“In the middle of the road of my life I awoke in the
dark wood where the true way was wholly lost.” (Dante Alighieri 1265-1321)
Truth Uncovered
The accumulated angst that was felt last week is a
reflection of suppressed, negative sentiments. The broad indexes were wobbly in
fourth quarter and now that fragility is center-stage. Interestingly, August
2015 warnings regarding China came and went, and then last week were
ferociously revisited. The truth cannot be
deferred, and upbeat interpretations are proving to be inaccurate again and
again.
Now that the first week has produced some known drama
and some vicious responses, investors are asking, “What now? What next?” When
one sees the S&P 500 index down 6% in any week, it is rather stunning. To
judge a year by one week is a bit premature and reactionary. However, a frantic
start in the first week of a year stirs even more reactions, but keeping the
seven -year perspective in mind is very critical.
Some may allude to one of the worst starts to the
years as sign of urgent caution. But more than that, the synchronized
sinking across asset classes stands out as a vicious response. This is front
page material even for casual observers. From equities to commodities and from
fixed income to currencies, the action-packed market responses are strongly
felt.
Thinking Ahead
The question is not only about the uncertainly in
China, but what other areas are also vulnerable?
To only isolate market concerning matters to China is
not only a convenient narrative, but is also a misleading narrative. It fails
to tell the full story. It highlights an area that's been hurting severely for
months, as growth rate expectations have come down.
The NASDAQ 100 index last week felt the bleeding (down
7%) like other areas; even big known winners, such as Apple & Google,
showed some weakness. Momentum stocks (previous winners) that went up when
commodities and Emerging Markets are showing some weakness. Investors that felt
insulated by investing in Tech/biotech or developed markets (e.g. Germany,
Japan etc.) were equally rattled. Inter-connected markets who responded in a
similar worrisome way raised turbulence. The Volatility Index (VIX), which has
stayed below 20 for a while, finished trading last week at 27. In recent years,
turbulence has been short-lived and shrugged off, and the consensus view seemed
to be based on the near-term history. Nonetheless, the confidence of
those holding on to the “status-quo” mindset are bound to be tested.
Credibility Dissected
Reliance on the Fed (and other central banks) is bound
to be scrutinized heavily, as that's the most likely risk factor to trigger more emotional
responses— a habit that’s formed in recent years. When all the dust
settles with Oil and China's selling-pressure, then the observers are set to
shift their attention to the overly idolized Central banks. At the same
time, attention is bound to shift to US economic growth and the dangers of the
stimulus game that's been played in recent years. The credibility of the
Federal Reserve has been shattered for some experts, but not for the mainstream.
Was there basis to hike interest rates last year? Was Yellen & Co
eager to accomplish their goal rather than accepting the data? Is their
narrative wrong and can they admit it? Eagerly, answers are awaited,
but until answers are clear, panicking may remain.
The risks that are appearing today are not shocking.
Credit risk was unveiled, as few credit hedge funds closed last year; the Chinese
and Emerging Market (EM) struggle are well documented, and that caused many to ponder possibilities; EM currencies crumbling
was a theme from 2014; and the central bank bubble that's been brewing is
nothing new, either.
The Dollar strength tells a lot of stories: flight out
of EM currencies, distrust of asset growth in BRICS, and the edge of the US
financial system and lack of "reliable" (at least in perception)
currencies and system, for that matter. Fragility of the developing world is
widely acknowledged, but the desperate situation is slowly being understood.
There is ugliness to be discovered from Russia to Brazil to Saudi Arabia and
other nations. Central banks cannot deny the anemic global growth, which stirs
further tensions in foreign policy. The drawn-out disconnect between the
real economy and financial markets is narrowing as the reality sinks in.
Slowly, but finally, the truth discovery will prevail and false narratives will
be called out.
Article Quotes
“Regarding China: It seems that a falling stock market sends too
transparent a signal of negative sentiment for officials to bear. The
fingerprints of the “national team”—a motley crew of state-owned financial
institutions—were all over the buy orders that swooped in when the market
tumbled. The regulator was supposed to end a ban this week on
share sales by big investors. Now it has drafted permanent restrictions, in
effect telling investors that they are welcome to buy shares, but not to sell.
It would be hard to conceive of a better plan for scaring money away. The poor
design of circuit-breakers, trading halts ostensibly designed to calm the
market, has added fuel to the fire. The tension between reform and control is
also evident in the currency market. The central bank has started to back away
from obsessive management of the yuan’s exchange rate. But the more leeway that
it creates for trading the currency, the bigger its headache. The central bank
judges that the yuan is more or less at fair value; the market disagrees and
has pushed it steadily lower. Selling dollars to prop up the yuan so as to make
for an orderly depreciation, China has run down its foreign-exchange reserves
by some $300 billion over the past half-year. The government still has a plump
cushion, but its reserves are not limitless. Accepting more volatility, even if
that means a sharper depreciation now, would be better.” (The
Economist, January 9, 2016)
“The ultra-defensive stance reflects investors’
skittishness about global economic growth and uncertain prospects for further
gains in assets. Pension funds have the added need to cut more checks as
Americans retire in greater numbers, while mutual funds want cash to cover the
risk that investors spooked by volatile markets will pull out more of their
money. Large public retirement systems and open-end U.S. mutual funds
have yanked nearly $200 billion from the market since mid-2014, according
to a Wall Street Journal analysis of the most recent data available from
Wilshire Trust Universe Comparison Service, Morningstar Inc. and the federal
government. That leaves pension funds with the highest cash levels as a
percentage of assets since 2004. For mutual funds, the percentage of assets
held in cash was the highest for the end of any quarter since at least 2007…
The movement of longer-term money to the sidelines has left the market
increasingly in the hands of investors such as hedge funds, high-speed traders
and exchange-traded funds that buy and sell more frequently, potentially leaving it more vulnerable to sharp swings, according to some
money managers.” (Wall Street Journal, January 10, 2016)
Key Levels: (Prices as of Close: January 8, 2015)
S&P 500 Index [1,922.03] – In August and September last year, the index dropped below 1,900 briefly
before rallying sharply. Now, re-visiting this level creates a suspenseful
action ahead for buyers or sellers. Since November 3, 2015 the index has been
down around 9%.
Crude (Spot) [$33.16] – Since November 3rd highs of $48.36, the commodity has drooped
over 30%. In the mid 1980’s up to the late 90’s, Crude was mostly around the $20
range.
Gold [$1,101.85] – After a multi-week
bottoming process, early signs of recovery in gold prices have appeared. The next
upside target appears near $1,180, as seen in mid-October last year.
DXY – US Dollar Index [98.54] – Remains mostly unchanged. Its strength remains intact, as the relative
appeal of the dollar as a currency is still a defining theme.
US 10 Year Treasury Yields [2.11%] – Yields remain low. In recent months, the pattern has been in a tight
range between 2.10% and 2.30%. The lower yields reflect the ongoing rush to own
treasuries in a period where volatility is accelerating.
Dear Readers:
The positions and strategies discussed on MarketTakers
are offered for entertainment purposes only, and they are in no way intended to
serve as personal investing advice. Readers should not make any investment
decisions without first conducting their own, thorough due diligence. Readers
should assume that the editor holds a position in any securities discussed,
recommended or panned. While the information provided is obtained from sources
believed to be reliable, its accuracy or completeness cannot be guaranteed, nor
can this publication be, in any Publish Post, considered liable for the future
investment performance of any securities or strategies discussed.
