The “Resetter” & “We all are alifornians”The “Resetter” & “We all are alifornians” When Trump announced he was running for President, I said to everyone “He’s gonna

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July 2018

The “Resetter” & “We all are Californians”

When Trump announced he was running for President, I said to everyone “He’s gonna make it”. Several

reasons behind the thoughts but the main ones were:

o Middle Class USA has not been doing that well since the big financial crisis and his way of speech has

been more appealing to them.

o He had no much to lose so…. the fact of not being a traditional “WDC political animal” made him go

for it.

o Hillary was too eager for power and had made the Presidency her life achievement. In addition, the

behind the scene “work” of the Clinton Foundation raised quite a few critics.

Trump has been elected and since then I say: People will dance on his tune since he will give the tone. Like in

the Apprentice TV show, he has no problem to push people and his peers out of their comfort zone and he

has been much criticized for his way of doing things. Doing that without a purpose would be a nonsense since

he is the president, so what are his goals when he talks about “Make America Great again”?

o Give back to the Presidency its importance and power. He is against the power of “Shadow

Government” which has grown into an extended and complex web of agencies/entities. The story

about the Russian involvement in the US election fall within that context. Shadow Government exists

and shall be an instrument of the Presidency, not a lobby of private and special interests which can

create friendly fire.

o He is not very keen with the concept of Supranational Power and multilateral agreements. Submitting

your country to “obscure” decision powers should not be the American way of doing things. Do you

remember the Paris Agreement on Climate Changes and the TPP (Trans-Pacific-Partnership)

agreement? The TPP was, in my view, a non-transparent and secretive process that only a handful of

interested people could fully understand.

o He has no problem in facing critics and to bash the medias. Twitter is a practical way to reach to the

world. Maybe the fact of being a common critic among many of his peers, is part of the strategy! To

be the “Boss” means establishing a winning strategy; not be loved by others.

o What is the strategy? Let the market decide if USA Corp is better than EU Corp or China Corp or etc…

If you have superpowers as contenders, you need to bring them to the play under the same rules.

Maybe the key element, for Trump, is that all players must be reserve currencies and adopt the existing

rules. The USD is the most important funding/reserve currency in the world, but this could change,

and China has been trying to build its own system under its own terms. Trump wants America’s terms!

Trade wars talks, and actions are part of the arsenal of that “game”. The pressure will probably

maintain and take additional turns like fiscal and currency war.

The issue of funding currency is, in my view, a hedge for peace. Most countries which have relucted in

becoming funding/reserve currencies have avoided and postponed internal political changes for too long.

Central government, like China, has a great track record for planned economic growth for decades and China

has always put itself first! The Chinese model has probably reached some limits which, in Trump’s view, are

weaknesses which ought to be explored. Timing is good, America is doing much better than the rest and in

case of downturn…. it will probably remain with its head out of the water. I am not underestimating America’s

The SGG Report

http://www.stowgrowglow.com/


problems here but just saying that it is about the same as in politics, most of the time you select the less worse

candidate instead of voting for someone.

Xi Jinping is viewed as the most powerful Chinese leader since Mao and his rise into power has certainly most

to do with the domestic challenges that China is facing. For Xi, time is the most important currency now and

if it means tariffs, he will probably bow and use the Renminbi as a buffer hoping for Trump to lose its grips

during the November 2018 elections. Xi’s decision to transform the Renminbi as a reserve currency needs to

be done under China’s terms which requires China to become an open book to the world. The implications

are huge and How Xi will manage the situation is still unknown. China has dealt step by step over the years

creating Renminbi trading hubs to accommodate and manage Chinese trading partners relationships. Such

architecture does no fully attend the needs of the market place.

It is interesting to observe that the FED is also align with Trump (even if Trump criticizes) . Is this a coincidence?

One of the most important news of the last 60 days has been a letter from Urjit Patel, Governor of the Central

Bank of India to Jerome Powell, President of the FED. Patel urges Powell to review its QT (Quantitative

Tightening) and interest rate increase policy which could create conditions for a global dollar shortage. Jay

Powell’s speech in Zurich on may 8th 2018 ( Monetary Policy Influences on Global Financial Conditions and International

Capital Flows ) gives us a good idea that America is first too . He thinks that the world can manage the QT

program of USD 380Bn reduction of the Fed’s balance sheet (for 2018 and USD 600Bn for 2019). Basically, he

is telling all emerging non-reserve currencies countries “your problems are not mine so …. Get your act

together”!

The following charts shows in blue the yearly change in M2 and in red the 10 years US Treasury bond yield.

Let’s focus on the green rectangle! Diminishing of QE (quantitative easing) and slight tightening in interest

rates has slammed down M2 growth to around 4.3% (June July 2018). The US budget deficit announced will

also impact market since it needs to be funded. Where the money will com from? Sales of assets? US savers?

Foreigners? Central banks?


https://www.bloomberg.com/professional/blog/new-u-s-trading-hub-chinese-renminbi-opportunities-corporations/

https://www.armstrongeconomics.com/international-news/china/china-cips-v-western-swift-system/

https://www.federalreserve.gov/newsevents/speech/powell20180508a.htm

https://www.federalreserve.gov/newsevents/speech/powell20180508a.htm


We can already observe some stress in emerging markets. Turkey is on a dangerous path and its liabilities in

foreign currencies could prove very difficult to manage (especially for Europe). The IMF is helping Argentina

and Brazil Real has been hit too. Mr. Patel’s letter is a clear message, but Powell’s practical approach has been

to play down the importance of USD capital flows with emerging markets. The reasons why I say that Trump

and Powell are aligned are that it seems that we are observing a US induced regime change or kind of reset.

If you want to compete with the USA, become world powers, become more like us, get your act together,

embrace the changes and let your currencies become reserves.

In practical term, SGG Portfolio has been long USD and look at long term USD interest rates around + 3% as

potentially excellent allocation. M2 changes have proven very sensitive between the 1.5%-3% range and

inflation is a lagging indicator.

The chart here below is an overview of the Swiss (red), German (Green, Italy (blue), Japan (orange) and USA

(indigo) 1-year interest rates. The green fluo line is the 0% level.

Much is said about the economic cycle and growth, but sort term interest rates tell us that the USA has been

the sole country which has been able to “normalize” its situation. Powell’s QT and gradual rate increase is an

important test and the first tremors have been felt in the emerging markets.

What level of “normalization” can an overleveraged world withstand? Let’s look at it a bit differently.

World Corp SA annual revenues are 100 and outstanding debt is 236% of revenues. To increase revenues by

3% it needs to borrow an additional 6 % on revenues (bringing the total debt to 250.16%). If debt servicing

is, on average, 3%, debt servicing is about 7.5% of revenues. If you were a banker or investor from out of

space, would you keep lending? If we play with the numbers, the 10 years outlook is:

Year GDP Leverage debt

servicing or % of

GDP

10 130.48 398.72% 11.96% 15.61%



McKinsey has done an excellent presentation about the dynamic of debt:

DEBT volume USD Total Debt/GDP


https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/visualizing-global-debt


These figures do not take into consideration the leverage in the financial sector.

A recent IMF working paper on “Leverage – A Broader View” states:

“In this paper, we seek to demonstrate that the omission of off-balance sheet items in the standard measures implies a

substantial underestimation of bank leverage”

It has been 10 years since the last financial crisis and the banking lobby has been doing a “wonderful” job to

keep us in the mist. No one has a clear understanding of the true systemic risks.

I guess, Her Majesty the Queen of England will probably have again the opportunity to ask a crowd of

economists: “Why you did not see it coming?”. The answer might be the same “At every stage, someone was

relying on somebody else and everyone thought they were doing the right thing."!

Resuming, “We all are Californians”. The financial system is our San Andreas Fault!

Timing these kinds of events is difficult. The last time, the real estate market was the initial trigger through

the mortgage securitization process. In fact, the reach for yield from institutional investors had been the

engine behind it and the rating agencies “discovered” a lucrative fee business to “safely” package the junk. I

was co-managing a hedge fund which foresaw the coming crisis and we were positioned to take advantage of

the situation. However, we did not foresee the off-balance sheet risks of the financial industry. Being right

was not a guarantee of survival since our prime broker could go bust. The discomfort among ourselves and

the investors made us close door in august 2008.

I had, at the time, quite a few sleepless nights of intense reflections. The conclusion was that governments

had to step in and print money to reflate the all stuff. Somehow, things worked out into that direction. QE is

money printing, but it did not reach main street as I thought it would.

I am not going to list the right things I have done. What matters is that you may be right on the forecast but

miss a good execution which will translate into good results. The 2008 closing of the fund was a “miss”. The

lesson is that we could have “played” it differently. Just buying US treasuries would have been a much safer

approach. Anyway, what we need to do is keep a close eye on the credit and bond markets.

The blue line of the above chart is not an accident. Italy has been a source of preoccupation and the sharp

movement in interest rate of the market is very symptomatic of the underlying angst of the investment

community.

Can the system be fixed?

I would say that the system will need to evolve. Fractional Reserve Banking is the present regime whereby the

illusion of fungibility wants to make us believe that the value of a bank note is the same as a credit balance in

your current account. The banking lobby is so good at its job that it has been able to take advantage of the

ire of the taxpayers about the Bail-Out rules. The Bail-In model is designed to “save” them and strip you out

of your money. A safer way to approach your investments is to avoid any kind financial instruments issued by

banks (CD’s, Fixed term deposit, Money Market funds because you have no control over the portfolio quality,

structure notes and other bank issued derivatives). 100% government debt funds/ETFs are better.


https://www.imf.org/en/Publications/WP/Issues/2018/03/19/Leverage-A-Broader-View-45720

https://www.imf.org/~/media/Files/Publications/WP/2018/wp1862.ashx

https://www.telegraph.co.uk/news/uknews/theroyalfamily/3386353/The-Queen-asks-why-no-one-saw-the-credit-crunch-coming.html

https://www.bloomberg.com/quicktake/bail-in


Quite a few think tanks and groups have been coming up with proposals to change the system. Basically, all

go in the same direction which is sovereign money. Switzerland recently voted on changing the system. A

small group of citizens took things in their own hand and were able to raise enough signatures for a vote to

take place. They lost but the importance of the minority who voted in favor will induce some changes. The

banking lobby and the government were totally against it and used all their influence to influence voters that

such changes could be dangerous. The fight is just starting and will probably resolve in the supreme court.

Why? Government’s obligations to provide cash (coins and bank notes) shall extend to digital cash. Banks

have this privilege when they hold sight deposits at the central bank, so it will become a legal and

constitutional question.

Some countries have already taken actions. Equator implemented digital money but the system failed to

attract customers since the money issued were claims on USD. The government had to acknowledge that it

was not sufficiently trusted comparing to private commercial banks. Uruguay is now the first country with

digital currency issued by the central bank. We will see if the element of trust in the government will be strong

enough, but public acceptance is growing. Brazil Central Banks has implemented some very interesting

regulation to increase competition. Payment institutions can be created, and payments accounts deposits are

100% secure with the central bank (sight deposits and or government securities). The fintech industry has

been growing fast but the banking lobby has been strong in creating difficulties for new players. The Central

Bank has recently summoned the banks and the cards industry to come up by late 2018 , early 2019 with a

solution for cheap peer to peer payments.

My view is that the rise in digital money will make bank obsolete. Will this happen? Well, the war on cash, (do

you remember India?) for whatever reasons, is a recurrent theme. Governments are pressured to improve

tax collection efficiency, policy makers in favor of such change are increasing and technology is available for

smooth implementation. Mobile phone penetration is deep, and smartphone are becoming commodity. It


http://www.initiative-monnaie-pleine.ch/english/

https://www.alt-m.org/2018/03/29/the-worlds-first-central-bank-electronic-money-has-come-and-gone-ecuador-2014-2018/

https://www.inswitch.com/e-peso-uruguay/

https://www.reuters.com/article/us-india-cenbank-dividend-breakingviews-idUSKBN1AR0CB

https://www.reuters.com/article/us-india-cenbank-dividend-breakingviews-idUSKBN1AR0CB


reminds me of some conversations I had in late 2017 about ZTE. Apparently, their additional new production

plants will be able to produce good quality smartphone for less than USD30.- by 2019! Interestingly they have

been making the headlines recently!!

The hype in cryptocurrencies like bitcoin is an interesting phenomenon. The blockchain technology has

resisted to the governments torpedoes. Will this be the selected model for digital currencies? Governments

do not like the idea of anonymity. Framing Crypto Currencies and Exchanges into the financial regulatory

framework is the strategy adopted. Crypto currencies fans might be left with one main attribute! Store their

crypto currencies in physical and or safe digital wallets. Digital cash will

When I say “100% government debt funds/ETFs are better.”, my thoughts go in the sense that in case of

another systemic shock, governments might decide upon converting such debt in digital cash.

Which cash or which currency?

The arguments might be interpreted as simplistic, but Central Banks balance-sheet quality is fundamental.

The:

1. FED has the best quality assets, is doing QT and has firepower if needed.

2. Swiss National Bank size to GDP is over 100%. Overall good quality but important equities holdings

should not be part of it. Negative interest rate policy is the pillar of the policy against CHF

appreciation.

3. The ECB is kind of stuck with potential negative fallout. It is now the size of Japan GDP, NPL (non-

performing loan ratio ) is source of preoccupation and the size of the BBB and BB bond markets

could become a source of additional stress

4. BOJ: Japan has fought deflation for many years without much success and its policy is probably the

most destructive for its currency. The BOJ is monetizing government debt at full speed while

keeping long term interest rates artificially low. It is also the largest equity holder (80% of the ETFs

market). The BOJ is stuck and cannot stop. Doing so would be a big tsunami for the Japanese

market.

The USD is the preferred choice for the time being. Since the USD is, by far, the most important funding

currency of the world, stress in the credit markets translate into a higher demand for USD. Emerging

markets spreads have widened, and emerging currencies have weakened. Urjit Patel’s concerns in his

letter are a clear sign from the top. The recent increase in loans (M2) needs to be confirmed as a strong

underlying demand but it provides more comfort to the decision process of Powell (QT + rate increased).

Have the markets already priced in all their expectations? In one sense yes. Powell has ben quite clear in

his talks and actions. Trump’s crusade on “fair” trade for America has not shaken up the US equity market

for the time being but the pressure will probably come from abroad. Our “Californian” way of life might

witness increasing tremors in the months to come.



Quick overview of the US treasuries Yield curve since 2000.

The market is looking at a possible inversion of the curve as a

signal of potential recession or economic contraction. So far,

the short side increase of the curve has impacted emerging

market and long-term rates have remained pretty stable.

Growth in M2 has recently pickup (see initial chart) and we

need to watch for the high yield US market as potential signal

of stress.

Data source Quandl :

The blue line is the inverted (1/X)

ML US High Yield Corporate Bond

Index (Yield) and the the S&P 500

in orange. (the lower the line is,

the higher the yield is). Stress

build up took about one-year, last

time, before the equity market

corrected.


https://www.quandl.com/data/ML/USTRI-US-High-Yield-Corporate-Bond-Index-Yield


0,75

1,5

3

6

US TB 10Y yield & Spread BBB US corp /TB10Y

WSJ Bonds benchmarks tracking: Excellent overview

The initial increase of the US

Treasury 10 years yield shows a

diminution of the spread

between US BBB Corp. Bond

yield and government debt.

Since a few months, we can

observe an increase of the

spread. Further increase of the

spread would signal that stress

is building up in the market

signaling risk of contagion for

the US equity market.


http://www.wsj.com/mdc/public/page/2_3022-bondbnchmrk.html


In red: Ratio of the AGG core US investment grade bonds against the IEF US treasuries 7-10 years. The market-weighted index

includes Treasuries, agencies, CMBS, ABS and investment-grade corporates. Green = S&P 500 index

In red: Ratio of the LQD core US investment grade bonds against the IEF US treasuries 7-10 years. LQD is a market-weighted index

of US corporate investment-grade bonds across the maturity spectrum. Green: S&P 500

Watch for a new high of the S&P not

confirmed in the ratio for higher

probabilities of equities correction

Broad investment grade market has

been underperforming for a long

time. Reflex of liquidity chasing or

fear of credit deterioration?



In red: Ratio of the CMBS core US investment grade bonds against the IEF US treasuries 7-10 years. CMBS ETF tracks an index of

investment-grade commercial mortgage-backed securities (CMBSs) with an expected life of at least 1 year. Green: S&P 500

In red: Ratio of the CMBS against the LQD LQD is a market-weighted index of US corporate investment-grade bonds across the

maturity spectrum. Green: S&P 500

Mortgage back securities have been

underperforming substantially against

liquid investment grade bonds. (see

AGG too above)



In red: Ratio of the HYG against the IEF. The iBoxx $ High Yield Corporate Bond HYG ETF tracks a market-weighted index of US

high-yield corporate debt. It replicates much of the overall junk bond market, but often with shorter maturity, less interest-rate

sensitivity, and, also less yield. (its rival is JNK). Green = S&P 500

HYG LQD ratio showed us a nice divergence in 2015. Prior the Feb-Mar equity correction, the divergence was a warning sign.

High Yield Bonds have remained strongly bid.

Interest rates increase and recent spread widening

(see above ML High yield BBB yield index) has just

slowed down HYG appreciation. Maybe sellers of

emerging mkt debt have selected HYG as

replacement. The Feb-Mar equity correction did not

really impact HYG. Divergences in tops /bottoms are

good indicators of changes.



JNK HYG ratio. sign. JNK tracks a market-weighted index of highly liquid, high-yield, US dollar-denominated corporate bonds. The

fund’s yield, duration, and credit risk tend to align with those of our benchmark.

SPSB /SHY ratio: SPSB invest in value -weighted index of fixed-rate investment-grade nonconvertible US corporate bonds with 1-3

years remaining in maturity. SHY invests in 1-3-year US treasuries.

JNK is more aggressive than HYG. JNK relative

underperformance to its rival HYG is a sign of flight

to “quality” and higher concentration on the shorter

side of the curve.



TIP SHY ratio: TIP invest in treasury inflation protected securities.

TIPs (Inflation Protected Bonds) have been riding the QE rounds. QE3 was

perceived by market participants as the “last” big monetary injection in the

market. Expectations anchored more on the “deflationary” /low inflation

side of the story. TIPs underperformed abruptly for a while. Note that TIPs

investors do not see inflation as a threat.



FLOT USFR: FLOT invest in investment-grade floating rate notes with maturities of 0-5 years. USFR does the same but Treasuries.

(Red line) PICB investment-grade corporate bonds issued in the currencies of G10 countries, excluding the US dollar. The gray line

show the G10 currencies against the USD (down = strong dollar)

The blue lines divergence shows us that G10

bonds have suffered in their respective currencies

Soft patch? Corporate had underperformed

before the Feb March equity correction. Prelude

to something bigger coming? We have an

interesting divergence taking place



EMB IEF ratio: EMB tracks an index of US-dollar-denominated sovereign debt issued by emerging-market countries with more

than $1B outstanding and at least two years remaining in maturity.

EMHY EMB ratio: EMHY focuses on US-dollar-denominated high-yield debt issued by governments and companies in emerging

markets. The fund excludes the short-term end of the market, only holding bonds with maturities of more than one year. The

ratio shows that corporate emerging debt has been underperforming sovereign emerging risk for more than a year

Divergences are always interesting “warning” to

be observed.

FED’s monetary policy has strongly impacted

emerging corp bonds



EMLC IEF ratio: EMLC , J.P. Morgan EM Local Currency Bond ETF tracks an index of debt issued by emerging market governments

and denominated in local currencies of the issuers.

EMLC EMB ratio: Emerging local currency vs emerging USD debt.

Emerging currency bonds recovery from the low of 2016 was

a good sign for overall market. However, weakening

emerging currencies has been a long underlying trend. The

recent Trade War talks & actions has taken a toll and interest

rates differentials will tell us the tale ahead.

Excellent indicator of credit market conditions. Somehow, local

emerging domestic condition have been stable since 2016 with

some improvements. The trade talk war & actions has taken a toll

and further weakening might be the sign of a much larger credit

crisis brewing.



Comparing asset classes and sub-asset classes is a very important tool to reduce the “noise” from the news

media. Prices changes tell us a deeper story. Potential stress signs from the USD bond markets are what we

need to keep a close eye on!

The Trump Trade war campaign is much deeper than tariffs on import and export. It is about geopolitical

power and China is the centerpiece. China’s GDP and “defense” spending is projected to outpace the United

States in a not too distant futures. My view is that Trump thinks he is the sole leader who has the power to

induce a regime change. China’s way of doing things is not good for America and the world. How Xi Jinping

will manage this? Will he use this to induce change within the Chinese political elite and gain more traction

and action for faster reforms? As a fallout, India will probably become a much stronger geopolitical ally for

the USA.

Equity markets

Just a broad picture.

Corporate profit after tax ratio to GDP tells us an interesting picture.

Taking apart the 2008-9 crisis, US corporate profits after taxes have been hovering around 9%-10% of GDP (9.31% Q1 2018). This is quite remarkable and shows how Corporate America has been efficient at making money. Sure, the performance of the US stock market has found ground into such performance, but will such margin increase to higher level? Let’s imagine that we reach 11% of GDP within the next two years with a GDP growth of 4.5%. This means that corporate profits would increase around 14% on y/y basis. The following approach might be criticized but it gives an idea about the relative expensiveness or cheapness of the market.

The PEG ratio is the relationship between the PE (price/ earnings) ratio and earnings growth. The rule of thumb is PEG ratio allows investors to assess if a stock’s price is overvalued or not. The PEG formula is: PE ratio / by annual EPS (earning per share) growth.

If we consider the market, its PEG ratio is: 24/14 = 1.71 PEG below 1 is viewed as cheap and above 1, can be viewed as expensive.



http://www.multpl.com/ gives us an excellent overview

Read more:

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Here is an historical view of the S&P 500 and its PE range. Above the PE red line range is considered overvalued.

Equity investors needs to understand that PE multiple expansion has been the main driver of the stock market

performance! What drives multiple expansion? There is no single answer, investors’ mood seems to anchor

into the belief that companies can sustain earnings growth. Sure, fundamentals are important since they feed

the market participants beliefs. There are some indicators which, at times, can prove more relevant.

Normal PE ratio: 24.32 Schiller PE ratio: 32.64

Price earnings ratio is based on average

inflation-adjusted earnings from the previous

10 years, known as the Cyclically Adjusted PE

Ratio (CAPE Ratio),


http://www.multpl.com/

https://ec.tynt.com/b/rf?id=arwjQmCEqr4l6Cadbi-bnq&u=Investopedia


The US High Yield Corporate Bond Index (Yield) shows an important correlation between High Yield debt and corporate earnings.

Mirrored inverted earning yield

see here below next charts. Line

going down means earning yield

increasing and up, decreasing!

Yields and spreads to treasuries have compressed quite a bit but this has not really

translated into higher earning yield. High Yield Corp. debt is a must watch since it could

impact much stronger than expected, investors’ expectations! Corporate Deb to GDP

ratio is at a high which mean that interest rate sensitivity is at a high too!



Multiple fundamental metrics show that investing into the US stock market is more about expectations

management than anything else. Can multiple expansion continue? Yes. Can the S&P break the 3000 level?

Yes. Can it deeply correct? Yes.

How do you manage mood?

Lat year I wrote a little article about volatility, showing that since VIX futures had gone electronic trading, a

huge crowd had become smart, making money by selling volatility. The Jan-Feb 2018 correction wiped out a

few short seller ETFs of VIX futures. I tend to believe that “professionals” sharks with deep pockets cornered,

after market hours, the market and forced a huge short covering squeeze in a low liquidity environment (do

you remember Volatility exploding after hours?). Well, smart street won over main street without

consequence. I tend to believe that the illusion of liquidity has become an instrument of few strong hands

and we shall see other similar “accidents” since they represent great opportunities. In the VIX case, billions

were made by very few.

Mood/Sentiment must be investigated through multiple lenses. Sometimes we have a convergence of many

indicators in one direction which brings more comfort in your decision process.

In red, the spread between the

Vix futures contract and the Vix

Spot



The SKEW index (red line) measures the “expensiveness” of out the money options. Ex: you own the S&P index

holding the SPY ETF. The market spot index is 2800 and you decide to hedge your risks by buying PUT options

maturing in 6 months with a strike at 2500.

We can observe (Red line) that hedging expensiveness has increased steadily during the whole rally and

Volatility (Vix) (green line) has diminished. In fact, the market has been climbing a wall of worry during many

years, squeezing out short sellers and “ridiculing” active managers like Hedge Funds which have been

underperforming (comparing to passive managers). It is also important to underline that regulatory pressure

on big banks may be a reason behind the increasing trend of the Skew Index. They have been obliged to hedge

big downside risks and out of the money options are natural instruments for that purpose. Such rising Skew

slope shall not keep forever, and we may have reached the limit. Why? Many interpret a high value of the

index as a probability of market accident in a near future, but the skew index has proven to hold a poor track

record of predictability. However rapid swings from one extreme to another might give more information

about the mood of the market participants. For example, a low Skew could be viewed as a pure expression of

the Bull animal spirit in charge as if nothing could stop the run. Extreme readings do not last!

The key is to look at the market from different angles and a vast array of indicators which tell you a story. Each

top and bottom hold unique particularities. The following indicator is proprietary. It seeks extreme conditions

as a warning of potential market changes. Yes, the SKEW is part of it and it is interesting to note that it provided

a clear warning at the end of January 2018.

S&P 500 line in blue . The red line is a proprietary indicator of Breadth (market participation).

Another point is market liquidity. Stress moments have been exacerbated by liquidity “squeeze” or illusion of

liquidity. High Frequency trading (HFT), Algos, Robots, investment automatization and other machine trading

represent today more than 80% of the market volume. Machines are competing against themselves to

squeeze out profits and no one has a clear understanding of this complex web. Dark Pools, kind of private

parallel exchanges, allow participants to trade large block trades and have driven down trading costs. Their

lack of transparency has proven to be a liquidity illusion at time of stress on numerous occasions.



We must acknowledge; the trading environment has changed quite a bit and might sound to some like a new

paradigm. The good news is that much information is available to many participants making it more difficult

for machines too.

In red: ratio of the S&P 500 against the MSCI World Ex-USA

In red: ratio of the S&P 500 against the MSCI Emerging Market

The outperformance of the US stock market

in relation to it peers has been outstanding

for the last 10 years. We have a similar

situation in the credit market too!

However, this “fairy” tale is showing some internal

deterioration. The FANG gang (Facebook, Amazon, Netflix

and Google) performance contribution to the index has

increased a lot. Narrowing leadership can last a while. At

the time of the internet bubble (1999-2000), a good part of

the last leg of the rally was led by around 20-25 stocks!

Since the 2016 low, Emerging

markets had been outperforming

well the S&P 500. The recent Trade

War Talks and actions have deeply

impacted them.



MSCI World Ex-USA versus MSCI Emerging Markets.

China must be looked from different angle due to trading restrictions for foreigners!

In red: MCHI MSCI China versus MSCI Emerging. MCHI provides broad, cap-weighted exposure to a wide array of investable

Chinese shares excluding mainland-listed A-shares. The fund has historically had significant sector tilts toward financials and

technology and away from industrials

FXI versus MSCI Emerging Market:

FXI holds 50 of the largest H-shares, P-chips and Red Chips listed in Hong Kong—mainland-listed A-shares and US-listed Chinese

mega-caps, like Baidu (classified as an N-share), aren't included. Understandably, FXI doesn't fit well with our MSCI benchmark,

which holds hundreds of securities and includes A-shares traded in Shanghai and Shenzhen which still aren't fully accessible to

Since the 2016 low, Emerging markets

had been outperforming well MSCI

World Ex-USA. The recent Trade War

Talks and actions have deeply impacted

them.



foreign investors. The fund also carries a heavy concentration in financials, with China's big, state-run banks making up a huge

portion of the portfolio.

Another way to look at it is comparing FXI (large Cap) to MCHI (broader based).

The underperformance of Chinese

Large Cap towards its “smaller” cap

peers have been signaling structural

underlying problems in the Chinese

market (Black Box syndrom?)



IN contrast INDA (INDIA) versus MSCI Emerging markets. INDA tracks a market-cap-weighted index of the top 85% of firms in the

Indian securities market.

India versus China (INDA -MCHI) tend to show that India is starting to overperform China.

EPI or Wisdom Tree India Earnings Fund tracks a total market index of Indian companies selected and weighted by earnings. It can

be an interesting choice for investors seeking more quality earnings. EPI picks stocks based on earnings in the prior fiscal year,

adjusted for the availability of Indian stocks to foreign ownership.

Trade talks War & Actions has been

positive for India relative to China!



Brazil versus MSCI Emerging markets. From Hell to Heaven and to Hell again. The good thing about the Brazilian market has been

the predictability of the outcome. I live in Brazil, so we have a deeper understanding of the situation. On the good side, Brazil has

started a few years ago a big crusade against corruption (operation Lava Jato) which has reinforced the institutions. However, Brazil

is a democracy ruled by a majority of kleptocrats and corrupted politicians which have been protecting themselves for too long. The

judicial system has achieved great results on lower instances. However, the supreme court is contaminated by politics and has been

a driver of legal insecurity. Brazil has gone through an economic depression and the recovery has been very mild. Brazil budget

deficit of +5% will only be addressed next year since it is election time in October. They are a few bright spots to be taken into

consideration. People are fed up and the traditional left hopes that bad economic conditions will make people think about the good

time they had with Lula when they cast their vote. However, new political forces have been emerging like Partido NOVO and the

“Brazilian Trump”, Bolsonaro. We can observe that liberal and reformist agenda is now part of most of the candidate’s proposals,

so we might have elections with much more constructive debates for once. Brazilians know the recipe for a good turn around. The

great difficulty is to gather enough political force to implement the much-needed changes. Brazilian tax burden which is Government

spending, is split in three big items: 1) Public debt servicing 2) public servants wages and 3) public servants retirements/pensions.

Just to give you an idea, out of a population of about 210 million, our workforce is around 100million. We have about 30 million

registered employees and about 10% are public servants. About 28 million Tax returns are filed annually. Breaking the vicious circle

of the privileges for a minority will be hard but chances do exist.

Let’s suppose for a moment that good and reformist politics makes it to the top. Brazil rates so badly on many counts (competitivity,

efficiency, operating costs etc..) that It will be relatively “easy” to improve substantially such ratings within a few years. Best case

scenario, Brazil becomes a well sought destination for long term investments. In addition, Brazil holds an advantage! It is not a

competitor to any superpower but a supplier of much needed commodities (agrobusiness).

SGG portfolio has taken advantage of the recent sell-off to buy a position of the EWZ ETF.

EWZ vs ARGT: Brazil versus Argentina. So ironic…. Brazil has been able to underperform Argentina which is under FMI reform

program (green line is EWZ)



In the US market, a few items under watch:

Red line is the Ratio of the S&P 500 versus the Dow Jones Industrial. Underperformance of the S&P 500 is a sign of narrowing

leadership which in two instances, has anticipated an important correction.

Banking sector relative to S&P 500:

The banking sector’s honeymoon with

Trump’s election was short lived. Tightening

cycles from the FED should impact

positively earnings but the banking sector

has remained very subdued. Is this aversion

from investors to the sector or a sign of

potential underlying problems?



XLU Utilities vs S&P500. The grey line is the yield of the 5Y treasury XLI industrial vs S&P500. Increasing rate is usually

Positive for industrial but !!?

XLK vs S&P500 : technology sector is the big outperformer XLE ratio to S&P500.

XLV: vs S&P500 Obama Care over,health care sector has suffered to adjust XLP vs S&P500; Staples is interest rates sensitive and has been hit

Energy sector underperformance has been very

pronounced despite of economic activity pickup

SGG has recently allocated a long XLP short SPY position

The Small Cap (RUT index) ratio with S&P500.

Confirming that the broad market is lagging.

The Trade War Talk has benefited them since

perceived as less immune to eventual

sanctions/tariffs.



Precious Metal & Commodities

Gold = yellow line, Silver = Gray line and red line is the ration of Silver/Gold.

SGG holds as core position, some exposure to the precious metal market. The Silver/Gold ratio justifies the overweight in Silver

metal instead of Gold. SGG hold also some gold mine index. The red line is the ratio of gold mines vs Gold. Since 2003, gold

mines have been underperforming gold. The 2016 rally may have proven to be a bottom but price require a close watch since

support price level could be broken down.

Very interesting correlation! The red line is

the ratio of the Copper Miners (COPX)

versus the Gold mine index (GDX). The

green line is the Yield of the 10years US

treasury bonds.



Inversed Commodity CRB index (red line, going up means lower commodity prices) and the USD currency Index (DXY) green line

Relatively narrow correlation between them.

Resuming:

A stronger pickup in M2 growth (credit growth) might signal higher interest rates ahead. Yearly change in M2

has been a good indicator of yearly change in 3 years treasury yields. M2 changes seem very sensitive to

interest rates so… yes ! Powell’s decision to increase moderately will probably be sufficient. Excess leverage

in the system is a deflationary factor strong enough to cool down monetary and economic indicators. High

Yield debt market is probably one of the most important indicator to watch.



Macro risks have increased quite a bit and world growth desynchronization is much more of a concern. Trump

has decided to act and provoke (alone.) the changes he believes are much needed. As exposed above, the

goal might not be trade but just peace by imposing a pace of changes to Americas’ biggest rival, China. The

way things happened with North Korea leader, Kim Jong-un have been quite surprising. At the end, from

whom Kim Jong-un should fear the most? Maybe his hidden wish is to move closer to South Korea and the

USA instead of remaining a second-class “satellite” of China.

The recent strength of the US dollar is maybe signaling a much more important move. Powell’s message to

emerging markets has been…. Sorry guys, America first, get your act together. Change! I believe that Powell

will act if the pinch gets too strong to fast and he has the firepower on his shoulder. Remember, the FED has

the cleanest balance sheet among its peers! If stress keeps building up…. a strong USD is in the card.

SGG looks also at the very long end of the yield curve. TLT ETF has been a strong position in the portfolio along

with a long USD position (UUP ETF). TLT has been sold out and UUP has been reduced by 50%. SGG biggest

portfolio position now is short term treasuries.

SGG Portfolio has returned :

I apologize if this has been a lengthy report, but I felt it was important to give an initial overview (incomplete)

of the situation and a feel of the approach.

Kind regards and thanks to all.

Renzo


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