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CROSS-INSIGHT 28 February, 2017

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Crossinvest (Asia) Pte. Ltd. 75A Amoy Street Singapore 069894 T: +65 6220 9339 F: +65 6220 6556 Website: www.crossinvest.com.sg Reg. No.: 200508686C

“We suspect that the disconnect between uncertainty and the public’s attitude is unsustainable. Individuals and businesses seem to be assuming highly favourable results -- pro-growth policy changes working their way through

Congress with little rancour and quick passage. Such an outcome is possible, but we have doubts”. Daiwa

QUICK SUMMARY

CROSSINVEST OUTLOOK A strong week for sovereign FI, but with so many uncertainties the possibility of a quick reversal is all too present. Equities grind higher ahead of important speeches by Trump and Yellen this week. That said, the ‘hope trade’ is surely almost fully discounted by now, and the risk is that ‘yuge’ infrastructure plans fail to impress in scale or timing. The majority view now is of a Fed hike in March, yet note below how complacent markets are.

[Please click on headers to go to in-depth analysis of each topic.]

US EQUITIES Twelve straight record closes for the DJIA. But Trump on Tuesday will illuminate (and possibly disappoint) on the border tax, tax reform generally, infrastructure spending plans, Dodd-Frank, and (if past is prelude) much more. With some weak consumption data recently, it’s worth paying close attention to developments this week.

EU EQUITIES Earnings are still coming up well, and economic data is largely resilient. There are possibly some bargains out there, but taking the chance on them potentially puts investors on the wrong side of political developments. We await further clarity.

APAC / GLOBAL EMERGING MARKET (GEM) EQUITIES H-shares are having their day, and Hong Kong, Singapore, India and Philippines names are also showing some real life. There remains an EM disconnect between short and medium terms: liquidity is good now, but expect underperformance in a regime of rising UST yields.

FIXED INCOME An unexpected and welcome drop in the UST 10-year, as well as French and German sovereigns and even hard-currency EM (including AXK). Once concern would be if China capital controls stem the flow into offshore USD FI.

FX Keep your eyes on political risk and real yield differentials. The latter should help the USD as ECB, BOE and BOJ all remain dovish.

COMMODITIES Oil, gold, and copper all have had good runs and generally retain improving supply/demand balances. How much further they can run is open to question and dependent on the commodity in question, but it’s less likely the next move will be down (for all the comfort that provides).

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DEEP DIVE

OVERVIEW

Last week saw Developed market (DM) sovereign fixed income rally with yields heading sharply lower led by 2Y German ‘Schatz’ bonds testing all-time low close to -1% whilst the 10Y Bund fell to below 20bps from recent high close to 50bps whilst the beleaguered French 10Y OAT yield fell from recent high at 1.14% to below 90bps as political risk eased as Macon advanced in the polls relative to Le Pen. US Treasuries 10Y yield also fell to test 2.3% from a recent high at 2.6%. DM Equities mostly flat-lined as US equities edged higher with Dow Jones index rising for 12 consecutive hew highs – the longest such streak in c.40-years but the Nikkei, moving inversely to JPY gains, fell sharply over the last 3 days to now be flat YTD. GEM equities trundled on led by BOVESPA up close to 12% YTD but pursued by other large GEM markets as PRC H-shares up c.11% and Indian equities c8.5% YTD. Global macroeconomic data remained at high levels close to 6Y-highs and Q4 global earnings remain supportive as average beat is close to +4% and best in several quarters. FX saw USD DXY hold onto 101 handle but not advance with JPY gaining on its ‘safe haven’ status, as did Gold that advanced to highest since Nov. to above $1,250/Oz, and GBP underperforming on ‘SCOXIT’ fears. Mexican Peso recovered after government altered hedging guidelines.

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CROSSINVEST OUTLOOK

We are sympathetic to the thesis the rally in equities and in DM sovereign bonds this month might be replaced by the mirror opposite as investor fatigue over the Trump ‘hope’ trade sees SPX retreat from all-time highs it has only been inching-up of late whilst FI markets discover the Fed is more hawkish than is being priced-into USTs. We think there is more of a chance we see USTs sell-off either way as if Trump does underpin the ‘hope’ trade by action this is inflationary and a development Yellen has already publicly noted would have a bearing on Fed’s monetary policy. If not we still think inflationary pressures are being underestimated with the US economy is at full employment and might close its output gap by YE17 even without a fiscal boost. This underpins our near zero weighting in DM sovereign FI but makes us wary on SPX given expensive valuations that requires the detail of planned tax reform and fiscal spending to further advance. For now investors in SPX can ignore STOXX given EU’s binary political

risk, Nikkei given uncertainty of USD-JPY and GEM on basis of risks from a stronger USD and Fed hikes whilst hope remains the ‘hope’ trade will be made good. Our base case is Trump, as a populist, will continue to provide enough ‘hope’ in the next few weeks to underpin SPX but fatigue will set-in once the reality Congress may not play ‘ball’ sets-in.

Trump’s speech tonight, and Yellen’s on Friday, may have important implications for risk assets directionality. The White House has intimated Trump might disclose a ‘massive infrastructure spending’ plan along with higher defence spending that would help equities and notably those in infrastructure and defence sectors we like. However we think a good part of the ‘hope’ trade has discounted such news and the risk is Trump disappoints on the detail and timing, as did US Treasury Sec. Mnuchin last week in suggesting benefits of fiscal stimulus only start next year, and US equities sell-off. Fed futures for a March hike rose to over 50% yesterday, vs. 78% for June, and it is likely Yellen will hint if a rate hike in March is being seriously considered – we think June remains more likely – which would catalyse a likely sell-off in USTs.


US EQUITIES

US equities are again at all-time highs with DJIA making fresh highs for 12th consecutive day and longest streak in 38-years. Bond ‘proxies’ helped keep momentum alive as UST yields fell through much of last week. Retailers’ sales YTD have been slow and a key factor is that IRS tax refunds are running at $33bn YTD vs. $93bn this time last year

Housing data was mostly supportive although new housing sales remain stuck in a moderate growth range for over 12 months. Dallas Fed was strong as were consumer durables orders and U of Michigan confidence survey. More potentially worrisome is bank lending has slowed the most in 5 years over Dec. and Jan, and Feb. is slow too so far, with corporate lending -3.3% Dec. worst fall since 2010

Despite falling UST yields Fed futures now predict a 50%+ chance Fed might hike at March 15th FOMC meeting and a 78% probability will do so by June FOMC meeting.


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CROSSINVEST OUTLOOK – US EQUITIES

Trump’s next major public outing in to speak to Congress on 28th tonight that might give greater clarity on what are his administration’s policy goals. MS gives only a 40% chance the polarizing Border Tax (BAT) might pass but the concern is if this fails to get through Congress it might hold-up the wider objective of tax reform and fiscal spending dashing the ‘hope’ trade.

The review of Dodd-Frank and other legislation to de-regulate restrictions on banks is starting and the hope is US banks will be major beneficiaries of this but HSBC’s detailed analysis suggests attempts to water down regulatory controls face serious bipartisan opposition in Congress and that the restrictions, anyway, had far less a hindrance than some argue.

This week is an important data week with ISM manufacturing Wednesday and Services Friday, although Feb. NFP out only Friday 10th, along with Conference Board’s consumer survey. This data, along with next week’s NFP, will play a role in Fed’s decision-making. Yellen’s speech this Friday might provide clues as to whether more hawkish comments by many FOMC voters in recent weeks is affecting the timing of monetary tightening.


EU EQUITIES

STOXX was flattish last week around 370 level despite French political risk waxing and waning although later in the week Macon appeared to move ahead in a poll should he face Le Pen in a 2nd round run-off. The recovery in French OATs helped sentiment although equities did not respond having, in part, not followed OAT’s down earlier

Q4FY16 earnings remain positive and on course to be the first YoY increase after 6 consecutive quarters of declines.

Latest EU economic data continues to be resilient but latest Jan. and Feb. data is slightly off near 6Y-highs at YE16. EU car sales hit a decade-high Jan. UK data was mixed as retail confidence survey remained weak at -6 in contrast to more positive manufacturing data but FTSE takes its lead from GBP moves and GBP was soggier on fear another independence referendum in Scotland might be lost and so breaking-up the UK which would cause serious economic damage and added uncertainty


CROSSINVEST OUTLOOK – EU EQUITIES

We will remain underweight both the STOXX and FTSE 250 until the political uncertainty that could, at worst, result in the disintegration of the EU and Eurozone, is less worrisome i.e. Up to May 7th French 2nd round presidential vote. MS estimates Le Pen has just a 15% chance of winning and almost no chance of controlling the French Parliament, even if she won, making a referendum on EU virtually impossible. However UBS forecasts CAC 40 could fall almost 25% if she did win vs. a 5-10% jump if she lost and that France requires structural reforms to justify a more positive view

FTSE 100 continues to closely track GBP and we suspect GBP will be range-traded between 1.22-28 until greater clarity emerges as to whether the economy, so far surprisingly resilient, will weaken, what tactics the bumbling UK government might pursue over a transitional agreement with a reluctant EU and whether a referendum on SCOXIT becomes a reality. We remain bearish on GBP and thus modestly positive on FTSE 100


APAC / GLOBAL EMERGING MARKET (GEM) EQUITIES

The Nikkei continues to underperform SPX YTD as JPY waxes and wanes as we saw Friday when ‘risk-off’ sentiment over EU political risk drove JPY stronger and Nikkei fell over 1.4%. Despite JPY driver underlying fundamentals are improving as macro data is gradually picking-up and Q4 earnings beat

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AXJ markets were mostly positive with last year’s laggards leading. H-shares up 10% YTD then HK +9% are the top performers in APAC helped by inflows from the ‘connects’ into HK from the mainland. Singapore’s STI, India’s BSE and Philippines’s PSEI, have been some of the other best performers YTD whilst KOSPI has under-performed along with last year’s ASEAN ‘darlings’, SET and JCI. Vietnam’s VNI is up 7.5% YTD to a new 9-year high

We are concerned the arrest of a prominent Philippines opposition Senator, Ms de Lima, on charges she used drug money in her election race might be a further sign Duterte is moving towards an undemocratic Presidency that might result in mass opposition protests and a another period of political instability and derail plans to boost critical infrastructure spending. Elsewhere the SP-Congress alliance is leading BJP in polls for the UP election where 5 of 7 phases have now taken place with the result out later in March but we doubt this will have a major impact on the BSE

BOVESPA leads the EM pack up over 11%, although came off last week, and there are positives with inflation falling more than expected, latest unemployment number was below forecast as more joined the workforce than predicted and HSBC noted even its fiscal position may soon stop deteriorating, helped by a recovery in commodity prices, whilst earnings are beating with upgrades to FY17 coming through.


CROSSINVEST OUTLOOK – APAC / GLOBAL

EMERGING MARKET (GEM) EQUITIES

We will look to move our exposure to Japanese equities to overweight into any ‘dips’ on JPY strength below 112 as our base case is that the JPY will weaken further to 125 in ’17. Nikkei offers the most attractive DM equity market valuations on 13.5x FY17 PER and foreign investors remain underweight. We would hold this via hedged JPY share classes.

We remain underweight EM for the medium term, even if they might outperform still in the shorter term, as they generally underperform in times of rapid gains in UST yields, a stronger USD and are significantly at risk to trade protectionism – notably the AXJ exporting countries. Non-AXJ EM equities are more exposed than AXJ to rising UST yields and a stronger USD and are so doubly hurt by contagion from investors selling less liquid EM FI

We are sympathetic to the argument PRC equities are in the early stages of a structural bull market on rising ROEs and earnings, that a financial crisis is unlikely and investors, both local and foreign, are underweight with GEM investors close to multi-year lows in PRC equities and notably in the much trashed PRC banks. We increased exposures to PRC equities this year and we have recently added to the larger banks we think are undervalued.


FIXED INCOME

UST 10Y yield fell sharply last week to a low 2.31% before recovering yesterday by 6bps to 2.37%, despite Yellen’s more ‘hawkish’ testimony and stronger US macro data, as concern set-in that Trump’s tax reform and fiscal spending plans might be delayed after Mnuchin lowered expectations on timing suggesting more likely be felt in ’18.

French sovereign OATs outperformed Bunds as 10Y yield fell to below 90bps from a high at 1.14% earlier this month as political risk was more carefully calibrated. German 10Y Bunds saw its yield fall below 20bps as it continued to benefit whilst 2Y yield almost reached -1%, a record low, before easing-back to 94bps.

EM and AXJ hard currency FI remained firm last week despite significant issuance although growing concern over the political situation in Philippines saw its sovereign paper well offered and the Peso continue to underperform other AXJ FX too, despite signs its central bank, BSP, might be one of the first to tighten in the region. The concern is heightened as the much respected BSP governor steps down shortly.

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CROSSINVEST OUTLOOK – FIXED INCOME

We favour HY over IG, as we do not see IG offering an adequate reward, we do accept the significant compression in spreads over USTs for HY, since Trump’s victory, to 2Y-lows, offers little upside and prefer floating rate senior loans that offer a similar yield but are higher up the credit ‘curve’ and offer better protection to rising rates. Tight spreads and huge retail inflows to both HY and floating rate funds, since Nov. 8th, suggests caution for now.

A UBS report, on the impact on US credit from Trump’s putative tax reforms, suggests the biggest winners are large cap IG companies than smaller companies more in HY space as latter’s gains from lower tax rates might be offset by the abolition of interest rate tax deductibility with interest rates rising.

A potential risk for hard currency AXJ FI might be if the bond sell-off in CNY FI and further capital controls slows the outflows from PRC investors into offshore USD FI and notably into mainland PRC bonds as PRC has clearly been a key source of demand.


FOREIGN EXCHANGE

US Dollar index (DXY) remained around 101 last week with most DM currencies stuck in well-established trading ranges as

USD long positons unwound further. JPY remains the most volatile as it is caught between its ‘safe haven’ attraction and a ‘dovish’ BOJ seeking to hold down JGB yields via ‘financial repression’ with support at 111.50 and resistance at 115. Euro remained in a range of 1.05-1.07 last week

GBP briefly fell below 1.24 last week before recovering slightly to 1.2450 as concern mounted Scotland’s independence party, SNP, might seek an early referendum on staying in the UK now BREXIT is likely. The concern is this time the chances of success are considerably higher, lower oil prices notwithstanding, as Scotland voted to remain in EU in the BREXIT referendum and this has given SNP an extra lever in persuading Scots how to vote.

In AXJ FX CNY remained stable vs. USD around 6.88 last week. The SGD was an unexpected winner as a surprisingly strong Q4 GDP saw forecasts MAS might soon shift to an easing bias withdrawn and lowered YE17 estimates to a consensus 1.47 from 1.50 before. Philippines peso fell to a decade-low last week on political concerns noted above


CROSSINVEST OUTLOOK – FOREIGN EXCHANGE

We think the two main drivers for DM FX remain political risk and the real yield differentials. Whilst the former will wax and wane the latter we think will be supportive for USD as we see US inflation reaching 3% by Q2 and that the Fed will likely hike 3 times in ’17 starting June vs. continued dovishness by ECB, BOJ and BOE. We think JPY will weaken to 125 during ’17 and that EUR might test parity to USD whilst GBP faces BREXIT risks that could see 1.15

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We remain wary about AXJ and GEM FX outlook as long as the main driver is USD strength. AXJ especially was the main beneficiary of globalization in the last 30Y and stands to be the biggest loser should protectionism return. We see the need to be selective with greater risks for low yielding EM/AXJ currencies as SGD, NTD and KRW along with those more vulnerable currencies as TRY and ZAR running still sized current account deficits although last HSBC saw better supported after a prudent budget.


COMMODITIES

Brent oil price remained above $55/bbl. for Brent helped by OPEC’s effective production cut compliance and news out that speculative long oil contracts hit a new record high last week.

Gold is proving resilient and has gained 10% YTD, vs. SPX +5%, to move above $1,250/Oz important psychological level, to $1,263/Oz and positives included news of sized inflows to the largest gold ETF MTD and continued central banks’ buying as well as its ‘safe’ haven status.

Copper eased back from multiyear highs, after strikes in Chile, that took the price to over $6,000/T to settle back just above

$2,900/T. Nickel remains the preferred base metal whilst Iron ore forecasts were also raised by some strategists last week.


CROSSINVEST OUTLOOK – COMMODITIES

Our base case is the oil market fundamentally improves gradually through ’17 and the excess supply shifts to a moderate deficit that starts to very slowly reduce the glut of global stocks. This thesis relies in part on the fiscal arithmetic OPEC cannot afford oil prices to drop below $50/bbl. for long and would follow its first production cut by more. The other part is whilst we do see US shale oil production acting as the ‘price maker’ we do not think it will rapidly increase production YoY either until prices go north of $60/bbl. However in the short term oil could pull back to re-test $54/bbl. And is vulnerable should record long positions be cut

We continue to see the merits of gold as a defensive safe haven, arguably the only traditional such haven given risks to USTs, and would hold 3-5% in portfolios as the ‘insurance policy’. With the uncertainty around what Trump might do and rising political risks in EU we think the argument for gold has become stronger, not weaker, since Trump was elected. This holding is not a short term view and may require patience through volatile periods but the likelihood is we will suffer another meaningful risk off period having gold will help dampen losses. Gold offers, additionally, portfolio diversification benefits and has enhanced returns over the last 20Y.

The probability is this long period of good weather globally, since 2012, will end and the unprecedented low volatility in agricultural prices will be replaced by sharply higher price volatility. We like Agricultural funds that can take advantage of any pick-up in volatility as well as insurance linked securities that typically see yields improve after a major ‘weather’ event


Email us at <[email protected]>

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DISCLAIMER: The information, recommendations and other materials presented within Cross-Insight are provided for information purposes only and should

not be considered as an offer or solicitation to buy or sell securities and/or financial instruments. This publication is intended as a general outline only and is not a definitive statement on the subject matter and does not constitute any advice or recommendation for any specific person or entity receiving it. Crossinvest

(Asia) Pte Ltd relies on a variety of data providers for economic and financial market information. The data used in this report are judged to be reliable, but

Crossinvest cannot be held accountable for the accuracy of data used herein.


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