Imagine the Unimaginables Q1 2018 Update – “Markets are angry!”

Last December, IAV published a list of Capital Market Unimaginables for 2018 (link) with lots of charts and now lets see how things progressed in the first quarter…

Now what can happen in 2018 that most cannot imagine, here is the original list:

Unimaginable #1: More of the Same – Business as Usual — Markets continue to rally including the bond market. 

After Q1 2018, markets continuing to rally remains unimaginable, maybe now even more so after a very weak Q2 start AND the threat of a trade war. This is creating a lot of anger esp. when every day comes a new unanticipated announcement…

Nasdaq, Italy and some emerging markets were the only markets in the plus in local currency terms ytd in Q1 this year. Bonds were also weaker, which shouldn’t be a surprise. Rising skepticism over the true strength of the US economy which is pretty much meant to carry the global economies has started to make bonds interesting.

Bulls will say this is a healthy correction except the real events not mentioned in the unimaginables taking place, i.e. a possible trade war with China and the possible demise of both the Iran Nuclear Agreement and NAFTA. On top of these uncertainties, we got the Facebook scandal and Autonomous Driving fatalities putting doubts into the proper valuation of the Tech Stocks which have been leading the rally through January 2018. The massive correction in February which sent volatility through the roof also caused investors to take risk off. Shorting volatility was a very crowded trade and one simply asking to be unwound. Now some think, the crowded trade is long volatility!

What seems hardly discussed is the obvious — the bull market reflects momentum and growth and most importantly, the popularity of index driven ETFs which are dependent on momentum. Value oriented investors cannot compete as momentum works both ways, also when an index linked security reflects short selling momentum. The law of greater tonnage (index trading) is being tested currently, but prices will get to an irresistible level and buyers will resume their enthusiasm.  Stocks and bonds will resume their rallies esp. as evidence grows that the global growth momentum remains in place!

Bonds have actually rallied during the stock market correction (bond volatility remains subdued!) There are charts below illustrating the outflows mostly out of large cap US funds and that non-Fed Americans remain the largest buyers of bonds.

Investors exited large-cap US equity funds last month (March 2018) – Hedged Currency is taking a hit and Global and International, esp. Emerging remain more attractive.

Source: SPDR Americas Research / WSJ-The Daily Shot 
Source: Deutsche Bank Research / WSJ-The Daily Shot

Momentum vs. Value:

Here is how different strategies (factors) performed in the first quarter. Momentum, Growth and Quality strategies were the winners. Value and Dividend Yield missed out!

Source:; Read full article / WSJ-The Daily Shot

But Value is gaining traction as Tech stocks correct. Growth has given up some of its outperformance over the last 12 months, but remains considerably high!

The dispersion in valuations has widened recently, creating more opportunities for value investors.

Source: BofAML / WSJ Daily Shot

“Tech has given us more than it has taken away,” said Kim Forrest, senior portfolio manager at Fort Pitt Capital Group LLC in Pittsburgh. “The future is going to have more connected devices.” (Bloomberg story link)

European weakness is disturbing…

More bothersome is the European weak performance over the first quarter due to a strong euro, but also due to capacity constraints (!)–European manufacturers are drowning in orders, which seems to go unnoticed. It is reflected in lower PMIs and ifo statistics. Germany cannot get enough qualified workers, even with its model educational system (vocational training options)! The European markets, esp. Germany, seem to be suffering from a lack of momentum and perhaps limited Tech plays. (Bloomberg story link)

Finally, Deutsche Bank’s shares keep falling on lower guidance. This time, the bank was hurt by higher funding costs, stronger euro. In recent years, the bank’s share price has been a good indicator of financial market uncertainty. Now they get a new CEO!

Libor has climbed making people nervous (Deutsche Bank sensitivities):

“Part of the explanation is the US government flooding the markets with Treasury bills, pushing up all short-term rates. But there is another reason for this dislocation. The new US tax law ‘penalizes’ foreign banks in the US for borrowing dollars from their parent company abroad. In the past, a foreign bank could borrow in its local currency, swap the proceeds into dollars, and lend them to its subsidiary in the US. Now US branches and broker-dealers of foreign banks have to go out and borrow dollars from US banks, raising demand for interbank financing (pushing LIBOR higher). Will some foreign banks shrink their US operations going forward as the cost of funds climbs relative to US-based competitors?” (Source: WSJ-The Daily Shot)

Source:, h/t Paul Menestrier; Read full article /WSJ-The Daily Shot

Simply profit taking…

“Is the pullback in asset managers’ exposure to the stock market pointing to a sharp slowdown? Perhaps the end of this economic cycle?” (WSJ-The Daily Shot) Most likely one can contribute it all too simple profit taking and sell on good news (strong economic indicators, subdued inflation and perhaps tech winners looking for an excuse)!

This chart compares market exposure to the ISM Manufacturing PMI (Source: IHS Markit; Read full article . “Is the stock market correction also pointing to a slowdown in growth? Or are stocks just oversold?” (WSJ-The Daily Shot)

Source: Deutsche Bank Research /WSJ-The Daily Shot 

Here are charts used to support the case for “business as usual”:

The US index of leading economic indicators (LEI) has been quite strong, but is it overstating growth or simply business as usual?

Source: Pantheon Economics / WSJ-The Daily Shot

German Ifo coming off its January highs, but remains high

Source: German ifo Institute / WSJ – The Daily Shot

This recovery has been remarkably synchronized – most synchronized in 50 years!

Source: @ldaalder; Read full article / WSJ-The Daily Shot

Unimaginable #2: Inflation remains elusive such that rates stay low and bonds continue to rally AND economies compete to lower taxes! 

The threat of increasing inflation sparked the February sell-off as wages appeared to be accelerating. They are, but not at a disconcerting pace. The combination of possible higher inflation and aggressive rate hikes plus the weak dollar and now a possible trade war hampering growth created for some a much desired volatility. But subdued inflation and gradual rate hikes seem to be the more likely prospects.

Source: Credit Suisse / WSJ-The Daily Shot

Atlanta Fed Wage Growth Tracker Overall (Bloomberg)

The bond market remains a challenge? Rate hiking cycles typically push the 10yr Treasury yield higher, but that hasn’t been the case this time around (so far). This type of activity–increasing short term and falling longer term rates– implies a flattening yield curve and fears of pending recession–not an inflationary scenario, although some may bring up stagflation…Source: Bloomberg / WSJ-The Daily Shot

The following was posted late February when it looked like inflation could have been on the up and up…

Unimaginable #2: Will Inflation Really Remain Elusive?

Unimaginable #3: European growth outpaces the USA turning negative interest rates positive, narrowing the differential keeping the EURO strong with little volatility.

European economies got off to a very strong start in 2018 and now appear to have peaked since January, but have they really? I am tempted now to accept that a strong Euro may remain unimaginable as there appears to be some major parallels to Reagan’s first years in office when policies sent the USD flying (1984-1985). Of course that was his second term. Still, monetary policy in Europe will remain easy longer, giving the US a clear interest rate advantage. Europeans would welcome a weaker currency.  The easy monetary policy and global growth may make people wonder if European shares offer attractive values now…

This post was published at the end of January, fyi:

Unimaginable #3 Update: Europe Outpaces USA Growth -“New Global Contract” (Christine Lagarde, Head of IMF at Davos)

The Eurozone GDP-per-capita growth lags other economies (see the potential for Italy and Spain)?

The euro area manufacturing output is still expanding but has visibly slowed this year. The PMIs are significantly (for European standards) above 50, which should be respected!

Source: IHS Markit; Read full article /WSJ-The Daily Shot
Source: Scotiabank Economics / WSJ-The Daily Shot

Unimaginable #4: Consolidation across industries continues to drive the markets, ‘Mittelstand’ companies combine forces and get larger…

Airlines and financials are the most sited. ‘Mittelstand’ companies are investing in Start Ups to increase their know-how in digitalization.

Unimaginable #5: Oil prices approach $35! (2017 repeat)

Oil is stuck in a trading range between $60 and $70, which keeps this unimaginable unimaginable. Strong economic activity supports higher prices, but also much more supply esp. out of the USA. Threats of a dissolving of the Iran Nuclear Pact has also fuelled oil bulls.

Lots of supply…

This chart shows US energy exports since 1950.

Source: EIA; Read full article / WSJ-The Daily Shot

Strained demand…

US net oil imports hit the lowest level since 1982.

Source: EIA; Read full article / The Daily Shot

…except for China!

China imports more oil than the USA

Source:, h/t Paul Menestrier; Read full article / WSJ-The Daily Shot

Unimaginable #6:  Green Technology shares will be the big movers in 2018 (#5 and #6 may appear to contradict one another which makes the combination unimaginable)

Wind Energy is making a comeback and if lithium prices are an indicator, electro-mobility and flexible energy storage will grow in appeal.

Residential solar panel installations declined last year, but remain at a very high level!

Source:, h/t Paul Menestrier; Read full article / WSJ-The Daily Shot

US ethanol capacity continues to climb. The links below describes the complexities in the regulation

Source:, h/t Paul Menestrier; Read full article & On Fuel Economy Measures/ WSJ-The Daily Shot

This chart compares gasoline/diesel taxes across regions. The Europeans pay the highest, so you can imagine European Governments struggling to prohibit diesel…

Source: Goldman Sachs / WSJ-The Daily Shot
Source: Moody’s Investors Service / WSJ-The Daily Shot

Unimaginable #7: 2018 is an election year, will the Republicans keep their majorities? A surprise 3rd party (!?!)–USA gets a “Macron Effect!”

Source: Deutsche Bank Research / WSJ-The Daily Shot

Unimaginable #8: Britain capitulates on Brexit…NOT. Changed my mind on this one! 

Actually capitulation gets more and more discussed as housing values start to fall as well as consumer activity (weather related) and companies decreasing their presence… If Brexit, it should rather be a soft one…

More international firms will be cutting staff in the UK.

Source: @gadfly; Read full article / WSJ-The Daily Shot

Unimaginable #9: Populists on the retreat? Not in Europe’s member countries who ironically benefit the most from being EU members! 

Viktor Orban and his Fidesz Party in Hungary has a stunning victory!

This map shows the rise of populist parties in Europe.

Source: Deutsche Bank Research / WSJ-The Daily Shot

Unimaginable #10: Women Disrupt! 2018 – The Year When Women Lead the Way!

 As of Thursday, 5 of April, 309 women have filed papers to run for seats in the House (link), which, along with the rest of Congress, is predominately filled with men. As the AP noted, 40 women are running for gubernatorial races around the country — up from a record 34 candidates in 1994. In Texas, too, a record-number of women are running for office — including in races for congressional seats or local seats.


Source:, h/t Paul Menestrier; Read full article / WSJ-The Daily Shot

The Economist magazine wrote a detailed report on the results of the official request for firms with 250 or more employees to state the gender pay gap at their companies. Their conclusion is that women are just not offered the same opportunities as they rise in the ranks and much is attributed to maternity or parent care needs. Here is a brief summary.

Black Swans?  Tensions arise between India and China, as well as deepening between Saudi Arabia and Iran…. but America maintains the peace and eventually comes to the rescue (unimaginable?) while deliberately or not isolates China with an Indo-Pacific and Quad Alliances (Japan, Australia, India, and the U.S.)

Stock and Bond markets will be fine, but will require discipline by setting proper entry and exit values. Europe is still in a catch-up mode which will allow for significantly accommodative policies. Volatility will offer opportunity! Good luck in Q2!


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