JP  Capital    Perspective  is  everything  

September 23, 2015

Equities Markets remained subdued after the Fed’s decision to keep rates unchanged at historic low levels. Fixed Income Bond yields rallied on the back of the FOMC statement as investors reached for the safe havens of U.S Treasuries. Currencies Dollar Yen remains range bound as U.S weakness is offsetting the Bank of Japans monetary policy. Aussie dollar back ups amid weak Chinese PMI data. Commodities The China slowdown continues and commodities come under pressure from demand weakness.

Market roundup

Source: Bloomberg, Spot returns. All data as of last Friday’s close. Past performance is no guarantee of future returns

EquitiesTotal Return in USD (%)

Level WTD MTD YTD

DJIA 16,384.6 -0.3 -0.7 -6.4Nasdaq 4,827.2 0.1 1.1 2.8S&P 500 1,958.0 -0.1 -0.6 -3.5MSCI World 1,630.7 0.2 -0.8 -3.2Fixed Income

Total Return in USD (%)Yield WTD MTD YTD

U.S. 10- Year Treasury 2.13 0.5 0.7 1.7U.S. Corporate Master 3.37 0.4 0.8 0.2ML High Yield 7.34 -0.5 0.1 0.1Commodities & Currencies

Total Return in USD (%)Level WTD MTD YTD

Gold Spot 1,139 2.8 0.4 -3.9WTI Crude $/Barrel 44.7 0.1 -9.2 -16.1

Current Prior Week End Prior Month End 2014 Year End EUR/USD 1.13 1.13 1.12 1.21USD/JPY 120 120.6 121.2 119.8

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EQUITIES

Tactical Allocation

1

Sovereign Wealth Funds Norway has long been a role model when it comes to Sovereign Wealth Funds. In 2005, the funds total assets as a percentage of domestic output surpassed 100%. Today this figure is in excess of 260% and is accelerating. Understanding government asset allocation strategies is useful because of the clout they have on the market. One of the arguments in favour of Japanese equities, other than favorable tax policies, a large-scale quantitative easing program and a weaker yen, is the change of strategy in the Japanese Government Pension Investment Fund (GPIF). When they announced a rotation out of safe securities and into Japanese domestic equities, the markets rose. GPIF’s total assets stands at 141,120 billion JPY, with roughly 38% in domestic bonds and 25% in domestic equities. It is no wonder that the 10-year JGB sits at 30 basis points.

2

China also has a sovereign wealth fund, the Chinese Investment Corporation (CIC). It began in 2007 with $200 billion, which has now risen to $575 billion, with the majority invested in equities (44.1%). With the Chinese authorities using their reserves to stem the tide of a falling Yuan, intervention is likely to be a regular occurrence going forward. To some extent there has always been a tight grasp on domestic markets, but with the economy slowly opening up, the CIC may be a key indicator in where to be positioned for Chinese markets. Japan looks to be well positioned after Shinzo Abe announced a corporate tax cut which should improve bottom lines but ultimately, share prices rise on the back of increasing sales growth. With a weaker yen in part due to a stronger dollar, we feel these should aid the sector in the short term. Over the medium and long term we should see some of these structural reforms such as improving the gender ratio at the executive level and establishing Japanese universities amongst the world’s top 100 by the end of the decade.

Next- Oil update: Aussie concerns on commodity crisis

Exhibit 1: GPIF Asset Strategy

Source: JPIF , as of June 30th 2015

Domestic bonds

Domestic equities

International bonds

International equities

Short- term assets

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FX & COMMODITIES Iron Ore Cracks

Next- Bond update: Spreads narrow

Exhibit 2: Correlation between the price of Iron Ore and the price of the AUD vs. USD

Source: Bloomberg data

EURUSD Last Thursday we all waited patiently to see whether Mrs Yellen was finally going to increase interest rates. Disappointingly, the rates were unchanged and the explanation was mainly that they take into account the global economic slowdown and not just what is happening in the U.S. As expected the EUR climbed against the USD to 1.1435, however this rebound of the EUR was short lived as it’s currently trading at 1.1160. Good figures from the EU came out today, slightly helps the climb of the EUR. AUDUSD As it is the Rugby World Cup it is interesting to look at certain currencies that normally would not be too much in the spotlight. The Aussie dollar has depreciated by 20% year on year against the USD. There are a few reasons for that, but one of the main reasons is due to Iron Ore.

Australia is the second largest producer of Iron Ore in the world just behind China however, Iron Ore has depreciated by 27% in the last year alone! The issue with Iron Ore is that China produces more than 50% of the hard metal and as China’s growth rate slows, this directly affects the price of Iron. The yearly decline of Iron ore (see Exhibit 2) is directly impacting the AUD/USD rate, with the blue line being the exchange rate and the orange is the Iron Ore spot price. Commodities There are some pretty gloom views regarding commodities at the moment and the stats are not helping its case. The Bloomberg index is currently at a 16 year low, tumbling 15% since June 30th. Further to that, China’s PMI came out on Wednesday and the readings are lower than the estimated 47.5, which already shows that there is a contraction. The important question now is to wonder how low it can go? Citigroup feels that it can still go lower!

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FIXED INCOME

Australian national output is dependent on the mining sector. It accounts for around 14% with manufacturing at 11% and construction just behind at 9.5%. The collapse in many commodity markets has caused Australia to suffer along with the rest of the Asian markets; and just to make things worse, China opted for a currency devaluation that makes Australian exports less competitive. A measure of risk in debt markets is the credit spread (the difference between sovereign and corporate bonds). The wider the spread, the more investors would rather hold safer debt such as government-backed securities. After all, in theory, governments can’t default on their obligations. During the 1980s, Australian debt was actually riskier according to the corporate bond sector (see Exhibit 3), with the spread around 600 basis points. Conditions are very different today with the Aussie 10 year reaching 2.5% on the back of a low global interest rate environment, due in part from lackluster growth prospects in developed markets.

But the question is, where will we go from here? With the consensus for oil to not go above $65 for at least a year, the Auto market should benefit with consumers spending their increased disposable income. On the flipside, with China’s policy shifting and other hard commodities slipping, the key sectors (mining) will be under pressure at least over the short- medium term. Whether you look at the core inflation rate or the prices producers sell at, inflation has halved in 12 months. Undoubtedly weak commodity prices are the culprit. The Reserve Bank of Australia (RBA) has cut rates twice over the past year. Even with a depressed Aussie Dollar, the RBA is confident inflation can return back to target. But with property prices rising, particular in the Sydney area, an interest rate rise would be damaging for an economy already suffering from tight effective conditions.

Exhibit 3: Spreads narrow as commodities fall

Tight Spreads

Source: St Louis Federal Reserve

0.00 2.00 4.00 6.00 8.00

10.00 12.00 14.00 16.00 18.00

1969$07$01'

1970$12$01'

1972$05$01'

1973$10$01'

1975$03$01'

1976$08$01'

1978$01$01'

1979$06$01'

1980$11$01'

1982$04$01'

1983$09$01'

1985$02$01'

1986$07$01'

1987$12$01'

1989$05$01'

1990$10$01'

1992$03$01'

1993$08$01'

1995$01$01'

1996$06$01'

1997$11$01'

1999$04$01'

2000$09$01'

2002$02$01'

2003$07$01'

2004$12$01'

2006$05$01'

2007$10$01'

2009$03$01'

2010$08$01'

2012$01$01'

2013$06$01'

2014$11$01'

Corporate Aaa Bond Yield (%)

AUS 10 year yield (%)

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JP  Capital    Perspective  is  everything  

Jonathan Taubert FX and Commodities

Pete McCarthy Equities and Fixed Income

JP Capital Team

Going forward The Federal Reserve decided to leave the Federal Funds Rate unchanged at 0.25%, while equity markets tracked lower amid concerns over a weak global economy. In our August 20th edition, we outlined that equities tend to perform relatively well after rate hikes, which may explain the recent market reaction to the FOMC statement. Asia will continue to be under pressure as China transitions from an export model to a more consumer lead economy. That then puts the emphasis on companies who are exposed to the Chinese consumer. Over the next 1-3 years, those business models will likely outperform commodity cycles, which is why Australia could be a tough market, both for equities and bond prices. We favour Japan due to the chance of more monetary easing from the Bank of Japan and in the medium term, Abe’s structural reforms will have a chance to impact the real economy. European exporters are also looking attractive, particularly after the recent sell-off. A weaker Euro should aid European automakers and with the Chinese consumer gaining more clout on the composition of demand, such models should be profitable sectors. An important point to remember is that over the medium term, equity markets rise on solid earnings, not multiple expansion.