Market Update Q4 I Internal Commitee I Kristal Advisors

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Q4 Market Update – Kristal Internal Committee

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Equities – US {Neutral to Underweight: Selectively overweight on consumer staples/health care/REITS (non-Residential)}

1. Equity valuations appear expensive relative to longer-term history, but reasonable relative to interest rates and more recent history. Across regions, they reflect the general outlook and are most elevated relative to their 10-year median in the United States, where prospects have been most resilient.

US Equities - Q4 update - Kristal Advisors

2. Fourth quarter will provide critical insight into the near-term direction of the US-China trade conflict as well as into whether the Fed will maintain the narrative of a mid-cycle monetary policy adjustment or switch to acknowledging an outright easing cycle. Impact of trade tensions is beginning to filter through not just to markets, but also to the broader US economy. Industrial and trade-exposed sectors have been suffering for several quarters, as have the major economies most reliant on these sectors. However, household consumption accounts for roughly 70% of US GDP, and US households remain in a relatively good spot, implying that they can sustain economic growth just as they did during global economic weakness in 2015 and 2016.

3. Weak capex trends suggest that businesses have become more cautious in their expectations and may be inclined to wait and see what happens with policy before putting capital to work. Similarly, jobs growth has slowed, although it is unclear whether this is due to the declining supply of available labor or employers pulling back on hiring in the face of uncertainty. Most importantly, while retail sales still look good and housing activity has rebounded, there are signs that consumer confidence is softening and that households are becoming more concerned about the economic outlook and tariffs.

4. For Q3 2019, the blended earnings decline for the S&P 500 is -4.7%. If -4.7% is the actual decline for the quarter, it will mark the first time the index has reported three straight quarters of year-over-year earnings declines since Q4 2015 through Q2 2016. For Q4 2019, 9 S&P 500 companies have issued negative EPS guidance and 4 S&P 500 companies have issued positive EPS guidance. The forward 12-month P/E ratio for the S&P 500 is 17.0. This P/E ratio is above the 5-year average (16.6) and above the 10-year average.

Equities – Other Developed Markets Neutral

Risks and opportunities continuing to look reasonably balanced, but sector composition remains a headwind. Compared to the S&P 500, the MSCI EAFE Index, a proxy for foreign developed markets, has a far lower weighting in growth sectors such as technology. Meanwhile, heavier weights to sectors such as Industrials and Materials have been a headwind for the MSCI EAFE Index due to slower growth in global activity. Finally, valuation of foreign developed equities relative to the S&P 500 remains extremely low, reflecting continued investor preference for U.S. securities, given higher confidence in U.S. economic and corporate profit outlook.


They are particularly vulnerable to a Chinese slowdown with a Bank of Japan that is still accommodative but policy-constrained. Other challenges include slowing global growth and an upcoming consumption tax increase.


European risk assets modestly overpriced versus the macro backdrop, yet the dovish shift by the European Central Bank (ECB) should provide an offset. Trade disputes, a slowing China and political risks are key challenges.

Equities – China Neutral

Policymakers have reacted to the imposition of increased tariffs and the global slowdown with renewed fiscal stimulus and liquidity measures. Growth is still moderating towards 6.0 per cent going into 2020, and trade will continue to be a drag. The USDCNY exchange rate was allowed to depreciate 6 per cent, to above 7.0; this will cushion the trade war’s impact for exporters but also weaken Chinese demand for the rest of the world’s goods.

For now, Chinese authorities have refrained from aggressive monetary measures, but have begun to cut the new LPR rate slowly while continuing RRR cuts; similarly, a big, leverage-fuelled infrastructure binge or property boom is not on the cards. A minor trade deal is a possibility, but full de-escalation is extremely unlikely given political constraints in both Beijing and Washington; this will crimp investment and business sentiment, and negative PPI inflation is an inauspicious omen for industrial profits, which will follow suit.

Equities – Emerging Markets (ex China) Selectively Overweight

Market expectation on market expectations for Chinese stimulus may be overly optimistic. Opportunities in Latin America, such as in Mexico and Brazil, where valuations are attractive and the macro backdrop is stable can be worth considering. An accommodative Fed offers support across the board, particularly for EM countries with large external debt loads.

US Treasuries Underweight

We do expect the Fed to cut rates by a further quarter percentage point this year. Yet market expectations of Fed easing look excessive to us. This, coupled with the flatness of the yield curve, leaves us cautious on Treasury valuations. We still see long-term government bonds as an effective ballast against risk asset selloffs.

Yield Curve Shape Overweight on Steepening

The U.S. Treasury market may have gotten ahead of itself after the latest decline in yields, which looks stretched versus the Fed Monitor. We still expect the Fed to deliver just one more rate cut at the FOMC meeting at the end of October, as the “hard” U.S. data is outperforming the “soft” data like the weak ISM surveys. That leaves Treasury yields vulnerable to some rebound if global growth stabilizes, although that is conditional on no new breakdown of the U.S.-China trade negotiations – a factor that continues to weigh on U.S. business confidence.

Yield-Curve-Shape-Q4-Update-Kristal Advisors

Corporate Bonds IG Overweight

Investment grade credit spreads tightened on signs of a potential improvement in US-China trade negotiations. We remain modestly overweight in the investment grade corporate sector as we see value in current spreads, although we do not anticipate significant tightening from current levels. We expect to see some slowing in earnings growth for the third quarter due to slowing economic growth and a stronger US dollar.

High Yield Bonds Selectively Overweight

For the year to date through September 30, spreads had tightened by almost one percentage point. Energy has been a difficult sector in the market, and the overall market has favoured higher quality names. Supply trends have contributed to the improvement in issuer quality. During the 2007 to 2019 period, issuance of split B/CCC-rated bonds declined from about 38% of total new-issue volume to roughly 16%, according to Standard & Poor’s. A dramatic reduction in issuance to fund leveraged buyouts and mergers/acquisitions was a major reason for this downtrend in lower-quality issuance. In 2007 and 2008, upward of 50% to 60% of new-issue volume went to fund leveraged buyouts, and mergers and acquisition deals. By April 2019, this volume had dwindled to roughly 15%.

Dollar Index Overweight

U.S. Federal Reserve cut interest rates by 25 basis points at its July 31 meeting and again in September—outcomes that were in-line with the industry consensus of economists. The Fed leadership is trying to lean against policy uncertainty from the China/U.S. trade war, weak business investment and lacklustre economic activity abroad. However, Fed chair Jerome Powell emphasised that a few rate cuts should be seen as an insurance policy rather than the start of a big easing cycle. The U.S. Dollar Index (DXY) rose to new highs for 2019 after this “hawkish” surprise, suggesting that markets had raced ahead of themselves in pricing more than four rate cuts in the next 12 months.

In addition, weakness in global data ensures that the Fed is not the only central bank in easing mode. At its September policy meeting, the European Central Bank cut its deposit rate to -0.5% and announced that it will resume asset purchases, keeping the euro subdued and the U.S. dollar strong. While the U.S. has much more room to ease than other central banks, a deep and sustained rate-cut cycle would require a full-blown recession scare. We believe such a scenario would ultimately be negative for the U.S. dollar, but the day of reckoning for the greenback has been postponed.

Overall Stock Market Volatility

Volatility is here to stay for the foreseeable future amid continued uncertainty over economic and political issues. Investors now face an unappealing market environment that combines low growth, low inflation, and low yields.





The materials and data contained herein are for information only and shall in no event be construed as an offer to purchase or sell or the solicitation of an offer to purchase or sell any securities in any jurisdiction. Kristal Advisors does not make any representation, undertaking, warranty or guarantee as to the update, completeness, correctness, reliability or accuracy of the materials and data herein. All opinions, forecasts or estimation expressed herein are subject to change without prior notice. Kristal Advisors and its affiliates accept no liability or responsibility whatsoever for any direct or consequential loss and/or damages arising out of or in relation to any use of opinions, forecasts, materials and data contained herein or otherwise arising in connection therewith.