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BNP Paribas MarFA™ Summary: Equities Overshooting, Again (08 June 2018)

Core Content

BNP Paribas MarFA™ is a cross-asset correlation framework that identifies driving factors and trading opportunities across equities, rates, credit, FX, and commodities. It uses a combination of macro and market factors to assess asset valuations and detect mispricing.

Key Points

• MarFA™ Macro is based on 12-month correlations and identifies macro factors influencing asset performance.
• MarFA™ Trading is a short-term variant that focuses on market factors affecting asset prices.
• The framework suggests that assets deviating by more than 2 z-scores from fair value are likely to correct within 1-2 months.
• A trading strategy of buying undervalued assets and selling overvalued ones has historically provided a Sharpe ratio of 1.3 since 2016, with a strong performance in 2018 (Sharpe ratio of 2.8).

Macro Factors

1. Inflation expectations (5y5y inflation expectations and survey measures)

   • Important for USD FX pairs and selected risk-sensitive assets.

2. US 10y term premium (estimated using the Fed's ACM model)

   • Important for performance of rates and curves.

3. Economic activity data, especially from the eurozone and G10 data surprises

   • Most important for equity markets and credit indices.

Market Factors

1. Trade weighted USD and commodities

   • Important for performance of rates and equities.

2. US 10y term premium

   • Particularly correlated with yields and curves.

3. Implied volatility, especially in FX

   • Correlated with emerging market equities.

Equities Analysis

• Global equity markets appear slightly overvalued, with bearish signals for:
  • MSCI World
  • S&P 500
  • MSCI China
• Undervalued equities include:
  • Brazilian equities
  • FTSE MIB

Rates Analysis

• US 10y nominal and real yields are now too low by around 10bp.
• European yields are broadly in line with fair value.
• Eurozone Investment Grade (IG) and High Yield (HY) credit appear oversold.
• US IG credit has converged back to fair value.
• US HY credit appears slightly overbought.
• Australian 10y yields continue to appear too high.
• Canadian 10y yields are fairly valued.
• German and French 10y yields are trading within the +/-2 z-score corridor.
• Italian 10y yield is overvalued, but the confidence indicator has turned off due to political turmoil.

Commodities Analysis

• Oil prices appear undervalued after a recent decline.
• Copper is overvalued by almost 9% following a sharp price increase.
• Gold is trading in line with fair value.

FX Analysis

• Overbought FX pairs:
  • AUDUSD: Overvalued by 2.5%
  • USDMXN: Overvalued by 4.6%
• Undervalued FX pairs:
  • EURSEK: Undervalued by 2.1%

Deviations from Fair Value

Summary of Key Signals

• Equities: S&P 500 and MSCI China are overvalued, while MSCI Brazil is undervalued.
• Rates: US 10y yields are too low, while Italian yields are overvalued.
• Credit: Eurozone IG and HY credit are undervalued, while US HY is overbought.
• Commodities: Oil is undervalued, copper is overvalued, gold is fairly valued.
• FX: AUDUSD and USDMXN are overbought; EURSEK is undervalued.

Trading Strategy Performance

• Sharpe ratio since 2016: 1.3
• 2018 Sharpe ratio: 2.8
• Equity markets performance: 3.9
• Commodities performance: 0.8

Important Notes

• The document includes legal disclaimers and disclosures regarding the non-independent nature of the research and potential conflicts of interest.
• The content is for professional clients and relevant individuals only.
• All estimates and opinions are as of 08 June 2018 and may change without notice.