monthly strategy report july 2016 - banca march

Monthly Strategy Report July 2016

Alejandro Vidal CrespoDirector of Market Strategies

Of sunflowers, galaxies, and stock market rebounds: The Golden Ratio

Monthly Strategy Report. July 2016

Of sunflowers, galaxies, and stock market rebounds: The Golden Ratio

Centuries before Christ, when Greek thought illuminated Europe, Hellenic scientists and philosophers were obsessed with understanding the order and make-up of objects, convinced that a few geometric rules dominated the structure and purpose of things. Perfect forms and proportions were sought that constituted the basis of what we perceive as beautiful, natural, and harmonious.

Before long, they hit upon the fundamental shapes that form the premise of natural structures, such as the 120° angle (which includes the angles of the perfect pyramid, the hexagon, and the equilateral triangle) or the five Platonic solids, unique spherical-based geometric structures with perfectly symmetrical faces (tetrahedron, cube, octagon, dodecahedron, and icosahedron) that also constitute the majority of atomic and crystalline structures. In general, these shapes maximise efficiency by constructing figures with the least amount of surface area, which explains their proliferation in nature: they are highly efficient when using materials and distributing strength, and they are widely used in engineering and architecture for the same reasons.

By examining these ratios, it was discovered that a perfect rectangle is one in which the short side has the same ratio to the long side as the long side has with the sum of both sides.

Mathematical proofs aside, the rectangle that results from forming an inner square still complies with the Golden Ratio, therefore the structure can self-replicate to infinity (creating what is known as a fractal, another fundamental type of construction in nature).

This proportion, known as the Golden Ratio, was accurately defined for the first time by Euclid (3rd century BCE), though some mathematicians believe it dates from 2000 BCE. Although it is a number with infinite decimal places, its value is rounded to 1.618. This ratio is found, for example, in the Greek Parthenon, in the works of great composers (like Mozart and Beethoven, in the formal structures of their sonatas), and in the Pyramid at Giza.

Through geometric calculations, this ratio can be used to create a perfect spiral which, incidentally, is also the pattern evident in galaxies, snail and nautilus shells, and the arrangement of branches on tree trunks to maximise the absorption of sunlight and minimise interference between them.

By the 13th century, Leonardo of Pisa (also known as Fibonacci) devised an integer sequence in which each number is the sum of the previous two (0, 1, 1, 2, 3, 5, 8, 13, 21, 34…), as a solution to a problem raised in rabbit breeding. It is essentially a closed-form expression with one unique feature: from the sixth or seventh integer, by dividing these numbers by their immediate predecessor in the sequence, the quotient approximates the Golden Ratio (13/8=1.62; 21/13=1.615; 34/21=1.62).

Thus, it was discovered that the Golden Ratio not only underlies things we can measure, but also things we can count, for example, the arrangement of complex flowers (such as artichokes, pineapples, and sunflowers) or the growth of certain animal populations. It also represents a pattern of growth or regression (if applied in reverse).

By the 20th century, with the emergence of financial markets, we began to study behavioural patterns in the price fluctuations of assets, and how the collective psychology of investors could contain cyclical patterns that determined variations. In 1938, Ralph Elliott published his famous Elliott Wave Principle, in which he identified wave patterns in price graphs, broken down into bullish and bearish movements at certain intervals, in both the long and short term.


An examination of these waves also revealed the Golden Ratio through the Fibonacci sequence, defining what we know as Fibonacci Retracements. If we take the sequence, we discover that the Golden Ratio in reverse decomposes a retracement from a value in two stretches: a retracement of 61.5% from a number in the Fibonacci sequence results in the previous number in the sequence, and therefore an additional retracement of 38.5% results in 0.

Adding another point of symmetry, 50%, we obtain the points known as Fibonacci Retracements, where price resistance and support levels form, as demonstrated in the following graphs from the S&P 500 and the euro/dollar exchange:

Naturally, the Elliott Wave Principle is not exact, and in fact is still a topic of debate, despite being widely excepted and used as the basis of further technical analysis studies.


However, it allows us to raise some interesting questions. Fifty percent is a natural and understandable symmetrical point, the concept of “half” is very evident.

But could other less evident concepts, like “somewhat” (38.5%) or “a lot” (61.5%), also be ingrained and our collective psychology based on the most fundamental rules and ratios of construction in physics and biology?

Another thought emerges from the fact that it is an incalculable number, with infinite decimal places (like Pi, which determines the perfect squaring of the circle). Could it be that perfection is unattainable?

Monthly Strategy Report July 2016

Equipo de Estrategia de Mercados de Banca March:

Alejandro Vidal, Unit Director, Market Strategies

Rose Marie Boudeguer, Service Director, Research Services

Pedro Sastre, Service Director, Market Strategies

Sebastián Larraza, Director, Discretionary Management Services

Paulo Gonçalves, Specialist Technician, Research Services

Miriam Ordinas Sanjuán, Specialist Technican, Market Strategies

Joseba Granero, Specialist Technican, Research Services

The UK votes to leave the EU


The UK votes to leave the EU

A negative month for equities, especially in Europe.

Though global activity continued to improve, heightened political uncertainty adversely affected stocks, especially in Europe, where markets closed the month with losses.

By early June, the attention of the markets shifted toward two major economic policy events that would influence stock trends. First, it was expected that the US Federal Reserve would provide new clues about the future of interest rates, and second (and undoubtedly more important) was the United Kingdom’s crucial referendum about whether to remain in the EU.

The UK’s decision to leave the EU adversely affected markets…

Ultimately, the United Kingdom voted to leave the European Union, affecting markets from top to bottom. The “Leave” camp won with 51.8% of the votes, with voter turnout of 72.2%. This decision triggers a complex political process for which, as of today, there is no clear roadmap, as the UK is the first nation to leave the Union since its inception.

… due to the minimal visibility of the process and its economic and political effects.

Furthermore, British Prime Minister, David Cameron, tendered his resignation, necessitating the appointment of a new conservative party leader who will spearhead the process of exiting the EU. Meanwhile, the governments of Scotland and Northern Ireland are opposed to the break up, even as citizen petitions are submitted to the British Parliament for another referendum on EU permanence. All of the foregoing reflects the current divisions in British society and obscures the visibility of the departure process.

However, swift action from the central banks curbed the collapse.

The results of the referendum affected markets, which reacted initially with sharp declines, though subsequent sessions achieved some stability supported by the actions of the main central banks.

The Bank of England was the first to announce the launch a liquidity programme totalling up to GBP 250 billion (approximately 12% of GDP). The governor of the Bank also hinted at new stimulus measures.

The Bank of England, the ECB, and the Fed will maintain expansionary monetary policies.

For its part, the ECB reaffirmed its commitment to inject more liquidity into the market as needed, and during the week of the referendum, it increased asset purchases to EUR 21.8 billion, and specifically credit purchases under its new programme, acquiring EUR 2.6 billion.

At its latest meeting, the Fed decided to postpone interest-rate hikes until activity definitively improves, thus maintaining a cautious and unequivocally pro-growth stance. In the days following the referendum, the Fed confirmed that it would provide dollar liquidity to the financial system through existing swap lines..

Activity data confirm modest global growth…

Turning to the latest macroeconomic data published, though global growth remains modest, the data were generally positive.

… but in the US, consumer spending rebounded in Q2…

In the United States, activity recovered in Q2 with a rebound in consumer spending. Retail sales


accelerated at a rate of +2.5% y-o-y and consumer confidence rallied to its highest level since October. The real estate sector also remained buoyant and average growth in housing starts through May stood at +12% y-o-y. Industrial production, however, weakened after falling -1.4% y-o-y in May. But the biggest concern focused on the labour market, where job creation slowed to only 38,000 new positions compared to an average of 180,000 in the previous three months.

… in the eurozone, business confidence remained stable in June.

In the eurozone, business confidence indicators remained at levels consistent with economic growth: the composite PMI dipped three-tenths to 52.8. Inflation in the region emerged from negative territory in June, climbing to +0.1% y-o-y. ECB measures are beginning to take effect with regard to credit; lending to nonfinancial companies rose in May to a rate of +1.2% y-o-y.

The Bank of Spain expects growth will remain steady in Q2.

In Spain, the political arena also attracted attention with the general elections, which resulted in a victory for the Partido Popular with 137 seats, 14 more than six months ago. It will be necessary, however, to reach agreements in order to form the new government. Activity remained positive though less dynamic than in Q1: the Bank of Spain estimates that Q2 GDP advanced +0.7% q-o-q, one-tenth lower than in the previous quarter.

Emerging economies in recession show signs of stabilisation.

Among the major emerging economies currently undergoing a recession (Russia and Brazil), the data indicate some stabilisation. Inflationary pressures have slowed due to currency appreciation and weak domestic consumption: in Russia, CPI grew at a rate of +7.3% y-o-y, considerably lower than the 12.9% at the end of last year, while in Brazil, CPI remains high (+9.3% y-o-y). In this context, the Central Bank of Russia cut interest rates again by 50 b.p. to 10.5%, while the Central Bank of Brazil left rates unchanged at 14.25%.

In China, activity slows at a contained pace.

In China, May indicators confirm a contained slowdown: retail sales grew at rates of +10% y-o-y, while industrial production repeated its advance of +6% y-o-y. In view of this, leading indicators suggest that manufacturing will remain weak, after the sector’s business confidence fell in June (Caixin manufacturing PMI to 48.6, a level consistent with a contraction in activity).

Global sovereign debt benefits from increased risk aversion…

The political uncertainty that arose following the United Kingdom’s referendum boosted the purchase of safe-haven assets. Moreover, expectations that monetary policies will become more expansionary in the coming months, in an effort to prevent a deterioration of financial conditions, drove global sovereign debt. In the US, 10-year rates fell 38 b.p. to 1.47%, while rates on the German equivalent entered negative territory (-0.13%).

… and expectations of new stimulus measures from the central banks.

In the United Kingdom, despite being downgraded from the top credit rating, the announcement of a possible increase in the Bank of England’s assets-purchase programme bolstered British government bonds: the required yield for 10-year bonds declined 56 b.p. to 0.87%. The ECB’s asset-purchase programme also helped stem the contagion and peripheral debt ended the month positively, particularly that of Spain, which welcomed the results of the election: Spain’s 10-year rates fell to record lows (1.16%) and the Spanish sovereign bond index gained +4.9% at the close of the first half of the year.


European stock markets, and the financial sector in particular, were hit hard by the complex scenario resulting from the referendum...

Volatility increased on global equity markets following the results of the referendum. However, it is worth noting that losses were limited to European stocks, particularly in the financial sector. Considering global stock markets in aggregate (MSCI World), June losses totalled -0.8%, in stark contrast to the declines of -6.5% on the Eurostoxx50 and -21% on the Stoxx600 banking sector index. Nationally, the Ibex35 lost -9.6%, racked by the higher proportion of banks in the index and certain companies’ exposure to the United Kingdom. Lastly, the leading British index closed with gains of +4.4% by anticipating that the depreciation of the pound would stimulate sales abroad.

… on a global level, however, declines were moderate.

On a positive note, US and emerging stocks managed to recover from losses and the S&P 500 closed the month unchanged, while the MSCI Emerging Market Index gained +3.3%.

The pound sterling was the main casualty of the referendum’s outcome.

On the currency market, the pound suffered following the results of the referendum, depreciating -8.9% against the euro to 0.83 EUR/GBP. The dollar, meanwhile, benefited from its status as a safe haven despite pressures from receding expectations of a Fed rate hike. In this context, the euro-dollar crossover remained flat: the dollar appreciated +0.2% to levels of 1.11 EUR/USD.

Gains for gold in view of its safe-haven status.

Gold, another traditional safe haven, also closed the month with gains of +8.8% to $1,316/ounce. For its part, oil remained unchanged in June at roughly $50.


Strategy for July 2016

ASSET ALLOCATION

Positive Neutral Negative

Shares Bonds

Cash

ASSET ALLOCATION

Positive Neutral Negative

Equities

Eurozone EE.UU. Europa del Este

Asia Latinoamérica

Bonds

Peripheral Bonds Government Bonds(AAA, AA+)

Corporate Debt“High Yield”

Corporate Debt“Inv. Grade”

Convertible Bonds Emerging debt

We have revised global growth forecasts downward slightly…

Following the outcome of the British referendum, we anticipate a decline in our global growth forecasts for 2016 (to 3% from 3.1%, previously) and 2017 (to 3.4% from 3.5%, previously), triggered primarily by lower growth in the United Kingdom and the European Union.

… following the British referendum, due to declines primarily in the United Kingdom and the EU.

This preliminary forecast is based on declining investments and consumption due to uncertainty. A reduction in foreign trade (especially services) would be partially offset by interest-rate policies—the central banks have already pledged to provide liquidity for lower interest rates—and fiscal or economic stimulus measures in each country, according to circumstances and ability.

The global economy maintained its growth rate in Q2.

Based on the data currently available, in Q2 the global economy will maintain its growth rate, with activity in the United States accelerating and easing slightly in the eurozone. By the end of the year, it is expected that the sources of uncertainty will be largely limited to Europe, though we are also keeping an eye on developments in China, where the shift is underway toward a new economic model with heavier dependence on consumption at the expense of growth, which is expected to be between 6.5% and 7%.

US elections also generate some concern, although the economy has recovered.

Elections in the United States will also generate a degree of concern in the markets, though the US economy confirmed its recovery in Q2, thanks to consumer spending and the housing sector. The unemployment rate is very low, wages are on the rise, and economic activity usually rallies prior to the general elections, which will take place in November. As such, the growth rate should remain buoyant in the coming quarters.

Eurozone growth eased after a strong first quarter.

In the eurozone, growth eased two-tenths in Q2, after a strong first quarter. Over the course of the year, we anticipate that one or two tenths of forward momentum will be lost due to the Brexit. Therefore, we expect annual growth of 1.4% in 2016.


In Spain, growth will reach 2.5% despite political uncertainty.

In Spain, the elections have not yielded a conclusive result. We will have to wait until the government is formed and the economy could be affected by a lack of political leadership. Nevertheless, increased buoyancy in Spanish activity and lower financial costs, thanks to ECB support, will continue to drive growth, which could exceed 2.5% this year.

Emerging economies improve slightly, with the exception of Eastern Europe.

In emerging regions, the slight improvement in the commodities market benefits the major Latin American economies, which will boost the value of their exports. Emerging Asian economies continue to be propelled by domestic consumption and helped by tourism from China and less competition from Japan due to the strength of the yen. The United Kingdom’s departure will affect trade, investment, and finance in Eastern European countries, evident thus far in the weakness of its currencies.

The major central banks will be the focus of attention, with further monetary stimulus highly likely....

With regard to economic policy, the most important events in the next two months will be the meetings of the central banks: the ECB, the Bank of England, the Bank of Japan, and the Federal Reserve. The Bank of England, which is scheduled to meet on 14 July, has pledged to stimulate the economy by lowering capital requirements for British banks and examining the suitability of cutting benchmark interest rates, currently at 0.5%. The specifics of these measures will have to wait until the release of the August inflation report, which will include a downward revision of growth forecasts. The decline of the pound is also expected to increase inflation above the 2% target, though the Bank has said it would be willing to accept higher inflation rates in an effort to support growth.

… permitted by moderate global inflation.

The ECB will meet on 21 July and may modify the distribution of its monthly purchases and/or adjust the timeline of its corporate bond buying, increasing the volume in the initial months, or extending the programme. The possibility of interest rate cuts is also on the table. At its 27 July meeting, the Fed is expected to maintain its cautious stance and postpone further interest rate hikes, possibly until the end of the year or 2017. In the case of Japan, the appreciation of the yen, low inflation, and anaemic growth are conducive for further stimulus, though after years of ultra-expansionary policy from the Bank of Japan, which meets 29 July, these measures are nearly depleted. In general, with the exception of the United Kingdom, where inflation could soar, monetary stimulus measures are possible given that global inflation shows no signs of accelerating.

The market panic that followed the British referendum has begun to calm. The United Kingdom will have to yield in order to retain passporting rights.

The markets’ initial reaction to the results of the Brexit referendum was panic, which eased in subsequent days. The resignation of Prime Minister Cameron coupled with uncertainty about who will replace him and assume responsibility for formally presenting the exit resolution to the European Union (article 50 of the Treaty of Lisbon) and lead the negotiations, in addition to divisions within the Labour Party, places the United Kingdom in a difficult situation. EU authorities have asked that the withdrawal take place as swiftly as possible, and indicated unequivocally that the United Kingdom will have to yield if it wants to retain its “passporting” rights within the European Union. Negotiations are expected to take at least two years, during which time the United Kingdom will have to continue to meet its current commitments.


Negotiations will take two years; the contagion effect may be dissipating.

In addition to the direct impact on the economy of the European Union, which is expected to be able to manage with stimulus policies, there is also concern about the contagion effect spreading to other countries, with political movements that may want to emulate the British example. At the moment, the crisis and bewilderment in the ranks of the main parties, in Parliament, and in certain segments of the British population have partially quelled this fear, because it shows that the process of leaving the union could have detrimental consequences for any country, at least in the short and medium term.

Markets reacted with a sharp depreciation of the pound and declines in European equities. The United States and emerging markets remain relatively unscathed.

So, one week after learning of the “Leave” camp’s success, markets largely reacted through currencies, with the sharp depreciation of the pound (roughly 8% against the euro and 15% against the dollar), and the moderate depreciation of the euro (2.5% against the dollar and 4.8% against the yen). Bond markets also reacted strongly, with a drop in sovereign interest rates in the United States, United Kingdom, Japan, and Germany. Contrary to expectations, peripheral bonds have benefited from falling risk premiums. With regard to stocks, declines were concentrated in continental Europe (8% for the IBEX35 and 5% for France’s CAC), while US shares dipped slightly and shares in Asia and emerging countries rose (with the exception of Eastern Europe). As such, the damage appears to be limited to Europe.

The money market is unattractive except in terms of real returns.

In this context, we turn our attention to financial assets. Money market yields are mostly negative—repo, Euribor, Spanish treasury bill rates— and returns on deposits are increasingly meagre, below 0.1%. Despite this, these assets still appear attractive in terms of real returns, considering inflation is currently negative in Spain (-0.8%). Moreover, maintaining these positions helps shield us from the volatility of other assets.

Peripheral bonds will continue to benefit from ECB support.

Eurozone sovereign (government) bonds will continue to be supported by the ECB. However, we recommend peripheral alternatives given low or even negative returns on the bonds of central European countries. We also believe it would be advantageous to retain some exposure to US bonds, considering these are among the few safe securities with positive coupon rates in the short term.

We remain committed to credit, specifically high-yield credit on a global scale.

The economic climate continues to buoy credit, or corporate bonds, with relatively low default rates, low benchmark interest rates, moderate growth, and a reasonable level of risk premiums. In the eurozone, credit continues to be bolstered by the ECB through its corporate sector purchase programme, though coupon rates are unattractive. In this context, we remain committed to credit, specifically high-yield credit on a global scale.

We are optimistic about equities, though our position is more cautious with respect to European shares.

As for equities, we continue to be optimistic: valuations are reasonable but not cheap, and flows could return to this asset class, though this year’s earnings forecasts could be revised downward. By region, we are somewhat more cautious about Europe. European stocks have been adversely affected by political events that could continue to put pressure on the profits of European


companies. We would recommend a slight decrease in exposure to European indices that are heavily weighted in the financial sector, though we do not believe that other major changes to the equity portfolios will be necessary. Specifically, we remain optimistic about defensive securities and those with high dividend yields in sectors that are more closely linked to domestic consumption, and we maintain holdings on the US stock market, given its defensive character. We are also optimistic about the evolution of Asian stocks given their higher growth potential.

On the currency market, there is some room for modest appreciation of the dollar, but the pound will remain under pressure.

With regard to the currency market, we maintain our forecast that the dollar will appreciate slightly in the second half of 2016, though we suspect that the majority of the greenback’s upward momentum has already passed. At the same time, we hold an unfavourable view of the pound sterling, though its strong depreciation against the euro and the dollar—as much as 0.83 GBP/EUR and 1.33 GBP/USD—has minimised the weakening potential. The yen will stay strong unless the Bank of Japan cuts rates or increases bond purchases.

Though we expect improvements in commodities, we prefer to remain on the sidelines over the summer.

Commodity markets—energy and metals—have stabilised, though we do not anticipate an unequivocal rebound until the second half of the year. Therefore, we do not recommend taking positions given short-term volatility and uncertainty. With respect to gold, we do not see major opportunities in the absence of inflationary pressure, though lower interest rates on bonds increase its upside potential by reducing the opportunity costs of maintaining the precious metal.


Equity Indices IBEX35 (3 years)

Euribor Euribor 12 months (3 years)

EUR/USD (3 years)

10 years government yields

Currencies

Government Bonds

Corporate Bonds (1 year spread)

Commodities

Data: Bloomberg


Equity Indices performance (3 years)


Important Remark:

This contents of this document are merely illustrative and do not pretend, are not and cannot be considered under any circumstances as an investment recommendation towards the contracting of financial products.

This document has only been prepared to help the customer make an independent and individual decision but does not intend to replace any type of advice needed for the contracting of such products.

The terms and conditions described in this document are to be viewed as preliminary terms only, subject to discurssion and negotiation as well as to the agreement and final drafting of the terms affecting the transaction, which will appear in the contract or certificate to be issued.

Consequently, March Gestión de Fondos, S.G.I.I.C., S.A.U. and its customers are not bound by this conditions concerning the final documents to be approved. March Gestión de Fondos, S.G.I.I.C., S.A.U. does not offer any guarantee, expressly or implicitly, in relation with the information shown in this document.

All terms, conditions and prices contained in this document are merely informative and subject to modifications depending on the market circumstances, changes in laws, jurisprudence, administrative procedures or any other issue which may affect them. The customer should be aware that the products mentioned in this document may not be appropriate for his/her specific investment targets, financial situation or risk profile. For this reason the customer must make his/her own decisions by taking into account such circumstances and by obtaining specialized advice in tax, legal, financial, regulatoy, accounting issues or any other type of information required.

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Please note this document has been translated for your information only. In case of any errors or misinterpretations, the Spanish text will always prevail.

monthly strategy report july 2016 - banca march

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