Towards the end of each year my prop desk traders convene to discuss big picture themes, opportunities and trading strategies that will help navigate the year ahead so that we not only make money but can do so consistently with minimal drawdowns and no surprises. We throw every idea possible on the table, challenge each other, leaving no stone unturned. This results in having a very clear map and expectation of how the year will unfold which we can reference and adjust as the year progresses.
We identify long opportunities and naturally major market risks (with strong emphasis on timing) but the main focus is to really predict the first 2-3 months correctly. A solid start to a year in terms of profitability does wonders for trader confidence, thereby minimizing growing pressure to perform and keep risk levels under control.
Late 2015 I wrote a very bearish piece on Share Café of how 2016 would unfold and we witnessed one of the worst ever starts to a year by the S&P 500. Being on the right side of that market rout allowed for our prop desk to be on the front foot for the year not trying to recover heavy losses, hoping to claw back to break even again.
So how does 2017 look? This year will be littered with more uncertainty than ever before. Equity markets have already surged in the last quarter of 2016, seeing many of our trading opportunities already unfold, while the growing populism movement across the globe means potentially big corrections.
This year more than ever before, it will be important to focus on 2-3 month trading periods at a time. In the office we have big 2017 timeline on the wall identifying all the major known events that could create volatility. The first being Dutch elections in March followed by French elections on April 23rd.
Between now and that point, we could continue to see equity markets rise as Donald Trump enjoys a brief “honeymoon” period and the switch from bonds to equity markets that dominated late 2016 persists.
As the switch from bonds to equities continues, interest-rate sensitive stocks will suffer. Think property trusts and infrastructure. These two sectors have enjoyed an unprecedented boom of artificially low interest rates and the sheer influx of funds into this space in recent years will take some time to reverse. The weakness seen so far is not an opportunity buy. Moreover, the property trusts are vulnerable to a residential price correction as an oversupply of apartments loom in 2018. Below the big top formation across the weekly charts in Sydney Airports (SYD) is clearly visible and it would unwise to see value in light of the major interest rate risks present.
The winner of higher interest rates is undoubtedly US investment banks and QBE Insurance (QBE). Unfortunately all have already rallied strongly but I believe there is still more to be seen in QBE, especially when looking at the extent of declines seen in recent years and the point in the insurance cycle QBE is at.
Firstly, QBE has a $26 billion bond portfolio with a short duration period of just 1.7 years. Therefore as each bond matures and is reinvested at a higher bond yield, profits increase. SO for every 1% increase across the yield curve translates to an increase in earnings of $260 million. The leverage in QBE’s earnings to rising US bond yields is substantial and comes at a time when the company has shed many non-core businesses, reduced is catastrophe insurance risk profile through significant re-insurance policies as the insurance premium cycle has begun to turn up. This places QBE in a strong position to see a tailwind of positives for underlying earnings versus the headwinds of recent years.
As a result the share price should continue to see a major recover throughout the year and bouts of weakness would be ideal buying opportunities. When considering the longer-term performance of QBE, look at the chart below. The long-term downtrend has clearly broken along with the corresponding RSI downtrend. On each of the prior breakouts on the RSI in the past few years the share price has appreciated between $5 and $7. A similar move would see gains towards $16 but I see targets north of $18, as I genuinely see a major multi-year low forming here given the changing bond yield environment versus just a relief bear market rally. The fundamentals have turned and so are the charts.