By Michael Stanes, Investment Director at Heartwood Investment Management
Benign economic conditions, strong corporate earnings results in aggregate across regions and reduced political risks remain supportive of our pro-cyclical stance in the near term. While the so-called ‘reflation trade’ has suffered a modest setback over recent weeks, mainly arising from frustration around President Trump’s ability to deliver tax cuts, we expect markets to take a somewhat more positive view of growth-friendly US policy changes, further supported by growth that is durable, liquidity stimulated by ongoing central bank accommodation, and corporate earnings improvements. US policy outcomes are uncertain, but it is our view that if the Trump administration can at least make some headway on its proposals, such as tax relief on overseas cash repatriation, then this cannot be ignored for its potentially positive impact on US capital expenditure and broader economic activity. Furthermore, headline inflation measures have started to peak, due to energy price effects, which should in time help to relieve the pressure on real incomes, adding support to consumption.
While our view remains constructive in the shorter term, we can envisage being more cautious further out. We remain modestly overweight in risk assets and have not made any meaningful changes to portfolios. Our risk exposures are tilted towards more specific and targeted areas of the market, whether by sector or market-cap, to reflect our degree of confidence in the near-term fundamental outlook. However, we also recognise that we are in the later stage of the market cycle and investor sentiment could be more vulnerable to potential pressure points as we move through the year. In particular, we would highlight the potential headwinds of higher US interest rates and tighter financial conditions in China. Furthermore, one of the key elements to a stable financial environment over the last few years has been central bank support, which has been reflected in rising valuations across asset classes. We expect this comfort blanket to be tested more by investors in the second half of the year, particularly as we pass through the electoral cycle in Europe. Overall, we are maintaining our positive view in the shorter term but expect to be more cautious as the year progresses.
Equities: Notwithstanding the generally supportive backdrop, our view remains that a modest overweight in equity is appropriate. Valuations and performance prevent a more positive stance towards equity overall, as we are mindful of potential event risk and the later stage of the market cycle. We wish to remain fully invested in the US (and no more given valuations), with more targeted exposure to specific sectors. We are maintaining our overweight positions in European and Japan, which favour our pro-cyclical stance. In Japan, we have taken some exposure to small- and mid-cap Japanese equities in our higher risk strategies. UK equity remains an underweight position and we believe it is still too soon to repatriate assets. However, to mitigate the risk of a further bounce in sterling, we are slight re-orientating our UK equity position towards more exposure to mid-caps. The resilience of emerging market equities has been impressive and suggests a more positive outlook in the absence of a trade shock out of the US. However, we do not want to chase performance from here, already having a reasonable exposure to this asset class.
Bonds: Over the last month, bonds have benefitted from elevated geopolitical tensions and softer inflation expectations. We do not believe the downward trend in yields is being driven by a deteriorating growth backdrop and therefore do not see durability in this trend. Furthermore, investor positioning is less of a headwind to higher yields than it was six months ago. Given the Fed’s more hawkish tone, albeit at the margin, as well as more focus on an ECB exit strategy, we continue to believe that being short duration remains appropriate. Credit spreads – both US corporate credit and emerging market sovereign debt (hard and local currency) – continue to tighten given the solid growth backdrop.
Property: UK property developers and listed vehicles continue to perform well, supported by better than expected fourth quarter results and the fall in UK gilt yields. Nonetheless, there are few catalysts that we can see in the shorter term, given supply concerns and uncertainty around Brexit, and we retain our underweight position. On a regional basis, we are primarily invested in cities outside of London, which are less exposed to ‘Brexit’ fallout. Outside of the UK, we are also looking at opportunities in the US REIT (real estate investment trust) market, although we remain wary of the impact of the Fed’s more hawkish stance.
Commodities: Notwithstanding the recent slide in the oil price, we continue to expect that an improving global economic environment and a tighter supply/demand balance will ultimately be supportive to commodity prices later this year. Direct access to this market is through owning futures contracts rather than the physical assets and while the risk/return profiles are looking more attractive across some parts of the complex, they are not yet at levels where we are ready to invest. Despite its recent pullback, we maintain our position in gold as we continue to see it as a vital diversifier. Industrial/base metals have been weak, despite positive data surprises from China. Any further weakness may provide an opportunity to add.
Hedge funds: While we have held a limited allocation to hedge funds in recent years on concerns around performance, we believe that increasing interest rate divergence should create more opportunities going forward. Our preference remains for macro/CTA strategies, but we are also taking a more positive view on equity hedge strategies, given the greater likelihood of increased stock dispersion (i.e. between winners and losers), as well as credit long/short strategies.
Cash: We have reasonable levels of liquidity across our portfolios both in cash and short-dated bonds, which we will invest as and when we see specific opportunities. Market volatility remains low – a situation that we believe is unlikely to persist as we move into the second half of the year.
Barclays announces new trade finance platform for corporate clients
Barclays Corporate Banking has today announced that it is working with CGI to implement the CGI Trade360 platform. This new platform will provide an industry leading end-to-end global trade finance solution for Barclays clients in the UK and around the world.
With the CGI Trade360 platform, Barclays will provide clients with greater connectivity and visibility into their supply chains, allowing them to optimise working capital efficiency, funding and risk mitigation. By utilising cloud based functionality for corporate banking clients, Barclays will also be able to offer a leading client user experience through easy access and real-time integration to essential information, combined with the latest trade solutions as the industry-wide shift to digitisation continues to accelerate.
This move underpins Barclays commitment to supporting the trade and working capital needs of their clients and reinforces a commitment to innovation that has been central to the bank for more than 300 years.
James Binns, Global Head of Trade & Working Capital at Barclays, said: “We are delighted to announce our move to the CGI Trade360 platform and to have started the implementation process. We have a longstanding partnership with CGI, and the CGI Trade360 platform will mean we can continue delivering the best possible trade solutions and service to our clients for many years to come.”
Neil Sadler, Senior Vice President, UK Financial Services, at CGI, said: “Having worked closely with Barclays for the last 30 years, we knew we were in an excellent position to enhance their systems. Not only do we have a history with them and understand how they work, but part of the CGI Trade360 solution includes a proof of concept phase, which is essentially seven weeks of meetings and workshops with employees across the globe to guarantee the product’s efficiency and answer all queries. We’re delighted that Barclays chose to continue working with us and look forward to supporting them over the coming years.”
What’s the current deal with commodities trading?
By Sylvain Thieullent, CEO of Horizon Software
The London Metal Exchange (LME) trading ring has been the noisy home of metals traders buying and selling for over a hundred years. It’s the world’s oldest and largest metals market and is home to the last open outcry trading floor. Recently however, the age-old trading ring, though has been closed during the pandemic and, just a few weeks ago, the LME announced that it will remain so for another six months and that it is taking steps to improve its electronic trading. This news fits in with a growing narrative in commodities about a shift to electronic trading that has been bubbling away under the surface.
Something certainly is stirring in commodities. The crisis has affected different raw materials differently: a weakening dollar and rising inflation risks bode well for some commodities with precious metals being very attractive, as seen by gold reaching all-time highs. Oil on the other hand has had a tough year and experienced record lows from the Saudi-Russia pricing war. It has been a turbulent year, and now prices look set to soar. While a recent analyst report from Goldman Sachs predicts a bullish market in commodities for the year ahead, with the firm forecasting that it’s commodities index will surge 28%, led by energy (43%) and precious metals (18%).
Increasingly, therefore, it seems that 2020 is turning out to be a watershed moment for commodities, and it’s likely that the years ahead will bring about significant transformation. And whilst this evolution might have been forced in part by coronavirus, these changes have been building up for some time. Commodities are one of the last assets to embrace electronic trading; FX was the first to take the plunge in the 90s, and since then equities and bonds have integrated technology into their infrastructure, which has steadily become more advanced.
The slow uptake in commodities can be explained by several truths: the volumes are smaller and there is less liquidity, and the instruments are generally less exotic, essentially meaning it has not been essential for them to develop such technology – at least not until now. This means that, for the most part, the technology in commodities trading is a bit outdated. But that is changing. Commodities trading is on the cusp of taking steps towards the levels of sophistication in trading as we see in other asset classes, with automated and algo trading becoming ever prominent.
Yet, as commodities trading institutions are upgrading their systems, they will be beginning to discover the extent of the job at hand. It’s no easy task to upgrade how an entire trading community operates so there’s lots to be done across these massive organisations. It requires a massive technology overhaul, and exchanges and trading firms alike must be cautious in the way they proceed, carefully establishing a holistic, step-by-step implementation strategy, preferably with an agile, V-model approach.
The workflow needs to be upgraded at every stage to ensure a smooth end-to-end trading experience. So, in replacement of the infamous ring, these players will be looking to transform key elements of their trading infrastructure, including re-engineering of matching engines and improving communications with clearing houses.
However, these changes extend beyond technology. For commodities players to make a success of the transformation in their community, exchanges need to have highly skilled technology and change the very culture of trading. All of which is currently being done against a backdrop of lockdown, which makes things much more difficult and can slow down implementation.
What is clear is that coronavirus has definitely acted as a catalyst for a reformation in commodities. It is a foreshadowing of what lies ahead for commodities trading infrastructure because, a few years down the line, commodities trading could well be very different to how it is now, and the trading ring consigned to history.
Afreximbank’s African Commodity Index declines moderately in Q3-2020
African Export-Import Bank (Afreximbank) has released the Afreximbank African Commodity Index (AACI) for Q3-2020. The AACI is a trade-weighted index designed to track the price performance of 13 different commodities of interest to Africa and the Bank on a quarterly basis. In its Q3-2020 reading, the composite index fell marginally by 1% quarter-on-quarter (q/q), mainly on account of a pull-back in the energy sub-index. In comparison, the agricultural commodities sub-index rose to become the top performer in the quarter, outstripping gains in base and precious metals.
The recurrence of adverse commodity terms of trade shocks has been the bane of African economies, and in tracking the movements in commodity prices the AACI highlights areas requiring pre-emptive measures by the Bank, its key stakeholders and policymakers in its member countries, as well as global institutions interested in the African market, to effectively mitigate risks associated with commodity price volatility.
An overview of the AACI for Q3-2020 indicates that on a quarterly basis
- The energy sub-index fell by 8% due largely to a sharp drop in oil prices as Chinese demand waned and Saudi Arabia cut its pricing;
- The agricultural commodities sub-index rose 13% due in part to suboptimal weather conditions in major producing countries. But within that index
- Sugar prices gained on expectations of firm import demand from China and fears that Thailand’s crop could shrink in 2021 following a drought;
- Cocoa futures enjoyed a pre-election premium in Ghana and Côte d’Ivoire, despite the looming risk of bumper harvests in the 2020/21 season and the decline in the price of cocoa butter;
- Cotton rose to its highest level since February 2020 due to the threat of storm Sally on the US cotton harvest, coupled with poor field conditions in the US;
- Coffee rose 10% as La Nina weather conditions in Vietnam, the world’s largest producer of Robusta coffee, raised the possibility of a shortage in exports.
- Base metals sub-index rose 9% due to several factors including ongoing supply concerns for copper in Chile and Peru and strong demand in China, especially as the State Grid boosted spending to improve the power network;
- Precious metals sub-index, the best performer year-to-date, rose 7% in the quarter as the demand for haven bullion continued in the face of persistent economic challenges triggered by COVID-19 and heightening geopolitical tensions. In addition, Gold enjoyed record inflows into gold-backed exchange traded funds (ETFs) which offset major weaknesses in jewellery demand.
Regarding the outlook for commodity prices, the AACI highlights the generally conservative market sentiment with consensus forecasts predicting prices to stay within a tight range in the near term with the exception of Crude oil, Coffee, Crude Palm Oil, Cobalt and Sugar.
Dr Hippolyte Fofack, Chief Economist at Afreximbank, said:
“Commodity prices in Q3-2020 have largely been impacted by COVID-19. The pandemic has exposed global demand shifts that have seen the oil industry incur backlogs and agricultural commodity prices dwindle in the first half of the year. The outlook for 2021 is positive however conservative the markets still are. We hope to see an increase in global demand within Q1 and Q2 – 2021 buoyed by the relaxation of most COVID-19 disruptions and restrictions.’’
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