Saxo Bank publishes its investment outlook for Q4 2014

The US, China and Europe are all headed for another Minsky moment but this challenging environment for investors can also be a fertile trading environment.

According to Saxo Bank, the online multi-asset trading and investment specialist, the flipside of quantitative easing has been the mountain of debt that the globe has accumulated over the last few years.

In its latest Quarterly Outlook report for the financial markets, the bank said Asia’s foreign debt has soared to $2.5 trillion from $300 billion in a decade, and China is spending a fortune just to manage a debt service cost that stands at 39% of GDP. The US is not faring that much better where interest on US government debt costs 6% of the budget in 2013 despite neglible interest rates and the debt load has nearly doubled to 80% of GDP in 10 years. The bank said that the western world continues to ignore the need for the kind of fundamental structural reform that will enable private entrepreneurship to flourish and grow.

Chief Economist Steen Jakobsen commented: “It’s time we talked about debt. It is the elephant in the room that no-one wants to discuss, but it has now grown so large that the foundations are shaking. Whatever the timing, the US, China and Europe are all headed for another Minsky moment.

“Never has the gap between the reality and the perception of the present economic situation been greater. Yet, never have the opportunities to trade this been better. The world is not ending, it’s getting ready for a new beginning where we must address the elephant in the room - debt. “

Saxo Bank’s Chief Economist says that debt only gets reduced two ways: by writing it off or through superior growth. Neither is politically or practically feasible during the next quarter which means that interest rates globally must remain unchanged-to-lower while we play pretend-and-extend one more time before Minsky gets his proper place in the limelight.

As we head into Q4, the markets aren’t going to get what they want: the US is not on an easy and smooth path to better days accompanied by a gentle Fed tightening. As the US recovery hits the low ceiling amid a raging USD bull, we will see uncertainty and volatility rise sharply about what comes next. Bonds will rally one last time and volatility will rise as well.

Commodities

Looking at gold priced in other currencies, Ole S. Hansen, Head of Commodity Strategy, finds that most of the weakness has been related to dollar strength, with gold measured in euros up almost 10% year-to-date and around half that against the Japanese yen.

Ole S. Hansen added: “We view a continued rise of the dollar in the final quarter as being gold and silver’s main challenge with the current slowdown in China, Europe and elsewhere potentially leading to less aggressive expectations for how hawkish the US Federal Reserve can and will be.“

The energy sector will struggle during the early part of the final quarter with the seasonal slowdown in US refinery demand leading to the usual rise in inventories. Additional price weakness is eventually expected to be met by a response from OPEC, if not before then during the next meeting, which is planned for November 27. The downside risk could be extended if OPEC fails to show unity with Iraq, Libya and eventually also Iran. All will be looking to increase market share at a time of falling demand for the cartel’s oil.

FX

As commodities are weak and bond yields are already low, to John J. Hardy, Head of FX Strategy, this suggests that the market is very concerned about global demand and growth potential - not to mention the potential for disinflation/deflation. Among currencies, it seems that the market has been very late in discovering that we are near multi-year lows in major commodities indices as we enter Q4 and that there is a considerable degree of further downside potential for commodity currencies on the weak commodity theme next quarter.

John J. Hardy said that his favourite question for Q4 is what if the ECB fails to move straight to QE (as the market has fallen all over itself to anticipate)?

He commented: “There is a strong anti-QE contingent within the ECB, led by the German Bundesbank. There is also strong German political resistance to direct central bank purchases of sovereign debt because this funds fiscal shortfalls by EU member governments. Along the same lines, then, what if the ECB targeted long-term refinancing operations and asset-backed securities purchases prove smaller than the market hopes, while the realisation dawns that the barriers to QE will likely take considerably more time to overcome?”

According to John J. Hardy, a slower than expected expansion of the ECB balance sheet could slow the euro’s decline, and even see it grow stronger against the weaker corners of the market if disappointed euro carry traders see rising volatility (which tends to negatively correlate with carry trades). Elsewhere, he expects continued USD strength to remain a prominent theme.

Equities

Equities are still fairly valued globally and are by no means in bubble territory. Based on the low interest rate environment and a still growing global economy, equities still remain the most attractive asset class.

Peter Garnry, Head of Equity Strategy, commented: “In our Q4 outlook, we present three trade ideas on equities that fit into our overall picture of the world, but also to direct your interest towards countries, sectors and stocks that would normally come to mind. We recommend being long the US natural gas segment following a 21% crash from the highs in June, short India on unjustified high valuation and bet on negative economic surprises, and finally long Goldman Sachs on a pickup in the US economy and capital markets activity.“

Link to report: https://www.tradingfloor.com/publications/quarterly-outlook