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<\/a><\/p>\nIs this new market paradigm going to last? We see several reasons to remain skeptical. First of all,
\nthe weakening trend of the dollar could be halted by the woes such trend inflicts on some trade
\npartners of the US economy. Obviously, the biggest losers of this new environment are clearly the
\noil-importing countries against which the dollar is depreciating, chiefly Japan and the euro area. In
\nthe euro area, the euro has appreciated beyond the informal \u201cline in the sand\u201d of 1.15 to the dollar,
\nwhich used to trigger verbal intervention by ECB speakers. But the ECB is running low on
\nammunitions to weaken the euro: the Germans have clearly indicated to Mr Draghi that a further
\nrate cut is out of the question. The euro could thus continue to appreciate way beyond 1.15.
\nDomestic demand seems robust enough to stomach such a rise in the short-run, but a renewed
\nslowdown in H2 2016 could re-awaken some political risks likely to scare off markets again (Italian
\nreferendum in October 2016, French and German elections in 2017). In any case, if economies of
\nthe euro area are likely to suffer in silence in the short-run, a rising euro could weigh negatively on
\nthe relative performance of the equity market.<\/p>\n
In Japan, the situation seems more dangerous in the short term. The sharp appreciation of the yen
\nthreatens to send the economy back into recession, at a time when the BoJ runs out of stimulating
\nbullets. In addition, the US Treasury has issued a warning that, along with Germany, China, Korea
\nand Taiwan, Japan should expect that any policy move to weaken its currency would be met with
\nretaliatory measures by the US government. At a time when the TPP ratification lies in the balance,
\nthis is a powerful injunction. Japan might instead enact a new fiscal package, but this will further
\ndeteriorate the country\u2019s public finances. A crisis of confidence in the yen could result, although
\nthis seems like a distant prospect as long as households continue to exhibit a very high preference
\nfor yen-denominated liquid assets. The end game for the unsustainable Japanese public debt could
\nstill be years away, but, as in the euro area, the equity market might continue to suffer from an
\nappreciating yen.<\/p>\n
What could then derail this market configuration in the short run? A weakening dollar and a rising
\noil price are likely to bring solace to the embattled manufacturing and energy sectors in the US.
\nWould this be enough to reconcile the Fed with its tightening plan? We doubt it, as the causes of
\nthe current slowdown run deeper than the manufacturing lull. Corporate leverage has returned to
\npre-crisis levels, and banks and credit market alike have taken notice. They will impose higher
\npremiums for corporates willing to continue the vicious game of piling up debt in order to pay for
\ndividends and share buybacks. In addition, households remain cautious in their spending behavior
\n(stable savings rate), despite the loosening in credit conditions (credit card, mortgages), and they
\nare already expecting a slowdown in their earnings. There is little chance, in our view , that a
\npossible cyclical \u201csweet spot\u201d would lead the Fed to change its ultra-prudent stance.<\/p>\n
The oil market could be the first to change course. As we approach the 45-50$\/bbl range, we
\nbelieve that some marginal players in the shale industry will restart drilling. This range coincides
\nwith the breakeven price for some well-positioned players, and we must keep in mind that the
\nreaction time in the shale industry is a matter of months, not years or decades as in the
\nconventional oil business. Saudi Arabia would not tolerate to lose more market share to the tight oil
\ncomplex, and would probably increase its production to chase them out of the market again,
\nthrough a weaker oil price. The kingdom has indicated that it was willing and able to increase its
\nproduction by 1 million bbl\/d in short order if need be.<\/p>\n
At the end of the day, the biggest and most immediate threat to the \u201c3R\u201d paradigm lies in China.
\nIn our opinion, Chinese leaders have learnt their lesson last summer when they witnessed the
\ndevastating effect of the bursting of the equity bubble. They have also studied with angst the
\nprecedents of massive real estate bubbles in Japan and in the US. So they know the dangers of
\ncredit-fueled asset bubbles, and it seems dubious they would tolerate the inflation of a new bubble
\nof real estate and commodities. We are likely to see some tightening measures aimed at cooling
\ndown the sector, followed by some new targeted stimulating measures \u2013 i.e. a succession of very
\nshort-term stop-go cycles. The next \u201cstop\u201d phase could not be far away when we see the explosion
\nof transaction values on the housing market (+70% yoy).<\/p>\n
This is why we believe that the oil and China factors of the rally have weak foundations, and are
\nskeptical that the rally in risky assets can last in its current configuration. We are long equity,
\ncommodities and emerging assets, but each time with a bias in favor of the lower beta: we prefer
\ndeveloped to emerging equity, we prefer emerging debt to emerging equity, gold to oil in the
\ncommodity complex.
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