mature economies economics_marketquantsmt_qqma.pdfhave entered the downside phase of the economic...

Mature Economies

Quantitative Market Alert

MarketQuant Research

Quarterly - 2019 Q1

Quantitative Market Alert – Mature Economies Quarterly MarketQuant Research 2019Q1

TAC ECONOMICS 2

www.taceconomics.com


TAC ECONOMICS 3


Contents Key messages – January 2019 ............................................................................................................ 5

Summary of Early Warning Signals .................................................................................................... 6

Summary on Market Fair Values ........................................................................................................ 7

Medium-term economic outlook ....................................................................................................... 8

Medium-term financial market outlook ............................................................................................ 9

S&P 500 .............................................................................................................................................. 10

CAC 40 ................................................................................................................................................ 12

DAX 30 ................................................................................................................................................ 14

FTSE 100 ............................................................................................................................................. 16

Nikkei 225 .......................................................................................................................................... 18

US Treasury 10 Year Yield ................................................................................................................ 20

French 10-year bond yield ............................................................................................................... 22

German 10-year bond yield ............................................................................................................. 24

UK Gilt 10 Year Yield ......................................................................................................................... 26

Japan JGB 10 Year Yield .................................................................................................................... 28

EUZ Corporate spread 5-7 year A ................................................................................................... 30

US Corporate spread 5-year A ......................................................................................................... 32

Thresholds for monthly signals: Reminder .................................................................................... 34


TAC ECONOMICS 4


This document provides the outputs of highly complex and extraordinarily powerful data-

mining and artificial intelligence tools applied to macroeconomic, financial and market

variables.

These outputs are:

- Early Warning Signals (EWS) on large reversal in market prices (upwards as well as

downwards) over a short-term horizon (from 1 to 6 months ahead).

- Outlook Signals over a short-term period (3 month and 6 month ahead), which represents

the market level for each period (3 month and 6 month ahead) compared to the current

market level.

The tools include an estimation of cyclically-influenced Fair Values (i.e. market prices that

would be fully consistent with the traditional set of economic and cyclical determinants of fair

values).

Results presented here are directly the outputs of the quantitative models and we do not tamper

with them.

Written on January 07, 2019 with data up to January 02, 2019.


TAC ECONOMICS 5


Key messages – January 2019

- Our latest Quarterly QMA (published in October 2018) had overall good

performances on Directional Trend Outlook (DTO) with 66% of correct

answers, even more pronounced on Government Bonds with 100% of correct

answers. The Early Warning Double Signals (EWS), inducing higher market

volatility, was well predicted but they masked the strong deterioration

observed in December.

- Compared to the previous quarter, the key messages have switched to higher

volatility, which confirmed a period of financial tensions up to 2019Q2

(strong volatility on equity markets and strong differentiation between

segments and maturity in US corporate bonds EWS). Thus, other signals are

pretty unchanged despite the worsening market conditions observed in

2018Q4: still upside potential on Equities, continuous increase in US bond

yields and corporate spreads widening with a short-term divergence

between US and EZ.

- On equity markets, our models indicate a higher valuation by March 2019,

thereby in a context of higher volatility across the whole period. The

combination of (1) higher volatility (2) upside Equity DTO, i.e. higher equity

indices levels compared to the current ones on March and June 2019 (3)

expected deterioration of the US credit market (with 2 out of 4 widening US

corporate spreads on a 6-month outlook) is the first “step” of larger risks for

the equity markets. Though our quantitative models continue suggesting

that financial variables are not yet at “breaking-points”, we remain extremely

cautious on 2019H1 outlook with most risks to our baseline scenario are

skewed to the downside. As our scenario (unchanged since 2018) becomes

more and more consensual, the risk of a market correction materializing

earlier than expected is increasing.

- On government bond markets, the differentiation between US and EZ bond

yields is still an issue. For the 10-year US Treasury, our signals suggest a

positive trend (above 2.66%) with potential for sell-off episodes each month

(“strong deterioration”). On EZ bond market, our outputs show a negative

trend (i.e. lower yields expected for 3- and 6-month horizons compared to

the current levels), consistent with higher risk aversion on Eurozone

government bonds markets and yields levels at their fair-values.

- The US corporate spreads signals point toward the materialization of the

“markets’ maturing phase” (i.e. corporate spreads higher, though equity

prices continue rising). Any large deterioration of the US credit market (with

widening US corporate spreads on a 3- and 6-month outlook) is the first

“step” of larger risks for the equity markets.

Retrospective

outlook Good predictive

signals on equity

Renewed

tensions Higher volatility up

to mid-2019

Bond yield

divergence US vs EUZ

Positive

outlook on

equity markets but higher

volatility over the

period

Corporate

spreads close

to fair value with overall US

spread widening

signals


TAC ECONOMICS 6


Summary of Early Warning Signals

Market Level

(Jan. 02) 01.2019 02.2019 03.2019 3-month

outlook 04.2019 05.2019 06.2019 6-month

outlook

Equity Indices

S&P 500 2,510 ↗ ↗ CAC 40 4,689 ↗ ↗ DAX 30 10,580 ↗ ↗ FTSE 100 6,734 ↗ ↗ Nikkei 225 20,015 ↗ ↗

10-Year Government Benchmarks

US Treasury 10 Year Yield 2.66% ↗ ↗

French OAT 10 Year Yield 0.66% ↘ ↘

German Bund 10 Year Yield 0.17% ↘ ↗

UK Gilt 10 Year Yield 1.21% ↘ ↗ Japan JGB 10 Year Yield 0.00% ↗ ↗

Corporate Spreads

Euro 5-7 Year A 78 bp ↘ ↘ US 5-Year A 136 bp ↗ ↘

Source: TAC ECONOMICS

Legend:

Strong improvement Strong deterioration Double signal No sudden change

↘↗ Medium term outlook compared to the current market level / - indicates neutral outlook


TAC ECONOMICS 7


Summary on Market Fair Values

The following table summarizes the estimated fair value for each market. The comparison with

the market level during the same month allows evaluating the expected short-term direction

assuming that market level oscillates around fair-value.

Market Level

(Jan. 02)

Fair Value

Nov. 18

Gap to

Fair

Value

Expected

short-term

direction

Change

over one

month

Equity Indices

S&P 500 2,510 2,730 -220 Increase Decrease

CAC 40 4,689 5,317 -628 Increase Decrease

DAX 30 10,580 12,449 -1869 Increase Decrease

FTSE 100 6,734 7,328 -594 Increase Decrease

Nikkei 225 20,015 21,784 -1769 Increase Decrease


US Treasury 10 Year Yield 2.66% 4.03% -136 bp Increase Decrease

French OAT 10 Year Yield 0.66% 0.68% -3 bp Stable Stable

German Bund 10 Year Yield 0.17% 0.32% -15 bp Increase Decrease

UK Gilt 10 Year Yield 1.21% 2.52% -131 bp Increase Decrease

Japan JGB 10 Year Yield 0.00% 0.02% -2 bp Stable Decrease

Corporate Spreads

Euro 5-7 Year A 78 bp 55 bp +24 bp Decrease Increase

US 5-Year A 136 bp 90 bp +47 bp Decrease Increase



TAC ECONOMICS 8


Medium-term economic outlook

2018 should be viewed as a transition year compared to 2017, from broad based and robust

to heterogeneous and decelerating economic growth, from accommodative to tightening

monetary policy, from low volatility and supporting valorization to sell-off episodes in financial

markets. This transition occurs in an uncertain environment with growing concerns over trade

protectionism and rising strategic tensions between US and China. Mature and EM economies

have entered the downside phase of the economic cycle at an uneven pace (still upside from

the US, slowdown in the EZ, risk materialization in specific EM countries).

2019 will be a year of synchronized slowdown, which can be split into two phases.

For 2019H1, an unstable phase with still supportive domestic economic environment (robust

labor markets and modestly increasing purchasing power because of lower oil prices on

households’ finance, neutral/accommodative monetary policy and mildly expansionary fiscal

policy) but combined with unresolved uncertainties (high volatility regime, trade tensions,

political events) and high probability of equity markets reversal. The negative impact of rising

interest rates spreading into reduced margins, weaker earnings to negative US corporate

profits will trigger a sharper US equity bear market during this first phase.

In 2019H2, the large equity markets adjustment will spread into the real economy (from the

US to the other mature economies and accentuated by the ongoing economic adjustment in

China) with a rapidly slowing demand and financial restructuring for borrowers with excess

leverage. For most of mature economies, our 2019 GDP growth scenario is almost unchanged

compared to our previous forecasts and still below the consensus: 2.3% in the US, 1.6% in the

EZ, 1.2% in Japan, except for the UK (at 1.5%) assuming our baseline scenario of an “orderly

Brexit” deal with the EU materializes.

The recent decline in equity markets and growing uncertainties / worries about 2019 probably

reflect a convergence of markets’ perceptions with our negative cyclical scenario for 2019H2

and 2020H1, with most risks skewed to the downside (political / geopolitical, pockets of

systemic vulnerabilities in both banks and non-bank financial institutions). Though our

quantitative models continue suggesting that both real economic drivers and financial

variables are not yet at “breaking-points”; the overall negative sentiment could prevent the

materialization of a short-term rebound in early 2019 with persistently volatile and mediocre

market performances.

Going forward into 2020, systemic (banking) risk appears so far limited, implying a “normal

cyclical unfolding”: the financial adjustment should be strong but temporary, and its impact

on real economic expansion concentrated in 2020H1 (1.3% y/y in the US, 0.9% in the EZ, 1.4%

in the UK, 0.1% in Japan). Oil prices and inflation should decline (with potential resurgence of

deflation threats) with end-2019 CPI projections at 1.7% in the US, 1.4% in the EZ, 2.1% in the

UK, 1.7% in Japan (VAT hike impact). Central bank’s ability to adjust their monetary policy

towards 2019/2020 will be key in determining the economic transmission. After 1 rate hike in

2019H1, the Fed will have fully “normalized” its policy instruments and therefore be ready to

lower Fed Funds (25bp cut by the end of 2019) and provide further “unconventional” liquidity

if needed inducing a large decline in US long-bond yields. Other central banks that were unable

to normalize their monetary policy (ECB, BoJ) will have to activate existing “non-conventional”

tools, alongside a plausible relaxation of budget policies and rules.


TAC ECONOMICS 9


Medium-term financial market outlook

This part aims at confronting our quantitative projections on sudden movements (EWS) and

directional trends (DTO) on financial markets with our global macroeconomic scenario and

financial analysis (key messages in the page above).

The main aspect compared to the previous quarter is the confirmation of our “judgment-based

assessment” of a period of financial tensions up to June 2019 (strong volatility on equity

markets and US corporate bonds with a large majority of EWS on “double signals”), though our

quantitative models continue suggesting that both real economic drivers and financial

variables are not yet at “breaking-points”.

Thereby, while the current QMA indicators validates our macroeconomic scenario of an

unstable phase with still supportive domestic economic environment (readable through

higher equity pricing and higher US government bond yields) but combined with unresolved

uncertainties (high volatility regime, trade tensions, political events), the high probability of

equity markets reversal around mid-2019 is still not shown by our models.

After the sharp market adjustment observed in December 2018, two types of scenarios may

be distinguished: (1) 2018Q4 markets’ moves are the beginning of our previously predicted

equity market reversal, which materialize earlier than expected; (2) 2018Q4 markets’ moves

allowed an adjustment of the past overvaluation/a risk reappreciation toward more consistent

macro-based analysis, thus may even lead to a “buy signal” for risk assets.

There are growing signs that the US and EZ economies are entering the downside phase of the

economic cycle, accentuated by worries about trade protectionism, political tensions and

emerging markets turbulences. But our models do not yet indicate a translation of

macroeconomic tailwind into a market financial adjustment albeit high financial market

volatility might persist with temporary sell-off episodes on specific markets (especially on US

government bonds). The January 2019 QMA signals indicate that the financial markets have

started an adjustment phase with several early signals of market reversal materializing

(financial conditions tightening pushing corporate spreads higher and higher volatility), but

still not close to “breaking points” (which would be shown by downward equity DTO).

We remain extremely cautious on 2019 outlook with most risks to our baseline scenario are

skewed to the downside. We highly recommend investors to prepare for an environment of

large volatility with subdued/negative returns to risky assets and a significant drag on

economic activity. Systemic risk appears so far limited, justifying a strong though short

financial adjustment, more limited in real economic terms.

Quantitative Market Alert – Mature Economies Monthly MarketQuant Research 2019Q1

TAC ECONOMICS 10


S&P 500

Early Warning Signals

(red=strong deterioration, blue=strong improvement, grey= double signal and white=no major change)

Jan.2019 Feb.2019 Mar.2019 3-month

outlook Apr.2019 May.2019 Jun.2019

6-month

outlook

Signals

↗

↗ Confidence * * * ** ** *

Source : TAC ECONOMICS

Evolution of S&P 500 Comparison of Actual vs. Fair Value

Fair Value (November 18) 2,730

Market Level 2,510

Gap to Fair Value -220

Expected short-term direction Increase

Change over one month Decrease


(Dotted lines in red represent EWS thresholds at -3.8bp and 4.2bp)

S&P 500 Early Warning Signals (EWS)

The red/blue line represents the deterioration/improvement probability of a major shock,

bars in red/blue the observed signals and the dotted line the EWS threshold


TAC ECONOMICS 11


Main drivers for S&P 500 EWS prediction

The following graphs describe the main archetypal determinants to predict strong changes for the next six months. We

distinguish macroeconomic indicators (in blue), financial market indicators (in red) from technical market analysis (in brown).

US Financing conditions Market correlations

US Financial stress index US Corporate spread 5-year A

EUZ Monetary conditions Market analysis


TAC ECONOMICS 12


CAC 40





6-month

outlook

Signals

↗

↗ Confidence * * * * * *


Evolution of CAC 40 Comparison of Actual vs. Fair Value


Market Level 4,689






CAC 40 Early Warning Signals (EWS)




TAC ECONOMICS 13


Main drivers for CAC 40 EWS prediction



EUZ Economic expectations US Credit Spread

Financial stress index EUZ Monetary Market



TAC ECONOMICS 14


DAX 30





6-month

outlook

Signals

↗

↗ Confidence * ** ** * * **


Evolution of DAX 30 Comparison of Actual vs. Fair Value


Market Level 10,580






DAX 30 Early Warning Signals (EWS)




TAC ECONOMICS 15


Main drivers for DAX 30 EWS prediction



US Financing conditions Market correlations

US Financial stress index US Corporate spread 5-year A



TAC ECONOMICS 16


FTSE 100





6-month

outlook

Signals

↗

↗ Confidence *** * * * * *


Evolution of FTSE 100 Comparison of Actual vs. Fair Value


Market Level 6,734






FTSE 100 Early Warning Signals (EWS)




TAC ECONOMICS 17


Main drivers for FTSE 100 EWS prediction



US Financing conditions Monetary policy

Market analysis GBR PER

EUZ Market volatility US Financial stress index


TAC ECONOMICS 18


Nikkei 225





6-month

outlook

Signals

↗



Evolution of Nikkei 225 Comparison of Actual vs. Fair Value


Market Level 20,015






Nikkei 225 Early Warning Signals (EWS)




TAC ECONOMICS 19


Main drivers for Nikkei 225 EWS prediction



US Financing conditions US Financial stress index

JPN PER EMBI+

Exchange rate US Financial stress index


TAC ECONOMICS 20


US Treasury 10 Year Yield





6-month

outlook

Signals

↗

↗ Confidence ** * * * * *


Evolution of US Treasury 10 Year Yield Comparison of Actual vs. Fair Value

Fair Value (November 18) 4.0%

Market Level 2.7%

Gap to Fair Value -136 bp





US Treasury 10 Year Yield Early Warning Signals (EWS)




TAC ECONOMICS 21


Main drivers for US Treasury 10 Year Yield EWS prediction



US Economic activity US Financial stress index

EUZ Consumer confidence US Financing conditions

Market correlations US Financial stress index


TAC ECONOMICS 22


French 10-year bond yield





6-month

outlook

Signals

↘

↘ Confidence ** ** * * * *


Evolution of French 10-year bond yield Comparison of Actual vs. Fair Value


Market Level 0.7%


Expected short-term direction Stable

Change over one month Stable



French 10-year bond yield Early Warning Signals (EWS)




TAC ECONOMICS 23


Main drivers for French 10-year bond yield EWS prediction



EUZ inflation EUZ economic activity

Global Economic activity Market correlations

Market correlations French Market conditions


TAC ECONOMICS 24


German 10-year bond yield





6-month

outlook

Signals

↘

↗ Confidence ** * * * ** *


Evolution of German 10-year bond yield Comparison of Actual vs. Fair Value


Market Level 0.2%






German 10-year bond yield Early Warning Signals (EWS)




TAC ECONOMICS 25


Main drivers for German 10-year bond yield EWS prediction



EUZ Economic activity US financing conditions

US Financing conditions EUZ Monetary conditions

Fair value Market correlations


TAC ECONOMICS 26


UK Gilt 10 Year Yield





6-month

outlook

Signals

↘

↗ Confidence * * * * * **


Evolution of UK Gilt 10 Year Yield Comparison of Actual vs. Fair Value


Market Level 1.2%






UK Gilt 10 Year Yield Early Warning Signals (EWS)




TAC ECONOMICS 27


Main drivers for UK Gilt 10 Year Yield EWS prediction



US economic activity EUZ Economic confidence

Fair value US Financing conditions

US Corp. Bond market US Corp. Bond market


TAC ECONOMICS 28


Japan JGB 10 Year Yield





6-month

outlook

Signals

↗



Evolution of Japan JGB 10 Year Yield Comparison of Actual vs. Fair Value


Market Level 0.0%


Expected short-term direction Stable




Japan JGB 10 Year Yield Early Warning Signals (EWS)




TAC ECONOMICS 29


Main drivers for Japan JGB 10 Year Yield EWS prediction



US Financing conditions US economic activity

EUZ money market Exchange rate

EMBI+ Oil prices


TAC ECONOMICS 30


EUZ Corporate spread 5-7 year A





6-month

outlook

Signals

↘

↘ Confidence * * * * * **


Evolution of EUZ Corporate spread 5-7 year A Comparison of Actual vs. Fair Value

Fair Value (November 18) 55 bp

Market Level 78 bp

Gap to Fair Value +24 bp

Expected short-term direction Decrease

Change over one month Increase



EUZ Corporate spread 5-7 year A Early Warning Signals (EWS)




TAC ECONOMICS 31


Main drivers for EUZ Corporate spread 5-7 year A EWS prediction



German Economic expectations EUZ Economic confidence

Fair value EMBI+

Market correlations Market analysis


TAC ECONOMICS 32


US Corporate spread 5-year A





6-month

outlook

Signals

↗

↘ Confidence * * * * * *


Evolution of US Corporate spread 5-year A Comparison of Actual vs. Fair Value

Fair Value (November 18) 90 bp

Market Level 136 bp

Gap to Fair Value +47 bp

Expected short-term direction Decrease

Change over one month Increase



US Corporate spread 5-year A Early Warning Signals (EWS)




TAC ECONOMICS 33


Main drivers for US Corporate spread 5-year A EWS prediction



US Labor market US Economic activity

US Financing conditions German Economic expectations

Fair value Market analysis


TAC ECONOMICS 34


Thresholds for monthly signals: Reminder

The following table summarizes the Early Warning Signals (EWS) thresholds for each QMA

available market.

EWS strong deterioration

signals threshold

EWS strong improvement

signals threshold

Equity Indices

S&P 500 -3.9% 4.3%

DAX 30 -5.5% 6.0%

CAC 40 -5.1% 5.0%

FTSE 100 -3.9% 4.0%

Nikkei 225 -6.2% 6.2%

BEL 20 -4.4% 4.7%

SMI -4.1% 4.3%


US Treasury 10 Year Yield -18.1bp 20.5 bp

German Bund 10 Year Yield -17.4 bp 15.3 bp

French OAT 10 Year Yield -20.3 bp 16.7 bp

UK Gilt 10 Year Yield -22.8 bp 20.8 bp

Japan JGB 10 Year Yield -7.6 bp 4.9 bp

EUZ Interest rate swap 10 YR -15.3 bp 13.0 bp

Belgium Bond yield 10 YR -21.9 bp 17.0 bp

Switz Bond yield 10 YR -12.7 bp 12.2 bp


US Interest rate swap 5 YR -16.0 bp 19.0 bp

German Bund 5 Year Yield -13.2 bp 11.6 bp

French OAT 5 Year Yield -16.3 bp 12.1 bp

UK Gilt 5 Year Yield -19.6 bp 17.8 bp

Japan JGB 5 Year Yield -4.1 bp 2.5 bp

Belgium Bond yield 5 YR -16.9 bp 9.7 bp

Switz Bond yield 5 YR -10.5 bp 8.6 bp

EUZ Interest rate swap 5 YR -12.3 bp 9.7 bp

Corporate Spreads

Euro 5-7 Year A -9.3 bp 8.5 bp

US 5-Year A -13.7 bp 14.1 bp

Euro 5-7 Year BBB -15.8 bp 15.7 bp

US 5-Year BBB -22.9 bp 22.6 bp

US 7-year A -15.0 bp 14.7 bp

US 7-Year BBB -22.9 bp 22.9 bp



TAC ECONOMICS 35


Disclaimer

These assessments are, as always, subject to the disclaimer provided below.

This material is published by TAC ECONOMICS SAS for information purposes only and should not be regarded as

providing any specific advice. Recipients should make their own independent evaluation of this information and no

action should be taken, solely relying on it. This material should not be reproduced or disclosed without our consent. It

is not intended for distribution in any jurisdiction in which this would be prohibited. Whilst this information is believed

to be reliable, it has not been independently verified by TAC ECONOMICS and TAC ECONOMICS makes no representation

or warranty (express or implied) of any kind, as regards the accuracy or completeness of this information, nor does it

accept any responsibility or liability for any loss or damage arising in any way from any use made of or reliance placed

on, this information. Unless otherwise stated, any views, forecasts, or estimates are solely those of TAC ECONOMICS, as

of this date and are subject to change without notice.

Your contacts at TAC ECONOMICS

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TAC ECONOMICS team is available for any economic, financial, technical questions and requests at the following e-

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