What a week and day it has been! Is it over yet? Should we be fearful or hopeful?
- Howard Isaacson
- Aug 24, 2015
- 6 min read
What a week it was! Is it over yet? Should I be fearful or hopeful?
Last week and today we have witnessed one of the craziest (and worst) markets that we have seen in many years. Having been advising clients for 20+ years now, I have witnessed first-hand the markets’ responses to following:
· the technology boom (1997-03/10/2000),
· the dot-com bust (03/2000-10/2002),
· the period of the “hanging chad” (11/7/2000-12/12/2000),
· 9/11 and the period that followed (9/11/01),
· Operation Enduring Freedom and subsequent actions in Afghanistan (10/07/2001-2014)
· The US Was in Iraq (03/20/2003-12/2011)
· the Lebanon War of 2006 (Summer 2006)
· the US financial and mortgage crisis and the resulting recession (2007-06/2009)
· the Lehman Brothers bankruptcy (09/15/2008) and the collapse of Merrill Lynch, Countrywide Credit, Bear Sterns, Washington Mutual, General Motors, Chrysler, WCI, etc.
· the Gaza War 12/08/-01/09,
· the Arab Spring (12/17/2010-02/2012),
· US Federal Government shut down (10/1/2013-10/16/2013),
· and numerous other events and periods of rising and declining interest rates.
(Normally I would include references for all substantial facts, but for expediency and ease of readability I am excluding references for the most part. Please feel free to Google any items for factual verification, if you wish.)
So what is going on now to cause such a drastic and harsh market move? I will try to break down the key issues:
China:
Issues:
Growth Slowing (or economy even shrinking)- Stats earlier this month indicated that China’s factory sector shrank by the most in 6+ years. The index is the Caixin/Markit Flash China Manufacturing Purchasing Managers' Index (PMI) and it was the lowest reading since March 2009 and was indicating the seventh consecutive monthly decline. The PMI reading came in at 47.1 for August, down from 47.8 for July. (50 indicates a non-growing and non-declining environment.) (Released on August 21rd, 2015)
The Chief Economist of the Caixin Insight Group stated “the likelihood of a systemic risk remains under control and the structure of the economy is still improving. There is still pressure on the front of maintaining growth rates, and to realize the goal set for this year the government needs to fine tune fiscal and monetary policies to ensure macroeconomic stability and speed up the structural reform. This will lead the market to confidence and renew the vigour of the economy.”
Devaluation of Yuan- On August 11th, China overnight officially devalued their currency by 2%, and the market has subsequently followed through and further devalued the currency on the open market by an additional 3%. (The devaluation could increase the foreign demand for Chinese goods and services, as they are now cheaper than before. Even if demand stays flat, those transactions valued in currencies other than the Yuan become more valuable.)
Likely to miss their national “growth target” – China’s government continues to have an official growth target of 7% for 2015, though there are private signs that they will be hard pressed to meet their goals.
China’s Internal Stock Markets: Though the Chinese markets have been pummeled over the past few months, they remain up 40% -56% from their 52 week lows, depending on the index one looks at. http://online.wsj.com/mdc/public/page/2_3022-intlstkidx.html Yes, the declines cam make us apprehensive, but given the very limited (if any exposure) of the general American or European investor to those gains or recent losses, as well as the failure of US indexes rallying due to the Chinese markets increases of more than 100% over a 12 month period, there should be a muted response on a rational US market.
But:
US Imports and Exports with China: Through the end of June, the US imported $226.7B of goods from China and exported $55.9B to China in 2015. In looking at the month by month numbers there has been no noticeable and consistent decline in either to warrant concern. There have been some changed versus the first 6 months in 2014: Imports in the first 6 months of 2014 totaled $214B and exports were $58.5. https://www.census.gov/foreign-trade/balance/c5700.html Some of the decline in exports may have been due to the decline in the prices of commodities rather than a decline in quantity of goods….. So this does not support any rational major moves in the markets.
China’s further militarization in the South China Seas – Though China continues along the path to build islands and military capacity over the past few months, this has not been cited by any economists or market strategists as a cause of global equity market volatility.
US Economy:
Either we are strong enough to have the Fed increase the Fed’s target rate, which is a positive sign to the world, or our economy is not yet so strong and the Fed will maintain their current targets between September and December. Either of these should be construed as “positive” for the US markets as cheap money is good and a strong economy is also good.
Based upon the current treasuries futures markets, there is a 24% likelihood of a Fed target rate increase in September. I, personally, believe the likelihood is much lower, given the recent volatility, US Dollar appreciation, weakness in the oil, gas and other industrial commodity markets, and lack of pressure on factory and employment capacity.
The Markit Flash US Manufacturing Purchasing Managers' Index (PMI) has continued to remain positive (ove 50) indicating continued growth, though at 52.9 in August, down from 53.8 in July, it was at the lowest level since October 2013. Manufacturing output has slowed from the three month high in July per their survey. Average costs have increased for the past four months, though they remain below long running averages. http://www.markiteconomics.com/Survey/PressRelease.mvc/40e0964ee7024a42b2526e063c7851ff
From this we see that the US growth continues to be positive, though nothing to be excited about. We also see that pricing pressures are minimum and that inflation does not appear to be an issue. The reports notes that August had “the slowest overall pace of manufacturing growth for almost two years.” This is definitely not great, but very, very far from bad.
One of the Fed Reserve Presidents, St. Louis President James Bullard, indicated on 8/19 that he would argue for a small increase in the short term rates “assuming the incoming data support it”. http://www.wsj.com/articles/feds-bullard-still-on-board-for-september-rate-rise-in-interview-1439998377 Assuming incoming data support a rate increase is a BIG Assumption, IMHO, at this point in time.
One of the Morningstar analysts made the following very interesting comments about the Fed failing to cite potential reasons for not raising their target rate in 2015 as a reason that the Fed continues to seek to raise the target rate in 2015:
· “…the FOMC didn't take this opportunity to highlight factors that might influence it to hold off on a rate hike this year. Instead it plodded along with a view that economic conditions generally point toward prospects for continued improvement.”
· “A lot will happen on the economic front in the coming months to influence the Fed's thinking. There is no question in our mind that the FOMC is eager, if not desperate, to get off the zero bound. It had the excuses at its July meeting (eg. China, commodities, strong dollar) to convey the idea that it might have to push back its rate hike hopes. It did not do that.”
· “There might not be a rate hike at the September meeting, yet the FOMC didn't provide any hint in the July directive either that there wouldn't be one before the end of the year. To be sure, it will be watching the data like a hawk to satisfy its desire.”
It certainly may be the institutional traders who are now afraid that the Fed will seek to boost their target rate when the risk levels are too high that might be really spooking the US markets. If this is the case, then some comments from Fed leadership could clarify the market’s understanding, which would result in a significant reversal of the negative sentiment.
Below is a series of charts compiled by Bloomberg as to the Fed’s “Labor Market Dashboard”. As you can see, only 3 of nine metrics meet the Fed’s objectives. Thus, the Fed may be hard pressed to raise the target rate without additional improvement to the labor markets.
Looking at some other economic data points from this past week:
The Bloomberg Consumer Comfort Index came in at 41.1 versus the prior week’s 40.7. It had fallen for four weeks prior to increasing this past week.
Housing Starts came in at 1.2M vs 1.174M in the prior month, a positive sign. New Permit filings was down though, including down by 9.9% in the West, indicating potential future weakness.
Leading indicators came in at -0.2% for July versus 0.6% for June and consensus of 0.0% to 0.4%. The decline was attributed to the decline in new permit filings mentioned above. Other components indicated continued moderate growth and possible improvement in the lending environment. Not so good, and okay.
The biggest negative surprise came on Monday with the Empire State Manufacturing Survey coming in at -14.92 for August, versus expected of 4.75 and prior month’s 3.86. Weakness in energy, exports, plus weakness in backlogs, orders and shipments all contributed to the decline. Definitely far from good news, and supports the Fed holding off on an increase.
Conclusion:
We will see lots of new data points in this new week. It appears that there is great sensitivity to declining rates of expansion in the emerging markets, weakening growth in Europe, and spots of weakness in the US. All data points do not at all imply any imminent collapse or significant recessions, etc. At the same time, there is great nervousness. CapitalRock will remain vigilant in examining news flows, versus noise, and seeking opportunities for income and capital appreciation.
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