“Real valor consists not in being insensible to
danger; but in being prompt to confront and disarm it.” (Sir Walter Scott
1771-1832)
Desperate Revival
Some early signs of revival commodities and Emerging
Markets has set a new tone early in 2016. These recoveries are after lengthy
and collective downside moves in recent years. The commodity and EM bull
markets both ended in ugly fashion, especially in the last three years. They spiraled
into crisis mode from Crude to Steel to soft commodities. Importantly, the recent post-demise bounce in
EM shares and prices of key commodities reflects an over-due (and natural)
recovery from cheap levels rather than a fundamental shift. Equally, the slowdown in US dollar
strength contributed to the current dynamic and remains a key macro factor. Strengthening of EM currencies in the first
quarter stood out as EM currencies came back to life:
“The ones [EM currencies] that have risen most in recent weeks are
typically those—the trouble, the real and the rand—that had lost most ground
since May 2013, when the emerging-market sell-off began in earnest.” (The
Economist, May 7, 2016)
A reversal of sorts is either maybe a major shift or a
short-term occurrence that masks other brewing problems in EM. For now, this feels like a short-term
response rather than a new trend.
However, desperation by investors
for returns is forcing a re-assessment of risk and a willingness to take a shot
in "cheap" assets. In a landscape where Nasdaq and other developed
market shares appear overly saturated (in-turn offering limited upside), this
line of thinking and action is not surprising.
Therefore, this begs critical questions: 1) Is the commodity run
sustainable? 2) Will any fundamental change in supply or demand to stir further
price increase? In both cases, odds are
less likely, but surprises last longer than imagined.
The oil demise has painfully hurt nations such as
Saudi Arabia, Russia, Nigeria and Venezuela. Commodity-rich countries, like Brazil
and South Africa, have felt the pain in the country's budget impacting growth
and outlook. Demand from China continues to
slow down, which further reflects the inter-connected weakness that's
lingering in the global economy. In terms of China, demand is certainly weak,
as confirmed by recently data:
“April imports dropped 10.9 percent from a year
earlier, falling for the 18th consecutive month, suggesting domestic demand
remains weak despite a pickup in infrastructure spending and record credit growth
in the first quarter.” (Reuters, May 8, 2016)The EM landscape is hardly on
solid footing, just like the fragile global growth climate. All the short-term
cheery moves aside, the fundamentals are not pretty and risk may be even higher
than most want to realize.
Disconnection Realized (Again)
As for all hopes of economic revival or any basis for
rate hike, once again the job numbers confirmed ongoing weakness. The notion
that US recovery is strong or even immune from global slowdown makes less sense
even for optimists. Financial shares are
battered, tech-related stocks are struggling with sustaining growth and central
banks are admitting the lack of basis for hike rates. There is no shortage of
weakness in the globe, as the case for crisis-like action is not far-fetched by
any means.
Low interest rates have spurred stock market rallies recently, but now there is a major shift
taking place. Japan and Germany are classic examples where stock prices are now
much lower despite having lower interest rates. For 2016, Japan's stock index,
Nikkei is down 15% and the German DAX is
down 8%. Both are developed markets with lower risk perception, but the
slowdown in growth, which battered EM last year, is now seeping into
shareholders' minds broadly. This
action in Japan and German is either a prelude to US sluggishness or an
over-due correction that’s been postponed.
Perspective
Notably, the Nasdaq peaked on April 20th, sending
some early clues of slowing US equities. Interestingly, the Nasdaq was immune
from commodity related slowdown recently, but the script is changing a bit. Interestingly, on that same day, the VIX (Volatility
index) hit annual lows. Perhaps, this can mark a major turn-point as long
awaited, despite many prior false alarms. At this stage, participants have a
choice to go with the Fed’s narrative or to get cautious based on real live
actions. US job number weakness, slowing
Chinese demand, outflow of capital in hedge funds, excessive complacency by
most investors and misleading short-term optimism are all real signals.
If the Fed has lost credibility and ran out of
ammunition, then a natural correction is not unreasonable. Rate hike
possibilities now require a miracle and low-rates have failed to stimulate the
real economy. As “Brexit” and election uncertainty loom, much distraction
awaits, but the real economy has been weak for a long while. The Fed’s adored
script has created a narrative that dismissed the ground-level pain at corporate
and consumer levels. Perhaps, an unraveling action at this stage is not overly
strange. Money managers have to confront the current data rather than
being overly hopeful of unknown pending twists and turns.
Article Quotes:
“MetLife Inc., the largest U.S. life insurer, said
it’s seeking to exit most of its hedge-fund portfolio after a slump in the
investments. The insurer is seeking to redeem $1.2 billion of the $1.8
billion in holdings … MetLife, which has an investment portfolio of
more than $520 billion, has been looking in recent years for alternatives to
bonds because interest rates are so low. While results from private equity have
been satisfactory, hedge funds have been more volatile, Goulart said. Chief
Executive Officer Steve Kandarian is seeking to increase the portion of
earnings that can be returned to shareholders. That focus on free cash flow
factored into the decision to cut the hedge-fund investments, Goulart said.
Competitor American International Group Inc. is also shifting allocations after
posting three straight unprofitable quarters. The company said Tuesday that it
has submitted notices of redemption for $4.1 billion of hedge-fund holdings
through March 31. Average invested assets in hedge funds at AIG were $10.1
billion for the first quarter. (Bloomberg, May 5, 2016)
“This golden era has now ended. A new McKinsey Global
Institute (MGI) report, Diminishing returns: Why investors may need to lower
their expectations, finds that the forces that have driven exceptional returns
are weakening, and in some cases reversing. The big decline in interest
rates and inflation is reaching its limits, global GDP growth will be lower as
populations in the developed world and China age, and the outlook for corporate
profits is cloudier. While digitization and disruptive technologies
could boost margins for some companies, the big North American and Western
European firms that took the largest share of the global profit pool in the
past 30 years face new competitive pressures from emerging-market companies,
technology giants, and digital platform-enabled smaller rivals. These forces
may curtail margins going forward. MGI’s detailed analytical framework linking
investment returns to the real economy finds that returns on equities and
fixed-income investments in the United States and Western Europe over the next
two decades could be considerably lower than they have been in the past 30
years. The report, written in collaboration with McKinsey’s Strategy and
Corporate Finance Practice, estimates that for equities in both regions,
average annual returns could be anywhere from approximately 150 to 400 basis
points lower, or 1.5 to 4.0 percentage points. For fixed-income, the
gap could be even larger, with average annual returns between 300 to 500 basis
points lower (3 to 5 percentage points), and in some cases even lower than
that.” (McKinsey Insights, April 2016)
Key Levels: (Prices as of Close:
May 6, 2016)
S&P 500 Index [2,057.14] – As 2015 showcases, a
major resistance around 2,100 remains a crucial hurdle for buyers to
overcome. Previously, the index peaked
in July 2015 (2132.82) and November 2015 (2116.48). April highs of 2011.05
failed to hold, hinting at another potential peak.
Crude (Spot) [$44.66] – Signs of price
stabilization appear around $38. From a big picture point of view, prices are
still fragile after the heavy sell-off earlier in the year.
Gold [$1,289.00] –
A lengthy bottoming process has been occurring for over 3 years. The next
target of $1,300 is on the radar. Some lively momentum is visible within the
bottoming process.
DXY – US Dollar Index [93.88] – Since peaking at
100 on December 2, 2015, the dollar has weakened. After being a very crowded
trade in 2015, the strength is fizzling a bit.
US 10 Year Treasury Yields [1.77%] – Hardly moving at
all recently. The 50-day moving average stands at 1.83% and tells much of the
recent story as yields remain low.
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