GLOBAL / EM LIQUIDITY TRENDS & MARKET …...GLOBAL / EM LIQUIDITY TRENDS & MARKET IMPLICATIONS IAN...

GLOBAL / EM LIQUIDITY TRENDS & MARKET IMPLICATIONS GLOBAL / EM LIQUIDITY TRENDS & MARKET IMPLICATIONS

IAN BEATTIE & SIMON WARD

JANUARY 2018

1 NS PARTNERS | Money moves markets. Issued by NS Partners Ltd. Authorized and regulated by the Financial Conduct Authority.

• How we use monetary / liquidity analysis (Ian)

• Global macro / policy outlook (Simon)

• Implications for EM (Ian / Simon)

• Q&A

PRESENTATION OUTLINE

HOW WE USE MONETARY / LIQUIDITY ANALYSIS

IAN BEATTIE


1. Real (i.e. inflation-adjusted) money leads the economy

2. “Excess” money drives markets – “the liquidity theory of asset prices”

HOW WE USE MONETARY / LIQUIDITY ANALYSIS


• Turning points in real money growth lead turning points in economic growth by 6-12 months (average = 9 months)

• Narrow money (M1) works better than broad money (M3)

• Narrow money = currency in circulation plus demand / overnight deposits

REAL MONEY LEADS THE ECONOMY


-15

-10

-5

0

5

10

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

G7 + E7 INDUSTRIAL OUTPUT & REAL NARROW MONEY (% 6M)

INDUSTRIAL OUTPUT REAL NARROW MONEY

REAL MONEY LEADS THE ECONOMY - EXAMPLE

Real narrow money trends correctly signalled that the global economy would be strong in 2017, contrary to downbeat consensus expectations in late 2016.

Weakness signalled 2008-09 recession

Rebound signalled 2009-10 economic recovery

Strength in 2016 signalled buoyant economy in 2017


-20

-15

-10

-5

0

5

10

15

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

G7 INDUSTRIAL OUTPUT & REAL NARROW MONEY (% 6M)

RECESSIONS INDUSTRIAL OUTPUT REAL NARROW MONEY

REAL MONEY LEADS THE ECONOMY – LONG-TERM PERFORMANCE

Real narrow money has led economic swings consistently and contracted ahead of the six global recessions since the 1960s.


-20

-15

-10

-5

0

5

10

15

1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

G7 INDUSTRIAL OUTPUT & REAL NARROW MONEY (% 6M)

RECESSIONS INDUSTRIAL OUTPUT REAL NARROW MONEY REAL BROAD MONEY

REAL MONEY LEADS THE ECONOMY – NARROW VS BROAD MONEY

Broad money signals have been less reliable – real broad money did not contract before the last two recessions.


• According to liquidity theory, asset prices tend to rise if money grows faster than the needs of the economy

• Conversely, slow money growth relative to economic needs results in a liquidity drain on markets

• The impact of excess / deficient liquidity on particular markets depends partly on the economic cycle

“EXCESS” MONEY DRIVES MARKETS


• How to measure excess money?

1. Difference between real money growth and long-run average (G7 = 3% per annum)

2. Difference between real money growth and industrial output growth

• Both approaches have value



-14

-7

0

7

14

21

28

35

5

10

20

40

80

160

320

640

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

MSCI WORLD RETURN VS USD CASH & G7 "EXCESS" MONEY

MSCI WORLD RETURN VS USD CASH (LHS)

G7 REAL NARROW MONEY % YOY MINUS 3 (RHS)

G7 REAL NARROW MONEY % YOY MINUS INDUSTRIAL OUTPUT % YOY (RHS)

Above zero = “excess” money

Below zero = “deficient” money


Global equities outperformed cash on average when the excess money indicators were positive, and underperformed on average when they were negative.


50

100

200

400

800

1600

3200

1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

MSCI WORLD RETURN VS USD CASH & SWITCHING STRATEGIES

MSCI WORLD RETURN VS USD CASH

1) HOLD CASH IF G7 REAL MONEY % YOY < 3 OR FALL FROM 6M PEAK > 3

2) HOLD CASH IF G7 REAL MONEY % YOY < INDUSTRIAL OUTPUT % YOY OR FALL FROM 6M PEAK > 3

EXCESS RETURN ON SWITCHING STRATEGY 1) = 3.5 PP PA EXCESS RETURN ON SWITCHING STRATEGY 2) = 2.6 PP PA


Simple switching strategies based on the excess money indicators would have captured much of the upside in equities while limiting drawdowns.


• Monetary / liquidity analysis can provide important insights about economic and market prospects

• The excess money indicators are still positive but have fallen, suggesting a less favourable outlook for markets

SUMMARY

GLOBAL MACRO / POLICY OUTLOOK SIMON WARD


6/17

3/18?

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-10

-5

0

5

10

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018

G7 + E7 INDUSTRIAL OUTPUT & REAL NARROW MONEY (% 6M) AVERAGE LEAD TIME AT HIGHLIGHTED PEAKS = 9 MONTHS

INDUSTRIAL OUTPUT REAL NARROW MONEY

GLOBAL MACRO / POLICY OUTLOOK

Real money growth has fallen significantly since June 2017, suggesting that economic growth will weaken from around spring 2018.


REAL NARROW MONEY (% 6M)

2010 2011 2012 2013 2014 2015 2016 2017-4

-2

0

2

4

6

8

10

12

14

USJAPANEUROLAND

UKCANADAAUSTRALIASource: Thomson Reuters Datastream

REAL MONEY GROWTH – MAJOR DEVELOPED ECONOMIES

Real money growth has weakened in most economies since mid-2017.


Q4 1995 Q3 1998

Q4 2001

Q3 2005

Q2 2009

Q4 2012 Q1 2016 Q3 2019?

-2

-1.5

-1

-0.5

0

0.5

1

1.5

2

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

G7 STOCKBUILDING AS % OF GDP, YOY CHANGE

STOCKBUILDING CYCLE TROUGHS

G7 STOCKBUILDING CYCLE – SCHEDULED TO PEAK SOON?

Recent strong growth partly reflects an upswing in the stockbuilding cycle but this may peak in H1 2018 and become a drag in H2 2018 / 2019.


G7 CONSUMER PRICE INFLATION

A reversal higher in energy and food prices lifted headline inflation in 2016-17 but core inflation remained stable.

G7 CONSUMER PRICES (% YOY)

05 06 07 08 09 10 11 12 13 14 15 16 17-2

-1

0

1

2

3

4

5

TOTALCORE

Source: Thomson Reuters Datastream


G7 UNEMPLOYMENT RATE – LOWEST SINCE 1980

Increasingly tight labour markets suggest upward pressure on wage growth / core inflation.

G7 UNEMPLOYMENT RATE

80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 164.50

5.00

5.50

6.00

6.50

7.00

7.50

8.00

8.50

9.00



QE SUPPORT FADING

The 12-month flow of QE peaked in March 2017 and is on course to halve by mid-2018.

G7 NARROW MONEY & G4 QE BOND PURCHASES

05 06 07 08 09 10 11 12 13 14 15 16 17 18 190

2

4

6

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10

12

14

0

200

400

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800

1000

1200

1400

1600

1800

G7 NARROW MONEY % YOYG4 QE GOV & AGENCY SECURITIES 12M SUM $ BN(R.H.SCALE)PROJECTION(R.H.SCALE) Source: Thomson Reuters Datastream


• Global growth is likely to cool from spring 2018

• However, G7 central banks will probably tighten policies in response to stronger wage / core inflation pressures

• Coupled with the planned wind-down of QE, this may cause money growth to weaken further

SUMMARY

IMPLICATIONS FOR EM IAN BEATTIE & SIMON WARD


• We use a seven-factor checklist to assess whether emerging equity markets will outperform or underperform developed markets

• One of the factors is the gap between real narrow money growth in the E7 major emerging economies and the G7 developed economies

IMPLICATIONS FOR EM


EM RELATIVE PERFORMANCE & G7 VS E7 REAL MONEY GROWTH

The real money growth gap was positive for EM between late 2015 and early 2017 but is now neutral.

MSCI EM VS WORLD & G7 / E7 REAL MONEY

2010 2011 2012 2013 2014 2015 2016 201730

40

50

60

70

80

90

100

-2

0

5

10

15

20

MSCI EM / MSCI WORLDG7 REAL NARROW MONEY % 6M(R.H.SCALE)E7 REAL NARROW MONEY % 6M(R.H.SCALE)Source: Thomson Reuters Datastream


Factor Condition for Outperformance Current Assessment

Real money growth E7 above G7 ≈Similar

Valuation Low absolute / relative to DM Relative yes

Earnings revisions ratio Above DM No

Global Industrial cycle Upswing Nearing peak

Global Excess Money Positive Yes but falling

Commodity prices Upswing Yes

US Dollar Falling ≈Trend unclear

EM RELATIVE PERFORMANCE CHECKLIST

The checklist is mixed.


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0

2

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12

2010 2011 2012 2013 2014 2015 2016 2017 YTD

CHINA GDP BY EXPENDITURE COMPONENT (PP CONTRIBUTION TO GDP % YOY)

GDP FINAL CONSUMPTION GROSS CAPITAL FORMATION NET EXPORTS

CHINA IS REBALANCING SUCCESSFULLY

Consumption accounted for two-thirds of GDP growth in 2017, up from about 40% in 2010.


CHINA ECONOMY & NARROW MONEY

Money trends gave a positive signal in 2015-16 but now suggest caution.

CHINA NOMINAL GDP & NARROW MONEY (% 6M)

05 06 07 08 09 10 11 12 13 14 15 16 17-2

0

2

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6

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12

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16

18

NOMINAL GDPNARROW MONEY



CHINA HOUSING MARKET

Housing market weakness may contribute to a policy reversal during H1 2018.

CHINA HOUSE PRICES & SALES VOLUME (% YOY)

05 06 07 08 09 10 11 12 13 14 15 16 17-8

-6

-4

-2

0

2

4

6

8

10

12

14

-60

-40

-20

0

20

40

60

80

100105

NEW HOUSE PRICESRESIDENTIAL FLOORSPACE SOLD(R.H.SCALE)



REAL NARROW MONEY – CHINA VS INDIA

China outperformed India in 2017 but relative money trends suggest a reversal.


2010 2011 2012 2013 2014 2015 2016 2017-20

-15

-10

-5

0

5

10

15

20

25

CHINAINDIA



REAL NARROW MONEY – BRAZIL VS RUSSIA

Policy rates have been cut by more in Brazil but money trends favour Russia.


2010 2011 2012 2013 2014 2015 2016 2017-15

-10

-5

0

5

10

15

BRAZILRUSSIA



REAL NARROW MONEY – SOUTH AFRICA VS THAILAND

The political backdrop has improved in both countries but money trends favour Thailand.


2010 2011 2012 2013 2014 2015 2016 2017-3

-2

-1

0

1

2

3

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SOUTH AFRICATHAILAND



• Cautious economic / market outlook

• Slowdown and policy tightening risks focused on developed markets

• EM checklist neutral

• China: long-term positive, short-term cautious

• Significant liquidity divergences within EM – potential for country selection

SUMMARY


These materials (“Presentation”) are furnished by NS Partners Ltd (“NS Partners”) on a confidential basis for informational and illustration purposes only. This Presentation is intended for the use of the recipient only and may not be reproduced or distributed to any other person, in whole or in part, without the prior written consent of NS Partners. Certain information contained in this Presentation is based on information obtained from third-party sources that NS Partners considers to be reliable. However, NS Partners makes no representation as to, and accept no responsibility for, the accuracy, fairness or completeness of the information contained herein. The information is as of the date indicated and reflects present intention only. This information is subject to change at any time, and NS Partners is under no obligation to provide you with any updates or amendments to this Presentation. This Presentation is not an offer to buy or sell, nor a solicitation of an offer to buy or sell any security or other financial instrument advised by NS Partners. This Presentation does not contain certain material information about the strategy, including important risk disclosures. An investment in the strategy is not suitable for all investors, and before making an investment in the strategy, you should consult with your professional advisor(s) to determine whether an investment in the strategy is suitable for you in light of your investment objectives and financial situation. NS Partners does not purport to be an advisor as to legal, taxation, accounting, financial or regulatory matters in any jurisdiction, and the recipient should independently evaluate and judge the matters referred to in this Presentation.

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