rubrics asset management global reflation fades march … · global reflation fades march 2019...

OVERVIEW

2019 has seen continued divergence between financial markets and economic reality. Risk assets have

had one of their strongest starts ever despite the clear decline in economic data - a theme that has

become especially prevalent post 2008.

We examine in this piece some of the current macroeconomic trends which have supported financial

markets in the past 3 months, whilst exploring the longer term sustainability and effectiveness of

further central bank support. Lastly we highlight what we believe might be the catalyst for renewed

volatility.

March 2019Global Reflation Fades

RUBRICS ASSET MANAGEMENT

Overview

2019 has seen continued divergence between financial markets and economic reality. Risk assets have had one of their strongest starts ever despite the clear decline in economic data - a theme that has become especially prevalent post 2008. We examine in this piece some of the current macroeconomic trends which have supported financial markets in the past 3 months, whilst exploring the longer term sustainability and effectiveness of further central bank support. Lastly we highlight what we believe might be the catalyst for renewed volatility.

Current Dynamic – Risks Assets vs The Real Economy

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Citi Economic Surprise Index - China

China Exports-20.7% vs -5.0%

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US Retail Sales-1.2% vs +0.1% exp

Non Farm Payrolls20k vs 180k expected

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S&P 500 Index (YoY, in %, right axis)

36 per. Mov. Avg. (US Real GDP Growth (SA, YoY, in %))

36 per. Mov. Avg. (S&P 500 Index (YoY, in %, right axis))

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Clear deviation between economicand financial market growth. Is convergence inevitable?S&P 500 Yoy % Chg Mov Avg

US Real GDP Yoy % Chg Mov Avg

Historical Performance Dichotomy - S&P 500 vs US Real GDP

2019 Surge in Risk Assets 2019 Economic Data Disappointment

Source: Bloomberg

Source: Bloomberg

Source: Bloomberg

Source: Bloomberg

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US High Yield ETF (HYG) LHS

US Equity ETF (SPDR) RHS

Global Reflation Fades

Reflated Expectations

Notwithstanding news headlines on trade war resolutions, Brexit agreements etc., the dramatic turnaround in risk assets from December ‘18 lows has been driven mainly by the substantial shift in global central bank positioning to a more dovish stance. This change has emanated from the Federal Reserve, the People’s Bank of China and the European Central Bank.

Source: Bloomberg

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Global Money Supply in USD, 3m chgs in bps / in % (or gwth rate in %) ann

S&P 500 INDEX, 3m chgs in bps / in % (or grth rate in %) ann (right axis)

Global USD Liquidity Impulse and Risk Assets

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US Real Interest Rates (QoQ, chgs in bps, inverted axis, adv by 30 trading days)

US High Yield Index (QoQ, returns in %, right axis)

Tightening

Loosening

US Real Rates and US High Yield Performance

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Probability of Hike Probability of No Change Probability of a Cut

Drop in rate

expectations

Shifting Rate Outlook

Along with the change in expectations, in the past 3 months the global system has seen an increase in USD liquidity (approx. +$250bln), a drop in US real rates (approx. 70bps) and a non-appreciating US Dollar (a critical element). All positives for risk assets. While heightened anticipation of increased monetary support has no doubt buoyed market sentiment – how likely is this to materialise in reality? And furthermore, do the credit markets have sufficient capacity to make these policies as effective as in previous cycles?

Future Stimulus Constrained

With the so called ‘Shanghai Accord’ of early 2016 still relatively fresh in the memory, the heightened level of investor expectation for a renewed stimulus push is palpable. We are not so convinced however. For one, we do not believe that central banks currently have the ammunition (political) for such a co-ordinated action. Secondly, we would strongly question the current global capacity for yet another round of expansion due to the highly leveraged nature of the world’s largest economies and thirdly, we feel the effectiveness of potential future programmes would be limited with markets at current valuation levels.

ECB – Diminishing Marginal Returns

Previous ECB programmes have had the undoubtedly positive impact of compressing peripheral bond spreads, reducing corporate borrowing costs in addition to helping promote a degree of growth in the money supply. However as noted above, with spreads currently close to all time lows, the impact of further stimulus would surely be negligible – witness the muted response to the latest ECB TLTRO announcement.

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iTraxx Sub FinancialsLTRO

TLTRO I

TLTRO II TLTRO III

Source: Bloomberg

Market Reaction – Peripheral Bond Spreads and ECB Intervention

Real World Impact – Money Flowing to the Economy

Source: Bloomberg

Source: Bloomberg

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Low Impact

Market Reaction – Sub Financial Spreads

Meanwhile the failure of previous programmes to create sustainable growth in money supply is likely indicative of a problem with the transmission mechanism. Put simply – do banks want more central bank liquidity? Lest we forget, the new dovish policies being hailed by financial markets do not represent fresh stimulus, but are merely replacement financing for existing programs which begin to roll off in 2020.

China – Unstable Credit Dynamics

After a decade of substantial stimulus - both monetary and fiscal – allied to a still favourable demographic profile, China’s capacity to continue on its elevated growth trajectory has come into question. Despite $trillions in fiscal and monetary intervention, economic reflation has ultimately proved unsustainable. Headline figures like credit defaults and elevated shadow banking markets combined with slowing money supply demonstrate the challenging environment for the PBOC. Recent stimulus package announcements have been conspicuous in their lack of size compared to previous stimulus efforts e.g. 15 March NPC announcement.

What Reflation?

The spectacular jump in Chinese Aggregate Financing in January generated heightened optimism in financial markets of a renewed credit expansion. The subsequent follow through however has been underwhelming. Despite recently announced measures (VAT reductions etc), China remains a long way away from matching the size of the 2015/2016 stimulus which had a real impact on China’s (global) credit impulse. As with the world’s other largest economies, question marks remain over the likely effectiveness of further programmes given a) the scale of China’s debt burden and b) the level of industrial over-capacity, both of which are creating a drag on economic momentum.

Source: BloombergSource: World Bank, Morningstar

Source: BloombergSource: Bloomberg

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China Credit Impulse (12mo lead) Industrial Metals Commodity Index

China Money Supply

China Fiscal Stimulus - Aggregate Financing

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China Credit Impulse and Global Commodities

China Debt Burden

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US – Balance Sheet Conundrum

Following the previous discussion on the re-alignment of rate expectations in the US, there has also been a decided shift in the narrative coming from Fed Chair Powell regarding the balance sheet runoff programme. In a short period of time (late November to late December) the Fed have shifted from a stance of ‘QT on autopilot’ to one where they ‘wouldn’t hesitate’ to adjust the normalisation process in response to market turmoil.

Whilst it is clear that the terminal size of the Fed’s balance sheet will be significantly larger than pre-crisis levels, there are differences of opinion in exactly how far the Fed will go in its normalisation.

Soundings from the Fed have been decidedly more dovish in this regard in the aftermath of December’s market correction. Nonetheless, it has been mentioned numerous times by Federal Reserve governors that they will act on rates first in response to a deteriorating growth environment. Any policy change regarding the balance sheet will be a second order occurrence perhaps in response to a larger correction in asset prices.

Source: Bloomberg

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Estimates for Terminal Size of Fed Balance Sheet

FED Total Assets (in USD mil)

S&P 500 Index (right axis)

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Not only is credit creation important for continued economic growth, but it is also fundamental to the central banks’ ultimate goal of supporting economic growth through a wealth effect. Over the last decade central banks have facilitated rising markets in two essential ways; firstly, by keeping nominal rates low it has boosted valuations of many different asset classes like equities and corporate bonds that benefit from lower discount rates. Secondly, Quantitative Easing has encouraged excessive credit creation and facilitated higher leverage ratios. This in turn has supported markets as improved fundamentals have underpinned further asset price appreciation. These actions, while positive for asset prices, have unintended consequences when things start going the other direction.

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Global Money Supply in USD, 3m chgs in bps / in % (or gwth rate in %) ann

S&P 500 INDEX, 3m chgs in bps / in % (or grth rate in %) ann (right axis)

Global USD Liquidity Impulse and Risk Assets

Source: Bloomberg

US – Credit Constraints

The impact of nearly a decade of expansive monetary polices has certainly been felt in the amount of debt taken on in the US system. Consumer debt via auto loans, student loans and credit card debt continue to hit new highs while on the corporate side, C&I loans, corporate bonds and leveraged loans have also seen exponential growth. As a % of US GDP, the amount of non-financial corporate debt continues to surpass the tipping points of previous cycles. Morgan Stanley's analysis on the investment grade credit market showed how on leverage ratios alone, 50% of investment grade corporate bonds would in fact be high yield1. Meanwhile 72% of EPS growth since 2012 has been driven by share buy backs2, a great deal of which were financed by this explosion in corporate debt.

Diminishing Marginal Returns on Credit Expansion

Our concern at the moment is not whether we are facing another credit crisis this year (we still believe financial conditions are OK) but as explored previously, how effective more stimulus be. Yes, low rates can help expand future debt levels, however as with previous cycles, at some point the threshold will be breached and a similar outcome reached. Credit has been the major driver of growth over the last 20 years and as a result of chronic over capacity, we are now facing major constraints in terms of further debt creation. It is our belief that any future stimulus announcements will ultimately disappoint in terms of their economic outcomes and could create an environment even less sustainable than the current one.

March 2019

Source: Bloomberg

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1. https://www.bloomberg.com/news/articles/2018-11-16/morgan-stanley-warns-bond-boom-and-b-b-bust-would-hit-growth2. https://seekingalpha.com/article/4157367-stock-buybacks-driving-market-current-status?

March 2019

https://www.bloomberg.com/news/articles/2018-11-16/morgan-stanley-warns-bond-boom-and-b-b-bust-would-hit-growth

Macro Financial Conditions – Tightening in store?

Whilst we have witnessed pockets of volatility in credit over the past 12 months, driven by tightening central bank liquidity and an increase in real rates, the key component of the financial conditions equation (growth) remained in tact. With an aging business cycle and falling growth this can cause a tightening in macro financial conditions leading to a significant re-pricing (amongst other things) of credit risk.

Micro Level – Defaults rising

Spreads on US high yield have so far tightened by approximately 160 bps in 2019 with aggregate levels now back below 400 basis points1. In spite of this, ratings agencies are downgrading more companies than they are upgrading in the high yield space with US issuers in particular seeing a higher downgrades to upgrades ratio. In addition, there have been some reasonably sized debt issuers filing for bankruptcy – e.g. PG&E (~$18bn of long term debt) and Windstream ($3.5bn of debt) - with the “pipeline” of companies that may file in the next year adding up judging by the number of bonds trading at distressed levels.

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Selection of Global Manufacturing PMI DataMacro Financial Conditions: Real Rates – Real GDPFeb

2019Jan

2019Dec

2018Nov 2018

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Sep 2018

Aug 2018

Jul 2018

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Mar 2018

Brazil 53.4 52.7 52.6 52.7 51.1 50.9 51.1 50.5 49.8 50.7 52.3 53.4

Canada 52.6 53.0 53.6 54.9 53.9 54.8 56.8 56.9 57.1 56.2 55.5 55.7

Mexico 52.6 50.9 49.7 49.7 50.7 51.7 50.7 52.1 52.1 51.0 51.6 52.4

U.S. 53.0 54.9 53.8 55.3 55.7 55.6 54.7 55.3 55.4 56.4 56.5 55.6

Austria 51.8 52.7 53.9 54.9 53.8 55.0 56.4 56.8 56.6 57.3 58.0 58.0

Czech Republic 48.6 49.0 49.7 51.8 52.5 53.4 54.9 55.4 56.8 56.5 57.2 57.3

France 51.5 51.2 49.7 50.8 51.2 52.5 53.5 53.3 52.5 54.4 53.8 53.7

Germany 47.6 49.7 51.5 51.8 52.2 53.7 55.9 56.9 55.9 56.9 58.1 58.2

Italy 47.7 47.8 49.2 48.6 49.2 50.0 50.1 51.5 53.3 52.7 53.5 55.1

Spain 49.9 52.4 51.1 52.6 51.8 51.4 53.0 52.9 53.4 53.4 54.4 54.8

Turkey 46.4 44.2 44.2 44.7 44.3 42.7 46.4 49.0 46.8 46.4 48.9 51.8

China 49.9 48.3 49.7 50.2 50.1 50.0 50.6 50.8 51.0 51.1 51.1 51.0

Japan 48.9 50.3 52.6 52.2 52.9 52.5 52.5 52.3 53.0 52.8 53.8 53.1

South Korea 47.2 48.3 49.8 48.6 51.0 51.3 49.9 48.3 49.8 48.9 48.4 49.1

Taiwan 46.3 47.5 47.7 48.4 48.7 50.8 53.0 53.1 54.5 53.4 54.8 55.3

Contraction ExpansionDecline

1. Bloomberg Barclays US Corporate High Yield Average OAS

Headwinds / Tailwinds

We have examined some of the longer term factors which we believe will act as catalysts for an environment of increased volatility. Ultimately it will come down to concerns about the future growth outlook and the potential effectiveness of future central bank policy actions. In the short term however there are a few factors worth mentioning which can potentially act both as a tailwind or headwind for risk assets.

US Dollar

As we had indicated at the beginning of the year, US Treasury Deposits held at the Federal Reserve dropped as a result of the upcoming debt ceiling impasse on the 2nd of March. This dynamic has in the past tended to create an increase in excess USD liquidity. We believe a reversal of the aforementioned trend (increase in treasury deposits) could represent a de facto tightening in USD liquidity. This could potentially be more dollar bullish, however if this tightening of dollar liquidity coincided with weaker US growth and an even more dovish Fed in respect to actual rate cuts, the dollar would ultimately be softer.

The macro growth differential between the Eurozone and US has been effective in explaining the directionality of the USD over the past 12 to 18 months. While US economic outperformance led a stronger dollar throughout most of 2018, looking ahead a reversion of US growth to that of Europe can conversely create pressure on the USD to weaken. The caveat to this would be a sharp decline in growth leading to a classic risk off scenario.

Source: Bloomberg

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The Trump Effect

With Trump on the campaign trail ahead of the 2020 election, the incentive for strong equity market performance will be significant. The US President has linked the performance of the US equity market to his presidency and speculation is mounting that he is keen to reach a deal with China in order to give markets a boost ahead of the 2020 campaign. In December Treasury Secretary Mnuchin reportedly organised a call with US bank CEOs to address stock market weakness in an example of the administration’s willingness to intervene in markets. Whether this type of intervention can lead to sustainable market strength or economic growth is doubtful.

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Rubrics Global Fixed Income UCITS USD vs Peers1 Year

RUBRICS GLOBAL FIXED INCOME UCITS A USD PIMCO FUNDS TR BOND I UNHDG ACC USD

AMUNDI LUXUMBERG GLOBAL AGGREGATE I CAP BLACKROCK MLIIF FIXED INC.GLB.OPPOR.FD.A2 USD

GS FUNDS GLOB FIXED INC. PORTF I USD HGD.CAP.

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Rubrics Global Fixed Income UCITS USD vs Peers3 Year

RUBRICS GLOBAL FIXED INCOME UCITS A USD PIMCO FUNDS TR BOND I UNHDG ACC USD

AMUNDI LUXUMBERG GLOBAL AGGREGATE I CAP BLACKROCK MLIIF FIXED INC.GLB.OPPOR.FD.A2 USD


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RUBRICS GLOBAL FIXED INCOME UCITS A USD

PIMCO FUNDS TR BOND I UNHDG ACC USD

AMUNDI LUXUMBERG GLOBAL AGGREGATE I CAP

BLACKROCK MLIIF FIXED INC.GLB.OPPOR.FD.A2 USD


Positioning in the Global Fixed Income Fund

over the past 12 months has reflected our

broader macro view - that a decline in

global growth can lead to tighter macro

financial conditions.

Throughout 2018 a combination of carry

from our short dated corporate and

government securities, in addition to active

duration management of 5, 10 and 30 year

government bond exposure ensured the

fund was not only able to preserve capital in

a difficult year but also achieve some capital

gains (+1.81% in USD)

The Fund has not looked to add to credit

exposure so far in 2019 both on account of

our macro view in addition to what we

believe is inadequate compensation for

risk/liquidity. Should we see increased

volatility heading into Q2/3, the fund is very

well placed to capitalise given the high

levels of liquidity in the portfolio.

We believe that 2019 ca provide us with the

entry point to significantly increase yield in

the portfolio and build out return.

Fund Performance – Rubrics Global Fixed Income UCITS USD A

AnnualisedReturn (5 Yr)

Annualised Volatility

Sharpe Ratio

Rubrics 3.17% 1.48% 1.59

Pimco 2.39% 2.92% 0.54

Amundi 3.06% 2.53% 0.88

Blackrock 1.64% 1.50% 0.55

GS 2.99% 2.20% 0.99

Source: Bloomberg

March 2019Performance Update

Fund Performance – Rubrics Global Credit UCITS USD A

AnnualisedReturn (5 Yr)

Annualised Volatility

Sharpe Ratio

Rubrics 4.28% 1.4% 2.5

Pimco 4.27% 2.6% 1.3

Std Life 2.92% 3.0% 0.7

Blackrock 3.56% 2.7% 1.0

Bluebay 3.19% 2.0% 1.2

Wellington 3.93% 2.8% 1.1Source: Bloomberg

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Rubrics Global Credit UCITS Fund USD vs Peers1 Year

RUBRICS GLOBAL CREDIT UCITS A USD PIMCO GIS GLO INVT GRD CRDT INST USD ACC

SLI GLO SICAV GLOBAL CORPORATE BOND A ACC USD BLACKROCK GLB.FUNDS LUX CORPORATE BD.X2 USD

BLUEBAY FUNDS INVESTMENT GRADE BOND FD.R CAP. WELLINGTON GLOBAL CREDIT PLUS USD G ACC HDG

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Rubrics Global Credit UCITS Fund USD vs Peers3 Year




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124 Rubrics Global Credit UCITS Fund USD vs Peers5 Year




In line with our macro view, the reduction in duration and credit risk in Q1 2018 involved taking profits on “core” & “tactical” bonds acquired in 2016. This helped limit drawdowns driven by spread widening in credit later on in the year.

Purchasing activity over the past 12 months has centred around “roll-down” bonds which have tended to generate attractive low-vol carry. Credit opportunities have tended to centre on less crowded areas, e.g AUD Sydney Airport 2020 Inflation Linker @ ~4% in USD terms for short dated IG rated paper.

Valuations in 2019 have tightened significantly on risk assets, which has benefitted the portfolio from a return perspective. It has also resulted in modest purchasing activity and more defensive positioning. Currently the portfolio has approximately 8% in cash and cash equivalents.

With a portfolio yield of 4.4% and duration less than 2.0 we remain well placed to generate solid carry and potentially capture future volatility by building in higher yields into the portfolio.

March 2019Performance and Market Update

Rubrics Global UCITS Funds Plc is a variable capital umbrella investment company with segregated liability between sub-funds; incorporated with limited liability in Ireland under the Companies Acts 2014 with registration number 426263; and authorised by the Central Bank of Ireland pursuant to the European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations 2011, as amended). This document is for information only and does not constitute an offer or solicitation to deal, whether directly or indirectly, in any particular fund. Nothing in this document should be taken as an expressed or implied indication, representation, warranty or guarantee of performance whether in respect of income or capital growth. No warranty or representation is given as to the accuracy or completeness of this document and no liability is accepted for any errors or omissions that the document may contain. The Key Investor Information Documents (“KIIDs”) and prospectus (including supplements) for Rubrics Global UCITS Funds Plc are available at www.rubricsam.com. The management company of Rubrics Global UCITS Funds Plc is Carne Global Fund Managers (Ireland) Limited (the “Management Company”). The Management Company is a private limited company, incorporated in Ireland on 16 August, 2013 under registration number 377914. The investment manager of Rubrics Global UCITS Funds Plc is Rubrics Asset Management (Ireland) Limited (the "Investment Manager"). The Investment Manager is a private company registered in Ireland (reference number:613956) and regulated by the Central Bank of Ireland in the conduct of financial services (reference number:C173854). Details about the extent of its authorisation and regulation is available on request. Data Source: © 2016 Morningstar. All Rights Reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information. www.morningstar.co.uk.

For South African investors: In the Republic of South Africa this fund is registered with the Financial Sector Conduct Authority and may be distributed to members of the public. In addition to the other information and warnings in this document, the Financial Sector Conduct Authority of South Africa requires us to tell South African recipients of this document that collective investment schemes are generally medium to long-term investments, collective investment schemes are traded at ruling prices and can engage in borrowing and scrip lending and that a schedule of fees and charges and maximum commissions is available on request from the manager. Because foreign securities are included in the investments within this collective investment scheme, we are also required to disclose to you that there may be additional risks that arise because of events in different jurisdictions: these may include, but are not limited to potential constraints on liquidity and the repatriation of funds; macroeconomic risks; political risks; foreign exchange risks; tax risks; settlement risks and potential limitations on the availability of market information.

Additional Information for Switzerland: The prospectus and the Key Investor Information Documents for Switzerland, the articles of association, the annual and semi-annual report in French, and further information can be obtained free of charge from the representative in Switzerland: Carnegie Fund Services S.A., 11, rue du Général-Dufour, CH-1204 Geneva, Switzerland, tel.: + 41 22 7051178, fax: + 41 22 7051179, web: www.carnegie-fund-services.ch. The Swiss paying agent is: Banque Cantonale de Genève, 17, quai de l’Ile, CH-1204 Geneva. The last share prices can be found on www.fundinfo.com. For the shares of the Funds distributed to non-qualified investors in and from Switzerland and for the shares of the Funds distributed to qualified investors in Switzerland, the place of performance is Geneva.

IMPORTANT INFORMATION March 2019