MACRO HIGHLIGHTS & STRATEGY€¦ · MACRO HIGHLIGHTS & STRATEGY | JAN. 25TH 2016 4/15 EDMOND DE ROTHSCHILD | B. JACQUIER, F. LÉONET, L. TURK The result of this exercise is clear,

PRIVATE BANKING

EDMOND DE ROTHSCHILD | B. JACQUIER, F. LÉONET, L. TURK 1/15

MACRO HIGHLIGHTS & STRATEGY JANUARY 25TH 2016

OUR ROUNDUP:

The markets got a boost last week from words by the ECB president, Mario Draghi. China is making progress in its transition but the process will be long. Oil prices and inflation will be the key issues in monetary policies this year. So far the recession in US manufacturing has not spread to services.

MARKETS

THANKS MARIO!

After a demoralising start to the new year, investors are trying to gather their composure:

Late last week, in line with our expectations, the markets were reassured by China’s Q4 GDP data (see

article on p.2) and the dovish comments of ECB President Mario Draghi. In the coming months attention

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Year to Date Performances (%)

1-Week Performances (%)

----------------------- Equities ----------------------- ------------------------ Bonds ------------------------ ------- Commo ------- ------------- Currencies -------------

MACRO HIGHLIGHTS & STRATEGY | JAN. 25TH 2016

2/15 EDMOND DE ROTHSCHILD | B. JACQUIER, F. LÉONET, L. TURK

will focus on the oil price, inflation and moves by central banks (see article on p.3). The recession in

manufacturing will also be scrutinised to see whether it is spreading to services sector (see article on p.6).

CHINA

THE LONG ROAD AHEAD

China’s fourth-quarter GDP data suggest that the economy is bottoming out without any severe

bumps in sight for the time being. Growth in 2015 as whole came to 6.9%, just shy of the 7% target set

by the central government. Economic activity has been slowing for years but this is consistent with China’s

increasing reliance on consumption rather than on the old standbys, exports and infrastructure investment.

The trends in these sectors prove that the shift is still under way. Despite a slight upturn in

manufacturing, emblematic of the former paradigm, expansion in that space continues to slow even as

private consumption remains resilient (see chart below).

The present stabilisation in the overall growth rate is no assurance that China’s mainland markets

will settle down. To begin with, Beijing’s determination to achieve 6.5% growth until 2020 does not sit well

with the inevitable downturn stemming from the transition to a consumption-based economy. The

adjustment of investors’ expectations to this more moderate pace of expansion will mean greater market

turbulence, like the spate seen at the start of the year. Volatility is also magnified by the immature state of

China’s equity markets, not only due to nature of their shareholder base but also to the authorities’

sometimes clumsy moves. This results in movements that are driven more by broad sentiment than by

fundamental factors.



Meanwhile, although caution is advisable near term these swings should be played down. Fluctuations in

share values and the yuan are part and parcel of the general internationalisation of Chinese assets.

They may cause pain but are necessary and even desirable longer term. In our view the real sources of risk

in China lie in the banking system, debt and a possible slowdown in the pace of structural reforms, rather

than in scope for a marked economic downturn.

Another concern is that the contribution of trading to banks’ overall revenues at this time last year, when the

stockmarket was booming, will gradually dwindle. Data from the services sector will have a slightly negative

impact on overall Q1 2016 GDP as a consequence. Nor should we forget that the success of China’s

transition will have to be measured over a long period of time and not just a few quarters.

MONETARY POLICY

WILL THE FED STAY ITS HAND?

Since July 2014 the price of crude oil has collapsed, falling more than 75% from $108 a barrel to $26

last week (see chart below). The reasons are many, including the lifting of international sanctions against

Iran, oversupply, slowing global expansion and dollar appreciation. Oil is struggling to settle at a new fair

value in tumultuous conditions.

0

20

40

60

80

100

120

140

0

20

40

60

80

100

120

140

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

OPEC Crude Oil Basket (USD)

Our 2016 economic forecasts were based on the assumption that, while remaining highly volatile, the price

of crude petroleum would range around an average of $45 a barrel for the year as a whole. This scenario is

still possible but less and less plausible in some people’s view. Since this is understandable, we subjected

our inflation forecasts to the downside shock of an oil price averaging $30 a barrel throughout 2016.



The result of this exercise is clear, both for the US (see left-hand chart below) and the Euro Zone (see

right-hand chart below): inflation still swings upward in the first quarter (since the drop in petroleum is

less steep than in the same period last year, though the impact of the change is less dramatic than

expected). It then tapers off to a very low range between 0.3% and 1.2% year on year. The deflationary

effect of the oil variable does not disappear until 2017, when consumer price indices can finally move back

up towards 2%, the level sought by central banks.

-4

-2

0

2

4

6

-4

-2

0

2

4

6

06 07 08 09 10 11 12 13 14 15 16 17

United-States Inflation (CPI, %YoY)

EdR Forecasts (Hyp : Oil Price at 45$)

Alternative EdR Forecasts (Hyp : Oil Price at 30$)

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-1

0

1

2

3

4

-2

-1

0

1

2

3

4

06 07 08 09 10 11 12 13 14 15 16 17

Euro Area Inflation (CPI, %YoY)

EdR Forecasts (Hyp : Oil Price at 45$)

Alternative EdR Forecasts (Hyp : Oil Price at 30$)

This naturally begs a second question: will central banks be more accommodative than expected

this year? The answer is: yes, probably.

As we had forecast in the 18 Jan. edition of Macro Highlights & Strategy), the Central European Bank

(ECB) last week announced that it would do more in terms of money printing and rate cuts. Unlike in



December, this time Mario Draghi did not dash investors’ hopes. The ECB president will likely even put his

words into action at the March meeting on monetary policy.

Meanwhile the policy committee of the US Federal Reserve (Fed) will meet on Tuesday and

Wednesday (26-27 Jan.) and could state whether it will continue to raise interest rates from March or

keep them on hold instead. On the one hand the outlook for the US economy has not changed

fundamentally. GDP is still growing, core inflation ex food and energy prices is rising (see left-hand chart

below), job creation remains promising, Congress has just raised the minimum wage and upside pressure on

wages in general is increasing. All these factors argue in favour of the Fed continuing to tighten at the rate of

25 basis points per quarter. Moreover interest rates are still very low and the business cycle is already well

under way. But on the other hand the global economic slowdown, weak inflation, its pass-through impact,

falling inflation expectations (see right-hand chart below) and turbulence in financial markets do not support

additional strong action by the Fed. There is no rush.

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2000 2002 2004 2006 2008 2010 2012 2014 2016

US Personal Consumption Expenditure Core Price Index (%YoY)

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2002 2004 2006 2008 2010 2012 2014 2016

US 5-Year Breakeven Rate (%)

The Fed’s mandate calls for it to encourage economic growth and control inflation. Officially it does not have a

brief to stabilise the markets. In practice, however, for the last three decades investors have got used to Fed

protection (or at least buffering) from market shocks. In a reference to former Chairman Alan Greenspan,

many observers call this protection the “Fed’s put”—a free hedge on a fall in equities. Others more jadedly

refer to it as a “moral hazard”, since it encourages the formation of asset bubbles.



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0.8

1.2

1.6

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

1-Year Implied US Monetary Policy (%)

So what will it be? Will the Fed yield to the temptation to stay its hand? Yes, probably. If it leaves

everyone guessing instead, two factors are already certain. First, an economist would find it reasonable

that the Fed should go on normalising its monetary policy from March, with four 25-bp upticks in 2016.

Second, investors are anticipating only one rate hike this year (see chart above). It will therefore be

difficult for the Fed to deliver a pleasant surprise.

UNITED STATES

WILL THE SLUMP IN MANUFACTURING HAVE A KNOCK-ON EFFECT?

Although a good part of American industry has already been in recession since November, the

overall economy seems to be holding up well as illustrated by the excellent health of services and

the labour market. How Why are services all of a sudden so resilient? Historically the behaviour of

manufacturing has often been a leading indicator for the economy at large (see left-hand chart below).



Manufacturing

US industrial production has been brought low by two of its subsectors, oil and manufacturing. For the

moment the big problem is in the fossil fuels segment, though manufacturing is on the verge of tipping into

recession as well. The ISM manufacturing index, the leading indicator for this latter segment, has fallen

below 50 points, signalling that a contraction is nigh (see right-hand chart above).

Two main reasons can be cited for the downturn in US manufacturing:

- falling capital investment by US manufacturers (see left-hand chart below)

- sharply lower exports due to weak international demand and dollar strength. American companies

are struggling to compete with European and Asian peers. And manufacturing is export-oriented,

with nearly 25% of revenues earned on foreign sales.



The bad news comes primarily from leading indicators that are showing no significant upswing near

term. Polls of manufacturers’ purchasing managers and on export order intake put these indicators at 48

basis points, i.e. below the 50-point dividing line between expansion and contraction. The steep decline in

new orders of capital goods is a further sign that industrial production is slumping (see right-hand chart

above).

Services

As shown in right-hand chart on p.6 above, t the trends in manufacturing and services are diverging

sharply. The reason for this decoupling is that service companies are mainly positioned in the

domestic market, which for the time being remains robust. Proof of this can easily be seen in strong job

creation and consumer spending (see charts below). Thus services are not hurt by the dollar’s muscle-

flexing or by slacker international demand. Moreover, unlike industrial production as a whole, the services

sector is benefiting from low oil prices via the lower cost of retail items, transport and leisure.



Moreover American firms are increasingly intent on upgrading their IT systems and using new technologies

like the cloud and cyber security. Thus, in recent years capital investment has favoured services

rather than manufacturing of equipment, machines, etc. (see left-hand chart below). Finally, the services

sector’s leading indicators are very buoyant. The PMI services index currently stands at 55.3 points. Its

strongest subcomponents are production (58.7), new orders (58.2) and employment (55.7) (see right-hand

chart below). These excellent data point to a rosy near-term trend. And since services account for 70% of

US GDP, this conclusion holds promise for the economy as a whole.



What does the future hold in store?

There is no reason to be giddy. The US economy will feel the repercussions of slowing manufacturing

activity, even though this represents only 12% of overall GDP and employs only 9% of the working

population. A knock-on effect on the services sector is inevitable, though so far there are no visible signs of

this happening. Some channels of contagion are obvious: manufacturers use plenty of services:

accounting, human resources, management and consulting, transport, IT, etc. If a struggling firm has to

increase its profitability, there are bound to be adverse consequences for services.

The question is when and how deeply the repercussions will be felt.

- Magnitude – This is difficult to gauge, since there is little information on services and it is often

separate from manufacturing data. But two things are clear: 1) the share of manufacturing in GDP

has fallen in recent years, reducing its impact on the overall economy (see left-hand chart below);

and 2) many services that are totally divorced from manufacturing, such as healthcare, education,

science / technical services, leisure and finance, have grown in importance.

- Timing – Our econometric modelling points to a general slowdown but not a recession in the US

economy from the last quarter of 2016 (see right-hand chart below). America’s GDP has been

expanding above trend for two years, so a return to its potential rate would be logical. The expected

contraction will come from manufacturing and its impact on services.

In the coming months we will be watching the following parameters closely:

- leading indicators for services (a crucial signpost)

- the level of US consumer confidence



- the labour market, with a focus on wage growth.

For the moment, there is every indication that the American economy will remain resilient for

another few months.



ECONOMIC FORECASTS

Contributions to global GDP growth

Comments The GDP growth rates shown above are actual for 2014 and projections for 2015 and 2016. Each country’s weighting is based on its GDP in US dollars as calculated by the World Bank. Contributions to global expansion are calculated by multiplying the GDP growth of each country by its weight. The sum of the

contributions works out to 3.6% for 2016, a good estimate of this year’s global GDP growth.

Economic Activity GDP 2014GDP 2015

Economist Estimates

GDP 2016Economist Estimates

Country

WeightsContribution 2016

United States 2.4% 2.4% 2.4% 23.2% 0.56%

Canada 2.4% 1.2% 1.8% 2.0% 0.04%

Euro Area 0.9% 1.5% 1.6% 14.5% 0.23%

United Kingdom 2.6% 2.2% 2.2% 4.0% 0.09%

Switzerland 1.9% 0.8% 1.2% 0.8% 0.01%

Russia 0.5% -3.8% -0.5% 1.9% -0.01%

Japan 0.2% 0.6% 1.0% 4.9% 0.05%

China 7.4% 6.9% 6.5% 17.8% 1.16%

India 4.7% 7.4% 7.4% 3.6% 0.26%

Brazil 0.1% -3.7% -2.8% 2.1% -0.06%

Mexico 2.1% 2.5% 2.8% 1.6% 0.04%

Others 4.4% 3.5% 4.4% 23.6% 1.03%

WORLD 3.4% 3.1% 3.4% 100% 3.4%

Source : Bloomberg Momentum (vs Last Estimates) Performance (Over \ Under)



RETURNS ON FINANCIAL ASSETS

Major benchmarks and currencies

Markets Performances

(local currencies)

Last

Price1-Week (%) 1-Month (%) Year-to-Date (%) Last Year (%)

Equities

World (MSCI) 368 1.0% -7.1% -7.8% -1.8%

United States (S&P 500) 1'898 1.4% -6.4% -6.6% 1.4%

Euro Area (DJ EuroStoxx) 318 2.4% -5.6% -7.4% 11.2%

United Kingdom (FTSE 100) 5'870 1.7% -2.9% -5.4% -1.0%

Switzerland (SMI) 8'235 2.0% -2.9% -6.2% 1.1%

Japan (NIKKEI) 17'111 -1.1% -10.1% -10.9% 11.0%

Emerging (MSCI) 711 0.2% -10.5% -10.5% -14.8%

Bonds (Bloomberg/EFFAS)

United States (7-10 Yr) 2.03% -0.1% 1.9% 2.0% 2.1%

Euro Area (7-10 Yr) 1.48% 0.6% 1.3% 1.4% 1.0%

Germany (7-10 Yr) 0.48% 0.6% 1.8% 2.0% 0.9%

United Kingdom (7-10 Yr) 1.70% -0.4% 1.4% 2.0% 0.7%

Switzerland (7-10 Yr) -0.20% 0.3% 1.1% 1.5% 3.7%

Japan (7-10 Yr) 0.23% -0.1% 0.4% 0.3% 1.4%

Emerging (5-10 Yr) 5.25% 0.7% -0.2% -0.3% 1.6%

United States (IG Corp.) 3.63% -0.6% -0.1% -0.1% -0.8%

Euro Area (IG Corp.) 1.22% 0.1% 0.0% 0.0% -0.5%

Emerging (IG Corp.) 4.77% -0.1% -0.8% -0.8% -2.3%

United States (HY Corp.) 9.73% -0.5% -2.1% -2.8% -3.5%

Euro Area (HY Corp.) 6.12% -0.2% -2.4% -1.9% 0.3%

Emerging (HY Corp.) 11.42% 0.1% -1.7% -2.1% 3.6%

United States (Convert. Barclays) 41 0.8% -5.0% -5.5% -0.8%

Euro Area (Convert. Exane) 7'209 0.4% -2.7% -3.9% 7.6%

Real Estate

World (MSCI) 178 -0.1% -5.6% -6.5% 1.0%

United States (MSCI) 191 1.0% -3.4% -4.6% 4.6%

Euro Area (MSCI) 203 3.9% -1.3% -3.5% 16.1%

United Kingdom (FTSE) 6'545 -0.5% -0.5% -0.7% 9.4%

Switzerland (DBRB) 3'599 0.6% 0.3% -0.3% 4.6%

Japan (MSCI) 241 -3.9% -11.0% -10.7% 0.9%

Emerging (MSCI) 83 -2.9% -16.4% -17.0% -6.8%

Hedge Funds (Dow Jones)

Hedge Funds Industry 550 n.a. -0.8% n.a. -0.7%

Distressed 727 n.a. -0.7% n.a. -5.3%

Event Driven 593 n.a. -1.3% n.a. -6.3%

Fixed Income 303 n.a. 0.2% n.a. 0.6%

Global Macro 885 n.a. -2.1% n.a. 0.2%

Long/Short 677 n.a. 0.0% n.a. 3.6%

Managed Futures (CTA's) 317 n.a. -2.2% n.a. -0.9%

Market Neutral 269 n.a. 1.6% n.a. 1.7%

Multi-Strategy 521 n.a. 0.2% n.a. 3.8%

Short Bias 31 n.a. 4.8% n.a. 2.4%

Commodities

Commodities (CRB) 364 1.3% -2.5% -4.1% -15.2%

Gold (Troy Ounce) 1'106 1.6% 2.8% 4.2% -10.6%

Oil (Brent, Barrel) 30 10.9% -11.1% -13.4% -35.9%

Currencies

USD 99.3 0.4% 1.4% 0.7% 9.3%

EUR 1.08 -0.5% -1.1% -0.2% -10.2%

GBP 1.43 0.2% -4.3% -3.2% -5.4%

CHF 1.01 -0.9% -2.6% -1.3% -0.8%

JPY 118.5 -1.0% 1.6% 1.5% -0.4%

Source : Bloomberg Momentum (1-week / 1-month / 3-month) Performance (Negative \ Positive)



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Disclaimer

This brochure was prepared by Edmond de Rothschild (Suisse) S.A., 18 rue de Hesse, 1204 Geneva, Switzerland. Edmond de

Rothschild (Europe), located at 20 boulevard Emmanuel Servais, 2535 Luxembourg, Grand Duchy of Luxembourg, and subject

to the supervision of the Luxembourg Commission de Surveillance du Secteur Financier (CSSF), and Edmond de Rothschild

(France), a société anonyme (public limited company) governed by an executive board and a supervisory board with capital of

EUR 83,075,820 and with its registered office at 47 rue du Faubourg Saint Honoré, 75008 Paris, subject to the supervision of

the French Autorité de Contrôle Prudentielle et de Résolution (ACPR), limit themselves to making this brochure available to

clients at their offices and branch offices.

The figures, comments, analyses and investment research contained in this brochure reflect the opinion of Edmond de

Rothschild (Suisse) S.A. on market trends, formed on the basis of its own expertise and the economic analyses and the

information in its possession at this time. The figures, comments, analyses and investment research contained in this brochure

may no longer be current or relevant when the investor reads this brochure owing to its date of publication or changes in the

markets.

Each analyst mentioned in this document certifies that the views expressed about the evaluated companies and securities

reflect the analyst's personal opinion. Their remuneration is not tied directly or indirectly to the specific recommendations and

opinions expressed in this document. Details on the rating methodology used by Edmond de Rothschild (Suisse) S.A. are

available free of charge on request.

Neither Edmond de Rothschild (Suisse) S.A., Edmond de Rothschild (Europe) nor Edmond de Rothschild (France) may be held

liable for a decision to buy, sell or hold based on the aforementioned commentaries and analyses under any circumstances.

Furthermore, neither Edmond de Rothschild (Suisse) S.A., Edmond de Rothschild (Europe) nor Edmond de Rothschild

(France) may be held liable for harm incurred by an investor as a result of the contents or availability of this brochure.

This brochure is intended solely to provide general, preliminary information for the investors consulting it and should not be

used as a basis for any decision to buy, sell or hold.

Edmond de Rothschild (Suisse) S.A. recommends that each investor obtain the different regulatory descriptions of each

financial product before any investment in order to analyse the risk and form his or her own independent opinion, with the

assistance of advisers specialising in these matters if necessary, so as to ensure that the investment is appropriate to his or her

financial and tax situation.

Past performance and volatility are not a reliable guide to future performance and volatility, and may vary over time.

This information may not be used or reproduced in whole or in part.

Copyright © EDMOND DE ROTHSCHILD (Suisse) S.A. – All rights reserved



Documents

MACRO HIGHLIGHTS & STRATEGY€¦ · MACRO HIGHLIGHTS & STRATEGY | JAN. 25TH 2016 4/15 EDMOND DE ROTHSCHILD | B. JACQUIER, F. LÉONET, L. TURK The result of this exercise is clear,