Risk assets entered 2020 on a positive note, with realized and implied equity volatility at very low levels despite the unstable geopolitical backdrop
Following strong gains of c. 25% (MSCI ACWI) and 7% (Bloomberg/Barclays Aggregate Bond Index) in 2019, investor appetite remained firm in the first half of January mainly due to the anticipation of the US-China trade deal. A brief risk-off following US/Iran missile attacks faded quickly, with oil prices at $65/brl down from $69/brl in January 6th. At the same time, gold prices climbed to a 7-year high of $1600 per ounce in early January, albeit the risk premium narrowed as geopolitical concerns eased, with bullion prices still elevated at $1550 per ounce (+20% yoy).
The low level of realized (15% percentile since 2000) and implied (1% percentile since 2000) S&P500 return volatility suggests, inter alia, that investors may be too complacent about the 2020 growth outlook when manufacturing indicators remain deep in contraction territory and major central banks are expected to remain unchanged in the first quarter of 2020 (see graph). At the same time, equity positioning appears stretched following abnormal monthly returns since mid-December (S&P500 at 40% annualized rate) and the aforementioned slide in volatility.
The Q4:2019 earnings season will attract investor attention, with JPMorgan, Wells Fargo and Citigroup reporting today. For the S&P500, consensus expects a -2% yoy decline in Q4:19 from -2.2% in Q3, -0.1% in Q2 and -0.2% in Q1. This will be the first time the index has reported four consecutive quarterly declines in earnings since Q3:15, albeit a recovery is expected for 2020, with consensus analysts forecasting EPS at an optimistic $177 or +10% compared with 2019.
Regarding trade, the US and China are due to sign, on January 15th, the “Phase 1” trade agreement reached in mid-December. The agreement requires “structural reforms and other changes to China’s economic and trade regime in the areas of intellectual property, technology transfer, agriculture, financial services, and FX”.
Moreover, China has agreed to increase purchases of US agricultural products by $30bn and the deal likely entails an increase in overall Chinese purchases of US goods up to $200bn over two years. The US cancelled its proposed new tariffs of 15% on $160bn worth of imports from China and will also halve (from 15% to 7.5%) the tariffs on Chinese imports of goods worth $120bn that were implemented in September 2019. Tariffs of 25% on $250bn worth of Chinese imports will remain in place. The enforcement mechanism of the Phase 1 deal would likely include a clause for a potential re-establishment of tariffs, assuming implementation fails.
Regarding macros, the US labor market appears to have slowed, albeit with NFPs up by a still strong +185k three-month moving average and the unemployment rate remaining broadly stable at 3.5% (see Economics). Business confidence continued to diverge across sectors in December, with the differential between manufacturing and services the largest since mid-2015. All told, real GDP estimates range between 1%-2% annualized rate (saar) for Q4 from 2.1% saar in Q3:2019.
In China, December’s activity data (retail sales, industrial production, fixed assets investment) and Q4 real GDP (due on January 17th with the consensus estimate of 6% yoy unchanged from Q3:2019) will be closely monitored to assess the economic momentum. Note that the PBOC lowered the Required Reserve Ratio by 50 bps to 12.5% for major banks in January 6th in order to accelerate the supply of credit to the real economy, releasing liquidity of c. RMB 800bn or 0.8% of Chinese GDP.