Please note the views expressed in this bulletin are those of the author and do not necessarily reflect AMP Capital’s house view.

Theme 1: Federal Reserve on track to hike interest rates

The US economy is doing ok. The Federal Reserve plans to start normalising interest rates this year and probably will.

Dovish or not, the Federal Reserve (Fed) seems to be on track to hike interest rates this year and next year. The interest rate path dropped about 20bps across the Fed’s projection period in the June report, but this is more a reflection of the fact that rate hikes were delayed by about one quarter. This was due to the Q1 ‘hiccup’ which was weather, port strikes and importantly, US dollar and oil shock related. However, the US consumer has a set of powerful tailwinds behind it: i. jobs growth and wage growth at a collective pace of about 4%; b. cheaper oil cost savings; c. wealth effects pointing to a lower savings rate; and d. a strong housing market. The US small business sector is closely linked to the US consumer for a number of reasons, and looking at confidence indicators we can see that the US consumer and small businesses have only just recovered from the financial crisis. This means the recovery is likely to be more robust now. So that means the Fed will probably be on track to follow through with its plans - unless something external blows up.

Theme in pictures






Source: AMP Capital, US Federal Reserve *SEP = Statement of Economic Projections

Theme 2: Greece and the sentiment washout

There is an air of uncertainty in the markets at the moment as Greece stands on the precipice

I saw a headline the other day that went something along the lines “investors are too complacent about Greece risks”. Judging by the flows and shift in sentiment I would say that this is somewhat inaccurate. A lot of investors are clearly concerned about Greece, and are either paring risk back or putting on downside hedges. Given the idea that sentiment has momentum information through the range and contrarian information at extremes, there is a chance that this turn down in investor sentiment eventually becomes self-fulfilling. But it does make you wonder if there might be a big relief rally when we finally get a resolution to the Greece crisis.

Theme in pictures

 





Source: AMP Capital, Bloomberg, Datastream, BAML Fund Manager Survey

Theme 3: European equities look oversold

European equities currently look oversold, and may become even more oversold if Greece risks materialise. However, the case for remaining long is still strong!

As a bit of natural follow-on to Theme 2, European equities are looking oversold. However, a number of tactical indicators such as ETF sentiment, the volatility futures curve, and market breadth are well into oversold territory which from a contrarian perspective and may represent a good buying opportunity. That’s exactly how I see it. The economic story in Europe is still good and, valuation-wise, it’s still attractive relative to history and relative to the US. So, maybe Greece will find a way to make things worse in the short run (which would tend to make these arguments stronger), but things are looking good from here.

Theme in pictures





Source: AMP Capital, Bloomberg, Datastream

Theme 4: Chinese property market is improving

The Chinese property market is stabilising (led by tier 1 cities) which reduces downside risks for the Chinese economy

The latest data out of China shows the property market is improving - but the recovery in prices is not broad-based. The reason I say it is not broad is because if you look at tier-1 cities, they were up an average 3% month-on-month in June, while tier 2 cities were barely positive, and the rest were more or less unchanged/small negatives. Why is this happening? The reason is that tier-1 cities face under-supply issues, whereas smaller cities are facing over-supply issues. However, drilling into the rebound itself, three key catalysts triggered the rebound:

  1. The A-share bull market (clear spill-over/feedback-loops in operation)
  2. Targeted measures for the property market (e.g. wind-back of purchase restrictions, mortgage rule changes)
  3. Broader monetary policy easing (culminating in lower mortgage lending rates).

So what do we do with this? A rebound in the property market reduces downside risks materially. It also reduces the intensity of decline in demand for things like iron ore – however, I am not bold enough to call a large rebound on that front at this stage!

Theme in pictures



 




Source: AMP Capital, National Bureau of Statistics, Bloomberg

Theme 5: Will the real Chinese stock market valuation please stand up?

Shenzhen – overvalued; Shanghai – fairly valued; Non-domestic – undervalued. Expect volatility into quarter-end, and potential stimulus driven rebound thereafter.

I have seen a dozen different charts that show China as undervalued, fairly valued, overvalued, and extremely overvalued. So, below is my attempt to corral these contrasting pictures into something sensible. Basically, the key point is this: Shenzhen (smaller, newer, tech companies) is extremely overvalued, Shanghai is about fair or slightly over, and non-domestic (MSCI China Index) is undervalued.

In terms of the recent market action (Shanghai Composite is 13% off the recent high at the time of writing) my best guess is that we will see more volatility into the end of June due to bank quarter-end liquidity pressures and heavy IPO activity. But I would expect further stimulus measures to be announced soon (expect a RRR cut very soon to address said liquidity crunch) which would probably trigger a recovery rally thereafter. At the same time, an eventual passing of the Greek crisis risks should allow non-domestic shares to rally (non-domestic Chinese equities trade more on the international ebb and flow whereas the A-share market is domestic retail and liquidity driven). It is just my best guess, but that’s why I would prefer to own the lower beta and undervalued non-domestic stocks.

Theme in pictures

 






 
 Source: AMP Capital, Bloomberg

About the Author

Callum Thomas, MMgt (finance), MMgt (banking), BBS (finance), Investment Strategist

Callum is an Investment Strategist in the strategy team of the Multi Asset Group at AMP Capital. Callum has a passion for global macro investment strategy and constantly strives to generate unique and innovative insights that help inform the strategy team's dynamic asset allocation process. Callum is responsible for researching a range of asset classes and global macroeconomic themes to aid in formulating investment strategies across the Multi-Asset Group. He also keenly collaborates with the global equity and fixed income teams. Callum originally joined AMP Capital in June 2009 as an analyst in the investment business of what was then AXA New Zealand. He previously worked in strategy at the New Zealand Stock Exchange.