Market Commentary - September 2015
The traditionally quiet month of August, when all good city folk should be sunning themselves on the Riviera, has exploded into action. Now that we have high frequency traders running the show, allegedly supplying liquidity, which must be one of the biggest jokes perpetrated on a largely unsuspecting investment community, volatility has been eye watering. From the 23rd to the 28th the Dow Jones Industrial Average moved up and down by a total of 5,612 points! It has been the same story in commodities, notably oil where Brent crude started the week around $46 a barrel got down as low as $42 and then traded above $50. Bond markets, usually the safe haven when “things go a bit awry”, have also been in the eye of the volatility storm. The 10-year US Treasury yield fell below 2% to 1.9% on Monday morning, but by Friday it was as high as 2.2%.
What on Earth is going on? The explanations are legion; Chinese devaluation, Chinese economy, Chinese stock market, but not according to China. Oh no! As far as they were concerned it was about interest rate speculation in the US and the inability of the Fed to articulate their intentions without the customary obfuscation. Quite so… The commodity complex has been quietly imploding for some time. Punditry is of the opinion that lower commodity prices, notably oil and the industrial metals, would be good for increased economic growth, which of course it would be if there was any! Commodity prices rise as a result of growth, not the other way around, proven by the continuing decline of prices as news slowly leaks out of a slowing Chinese economy.
But this is all relatively old news, so why the mayhem in the equity markets? Well, as ever, it seems that it is all down to the inability of homo sapiens to act rationally, which is a huge problem for economists as they assume rationality as a given; otherwise their models don’t work... Once the creeping doubt, of which we have had much to ponder, translates into a “significant market move”, the herd mentality kicks in and up and down we go. The press then goes on the rampage searching for “the trigger” when it was “us” all the time!
After such a sharp fall, in four days the UK index went from 6,526 to 5,768 (11.6%), we can expect a rally; and we have had one + 8.3% since the low. What happens next is crucial. Are there still doubters out there? Or will “rationality” prevail? Is it rational to insist that “nothing has changed” so the bull market can continue? The topping action of the major indices, in particular the S&P500 and the UK, suggests otherwise. This distribution pattern when the market transfers stock from strong hands, who have ridden the bull for some time to the latecomers, who are now keen to get on board, is characterised by a rounded pattern that eventually gives way. A second bearish signal is that the 50-day moving average has crossed below the 200-day moving average, both of which are now falling. One swallow doesn’t make a summer (although we could do with one before September is out!) but without some more significant central bank manipulation, capitulation on interest rate rises through to more QE (the efficacy of which is very much open to question), we can, at best, expect markets to go nowhere with regular bouts of volatility to maintain the apprehension. A move below the recent low at 5,768 would suggest a lot more downside eventually testing 5,000. We will be watching how this corrective move unfolds.
Whilst there are more than a few pundits who have yet to see an interest rate rise, your correspondent has been around for just a while longer and a recent comment that corrections in August in thin markets were often a good buying opportunity reminded me of the summer of 1987. The UK index hit an all-time high of 2,455 in July – having opened the year at 1,679 - and then had what seemed like a dramatic fall of 300 points (12%) into the middle of August down to 2,157. For the rest of the month and throughout September, after the holiday season was over, the index retraced most of the losses back to 2,400. Then in mid-October the US trade deficit for August was notably above expectations and rumours circulated that the Fed would have to raise interest rates. What followed was a one day fall of some 20%! If that is the case then we wait with some trepidation for the Fed’s announcement on rates on September 17th.
Last month we said that, “The lack of momentum we highlighted previously continues and the S&P 500 is back close to the 200-day moving average, which has provided much support in the past. The market is still technically in an uptrend and a break of the MAV and a close below 2,000 is needed to encourage the bears into action.” The bears are now so encouraged. It is now up to the Fed to dissuade them from going on a rampage. Their job is made all the more difficult by the increasing realisation that they don’t actually know what they are doing, although they would be the last ones to admit it.
On the same day that the Fed are scheduled to opine on rates, the ECB general council will be in session and we can expect words of “wisdom” from Mario Draghi too. Three days later we have the Greek elections when the ECB will be hoping that the electorate make the “correct” decision this time around, although if comments attributed to Wolfgang Schauble are anything to go by they really won’t be too bothered if they don’t! Whilst the recent economic data on Club Med has been “encouraging” it has allowed the eye to be taken off the French and German ball where the news is less than good.
Yet another country where the central bank is expected to step up to the plate. We suspected that the 21,000 level would provide formidable resistance and so it has. There has been a significant spike up from the low at 17,700 and we will reappraise our stance on Japan if that level is re-visited.
Asia Pacific and Emerging Markets
The continuing falls in the Chinese stock markets, together with the weak economic data, have impacted on the Asia Pacific region as a whole and we expect this downside volatility to continue a while yet. The Chinese government are learning the lessons of capitalism the hard way, but, as ever, they have time and the potential of the world’s largest economy on their side. Weaker oil prices and dollar strength, which is making a comeback, having paused for breath over the past few months, will impact negatively on already declining emerging indices. There will be a time to get back in to these markets when all the speculative froth has been blown away; it won’t happen in a hurry.
Commodities and gold
Last month we said of oil and copper that, the global economy is still fragile overall so perhaps more sideways than up is the best we can anticipate.” For once we were too optimistic and the whole commodity complex has started another leg down. If there was some real fire in the global economy this index would not be in a downtrend. Since 2013 there has been a disconnect between the World equity index and the commodity complex. Either equities are too expensive or commodities are too cheap. The market action is currently suggesting the former.
Gold has decisively fallen through the key $1,200 support level and $1,000 looks likely to be the next stop, although “benign” Fed action would spur a rally.
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Value is almost impossible to find and the other major concern in these markets is liquidity. In the sovereign debt markets, volatility, on top of burgeoning regulation, is frightening off even the biggest players. Ironically the Basel banking regulations, which have set the capital requirement for holding “very secure” sovereign debt at 0%, allowing some significant gearing into these markets, may well turn out to be the catalyst for the next crisis; the law of unintended consequences always strikes where it is least welcome.
The central banks, as ever, hold the key to market movements. ECB and Fed meetings on September 17th will set the tone for the rest of the year, but can they maintain the façade of invincibility?
•Government bonds still look expensive, despite deflation yet again being discussed as the bigger problem.
•Spreads on corporate bonds are still tight. They are not cheap either and default risk can only rise from here, making high yield potentially less attractive. Is the yield premium adequate? There is also significant concern over liquidity risk.
•Western equity markets have started a long expected correction. Whether it turns into something more extreme hinges on central bank action, as well as the nerve of investors.
•Property remains attractive as a real asset offering a higher spread against most fixed interest markets, but not without risk.
•European markets are in a state of flux. Conventional wisdom says that ECB QE should be beneficial for financial assets but the Greek issue is yet to be fully resolved and the imminent elections won’t necessarily produce the “required” outcome. The Nikkei index has reached our initial target at 21,000 and has started to see a retracement of some of the gains. Emerging and Asia Pacific markets are not overly expensive, but will continue to be volatile and negatively affected by dollar strength and Chinese economic weakness.
•Central banks are committed to supporting the markets but their aura of invincibility is beginning to slip. Ultra loose monetary policy will create inflation eventually, but currently deflation is still an issue and it is getting harder to see where anything other than tepid growth is going to come from; even China is succumbing to the malaise.
•Gold has fallen through support at $1,200 driven down by unusually aggressive and abnormal selling on the futures market. Physical demand remains strong and there will be a significant buying opportunity when this market shows signs of bottoming, but not, we suspect, for a while.
•Commodities generally will not see a sustained trend change until the global economy shows more signs of life.
Clive Hale, Director - September 2015
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