9/1/17

Kyle Jacobsen
Markets Summer Analyst Candidate
Macro Outlook as of 9/1/17
U.S. Equities
The major U.S. indices have enjoyed a post-election move to the upside that has remained fairly
stable over the past few months. The summer in domestic markets was categorized by exceptional
earnings growth, low volatility, and the continued expectations of favorable policy changes from
Washington.
Moving into this summer, our equity markets flashed signs of a matured bull market. Sentiment
and thematic sector trends like we saw in broader information technology (semiconductors and
FAANG), inflows into utilities, and financials with favorable policy and rate implications. These
factors allowed sentiment and technicals to overshadow typical fundamental-based performance.
The underlying sentiment for the continuation of this slow bull market will be tested in the next
few months by many large factors: The debt ceiling vote is approaching on September 29th, the
Federal Reserve must address its balance sheet reduction this month, CPI inflation data is still
lacking at 1.7%, and there is a decreasing likelihood of another rate hike this year. All factors set
the framework for a highly pivotal and volatile season for domestic markets.
Outlook:
While equities still remain attractive relative to bonds, I am bearish in the mid-term. Equities are
vastly overvalued with the S&P 500 trading at a P/E of 22 (ttm) compared to the 16 forward P/E
historical average. We face large geopolitical risks like North Korea nuclear tensions and policy
implementation. Lastly, we have the potential for downturn from balance sheet tapering by the
fed. Overall, all factors outweigh the slow continuation of positive sentiment and could easily lead
our market into a bearish cycle.
Fixed Income
The bond market is getting difficult to navigate in our current unattractive yield environment. In
treasuries, the spread between the 10 year and 2 year continues to flatten with a current spread of
80 bps. Treasury notes will still enjoy relative attractiveness from risk-off investor shifts, but a
December rate hike to increase their yield naturally is anything but certain. I am bearish on
treasuries as I believe the curve will continue to flatten and IG yields remain more lucrative for
the relative risk taken.
Investment grade yields are stable with an average of 3.6% and municipal’s still remain strong
options for those with large tax burdens. However, a large market decline remains a huge risk for
longer maturity instruments. Overall, I sit neutral on IG and municipal’s yields with the view of
trimming long duration and focusing on staggering intermediate-term bonds.
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High yield enjoyed a fantastic year in 2016 stemming from a rebound in energy (crude prices) off
of February 2016 lows. Currently, high-yield outlook is bleaker than the past with oil prices
continuing to weigh on many HY energy offerings and tightening spreads across most issues.
Overall, I believe high yield will remain steady in the short-term but I fairly bearish on their yields
in the long-term due to outlying equity correction possibilities, energy risks, and stronger inflows
back into equities.
Outlook:
With stable fundamentals in IG and altering expectations for a rate hike I am neutral on IG and
Treasuries but believe an intermediate-term allocation is best. I hypothesize that yields (Treasuries
and IG) hover around current levels until sentiment is shifted based off of Federal Reserve or
geopolitical actions later this fall.
Europe
After an uneventful Jackson Hole meeting between central bankers, the European Central Bank’s
(ECB) previously hawkish tone has been muted. This is setting the stage for a big decision on
whether to raise rates from their current level at –0.4% (deposit facility rate). ECB President Mario
Draghi most also outline the plan to cut back the current Quantitative Easing program that was
initiated in 2015.
The largest implication of a shift in ECB policy would be on the Euro spot rate. Currently with the
EUR/USD spot @ 1.19, the currency has appreciated drastically this summer. The ECB has a
highly anticipated rate policy meeting this Thursday. No hikes are forecasted but policymakers
will be expected to lay the framework for the October 26 meeting in a tone that doesn’t frighten
investors. Going forward, I expect the ECB to proceed carefully in policy meetings and hike rates
within the next 6 months. I remain bullish on the Euro in the short-term.
European equities remain stable but continue underperformance relative to emerging markets and
select U.S. markets. The Euro Stoxx 50 is up 4.5% YTD and the DAX 40 has returned 5.8% YTD.
With fundamentals regaining stability, I hold a neutral stance on European Equities.
Emerging Markets
Brazil: Following the Temer scandal in May, the BOVESPA index (7.1% return this month) and
Brazilian equities as a whole have stabilized. Brazilian Bonds and the Brazilian Real are risky
given the political backdrop so I expected a lack of performance to keep investors looking
elsewhere. Overall, with many economic reforms yet to be addressed and the overall political
skepticism, I remain neutral on Brazil.
Russia: Russia became more reliable for bulls in 2014 to 2015. The large headwind to Russian
markets will always be the reliance on global commodity cycles. After experiencing a rebound
following the 2016 oil glut, Russia now has returned into bearish territory due to poor crude
expectations through 2018 (consensus around $50 per barrel for WTI). The Russian Ruble which
is susceptible to oil pricing in U.S. dollars, shouldn’t experience any notable upside moves either.
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Lastly, a fall in sales and a large deceleration in inflation leave me mildly bearish on Russia in the
long-term.
India: With a spectacular run of the NIFTY 50 (21.2% YTD) and the BSE: SENSEX (19.5%
YTD) it is clear India is the shining star of EM plays. Prime Minister Narendra Modi has led a
series of reforms ranging from the removal of Rupee’s considered illegally circulated or untaxed,
growth reforms to reinforce consumer spending, and the proposed implementation of a unified tax
system.
With bullish geopolitical support, a young and rapidly growing population, and year-over-year
economic data boosts, I am bullish on India. An allocation shift out of many other emerging
markets to an overweighting in India is still justifiable at these levels.
China: The world’s second largest economy has made some large strides towards economic
development. In the second quarter of 2017, China’s GDP rose around 6.7% crushing expectations
and flashing positive signs for bulls. Rates are stable in regards to China’s MLF (medium-term
lending facility) at 4.35% and previous bearish trade news between the U.S. and China has been
muted for now.
The largest addressable negatives for China will be the need for government deleveraging of its
debt and the policy changes needed in property markets. The Yuan has enjoyed a strong move
against the dollar recently, however, U.S. rate expectations and Chinese policy changes could slow
down the appreciation of the currency.
Overall, I am short-term bullish on the CNY/USD (Chinese Yuan) but remain neutral on the
Shanghai Composite (SSE Index) due to China’s exposure to U.S. political developments and
impending policies.

Top Market Drivers for the Rest of 2017

 Monetary Policy Tightening by Central Banks
 High Valuations for U.S. Markets
 Geopolitical Tensions
 India outperforming EM competitors
 Flattening Treasury Curve
 Lower Yields for Bond Investors
 Low Market Volatility