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Gavekal Research
Tan Kai Xian
Sep 20th 2018
The Message From US Housing Construction
Wednesday saw a soft US housing data release for August, pointing to a coming weakening in residential construction. With the Fed raising rates and 10-year treasury yields well above 3%, equity investors may sniff late-cycle decay. KX shares such concerns, but advises investors to hold their noses for a while longer.
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Gavekal Research
Tan Kai Xian
Sep 06th 2018
The Signaling From US Autos
Even as the US economy fires up on tax cuts and government spending, interest rate-sensitive sectors show signs of rolling over. First it was housing, and now auto sales have slid to the lower end of their range after steadily softening this year. Over the next year, the question is less whether autos can boost growth, as how much they will detract from it. The fact that the Trump administration is still considering significant tariffs on...
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Gavekal Research
Will Denyer, Tan Kai Xian
Sep 04th 2018
Strategy Monthly: A Simple Guide To US Asset Allocation
We synthesize four years of work on asset allocation and present a model portfolio built around analysis of the cost of and return on capital; the real rate of return on equities, bonds and cash; and the ideal duration of fixed-income holdings. Today we recommend that US portfolios hold 75% in equities, 25% in cash, and shun bonds.
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Gavekal Research
Tan Kai Xian
Aug 20th 2018
A Benign View Of US Inflation
With US inflation now running above the Federal Reserve’s long term target rate, and the US labor market almost as tight as at any time since the turn of the century, the question for investors is not whether inflation will continue to push higher, but how fast it will rise. The distinction is important. Headline CPI inflation came in at a six-and-a-half-year high of 2.9% in July. And in June the overall and core PCE measures that the Fed...
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Gavekal Research
Tan Kai Xian
Aug 08th 2018
More Underperformance Ahead For US Bank Shares
It’s been a tough few months for investors in US bank shares. Since late February banks have underperformed the broader S&P 500 index, in large part on fears that the flattening trend in the US yield curve will compress bank net interest margins and depress earnings. Yet viewed on a longer time horizon, things look different. From the fourth quarter of 2015 until the first quarter of this year (the latest data point), bank net interest...
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Gavekal Research
Tan Kai Xian
Aug 03rd 2018
Weighing The Forces Driving The US$
Where is the US dollar going next? After weakening markedly against other developed economy currencies at the beginning of the year, the US dollar staged a vigorous rebound in April and May. Since then, the DXY US dollar index has essentially tracked sideways. Of course, trying to forecast the US dollar’s moves is frequently a thankless task. Nevertheless, it is important to examine both the bullish and bearish forces at work and to weigh their...
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Gavekal Research
Will Denyer, Tan Kai Xian
Jul 31st 2018
When To Buy US Equities?
Last month, Will and KX asked When To Buy US Bonds? This month, they turn their attention to US equities and devise a portfolio asset allocation model that advocates overweighting stocks against bonds when returns on invested capital and earnings yields exceed corporate funding costs. Back-testing gives an impressive historical outperformance at a reduced volatility relative to the S&P 500. But just as important is what the model has to say...
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Gavekal Research
Tan Kai Xian, Will Denyer
Jul 16th 2018
The Yield Curve As A Recession Signal
Every time since the 1960s that the US yield has inverted, a recession has followed within 18 months to two years. So it is no surprise that the recent flattening of the curve, which has seen the 10-2-year treasury yield spread fall to just 25bp, is attracting attention. Many observers say the flattening reflects market expectations of weaker aggregate demand ahead. Some argue that the flattening of the curve itself may cause a recession, by...
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Gavekal Research
Tan Kai Xian
Jul 09th 2018
Still Caught In The Cycle
The June US labor market report released on Friday appears to bear out Federal Reserve chairman Jay Powell’s view, set out in a speech last month, that “there is a lot to like about low unemployment”. Although the headline payrolls number grew by an unexpectedly strong 213,000 month-on-month, the unemployment rate actually ticked higher from 3.8% to 4%, as greater numbers entered, or reentered, the labor market.
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Gavekal Research
Will Denyer, Tan Kai Xian
Jul 04th 2018
A Better Fed Model
The “Fed model” which values US equities relative to bonds is now more than 20 years old. In that time, it has become widely used and has attracted equally widespread criticism. In this paper Will and KX revise the original to iron out some of its flaws, and come up with an improved model which offers greatly superior risk-adjusted returns.
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Gavekal Research
Tan Kai Xian, Will Denyer
Jul 03rd 2018
The Trade War And The US Cycle
How will the US administration’s trade disputes affect the US economic cycle? In the worst case scenario, if Donald Trump follows through on all his threats the disruption to global supply chains could be great enough to push the world economy into recession. At this point, the greatest impact flows from the high degree of uncertainty about future actions.
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Gavekal Research
Tan Kai Xian
Jun 28th 2018
The New Model Duration Rule
Choosing the right level of duration for a bond portfolio is devilishly tough. It is doubly so when the global interest rate environment is shifting. For this reason KX is introducing a new top-down based duration management tool which encouragingly offers superior signaling and can be used across multiple developed economy bond markets.
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Gavekal Research
Will Denyer, Tan Kai Xian
Jun 08th 2018
When To Buy US Bonds?
Since the early 1980s, buying and holding US long bonds has been a solid investment strategy. This macro environment was supported by a favorable demographic tailwind that ensured a bountiful supply of global savings. That situation is now changing, and as interest rates rise investors should not assume that yields will retrace as they did after the 2013 “taper tantrum”. In this piece Will and KX put their Wicksellian framework to work and...
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Gavekal Research
Tan Kai Xian
Jun 01st 2018
The Hurdles For US Profits
Corporate America shot the lights out in the first quarter as tax cuts helped S&P 500 earnings soar by 23%, while macro data released this week showed profits rising an aggregate 14% year-on-year, versus 4.8% in 2017. This week also saw good news for banks, as regulatory shackles were loosened. Yet investors who think US firms are headed back to the races must convince themselves that a series of late-cycle hurdles can be overcome.
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Gavekal Research
Tan Kai Xian
May 25th 2018
Does The Dollar's Run-Up Have Legs?
Being a US dollar bear has been a humbling experience over the last few weeks. The year started well enough for bears, with the DXY dollar index declining -4.2% over the first seven weeks. But since mid-April, the US currency has staged a rebound vigorous enough to leave the DXY up 1.95% year-to-date. This rally confronts investors with a baleful prospect: any further sustained appreciation of the US dollar will have a detrimental effect on...
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Gavekal Research
Tan Kai Xian
May 15th 2018
Playing A Flatter US Yield Curve
The US yield curve could invert towards the end of this year or early in 2019, the head of the St. Louis Federal Reserve said on Monday. For investors it’s a troubling thought. Over the last 50 years, whenever the US yield curve has inverted, a recession has typically followed within a year or two. Yet although the current flattening of the curve is set to continue, the process will be gradual, which means inversion and an ensuing recession...
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Gavekal Research
Tan Kai Xian
May 02nd 2018
Fade The US Dollar Rally
If a week is a long time in politics, then three months is an eternity in the foreign exchange market. Three months ago, sentiment towards the US dollar reached a nadir after US Treasury secretary Steven Mnuchin expressed his desire for “a weaker US dollar”. Over the following weeks, the US currency duly weakened. But since mid-April the dollar has staged a rally, with the DXY index gaining 3.5% as the market has noted the increase in US long...
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Gavekal Research
Tan Kai Xian, Will Denyer
Apr 30th 2018
The American Growth Dynamic
It is clear from data released on Friday that the US economy remains set on an expansionary and inflationary trajectory. Growth in 1Q18 came in at a stronger-than-expected 2.3%, while the US employment cost index rose 2.8% YoY to a high for this cycle. Even as consumer spending comes off the boil, US firms, in what looks like a classic late-cycle pattern, are responding to bottlenecks by investing more in their capital stock. We continue to see...
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Gavekal Research
Will Denyer, Tan Kai Xian
Apr 25th 2018
Still Bond Bears
Matching its 2013 peak, the world’s most-watched interest rate—the US 10-year treasury yield—yesterday touched 3%. Concerns are now high that it will soon move higher, perhaps much higher. For perspective, the US 10-year hit 3.75% in 2011, 4% in 2010 and 5% in 2007. In this cycle, we think yields will break above 3% and then march upwards. In short, we remain bond bears and continue to recommend keeping duration short. Today, we want to...
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Gavekal Research
Will Denyer, Tan Kai Xian
Apr 19th 2018
The Message From Credit Markets
Over the last three weeks US high yield credit spreads have collapsed by 100bp—a tightening that far exceeds the 10bp narrowing in investment grade spreads over the same period. Coming after a marked widening in the Libor-OIS and Ted spreads over February and March, this fall in credit spreads is clearly encouraging. It supports our contention that the widening of Libor spreads was an idiosyncratic anomaly, and nothing investors should be overly...
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Gavekal Research
Tan Kai Xian
Apr 11th 2018
US Budget Deficits And Long Term Interest Rates
On Monday the Congressional Budget Office published its latest projections for the US economy and government finances, incorporating for the first time the effects of December’s tax cuts. With government revenues set to fall from 17.3% of GDP last year to less than 17% over the next five years, and spending expected to grow from 20.8% to more than 22%, the CBO projects that the US budget deficit will expand from 3.5% of GDP last year to more...
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Gavekal Research
Tan Kai Xian
Apr 04th 2018
US Auto Sales: No Longer A Growth Driver
Strong US auto sales in March mask a stagnating longer term trend and rising auto loan delinquencies. Happily, as KX explains, neither has broader implications for overall US consumer demand. Although auto sales may no longer be contributing to US growth, rising bad loans in the sector do not prefigure a wider consumer credit crisis.
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Gavekal Research
Will Denyer, Tan Kai Xian
Mar 28th 2018
Don’t Fret About Libor
A disproportionate increase in Libor relative to other benchmark short term rates over recent months has got many observers flustered. In this concise paper, Will and KX dig down to the cause of the increase, and explain what it does and doesn’t mean for portfolio investors.
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Gavekal Research
Tan Kai Xian, Will Denyer
Mar 21st 2018
Don’t Wade Into Treasuries
Leading up to today’s Federal Reserve meeting, long-dated treasuries have slipped back into their trading range. There are two reasons to think this offers a good opportunity to “buy the dip”. First, global growth has eased off as shown by our diffusion index of OECD leading indicators, which tends to lead year-on-year changes in 10-year treasury yields by about four months. Second, investors overreacted to January’s spike in US wage growth data...
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Gavekal Research
Tan Kai Xian
Mar 16th 2018
The Corporate Bond Play
With high-yield and investment grade spreads having shrunk to historically low levels, US corporate bonds are hardly cheap. Yet the combination of favorable tax policy and fiscal incontinence recommends them to any US bond portfolio. As the US economy is likely in the dog days of this cycle, the tricky question is what duration investors should focus on.
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Gavekal Research
Tan Kai Xian
Mar 12th 2018
The Curiously Weak Dollar
Since early February, global markets have had a volatile ride. The big exception has been the US dollar, which has stayed stoically range-bound. This is odd considering the Federal Reserve’s fairly hawkish outlook for monetary policy and the fact that imposing tariffs on metal imports should lessen the US trade deficit. Not to pat ourselves on the back, but the general Gavekal view on the US dollar has in recent times been fairly bearish (see...
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Gavekal Research
Will Denyer, Tan Kai Xian
Mar 07th 2018
Housing And The US Economy
The last economic cycle in the US was marked by excesses in residential investment and a dearth of business investment, which proved negative for productivity growth. As the current cycle gets a pro-cyclical boost in its mature phase from last year’s tax reforms, that imbalance will be at least partially reversed.
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Gavekal Research
Tan Kai Xian
Mar 05th 2018
The US Current Account, Trump’s Trade War And Equities
US president Donald Trump’s announcement last week of tariffs on imports of steel and aluminum are just the first salvo of a trade war aimed at reducing the US$566bn annual US trade deficit. Yet even far more extensive tariffs than those announced on Thursday will do nothing to narrow the US trade gap. As KX argues in this report, more powerful economic forces are working to widen the US trade and current account deficits over the coming...
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Gavekal Research
Tan Kai Xian, Will Denyer
Feb 14th 2018
Deficits And Bondholders
Economics 101 says that when there is more of something, then other things being equal its price should go down. That is worrying for US bond investors as US lawmakers last week passed a budget deal that may raise deficits by US$320bn over the next 10 years (any new infrastructure spending will be extra). Interestingly, and perhaps not entirely coincidentally, just as debt-fueled big-government becomes the new normal in Washington, November’s...
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Gavekal Research
Will Denyer, Tan Kai Xian
Feb 05th 2018
Good News Is Bad News?
The US posted a solid employment report on Friday, and the markets didn’t like it one bit. Some 200,000 jobs were added in January, better than the expected 180,000 and prior month gain of 160,000. But what really spooked investors was the faster than expected pickup in wage growth to 2.9% YoY. On the face of it, this is good for economic growth (certainly in nominal terms) and top-line corporate revenues. The worry is that without productivity...
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Gavekal Research
Will Denyer, Tan Kai Xian
Feb 02nd 2018
Take Profits On US Homebuilders
Our view that real growth in the US will remain supported this year at a similar level to 2017’s 2.5% rate is based on three main elements: rising business investment following December’s tax cuts; a moderation in consumption growth as labor market tightness slows job ceation, and a neutral to mildly positive view on residential investment (see The Outlook For US Growth And Prices). The third element—our neutral view on homebuilding—merits...
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Gavekal Research
Tan Kai Xian
Feb 01st 2018
The Sustainable Rise In US Inflation
In her valedictory meeting yesterday, Janet Yellen presided over a slight tightening of language to indicate that the Federal Reserve’s official inflation target of 2% should be hit some time this year. Investors were not surprised as break-even inflation rates have risen to 2% from about 1.8% late last year, while the chance of four rate hikes materializing in 2018 is now priced at 22%. The fly in the ointment is still sluggish wage growth,...
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Gavekal Research
Will Denyer, Tan Kai Xian
Jan 29th 2018
The Outlook For US Growth And Prices
The first estimate for real US GDP growth clocked in at 2.6% for the fourth quarter, bringing full-year 2017 growth to 2.5%. Policymakers at the Federal Reserve forecast the same rate of growth for 2018, together with a moderate pick-up in consumer inflation from 1.7% to 1.9%. At Gavekal we try to avoid making such specific numerical forecasts; as the great Danish physicist Niels Bohr used to say, “It’s very hard to make predictions, especially...
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Gavekal Research
Tan Kai Xian
Jan 19th 2018
Taxes And Yields
US equity markets have started 2018 committed to the idea that Goldilocks is alive and well. Although no clear picture has emerged of its impact, the passage of the most significant tax reform since the 1980s has had S&P 500 firms opining publicly that they hope to invest more and treat staff better. The corollary is that this cycle might be getting a second wind. The fear is inflation, as shown by yesterday’s move in treasury yields to...
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Gavekal Research
Tan Kai Xian
Jan 17th 2018
Stick With Dollar Depreciation Plays
The last year has seen a rare outbreak of consensus at Gavekal. Since last January partners and analysts have been almost universally bearish on the US dollar. In that time, the DXY dollar index has slumped some -12% from its heavily overvalued level at the beginning of 2017. Now the first 12 trading days of 2018 have seen the DXY slide -1.9%, breaching September’s support level to sink to its lowest since the end of 2014. This latest...
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Gavekal Research
Tan Kai Xian
Jan 16th 2018
The Yield Curve As A Duration Guide
With US stock markets scaling new heights, there are multiple reasons why nervous equity investors might want to reduce portfolio risk. The usual way to do this would be by increasing allocations to long-duration treasury debt. But with long-dated yields now rising, what duration of treasuries should investors hold? And when and how should they adjust duration?
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Gavekal Research
Tan Kai Xian
Jan 11th 2018
US Inflation Expectations: Further To Run To Catch-Up
Over the last six weeks, market inflation expectations have undergone a signal shift to the upside. The US five-year break-even inflation rate has climbed from below 1.7% in early December to 1.95% this week. In other words, market expectations for US inflation, which had long remained markedly subdued, have now played catch-up with the Federal Reserve’s own projections, which see core PCE inflation rising to 1.9% this year and 2% in 2019....
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Gavekal Research
Tan Kai Xian, Will Denyer
Jan 08th 2018
Dare To Dabble In US High Yield
Last week US high yield spreads narrowed to within a whisker of their cycle low, bringing them within striking distance of their 2007 low. When things cannot get much better, they seldom do. However, this may be one of those rare historical occasions when things do indeed go from good to even better. The US tax changes that went into effect last week have the potential to drive credit spreads to record depths.
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Gavekal Research
Will Denyer, Tan Kai Xian
Dec 20th 2017
US Tax; Not What You Expect
With the Senate having voted its approval, Republicans are set to tomorrow finalize the biggest shake up in the US tax code since the 1980s. A common refrain among analysts is that the bill should propel equity prices higher, but do precious little for economic growth. We wonder if the reverse may unfold.
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Gavekal Research
Will Denyer, Tan Kai Xian
Dec 14th 2017
There Is Now An Alternative
There were no surprises yesterday, either in the Federal Reserve’s rate hike, or in its forecasts for next year. With the labor market set to “remain strong”, the unemployment rate likely to inch down to 3.9%—full employment—and growth forecast to get a modest boost from tax cuts to 2.5%, the dot plot projects three 25bp hikes in 2018.
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Gavekal Research
Tan Kai Xian
Dec 07th 2017
Avoiding Equity Duration Risk
Last week, Louis argued persuasively that investors should shorten portfolio duration in response to the prospect of further central bank monetary tightening, the potential threat of rising inflation in 2018, and the stretched valuations of long-dated assets (see Have We Just Glimpsed Growth Stocks’ Achilles’ Heel?). This goes not just for fixed income investors, but equity investors too.
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Gavekal Research
Will Denyer, Tan Kai Xian
Dec 05th 2017
Positioning For US Tax Reform
What’s not to like about tax cuts? Quite a lot as it turns out. Although the final shape of US tax reform has yet to be settled, there are enough common points between the House and Senate bills to allow Will and KX to conclude that the likely tax cuts will prove inflationary, and could prompt a more aggressive stance from the Fed. Despite some undoubtedly positive macro outcomes, the implications for investors are not exactly bullish.
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Gavekal Research
Tan Kai Xian
Nov 21st 2017
Dodging Late-Cycle Refinancing Risk
By most generally accepted metrics, the US economy is in the late stages of its cycle and any further overheating raises the chances of a recession. The issue is really one of timing. Will Denyer’s Wicksellian model and my US business cycle indicator are both flashing orange rather than red, suggesting that the US is edging towards the recession frontier, but not yet at it. We have both advised investors to dial back on US risk, but are not much...
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Gavekal Research
Tan Kai Xian
Nov 10th 2017
Contradictory Signals On US Corporate Credit Risk
US high-yield spreads have widened by 39bp over the last three weeks. Nevertheless, by long term historical standards, they remain exceptionally tight, indicating that the bond market is pricing in remarkably little US corporate credit risk. That message is at odds with the tale being told by the US equity market, which is signaling that corporate credit risk is on the rise. Only one of them can be correct. There are good reasons to think it may...
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Gavekal Research
Tan Kai Xian
Nov 07th 2017
Equities When The Dollar Declines
The US dollar has strengthened over the last couple of months. But the relative maturity of the US cycle, the US dollar’s overvaluation, and the prospect for changes in monetary policy stances outside the US all argue for US dollar depreciation over the medium term. Against this bearish backdrop, KX examines the characteristics of equities that tend to outperform when the US currency is depreciating.
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Gavekal Research
Tan Kai Xian
Oct 30th 2017
The Unconvincing Pick-Up In US GDP
US third quarter GDP growth came in on Friday at 3% QoQ annualized, much higher than the expected 2.6% rate. The strength of the headline number sparked optimism that the US economy had successfully shrugged off any negative impact from hurricanes Harvey and Irma, and certainly did nothing to discourage equity investors, as both the S&P 500 and the Nasdaq Composite rode buoyant earnings to new highs.
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Gavekal Research
Tan Kai Xian
Oct 26th 2017
US Equity Exposure For The Late Cycle
The US equity bull run continues even as the US economy issues an increasing number of late cycle indicators. For investors who want to maintain exposure to the stock market but are getting nervous that the economy may soon turn down, KX examines the characteristics that allow stocks to outperform in the late stages of the cycle.
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Gavekal Research
Tan Kai Xian
Oct 20th 2017
Back Away From Buyback Plays
From a cyclical peak of US$161bn in 1Q16, US corporate share buybacks fell to US$120bn in 2Q17. But although buyback activity is down, it is not out. In the past few weeks companies including Walmart, HP and Allergan have announced new share repurchase programs. The question for investors is whether they should chase these buyback plays.
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Gavekal Research
Tan Kai Xian
Oct 13th 2017
Don’t Count On A Miracle
Do animal spirits in the US live after all? As profits have picked up, firms’ capital spending has rebounded from contraction territory in 2015-16 to a perky 6.7% QoQ rise in 2Q17. A range of business surveys suggest the trend was sustained through the third quarter. Much is at stake, for if capital spending can break out of its post-2008 range, it is just possible that a productivity surge can follow, lifting underlying economic growth. KX...
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Gavekal Research
Tan Kai Xian
Oct 10th 2017
A Portfolio For The Monetary Cycle
Every US recession since the 1960s has been preceded by the combination of a fall in true money supply growth relative to real GDP growth, and a fall in the unemployment rate below NAIRU. In this paper, KX constructs a model portfolio which reduces exposure to risky assets in response to these signals, and finds that it offers investors superior risk-adjusted returns.
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