monthly strategy report november 2017 - banca march...monthly strategy report. november 2017 crisis....

Monthly Strategy Report November 2017

Paulo GonçalvesSpecialist Technician, Research Services

The green gold that changed Brazil... “um cafezinho”

Monthly Strategy Report. November 2017

The green gold that changed Brazil... “um cafezinho”

This roasted bean that figures prominently on our breakfast tables has obscure origins, often disputed by historians. Several legends aim to shed light on the discovery of its properties.

One of the most popular and imaginative—though not roundly accepted—theories places the discovery of coffee in the 7th century by a goatherd named Kaldi, whose goats roamed the slopes of Kaffa (Abyssinia, today a region of Ethiopia). One day several goats went astray and upon finding them, the goatherd was surprised by their state of excitement, realising they had eaten some small red berries nearby. This sparked his curiosity and he decided to try them for himself. Soon after, he too became energised and experienced trouble sleeping.

The goatherd decided to share his discovery with the local people and quickly the Imam began preparing infusions with Kaldi’s beans, confirming that he himself could stay awake all night. He offered them to his disciples to extend their prayers. From that moment, roasting the beans and trying to improve their flavour was a logical progression.

What is known for certain is that by the 15th century, and likely before, coffee was grown in Yemen. This essay will explore how a bean from Africa happened to change an economy as sizable as Brazil’s, omitting a portion of the fruit’s long trajectory.

Several attempts were made to extract fertile seeds from Arab populations, but they fought to prevent its cultivation in other territories and coffee production remained squarely in Arab hands until the 17th century. Such was the care taken to retain dominance of production that they boiled the seeds before permitting their sale abroad.

Venetian merchants were the first to introduce coffee in Europe, thanks to their commercial relations with the Arabs, but the Dutch would be responsible for the crop’s expansion. Stories tell of Dutch navigators who stole a coffee plant from the coast of Mocha and, from it, managed to propagate the cultivation of coffee in Dutch colonies in India. In any event, the late 17th century marked the loss of a monopoly in production as the coffee plant spread rapidly around the globe.

The Dutch began to control the coffee trade with production in its Asian colonies, and the Dutch East India Company supplied the thriving European market, where the aristocracy gradually began to acquire a taste for coffee.

But it was the French, under the reign of Louis XIV, who would take the plant on a new adventure, this time bound for their colonies in America. Following the signing of the Treaty of Utrecht, the Dutch gave the King of France a coffee plant, which was deposited with the utmost honours at the Jardin du Roi in Paris in 1714. Some years later, a young officer in the French navy, who served on the island of Martinique, Gabriel Mathieu de Clieu, one of the “heroes” of coffee’s expansion, decided to transport the plant to the Antilles, after noticing the enthusiasm that coffee consumption generated in the French metropolis.

This was no easy task for the officer. He was banned from obtaining grafts of the plant, so he had to remove it from Paris’s Royal Botanical Gardens by other, more unscrupulous means. And thus, in May 1723, de Clieu embarked in Nantes for Martinique with his prized coffee sapling.

The trip was laden with difficulties. Transportation of the plant required protection, so de Clieu crafted a wooden box protected by glass that provided the plant with sunlight on deck while sheltering it from the wind and salt water. During the journey, both the plant and the French officer survived an attack by Tunisian pirates and, naturally, violent sea storms. When the storms subsided and calm prevailed,


the absence of wind under a scorching sun prolonged the crossing and, according to Mathieu de Clieu’s diary, he was forced to share his minimal water ration with the plant.

At last, de Clieu reached his destination and quickly planted his precious treasure in the ground, effectively extending coffee cultivation to Martinique. The first bountiful harvest occurred within a period of 18-20 months. Thus, coffee had arrived in America but it remained in the control of the French, who guarded it like gold. But a new, surprising turn of events was approaching.

In 1727, the Portuguese governor of the state of Maranhão, João da Maia da Gama, dispatched the Luso-Brazilian lieutenant, Francisco de Mello Palheta, to French Guiana, supposedly to mediate a border conflict, but the true intent of the Portuguese, who knew the value of the crop, was to obtain coffee seeds at all costs.

Lieutenant Francisco quickly earned the confidence of the French governor and endeavoured to persuade him to part with a coffee plant, under the pretext that he would plant it in his own garden. However, his host, Mr. d´Orvilliers, explained that he had explicit orders from the King of France not to let a single coffee seed leave French soil. Despite the negative response, the lieutenant did not abandon his mission. According to legend, Francisco de Mello Palheta had also gained the trust (and something more) of the French governor’s wife, who—prior to his departure—secretly gave the Luso-Brazilian lieutenant a fistful of the much-desired fruit (coffee, in this case). This beautiful and—according to chronicles—passionate gesture opened the door to the loss of a valuable source of revenue for France.

Having fulfilled his mission, Francisco de Mello Palheta returned home and started a coffee plantation, which thrived in the Brazilian soil and climate. In 1731, in letters sent to Lisbon, it was reported that there were so many quality plantations that, within a couple of years, it would be possible to supply the city with all the coffee necessary.

Nevertheless, barriers persisted, planting the seeds of doubt in the minds of Brazilians, who curbed further expansion of coffee production. At the time in Brazil, sugar cane was the dominant crop and the country’s main product, while the coffee trade was still controlled by the Dutch and the French. It is at this point that a new development would catapult the production of Brazilian coffee.

In late 1806, Napoleon declared a ban on British products in Europe (Continental Blockade). This trade embargo, which sought to damage the British economy by depriving it of some of its most lucrative markets, also made it difficult for continental Europe to import commodities grown outside of the continent, with the primary routes under British control. In Germany, meanwhile, the chemist Marggraf discovered a process that enabled the extraction of sugar from beets, giving Europe a substitute for Brazilian sugar.

These events ultimately facilitated the establishment of coffee cultivation in Brazil, at the expense of sugar cane (coffee substitutes, mainly chicory, failed to achieve the same success in Europe as those of sugar). Production changed quickly in Brazil, which capitalised on its extensive territory and sizeable workforce at the time. The land was fertile and the climate ideal for the coffee plant. Thus, at the beginning of the 20th century, Brazil was already world’s primary coffee producer and much of its economic development would be based on the bean.

The seed’s long journey to Brazil, full of adventure and riveting detail, prompted profound changes not only in the history of Brazil, but of many other economies. It is another example of how trade and its barriers can transform societies. Seemingly insignificant details can result in perennial losses (or gains), factors that should not be ignored in our own time.

Not everything was rosy for Brazil. The rapid and overwhelming success of coffee cultivation also led to excesses. Years later, with the advent of coffee fever, overproduction arrived and with it, the crisis… but that’s a story for another day.

Monthly Strategy Report November 2017

Banca March Market Strategies Team:

Joan Bonet Majó, Director, Market Strategies Team

Pedro Sastre, Director, Analysis Services

Paulo Gonçalves, Specialist Technician, Research Services

Miriam Ordinas, Specialist Technician, Analysis Servies

Joseba Granero, Specialist Technician, Analysis Services

Catalonia, the ECB and corporate results occupy the spotlight in October


Catalonia, the ECB and corporate results occupy the spotlight in October

Tension in Catalonia: from the referendum to article 155 of the Constitution...

October saw the holding of an illegal referendum in Catalonia and the subsequent declaration of independence by the government of the Generalitat. At the request of the central government and in response to these events, article 155 of the Constitution served as the legal basis to dissolve the Catalan Parliament and announce a snap regional election on 21 December. Despite periods of volatility, the apparent return of the status quo allowed the stock market and Spanish bonds to close October with gains.

…and the earnings season advances at a healthy pace.

The European Central Bank kept interest rates at 0% and announced its strategy for the coming months: a curtailment of net asset purchases from €60 bn/month to €30 bn/month from January through September 2018 (with possible extensions), and unlimited liquidity auctions to be held as long as necessary, but at least until 2019. The ECB maintains that it will implement a gradual reduction of its accommodative policy in light of the improved economic climate. The announcement had a positive effect on European bonds and weakened the euro against the dollar.

The IMF improved its global economic outlook...

The corporate earnings season is unfolding as expected, with quarterly growth in profits and revenues that have eased slightly relative to the pace of recent quarters. In the case of the S&P500, the consensus suggests quarterly growth in profits and revenues of 7% and 5%, respectively. By month-end, 65% of companies listed on the index had published results with a positive-surprise ratio of 73% in EPS and 67% in revenue, both above the historical average.

In Europe, the corporate earnings season is less advanced, though the consensus suggests growth will surpass that expected in the US.

…with the United States and the eurozone looking good.

The IMF’s World Economic Outlook report forecasts higher global economic growth, similar to pre-crisis levels: +3.6% this year and +3.7% in 2018. The improvement is the upshot of better performance from developed economies and the good overall performance of the emerging bloc, where growth is only expected to decline in India.

The US confirmed an improved economic situation in the wake of hurricane season. Economic growth rebounded in the quarter to 3% annualised and the survey of private-sector job creation anticipates a sharp upswing in October. Business and consumer confidence indicators remain near maximum levels and industrial production rose after “Harvey” and “Irma.” In the realm of politics, we are still awaiting approval of the fiscal stimulus measures proposed by the White House.

In Europe, economic growth advanced at a good pace, with Q3 GDP at 2.5% y-o-y, consistent with very favourable confidence and activity data for the region. It is worth noting the unemployment rate, unchanged in August at 9.1%, the lowest level since 2009, and price moderation, with the October CPI at 1.4%, far from the ECB’s target.

In Asia, Abe’s victory and the Communist Party Congress eclipsed macro data.

In Spain, the macro data published failed to reflect the foreseeable adverse impact of the Catalan


crisis. Notably, Q3 GDP growth reached +3.1% y-o-y, and unemployment evolved favourably as of the September close: the number of workers registered for Social Security exceeds 19 million, the highest level since September 2009.

In Japan, Shizo Abe secured the electoral win that will allow him to move forward with tax hikes and the reform of the Japanese constitution. Despite the fiscal and monetary measures implemented in recent years, inflation remains very contained, closing September at 0.7% y-o-y.

Another positive month for equities, buoyed by the good global situation and corporate results.

In China, the tone of the 19th Communist Party Congress was more qualitative than quantitative in the pursuit of a more open economy, better relations with Taiwan, and the creation of companies with foreign capital. In this context, the soft landing of the Chinese economy was reaffirmed, with Q3 GDP of 6.8% y-o-y and improvements in industrial production and retail sales.

The good momentum of the global situation, a season of positive results, and the favourable currency effect explain the positive performance of European stocks in October: +2.2 EuroStoxx50, +3.1% Dax, +3.2% CAC, and +1.6% Footsie. The IBEX, meanwhile, gained +1.4%, an encouraging development slightly hindered by uncertainty in Catalonia. Leading the gains were securities like ArcelorMittal, Siemens Gamesa, and Cellnex, while banks like Caixabank (-5.2%) and Sabadell (-2.7%) suffered losses.

Slight losses for US sovereign bonds and gains in Europe thanks to the ECB.

It was also an outstanding month for Japanese equities (+8.1% Nikkei), buoyed by the election results. In the US, both the S&P (+2.2%) and the tech-heavy Nasdaq (+3.6%) saw gains, owing to a positive earnings season and in anticipation of approval for economic stimulus. For its part, the MSCI Emerging Markets Index posted notable gains of +3.4% in October.

Gains were repeated on the credit market, while sovereign debt in local currency suffered.

The anticipated US interest-rate hike adversely affected the country’s bonds, with the IRR on US 10-year bonds at +5 b.p. and its sovereign index at -0.1%. In Europe, by contrast, the ECB’s commitment to a very gradual withdrawal of stimulus served to bolster the continent’s fixed income. The German 10-year rate yielded 10 b.p. to 0.37%, while the Spanish equivalent yielded 14 b.p. to 1.5%. The risk premium closed the month at 109 b.p., from the 130 b.p. that it reached at the worst moment of the crisis in Catalonia.

The euro loses ground against the dollar.

The ECB’s pledge to continue buying corporate debt issues in Europe and the narrowing of credit spreads on the continent explain its positive monthly evolution in both investment-grade (+1.1%) and high-yield (+1.2%). US credit indices also experienced a positive evolution, albeit moderate, while the sovereign debt of emerging economies shed 2% in local currency.

Oil rebounds, gold declines.

For the second consecutive month, the single currency closed with losses against the dollar. The movement is justified by i) a potential increase in the rate spread between the two blocs, should the Fed increase rates in December as expected, and ii) US GDP data, which exceeded expectations. The closing price was 1.164 EUR/USD, down -1.4% during the month. The pound sterling, meanwhile, advanced 0.6% to 0.877 GBP/EUR, despite the sluggish progress of Brexit negotiations with the European Union.

Crude oil had another excellent month, gaining +6.6% to $61.37/barrel, following confirmation


of the agreement between OPEC and Russia to extend production cuts and the escalation of tensions in Iraqi Kurdistan. Gold, meanwhile, closed 0.7% lower, hitting $1,271/ounce, although it has accumulated +10% so far this year.


Strategy for November 2017

ASSET ALLOCATION

Overweighting Neutral Underweighting

Shares Cash Fixed Income

Alternatives

ASSET ALLOCATION

Overweighting Neutral Underweighting

EquitiesEurozone EE.UU.

Emerging market

Bonds

Emerging market debt

High-yield corporate debt

Investment-grade corporate debt

Convertible Bonds Sovereign bonds

Alternatives Absolute returnDiversified

Absolute returnMixed asset

Sharp cumulative returns, but still no need to reduce risk.

With only two months until year-end, the accumulated returns of the main global stock markets are significant, surpassing 11% in all European indices. The S&P 500 has seen gains in 11 of the last 12 months. Equity markets appear to have grown accustomed to an environment of low volatility. We know that cannot last forever, but history has shown us that very low volatility does not necessarily mean the equity party has to end immediately.

The factors propelling stocks will persist in the near future. Additional liquidity from the ECB.

The current market rally is based on three factors that we do not expect to change in the impending future:

1. The liquidity of the Central Banks. The economy and financial assets continue to be heavily influenced by the strong stimuli used by the central banks to intervene in the market. The ECB’s recent decision will entail an additional EUR 270 billion in the system and, therefore, EUR 2.3 trillion in unconventional programmes that will prolong this artificial liquidity situation until at least September 2018.

Strong corporate results exceed expectations.

2. The steady evolution of corporate results. More than half of European and American companies have already published their figures and profits are exceeding expectations. With growth surpassing 10% in Europe and 7% in the US, it is important to note that the percentage of positive surprises is higher in the US (+4%) than in Europe (+1%) because of the strength of the euro during the summer months.

Global growth improves.

3. Macroeconomic figures continue to improve. Leading economic indicators anticipate a recovery in economic growth. US business confidence is approaching levels not seen since 2004, consumer confidence in Europe has rebounded significantly, and business expectations in the manufacturing industry are buoyed by the favourable contributions of domestic spending and exports. In fact, in the PMI calculation, the rebound in demand


is so strong in Europe that companies cite problems with the current installed capacity, and employment in the manufacturing industry is growing at the fastest rate since data collection began in June 1997.

The cyclical bias continues.

We believe that despite sharp rises in the market and the fact stock market potential is increasingly limited, it is still too early to abandon a positive outlook for risk assets.

By sector, we continue to favour investment in sectors more sensitive to the economic cycle, like industry, technology, and finance.

Europe will begin to perform better.

By geographic area, we still prefer the European market where the cycle is less advanced, financing costs are lower, valuations are more attractive, and estimated profit growth is higher.

The impact on Spain’s macro figures will be perceptible from next month, but it will be -0.3% if the polls offer a quick solution.

In Spain, markets will remain expectant in the run-up to the regional elections in Catalonia on 21 December, despite the fact that the uncertainty generated since 1 October has already begun to have economic repercussions, with a slowdown in business investment and residential investment that accounts for 6% of GDP. These factors will mean Spain’s current GDP of 3.1% will decline -0.3%; this will be reflected in the figures from the end of this month. In any case, our growth forecast for Spain, despite the political uncertainty, is stronger than the average of eurozone countries, and Spain’s growth spread would only equal the European average with a prolongation of the current situation until summer 2018.

We remain cautious with bonds, particularly those with long durations.

With regard to fixed income, we recommend caution, especially in sovereign bonds with long maturities and very expensive valuations. The aforementioned decisions of the ECB lead us to believe that negative deposit rates in Europe will begin to normalise in the second half of 2018, but it is necessary to capitalise on the recent rise in long-term rates to reap the benefits.

In the US, the FED will begin to reduce its balance sheet this month, taking a further step toward curtailing the strong, unconventional measures carried out during the 10 years of economic stimulus.


Opportunities exist in emerging bonds and corporate debt.

Bond opportunities hinge on emerging markets in EUR and USD, as well as high-yield private debt issues. Within private fixed income it is important to favour short sections of the curve.

The USD should appreciate in the short term.

On the currency market, in light of the extension of stimulus by the ECB and expectations of a rate hike on the part of the Fed at the 13 December meeting, we maintain a positive outlook wherein the dollar should continue to appreciate slightly, to around 1.15 EUR/USD. In addition, the perception of the US economy could improve if a minimum agreement is reached to implement the Trump administration’s tax reform.

The upside potential of stock markets persists.

In conclusion, the medium-term scenario remains encouraging despite prolonged increases in US equities. The investment bias should favour assets with greater exposure to cyclical improvements. Nevertheless, we should avoid an excessive sense of security because current valuations are starting to become demanding and markets do not tend to behave linearly.


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.

March Gestión de Fondos, S.G.I.I.C., S.A.U. does not assume any responsibility for any direct or indirect cost or loss which may result from the use of this document or its contents. No part of this document can be copied, photocopied or duplicated in any way or through any means, redistributed or quoted without a previous written authorization by March Gestión de Fondos, S.G.I.I.C., S.A.U.

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 november 2017 - banca march...monthly strategy report. november 2017 crisis....

Documents