JP  Capital    Perspective  is  everything  

October 1, 2015

Equities The benchmark equity index, the S&P 500, dropped 1.4% amid continued uncertainty over the path of U.S interest rates Fixed Income Bond yields lost ground slightly, with the 10yr edging up 3 basis points to 2.16% Currencies The greenback rallies to 1.12 versus the Euro as the market still anticipates a rate rise coming at the back end of the year Commodities WTI and Gold climbed 2.3% and 0.6% respectively. Surprisingly Gold did not materially gain amid the global summer stock sell off

Market roundup

Source: Bloomberg, Spot returns. All data as of last Friday’s close. Past performance is no guarantee of future returns

EquitiesTotal Return in USD (%)

Level WTD MTD YTD

DJIA 16,314.7 -0.4 -1.2 -6.8Nasdaq 4,686.5 -2.9 -1.8 -0.2S&P 500 1,931.3 -1.4 -1.9 -4.8MSCI World 1,594.7 -2.2 -3.0 -5.4Fixed Income

Total Return in USD (%)Yield WTD MTD YTD

U.S. 10- Year Treasury 2.16 -0.3 0.4 1.4U.S. Corporate Master 3.42 -0.4 0.4 -0.2ML High Yield 7.71 -1.4 -1.4 -1.3Commodities & Currencies

Total Return in USD (%)Level WTD MTD YTD

Gold Spot 1,146 0.6 1.0 -3.2WTI Crude $/Barrel 45.7 2.3 -7.1 -14.2

Current Prior Week End Prior Month End 2014 Year End EUR/USD 1.12 1.13 1.12 1.21USD/JPY 120.6 120.0 121.2 119.8

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EQUITIES

Quality wins

1

Investing is as much of an art than a science. Models can predict outcomes with a degree of accuracy, but unforeseen events can occur when one least expects. As we entered 2014, everyone thought the U.S would bounce of zero but it failed to materialise. Entering 2015, we had a de ja vu moment and to this day, we are still yet to see a rate rise. Certain strategies play out in certain conditions and over the past few weeks, when volatility picked up, we saw a considerable flight to quality (see Exhibit 1). With more choppy conditions expected over the coming months, companies that can ride out the storm, i.e. dollar strength and a slowing emerging world, will be better placed to crank out solid earnings growth. Corporate America’s earnings growth came in at 3.1%. Cutting costs appears to be a popular play in the mining sector, with commodity prices going through the floor. While cutting costs may improve margins in the short term and thus a mini boost to the share price, over the medium term, top line growth ultimately drives the business.

2

Companies that can generate business amid challenging conditions will outperform those who are reliant on emerging markets and who are heavily indebted.

An important point to note was that over the summer, stocks sold off as an entire asset class. ‘Quality’ or ‘Junk’ status appeared not to matter. That said, markets were touching record levels for a long period and in order to realise profits, selling needs to take place. Paper profits are meaningless. That was a natural phenomenon but the trend over Quality vs. Junk is likely to rise further.

The Reserve Bank of India (RBI) cut rates to 6.75% amid concerns over China. A rate cut however is only effective if the commercial banks pass on the lower cost to consumers. Decreasing rates creates a weaker rupee making imports more expensive for companies buying raw materials from abroad. They may pass on this extra cost to consumers, creating a tightening effect, even though the RBI seeks the opposite effect. The SENSEX should rally heading into Q4.

Next- FX update: Quarter roundup

Exhibit 1: Flight to Quality

Source: Morgan Stanley

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FOREIGN EXCHANGE

Quarter

roundup

Next- Commodities update: Low, Low & Lower

Exhibit 2: Winners and Losers over the second quarter

Source: Bloomberg data

As we are nearing the end of one of the most volatile quarters we have had in a long time, its good to try and evaluate what happened and specifically, where fx markets stand. The Japanese Yen is our quarters’ winner; it surged by a mere 1.88% against the USD. This poses an interesting conclusion. Indeed, the Yen is considered a safe haven (the “go to” place whenever there are issues) but the fact that the Yen is climbing could mean that global growth is definitely slowing. The Brazilian Real is the worst performer with a drop of 22% against the greenback this quarter. Brazil and China are very close business partners, notwithstanding that, Brazil is drowning in consumption. Consumption as a percentage of GDP is around 60% yet surprisingly, continues to have inflation hovering around 9%. The economy is actually expected to shrink this

year and next year which is not great news for any emerging economies; in no way is the commodity rout helping either. This is also why we are seeing Australia and South Africa coming in at 14th and 15th place respectively. Outside of that, I believe that it is important to mention the problem with Asian currencies (not counting the Yen). The Asian currencies have actually had their largest quarterly loss since the financial crisis. Malaysia’s ringgit led the downward charge with a 14% slide as oil prices retreated and Prime Minister Najib Razak was caught up in a corruption investigation. Taiwan’s dollar slid to a six-year low after its central bank reduced interest rates last week for the first time since 2009. The People’s Bank of China lowered borrowing costs in August for the fifth time in a year, while India announced its fourth cut of 2015 on Tuesday. Sit tight for a volatile Q4!

Source: Bloomberg

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COMMODITIES

Commodities have definitely been in the headlines for a while now. Since China decided to devalue the Yuan due to bad export figures and to become a more open economy, people started asking questions. Since then, everything just went from bad to worse. At the moment we are experiencing some pretty bad returns when it comes to commodities. For example, returns on raw materials have descended to the lowest levels not seen since 1999. The problem is, that there is an overwhelming amount of supply in metals and other commodities. That in itself is an issue, but the worse part is that China is not using as much as it used too, and yet we are still supplying as much. Having said that, we are seeing Copper rebounding a little from its month low of 225.15 to 234 in the last few days. However we are still a long way from its 245.35 month high. The problem with Copper depreciating in value is that it is seen as the de facto currency that describes best how the global economy is doing. When Copper depreciates, more than likely than not, investors perceive global economic growth is robust. The French bank, Société Général, is expecting the oversupply of Copper to grow even further next year! Companies like Glencore are in trouble as around 30% of their earnings are generated from Copper; their share price is currently following Copper in its downward spiral. Gold is currently sitting at $1,115 and has dropped just over 6% since the beginning of the year. Strangely enough, Gold is not increasing when some equity markets are not doing too well, but that is not too alarming as the U.S dollar will likely have its say on the matter. When looking at the commodities market and seeing the repercussion that low prices are having on commodity led companies and countries, we have the view that we definitely are in a crisis situation (see Exhibit 3) and that it is not set to get any better for a while yet.

Exhibit 3: Winners and Losers over the second quarter

Source: Bloomberg Next- Bond update: Spreads widen

Oil drips lower

in Q3

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FIXED INCOME

After the Federal Reserve decided to hold off on its first rate rise in a generation, bond markets breathed a welcome sigh of relief. High Yield market spreads have been widening, indicating to us two things. One; as commodity prices come off the boil, revenues, earnings and repayment commitments face increasing pressure and second; as the market anticipates a rate rise, why put your money in the High Yield market when safer assets yield more similar returns. The Energy sector as a proportion of the total High Yield market is large, which can somewhat distort the overall picture. Comparatively, Airliners have very low spread changes (see Exhibit 4), as low commodity prices act as a tailwind for the cost structure in addition to favorable demand dynamics. Increasing disposable incomes allows people to fly more often thus airliners, both low cost and premium benefit.

Second Quarter U.S GDP was revised up to 3.9%. Consumer spending and business investment were the biggest contributors to the rise, which is contrary to a U.S slowdown. Euro area PMI declined slightly to 52.0 from 52.3. Friday’s Consumer prices release is forecast to come in at negative 0.1%, while the market expects 190,000 jobs to be added in the U.S economy during September. If we get a strong jobs report and PMI shows a bounce, the FOMC may look to tighten in October. A likely bet is December as data releases are limited over the near term. High Yield still looks attractive, as the Fed maintains its zero interest rate policy. Sector selection is key as the below chart shows that the High Yield market is highly idiosyncratic.

Exhibit 4: Commodities cause HY spreads to widen

Debt selection

Source: Morgan Stanley

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JP  Capital    Perspective  is  everything  

Jonathan Taubert FX and Commodities

Pete McCarthy Equities and Fixed Income

JP Capital Team

Going forward Global uncertainty remains amid mixed messages from the Federal Reserve. Japan’s flash PMI for September came in 50.9, down from 51.7 in August (a number over 50 indicates expansion, below 50 a contraction). New export orders dropped to the lowest level in 31 months, as a slowing Chinese economy weighs heavy on Japanese supply and employment levels fell for the first time since January. Further deterioration continues in the Asian region, with Taiwan’s manufacturing sector having experienced its worst performance for three years. New orders declined and output fell as weak Chinese demand continues to impact Taiwan’s export sector. As we begin the final quarter, we continue to see value in Japanese equities given the tailwinds from a weaker yen and a low corporate tax rate. In Europe, exporters remain our favourites with a sliding currency aiding earnings results and as China transitions to a more consumption-based model, automakers such as BMW should see profits rise if they manage to avoid the recent emissions scandal.