Views From the Floor

In this week’s edition - we look at what drove the sharp reversals in markets; and could we reach a ‘no-deal’ Brexit by mistake?

All Eyes Were on Markets Last Week…

Several markets experienced sharp reversals on October 10-11 – The S&P 500 Index and oil fell 4% week-on-week, while the Vix Index rose from 15 to a peak of about 29. Interestingly, the USD Index also fell 0.4% week-on-week. This is notable as during big moves like these, there has historically been a flight to haven assets such as the US dollar.

What is behind these big moves? The Wall Street Journal said that “many [analysts and portfolio managers] admitted they struggled to figure out what drove the 2-day tumble.”1

We believe that the moves occurred because of two main worries. The first worry is whether growth is sustainable, driven by rising US interest rates, concerns about the US/China trade war and stretched share valuations. The second is uneven growth, driven by the US outperforming and the resulting strong US dollar hurting emerging markets.

…While This Week May Be About Geopolitics

Looking forward to the coming week, we’re keeping an eye on the developments in Saudi Arabia. A journalist disappeared last week after entering the Saudi consulate in Istanbul and Turkey said it has evidence that Saudi agents murdered him. US President Donald Trump threatened “very “powerful measures” if the allegations turned out to be true, after which Saudi Arabia said it would retaliate against any measures against the kingdom. Could oil be one of those tools of retaliation?

Figure 1. Oil Prices Creep Higher and Higher

As of 15.10.2018

Brexit Scenarios – A ‘No Deal’ By Mistake?

On October 17-18, an EU summit is due to take place, seen as a deadline for an agreement setting out the terms of UK-EU divorce, as well as a political declaration on the future relationship between the UK and the EU.

We’ve done some analysis around the different Brexit scenarios, with four implied outcomes:

  • UK exits the EU with a deal;
  • UK exits without a deal;
  • UK stays in the EU;
  • Start the negotiation process again.

The UK parliament has been promised that they will be allowed a ‘meaningful vote’ on the final terms of the exit, whether this is with a deal or without. This vote must take place by January 21, 2019. While that much is clear, what is much more opaque is what happens if parliament were to vote down the government’s proposal. We think the probability of this could well be being underestimated by the market. Everyone we speak to seems to have a different view of what would happen at this point: some say the UK would default to WTO exit, some say there would be a general election, some a second referendum. Whatever the answer, given the hard exit deadline, the potential for this uncertainty increases the chance of no deal by mistake.

Keeping an Eye on Declining Chinese Auto Sales

Wholesale Chinese auto sales for the first week of October are estimated to have declined by 58% year-on-year, according to the Chinese Passenger Car Association (CPCA). This data follows 11% and 14% year-on-year drops for wholesale and retail sales, respectively, reported by CPCA for September.

The October decline implies that destocking through the chain is picking up pace and is a sign that underlying Chinese consumer confidence (and thus demand) is deteriorating, in our view.

During the third quarter, we’ve already seen several auto manufacturers issuing profit warnings and providing negative outlook statements, citing weakness predominately from the Chinese mass-market segment. We believe this is partly due to the Chinese government crackdown on peer-to-peer lending, a stimulus hangover from 2016/2017 (when Chinese government stimulus resulted in pull-forward demand, in our view), as well as a weaker stock market taking its toll on consumer confidence.

A Flight to Safety in Consumer

The MSCI Consumer Discretionary Index has declined about 8% this month to October 11, driven by both fundamental factors (Amazon’s announcement of increases to its minimum wage, oil prices continually moving higher and fears over US-China tariffs), as well as technical factors.

This is in contrast to the move experienced by the MSCI Consumer Staples Index, which has declined by about 1% over the same period. Our thesis is that there has been something of a flight to the perceived safety of staples as opposed to ‘non-essential’ discretionary. If market turbulence continues, we may see this trend accelerate as managers seek to shelter within staples.

Figure 2. Discretionary Versus Staples

As of 10.10.2018

Outlook for Gas Is Positive in Near Term

The near-term outlook for natural gas is positive in our view. We enter the 2018/2019 winter season with a storage balance of 3.2 trillion cubic feet (tcf) versus expectations of 3.5 tcf, according to our calculations.

Despite the recent tightness, prices remain rather tepid as supply has grown in excess of market expectations over the past year. US production growth has exhibited strong yearover-year growth driven by Northeast, Haynesville and associated gas in the Permian. Yet, due to lack of infrastructure availability out of the Permian Basin, we believe associated gas growth could be moderate. In addition, recent supply additions have been associated with pipeline projects in the Northeast, which could limit production additions once the lines enter service, in our view.

While the market has been focused on production given stronger year-over-year production growth amid weak pricing, we believe upside risks could be driven by deliverability issues. Despite a relatively low October inventory balance, inventory balances at the end of the winter season could be near 1.5 tcf as the production trend continues in the Haynesville and non-associated supply areas, according to areas, according to our calculations.

With contribution from: Otto van Hemert (Man AHL, Head of Macro Research), Ben Funnell (Man Solutions, Portfolio Manager), Teun Draaisma (Man Solutions, Portfolio Manager), Henry Neville (Man Solutions, Analyst), Daniel Collin (Man GLG, Portfolio Manager), Fritz Gallagher (Man GLG, Analyst) and Marvin Caze (Man GLG, Portfolio Manager).