US growth showing signs of resilience amidst lack of macro data: US economic sentiment remains resilient despite lack of macro data to paint a conclusive result. The US current fiscal year earnings estimates continue to be revised higher suggesting that US corporations are doing well despite tariff uncertainty and signs of labor market weakening. The PMI data remains in healthy territory which again points to room for corporate resilience.
BBVA FCI - False spike or early warning? Over the recent weeks we have seen our BBVA FCI indicator jump from -0.56 during mid-September to -0.33 as of last week. This phenomena was a repeat of last year when the Financial conditions troughed during mid-September before the Fed jumbo cut and continued to rise up until April this year. The recent rise in the FCI index brings the question if this is an early warning for difficult market conditions ahead of just false spike. Given strong earnings and still strong US growth outlook, we see the recent rise as in FCI as idiosyncratically driven which should suggest that the equity vol spike could be a good opportunity to be sold.
Diverging macro volatility: Over the recent weeks we have seen a rise in the VIX Index off its lows and also wider credit spreads. At the same time the higher volatility is in the absence of higher realized volatility given 10 day realized volatility on the SPX remains near 10%. This wide volatility risk premium is unsustainable for a long time in our view. Most recent rise in equity volatility was in the aftermath of the FOMC hawkish cut, although surprisingly the rates volatility (Move Index) continued on its downtrend even after the FOMC meeting. The drop in FX and volatility rates is currently driving improved Sharpe ratio in the FX carry space.
Drop in FX volatility makes FX carry trades look attractive: Despite the pick up in equity volatility we have seen rates and FX volatility continue to make new recent lows. The drop in FX volatility is currently making FX carry look attractive. BBVA FX carry Latam rate indicator remains above its 80 percentile levels, when combined with drop in volatility the expected Sharpe ratio of this trade looks even more attractive.
QIS allocation using BBVA Macro Indicators: In this note we share results of QIS allocation portfolio based on BBVA US Macro Indicator and BBVA US Financial conditions Indicator. Since 2007 and over the past 10 years, a portfolio of 60% US equities and 40% US bonds has delivered cumulative returns of 5.8% and 7.4%, respectively. During the same period, our model portfolio has delivered returns of 7.4% in both cases. Using Macro and FCI indicator in conjunction we are hence able to replicate the performance of a 60/40 portfolio with a much lower volatility and drawdown and as a result a much higher sharpe ratio.
QIS allocation using Macro and FCI: The current environment of recovery combined with loose financial conditions again remains favorable towards carry strategies. Our model allocates higher weight to Latam carry strategy which we see a higher beta FX carry trade and hence historically has delivered better performance during stable growth and loose financial condition periods.
Trade of the month: FX LatAm carry – in multiple publications this year, we highlighted our preference for the BBVA FX LatAm carry strategy. Since our publications, the popularity of EM carry trades has increased with the continued depreciation of the USD. While, BRL and MXN have appreciated substantially against the USD since the start of the year, the performance of LatAm currencies vs. our basket of lowest-yielding currencies showed marginal appreciation by 2.6% year to date with a higher rates differential than against the dollar. As a result our FX carry strategies continue to deliver better sharpe than equities YTD and proving to be a good diversifier in an environment of concerns regarding equity valuations and Tech bubble 2.0.