 0.5% gain in November, as bonus and overtime pay fell, government data showed. Stripping out inflation, overall wages fell 0.4% from a year earlier, the first decline in a year. Economists see wages as the main indicator of the effectiveness of Prime Minister Shinzo Abe’s economic policies.

US

Market

President Trump looms large over stocks despite deluge of earnings

It may be peak earnings season but the stock market’s main obsession seems to be President Donald Trump. And as investors continue to second guess his next move and decipher what his policies may mean for the economy, equities are likely to continue taking their cue from politics.

In a sign of how large the president looms over the market, an analysis of FactSet data by MarketWatch shows that one out of four companies referenced Trump during their most recent earnings conference calls. Much of the discussion appears to be driven by questions over the impact his policies will have on each company within the context of growth and trade, underscoring the apprehensive mood in the market.

That sense of uncertainty, in part, hobbled the market for much of the week as major indexes languished. The S&P 500 moved less than 0.1% in either direction for three straight days this week, the first such streak since November 2014, according to Dow Jones data.

Analysts blamed the market’s lackluster action on the absence of specific details from Trump’s administration even as the president moved quickly to fire off a string of executive orders on everything from a temporary immigration ban to withdrawing from landmark trade pacts.

The lack of clarity is likely to be an ongoing feature, forcing the market to fly blind, at least until April when the budget is released, said Steven Ricchiuto, chief economist for Mizuho Securities USA.

In the meantime, Ricchiuto urged investors to think outside of the box when it comes to Trump, adding that he’s smart enough to pull off many of his campaign pledges.

“Making the assumption that he is stupid is wrong,” said Ricchiuto, who believes Trump’s actions, no matter how irrational they appear to some, are governed by his background as a real estate developer.

“He will always start from a position of power and then moderate to a different position,” he said.

The Dow Jones Industrial Average DJIA, +0.94%  advanced 186.55 points Friday, or 0.9%, to close at 20,071.46 but slipped 0.1% for the week while the S&P 500 SPX, +0.73%  rose 16.57 points, or 0.7%, to 2,297.42 for a weekly gain of 0.1%, shrugging off its torpor after Trump took steps to overhaul Dodd-Frank law governing the financial industry.

Market sentiment remains bullish even as “Trump fatigue” sets in with Bank of America Merrill Lynch’s Bull & Bear Indicator rising to its highest in 2.5 years, according to the investment bank.

 Next week, 84 S&P 500 companies are scheduled to report quarterly results. The FactSet scorecard on fourth-quarter earnings shows 65% of S&P 500 companies beat mean earnings-per-share estimates and 52% have turned in better-than-expected sales.

Apart from earnings, financial stocks are likely to take center stage as expectations of a watered-down Dodd-Frank will be a boon for the industry, which had been chafing under the restrictions placed in the aftermath of the financial crisis.

Under former President Barack Obama, regulators have applied financial rules under the most severe interpretations. Under Trump, they are likely to look for the most lenient, said Ricchiuto.

Currencies

Why the Dollar Is Likely to Fall This Year

Politicians have been known to shed their campaign promises quicker than college kids shedding their inhibitions on Spring Break. That’s why President Donald Trump’s fidelity to his campaign rhetoric presents a conundrum for investors—and for the U.S. dollar.

On one hand, the key pillars of Trump’s fiscal promise—tax cuts, infrastructure spending, repatriating foreign cash—are expected to boost the U.S. economy and, with it, our currency. It is no coincidence that the dollar index jumped 5.3% in the seven weeks following the Nov. 8 election, to a 13-year high.

But Trump has also vowed to bring a new shine to America’s old Rust Belt by creating manufacturing jobs in the heartland of his voter base, and by expanding exports. His National Trade Council chief has even suggested that the U.S. should become more like Germany, which might mean nudging our manufacturing base as a percentage of gross domestic product toward 20% from about 12%. All of that can be awfully hard to pull off with a strong buck. That’s why Trump has begun talking down the dollar by lamenting that it is “too strong,” and that “it’s killing us.”

 Which Trump priority will win out? Conventional wisdom expects the dollar to rally in 2017, yet there are reasons that the herd might be surprised. For a start, nearly every 2017 forecast calls for a robust dollar, and global investors are already amply exposed to dollar assets. A January survey of 215 global fund managers by Bank of America Merrill Lynch showed a hefty 47% who say “long U.S. dollar” has become the most crowded trade (versus the next-biggest group, at just 11%, who picked “short government bonds”). “It’s as if everyone is standing on one side of the ship, admiring the view there,” says Ulf Lindahl, CEO of the currency management firm A.G. Bisset.

The dollar’s direction will affect more than just currency traders. Since the dollar index peaked on Dec. 28, it has corrected 3.5%. Russell 1000 companies that reap nearly all of their revenue domestically have seen their shares rise just 0.4%, versus 3.8% for companies that earn more than half of their revenue abroad, notes Bespoke Investment Group. Sectors with the most overseas revenue—namely materials (with 46%) and technology (with 45%)—are up 4.8% and 5.8%, respectively, in 2017, while telecom companies, with their largely local earnings, are down 5%. Emerging markets, where dollar-denominated loans could become costlier to repay when the dollar rises, have rebounded 10% recently.

It is easy to see why the dollar has become a heavier crowd favorite than La La Land. Our Federal Reserve is raising interest rates even as Frankfurt and Tokyo are holding rates near zero. Ten-year government bonds yield 2.48% here, trumping Germany’s 0.42% and Japan’s 0.1%. Increasing U.S. exports and energy production could improve our trade balance. Any uncertainty further accentuates the dollar’s status as a haven, and while levitating U.S. stocks show little anxiety, other barometers like the global economic policy uncertainty index are decidedly elevated.

As a result, the dollar today is overvalued in a comparison of purchasing powers—some say by nearly 20% against the euro and by more than 30% against the yen. Also, “the U.S. president is a clear mercantilist—and mercantilists tend to dislike strong currencies,” writes Louis-Vincent Gave, CEO of Gavekal Dragonomics.

Already, Trump has dissed China, Japan, Germany, and Mexico—the four countries with the biggest bilateral trade surpluses with the U.S.—for unfair trade practices and loose monetary policies. If Trump’s brand of diplomacy were to trigger a contraction in global trade, it could reduce foreign demand for dollars. Meanwhile, the global recovery limits the window through which central banks in Europe and Japan can keep flooding the market with euros and yen. Last week, China’s central bank surprised investors by raising short-term rates, the first time since 2008 that the U.S. and China are tightening in sync.

“The dollar’s continued rally hinges strongly on the Fed moving from one hike a year in 2015 and 2016 to more hikes in 2017,” notes Philip Wee, DBS’ currency economist. But U.S. unemployment at 4.8% is already near the lowest in years, and any uptick—along with still-muted wage growth, or Congressional tempering of Trump’s borrow-and-build ambitions—could give the Fed cover to hike less aggressively.

Bonds

Passive investing continues march into US bond market

The US bond market is succumbing to the advances of passive investing, with exchange traded funds and index-trackers now controlling more than a fifth of the fixed-income market — and rising fast.

ETFs have proven increasingly popular over the past decade, and absorbed more than $1bn a day globally last year, as investors continued to ditch more expensive, often poor-performing active money managers in favour of passive alternatives that merely seek cheaply to replicate an index.

The shift towards passive investing is most advanced in equities, with now nearly 40 per cent of US equity assets under management in the hands of ETFs and index-tracking funds. But there has been a similar but accelerating trend in the US bond market in recent years, pushing the share of passive vehicles to more than 20 per cent of the total, according to Bank of America Merrill Lynch.

“We’ve seen the stats, their market share is rising,” said Michael Lillard, head of fixed income at PGIM, Prudential’s $1tn asset management arm. “And it’s reasonable to assume that they will continue to gain market share.”

The flows into passive bond funds have been steadily rising since the financial crisis, but were long outpaced by gains from traditional fixed-income mutual funds, managed by the likes of Pimco and Franklin Resources.

But investor flows into active funds began to reverse course after the “taper tantrum” of 2013, when the Federal Reserve triggered a bond market rout by warning that it planned to unwind its quantitative easing programme.

Bond mutual funds regained their lustre last year, when yields plummeted to new record lows and even zero, but the election of Donald Trump in November proved another inflection point, spurring investors to yank out billions of dollars again.

Crucially, all of the fixed-income outflows came from active funds, not passive ones, which continued to suck in money through the year.

This trend is expected to continue, with Moody’s last week predicting that ETFs and index-trackers would exceed 50 per cent of all US assets under management in just four to seven years.

The passive shift is most advanced in the high-grade US bond market, with debts judged to be “investment grade” by the big credit rating agencies.

 Notably,however, most of the passive high-grade fixed-income money is in index-trackers, with ETFs only accounting for 10 per cent of the total assets under management, according to BofA.

The share of passive money in the high-yield market — popularly called “junk” because the debts are rated below investment grade — is more subdued, at just over 12 per cent, but also on the rise.

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