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    Gavekal Research

    Don’t Give Up On Eurozone Equities

    When a market fails to rally further on successive rounds of good news, investors can be forgiven for feeling a tad nervous about the outlook. It is little surprise, therefore, that many portfolio managers are expressing skepticism about the near-term sustainability of the bull market in eurozone equities. Since the election of Emmanuel Macron as French president two months ago, the macro headlines from the single currency area have been...

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    Video: A Cure For The Italian Malaise

    Italy’s economy is enjoying a cyclical upswing, and a long-delayed banking clean-up is finally under way. But while both these developments are welcome, they are not sufficient to change the underlying picture. Nick argues there is little chance that the general election due to be held by May 2018 will produce a government strong enough to press ahead with reform.

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    Sweden’s Secret Sauce

    Sweden is a high-growth economy with competitive firms in everything from retailing to metal bashing to software. Yet, there is a time to be in Sweden—or at least overweight—and there are times to be out. Sweden and the US had two of the 20th century’s best performing equity markets and I will simplify this decision by measuring their relative attractiveness. Spoiler alert: this report has a positive recommendation.

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    Gavekal Research

    The Real Macron

    On Monday Emmanuel Macron launched what is being dubbed an imperial presidency. He offered a neo-Gaullist vision of a strong leader nurturing a troubled nation’s recovery. Yet he also unfurled an electoral reform program aiming to break the old political duopoly. The worry is that Macron uses up his political capital and economic reform stalls.

    1
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    Gavekal Research

    Should Investors Chase Defense Stocks?

    Aside from health care, the other “Trump trade” that has worked wonders since November 9 has been defense stocks. After all, with the Dow Jones sector index up some 22% in the period, what’s not to like? On taking office, Donald Trump cranked up military spending, and during his state visit to Saudi Arabia in May secured weapon sales worth US$110bn. On Friday—just hours before Xi Jinping took the stage in Hong Kong to celebrate the 20th...

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    Gavekal Research

    Draghi’s Two Ps And The Euro

    When choosing three adjectives to describe the ECB’s evolving monetary policy stance, Mario Draghi this week alighted on confidence, persistence and prudence. Yet judging by the big reaction in currency and bond markets, traders ignored the two Ps and heard only about Draghi’s confidence in Europe’s strengthening recovery. Markets treated the speech as a unambiguous signal that the ECB is turning more hawkish.

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    Gavekal Research

    When Central Bankers Attempt To Change Direction

    In recent days , central bankers in the US and Europe have been signaling how much they want to end unconventional monetary policies and revert to a more normal monetary model that does not put asset prices at the heart of the system. It is a laudable aim. But, warns Charles in this piece, central bankers have seldom managed to transition from one monetary regime to another without causing convulsions in the financial markets. This time, the...

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    A Change In The Investment Environment?

    A couple of weeks ago, Louis asked if the downside breakout in bond yields (touching 2.10%) could foster a stable investment environment. At the time he foresaw three possible scenarios. After yesterday's hawkish pronouncements by multiple central banks, he is not so sure and is focusing on a narrower range of possibilities which may herald a new investment environment.

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    Common Sense Prevails In Italy

    The European Union authorities bowed to the inevitable yesterday. They agreed to let Rome spend as much as €17bn in Italian taxpayers’ cash to prevent losses among the senior bondholders and depositors in two Italian regional banks that the European Central Bank declared on Friday to be failing.

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    Gavekal Research

    A Hard Road Ahead For Italy’s Banks

    The eurozone’s rising tide is floating Italy’s boat. Earlier this month, the national statistics agency revised the country’s first quarter growth up from 0.2% on the previous quarter to 0.4%, marking nine consecutive quarters of economic expansion. This equals the longest stretch of continuous growth since the mid-1990s. What’s more, with unemployment down steeply to a five-year low of 11.1% in April and the composite PMI at a buoyant 55.2, the...

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    Gavekal Research

    A British Rebalancing?

    Last week the Bank of England left interest rates unchanged, but three out of eight policymakers voted for a hike. In the past any weakness in UK consumption has been met with a soothing monetary response. The fact that the consumer looks increasingly forlorn, yet the BoE is hanging tough suggests the game has changed.

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    Gavekal Research

    The French Reset

    French voters have handed President Emmanuel Macron a clear parliamentary majority after his La République en Marche party yesterday secured an estimated 360 out of 577 seats. He will also get support from many of the 170 or so Republican and Socialist party deputies who were just elected. After a record low turnout, critics may question his moral authority, but there is no doubting that Macron is now the master of French politics. Hence, he is...

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    May Day For Hard Brexit

    After the Conservative government of UK prime minister Theresa May lost its parliamentary majority in last week's general election, Anatole argues that the "hard Brexit" strategy formerly pursued by May no longer looks politically viable. That means a Norwegian-style soft Brexit is more likely, which makes sterling assets look relatively attractive.

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    Gavekal Research

    Goldilocks Beds Down

    Headline attention today is clearly focused on the car-crash general election result for UK prime minister Theresa May. At the time of writing, it was still unclear whether May would be able to form a viable government after the vote. Unsurprisingly, the uncertainty triggered a steep 1.6% sell-off in sterling (see Trading The UK Election).

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    Gavekal Research

    Figuring Out Where The Ball Will Be

    Rugby players fall into one of two categories: the forwards, who typically go where the ball is (and in the process put their heads in places most sane people wouldn’t put their feet), and the backs, who try to go where the ball will be, which enables them to look good and keep their kit clean, but earns them the scorn of the forwards. Peter FitzSimons, the first Aussie to play for a French club (Brive), once remarked: “Come the revolution, the...

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    Gavekal Research

    The UK’s Pre-Election Wobble

    In mid-April, when UK prime minister Theresa May took the decision to call a general election for June 8, she did so because she was confident her Conservative party would be returned to government with a massively increased parliamentary majority. Six weeks later, and with just one week of campaigning still to go, that confidence is a distant memory.

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    Gavekal Research

    German Ordo-liberalism vs French Keynesianism

    So I hear that happy days have returned to Europe’s single currency area as shown by improved purchasing manager readings. With German firms especially upbeat and a reassuring new fellow occupying the Élysée Palace, I understand that Berlin will soon roll over and allow a juicy fiscal expansion in return for France making its job market less rigid. I tend to be skeptical about such road-to-Damascus conversions.

    1
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    ECB Normalization And Why Not To Worry About It

    The US Federal Reserve will almost certainly announce the second of this year’s rate hikes at its next policy meeting on June 14. The week before, on June 8, the European Central Bank will probably state for the first time in years that the risks to the eurozone are now balanced “symmetrically” instead of tilting unequivocally downwards. If they were brave they might even echo Benoit Coeuré, the French governing board member who in an interview...

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    Gavekal Research

    A Less Flexible Britain

    Yesterday saw the release of robust UK retail sales data for April that reversed a weakening trend and pointed to still strong consumers. So it was notable that on a day that confirmed British economic resilience despite attendant uncertainties, Prime Minister Theresa May effectively renounced free market policies that long have been core tenants of the Conservative Party credo.

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    What Germany Wants

    What does Germany want? That was a question we asked in January as sabre rattling by the new US president unnerved Europe’s instinctive mercantilist. Our answer was that Germany was at a cross-roads in its modern history and could either double down on a narrow pursuit of surpluses, or instead embrace its European Union members with a fresh push to federalism. Monday’s meeting between Emmanuel Macron and Angela Merkel confirmed that the latter...

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    Gavekal Research

    Back To The Future

    Back in 1947, war was over but a ruined European economy needed full-scale reconstruction: the Marshall Plan. As I look at the way China is wooing its neighbors through its Belt and Road strategy and other economic and financial linkages, the approach looks like a remarkably effective “copy-and-paste” operation.

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    Why A Brexit Deal May Not Be So Hard

    European Union membership entails four core freedoms—goods, services, capital and people. To keep the first three, but not the last one as the UK wants has been dubbed “having one’s cake and eating it”. The UK also wants to be exempt from the European Court of Justice’s control and to exit the EU customs union, opening the way for free trade agreements to be made elsewhere. The assumption is that these demands will ensure the UK ends up with a “...

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    Video: How Brexit May Work

    The consensus is for a tortuous few years of negotiations between the UK and the European Union over the terms of Brexit and any subsequent free trade agreement. Following up on today’s Daily, Nick argues in this video interview that a deal may be easier than most people think. Moreover, the template for an FTA may already be in place.

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    Gavekal Research

    Macron And A New Europe

    With the populist, anti-EU tide now clearly reversing, first in Holland, then last night in France and finally in September’s German elections, investors can put to rest their worries about a breakup of the euro or the European Union and focus instead on the continent’s economic and financial fundamentals. These fundamentals have been steadily improving since the European Central Bank began its enormous bond purchase program in March 2015.

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    Gavekal Research

    So It’s Macron. What Next?

    The French presidential election did not play out as Charles had expected. With Emmanuel Macron having achieved a decisive victory, he concedes that the En Marche! Party is likely to carry the momentum into next month’s parliamentary elections. What this means for investors is that France is likely to be politically stable in the coming few years and will not be the focal point of eurozone ructions.

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    Gavekal Research

    Macron And French Optionality

    For investors, the great benefit of Emmanuel Macron is that even if his big plans for change fizzle a nice cyclical economic recovery will almost certainly play out. If the president-elect defies the stereotypical view of France as being basically unreformable, the kicker is huge optionality built into asset values that have non-challenging valuations. Either way, Cedric argues that France represents a stand-out investment opportunity.

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    Gavekal Research

    A New Franco-German Axis

    For the last decade, pretty much every politician who counted in France has spoken of the European Union in scathing terms. That is likely to change on Sunday if the pro-integrationist Emmanuel Macron confirms poll forecasts and scores a resounding win in the French presidential election. His upbeat belief in federal solutions to Europe’s structural problems will not just change the discourse, but according to Nick could renew the Franco-German...

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    Gavekal Research

    A Positive Cycle For Eurozone Earnings

    For many investors, last night’s televised debate will have removed any lingering fears about French political risk, freeing them to focus on the eurozone earnings picture—which is increasingly rosy. The majority of pundits awarded the debate on points to centrist candidate Emmanuel Macron. Their verdict was that the performance of far-right Euroskeptic Marine Le Pen was insufficiently “presidential” to sway undecided voters. As a result,...

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    Gavekal Research

    The Flip Side Of A Hard Brexit

    The pound has rallied strongly since Theresa May announced an early UK general election on April 18 and may soon break through US$1.30, opening the way for a rise back to levels not seen since last summer. This move has mostly been driven by politics in France, rather than Britain, but this may be about to change.

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    Gavekal Research

    An Alternative Explanation For The French Split

    One of the more interesting thinkers about the current political scene in France is Christophe Guilluy, an urban geographer and author of The Twilight of Elite France. His basic insight about French cities and by extension the structure of the French economy starts with the observation that most urban areas are divided into three concentric circles which contain very different social classes. Charles likes the argument which clearly illuminates...

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    Gavekal Research

    The Underperformance Of Energy Stocks

    Charles likes to say that good money management often involves taking a few key decisions and sitting on them for a decade. In 1982, for example, the avoidance of energy and material stocks ensured almost 10 years of outperformance. In 1990, avoiding Japan paid off for two decades. In 2000, sidestepping TMT and underweighting the US dollar worked for almost a decade. In 2006, avoiding financials also paid off for a decade, as did underweighting...

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    Gavekal Research

    Video: The French Election And Beyond

    In these video interviews Cedric looks at likely scenarios in the second round of the French presidential election, while Nick considers the potential for a renewed Franco-German axis as the driver of progress in the European Union.

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    Gavekal Research

    Europe’s Road To Reflation

    With fears of a political upset laid to rest, the European reflation trade is in full swing. The flash eurozone composite PMI hit a six-year high last week, French manufacturing confidence is at its highest since June 2011, and the European Central Bank’s bank lending survey published yesterday showed that banks are continuing to relax credit standards as demand for borrowing grows. With employment growth lifting domestic demand and external...

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    Gavekal Research

    Stop Worrying And Buy Europe

    The market reaction made good sense, assuming that the opinion polls—which turned out to be uncannily accurate in the first round of the French election—prove right again and Emmanuel Macron wins by a landslide on May 7. The polls may, of course, be completely wrong and Marine Le Pen may become the next President of France, but for this to happen the polling error would have to be many times larger than it was in the case of Brexit or Trump.

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    Gavekal Research

    Takeaways From France’s First Round

    For once the opinion pollsters got things right. Although the candidates of France’s traditionally dominant left and right wing parties were both eliminated in yesterday’s first round presidential election, the political center held. Independent Europhile centrist Emmanuel Macron emerged with the largest share—23.9%—of the vote, for a second round face-off against nationalist Euroskeptic Marine Le Pen, who captured 21.4%.

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    Gavekal Research

    French Political Trouble Just Started

    Investors cheer the win of centrist Emmanuel Macron in the first round of the French presidential election, presuming a victory in the second round would mark the end of Euroskeptic populism. Charles is not so sure about this benign interpretation and argues that France may in fact be on the cusp of a new era of political instability.

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    Gavekal Research

    Final Thoughts On The French First Round

    Going into Sunday’s first round vote in France’s presidential election, it is widely assumed that yesterday’s tragic events on the Champs Élysées will boost nationalist-populist candidate Marine Le Pen. What is clear is that the race has tightened: centrist outsider Emmanuel Macron is polling at 24%, Le Pen at 22.5%, Republican François Fillon at 19% and firebrand socialist Jean-Luc Mélenchon at 18.5%. Here are some final thoughts for navigating...

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    Gavekal Research

    Target2 Fears Are Wide Of The Mark

    With Euroskeptic candidates showing strongly in the opinion polls ahead of France’s presidential election, Italy’s debt trap as inescapable as ever, and negotiations over the next round of Greece’s bail-out making little headway, talk about a possible break-up of the eurozone is once again doing the rounds. And as it does so, fears are rising about the growing magnitude of the European Central Bank’s Target2 balances, and the financial havoc...

    5
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    Gavekal Research

    Pound’s Rally Based On Flawed Assumptions

    The spring sun was shining on UK prime minister Theresa May yesterday when she stood in Downing Street to announce a cut-and-run general election for June 8. The sun was shining too on sterling, which rallied 2% against the US dollar and 1.3% against the euro on the news. The market clearly expects that a greatly increased parliamentary majority for May’s Conservative government following the vote will boost the chances of a softer Brexit deal...

    2
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    Gavekal Research

    Whether Or Not To Underweight The US

    Charles has been shifting his asset allocation recommendations in recent weeks away from US assets in favor of foreign alternatives. This was squarely valuation-based as his models show the US dollar, corporate bonds and equities to be overvalued. Here, he road tests this view by incorporating non-valuation-based macroeconomic factors into the analysis.

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    Gavekal Research

    Beyond The Election Risk: Upturn Still Favors Eurozone Stocks

    For the next three weeks at least, the upcoming two-round French presidential election will continue to dictate short term sentiment among investors in the eurozone. Following a late surge in the opinion polls from far left candidate Jean-Luc Mélenchon, two of the four leading contenders are now professed Euroskeptics. That knowledge has colored investor attitudes, keeping the spreads between French and German sovereigns elevated—the 10-year...

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    Gavekal Research

    Who The French Will Not Vote For

    All the media commentary on the opinion polls ahead of the French presidential election concentrates on which candidates the electorate intends to vote for. This is the wrong way to analyze the current political situation in France. With just 10 days to go before the April 23 first round, readers should pay no attention whatsoever to the opinion polls. They are almost entirely meaningless: 40% of respondents say that they do not know who they...

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    Gavekal Research

    The New EM Intervention Playbook

    In recent years emerging market central banks have taken to intervening to support their currencies against depreciation pressure using non-deliverable forward contracts settled in local currency, a technique that helps preserve the headline value of their foreign exchange reserves. Although the strategy bought time in Brazil and Mexico for more fundamental policy changes to take effect, non-deliverables are no magic bullet.

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    Gavekal Research

    Video: How To Play A Le Pen Victory

    In this follow-up to yesterday’s interview Charles outlines how investors can position themselves to hedge against a European Union breakup scenario that would likely follow from a Le Pen victory in the French presidential election.

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    Gavekal Research

    Video: The French Election

    In this interview Charles assesses the political situation ahead of France’s two-round presidential election, which kicks off later this month. Topping everyone’s list of questions is whether National Front leader Marine Le Pen will defy the opinion polls to win a surprise victory, and what a Le Pen presidency would mean for France and the European Union.

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    Gavekal Research

    E Pur Si Muove

    Back in early 2011, I argued that the adoption of abnormally low short-term interest rates (in real terms) always leads to a collapse in productivity, followed by a decline in the economy’s structural growth rate. Since late 2010 marked the transition from the acute phase of the financial crisis to something approaching normality, at least in the United States, it is worth examining the US experience in the ensuing period.

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    Gavekal Research

    London Seminar — March 2017

    In Gavekal’s seminar in London last week Will Denyer, Charles Gave, Tom Miller and Anatole Kaletsky presented their macroeconomic outlooks and offered investors asset allocation advice.

    0
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    Gavekal Research

    The Dollar In The Coming Quarter

    The first quarter of the year demonstrated once again that there is little more uncertain than a sure thing in the foreign exchange market. Rewind to mid-December, just before markets eased back for the holiday season, and the consensus firmly favored a stronger US dollar in 2017 . Of course, when sentiment is so strongly aligned, it means there are few marginal buyers left to enter the market. As a result, the consensus was confounded, as the...

    0
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    Gavekal Research

    Strategy Monthly: Europe Braces For The French Election

    The macroeconomic stars are aligning for the eurozone. The region’s cyclical recovery is extending itself across economies and sectors alike. Inflation remains modest, reducing the chances of an early monetary tightening. Eurozone equities are relatively cheap in an expensive world. And the euro is fundamentally undervalued against the US dollar. However, the big risk for investors remains the possibility that nationalist euroskeptic Marine Le...

    0
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    Gavekal Research

    Regulating Complex Systems

    Everyone will surely agree that today’s financial system is sufficiently complicated and interconnected to qualify as a complex system.And regulating a complex system is by definition almost impossible, because it is in complex systems that Frédéric Bastiat’s observation that there is “what is seen and what is not seen” really comes into its own.

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