Edge and Odds

The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

Edge and Odds

Invest with smart knowledge and objective odds

NEW$ & VIEW$ (26 AUGUST 2015): QE4?

Richmond Fed: Manufacturing Dropped 13 Points

Fifth District manufacturing activity slowed in August, according to the most recent survey by the Federal Reserve Bank of Richmond. Shipments and order backlogs decreased, while new orders flattened this month. Manufacturing hiring softened this month; however, average wages continued to increase at a moderate pace. Prices of raw materials rose more slowly in August, while prices of finished goods grew slightly faster compared to last month.

Chemical Maker Index Signals U.S. Manufacturing Drop

The Chemical Activity Barometer, whose indicators include the production, inventory and selling prices of numerous chemicals as well as prices of chemical stocks, rose 1.8 percent in August from a year ago (on a three-month moving average basis), the slowest pace since late 2012. That’s concerning since declines in chemical demand have preceded drops in industrial output in the past, according to Kevin Swift, chief economist for the American Chemistry Council and creator of the index.

Mortgage Applications Increase Slightly in Latest Weekly Survey, Purchase Index up 18% YoY

Up YoY but against a pretty weak base. Purchase apps sure seem to be rolling over:

Summers and Dalio flag return of QE Industry figures argue Fed should restart bond buying plan

(…) Lawrence Summers, the former Treasury secretary, and Ray Dalio, head of the world’s biggest hedge fund manager, this week indicated that the US central bank should consider restarting its “quantitative easing” programme to counter deflationary dangers and ameliorate tensions on financial markets. In an opinion piece in the Financial Times, Mr Summers wrote that raising rates in the near future would be a “serious error”, but later went further and suggested on Twitter that the Fed should even consider another bond buying programme. (…)

In a note to clients on Monday afternoon [Dalio] predicted that the “next big Fed move will be to ease (via QE) rather than to tighten” due to global debt levels, the Chinese ructions and turbulence in emerging markets as a whole. “While we don’t know if we have just passed the key turning point, we think that it should now be apparent that the risks of deflationary contractions are increasing relative to the risks of inflationary expansion because of these secular forces,” he wrote.

“Our risk is that they could be so committed to their highly advertised tightening path that it will be difficult for them to change to a significantly easier path if that should be required,” he added, in the note seen by the FT. (…)

ECB Ready to Expand QE If Needed on Inflation Risks, Praet Says

The European Central Bank is ready to expand or extend its bond-buying program if needed as a slump in commodity prices and risks to global economic growth threaten its inflation goal, said Executive Board member Peter Praet.

“Recent developments in the world economy and in commodity markets have increased the downside risk of achieving the sustainable inflation path towards 2 percent,” Praet told reporters in Mannheim, Germany. “There should be no ambiguity on the willingness and ability of the Governing Council to act if needed.”

The comments came a day after ECB Vice President Vitor Constancio said the council “stands ready to use all the instruments available” if needed to ensure price stability.

FIBER: Industrial Commodity Prices Post Broad-Based Declines

The industrial commodity price index from the Foundation for International Business and Economic Research (FIBER) deteriorated last month by 4.6%. In the U.S. alone, a 0.8% rise in factory sector production during July left output so far this year up a modest 0.5% and 1.4% during the last twelve months. That’s down from 2.5% growth in 2014 and from 2.5%-to-6.0% growth rates from 2010 to 2012. Growth abroad similarly remained weak.

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Farm Income Set to Fall 

U.S. farm incomes will decline 36% this year to the lowest level in nine years, the U.S. Department of Agriculture projected Tuesday, reflecting a continued slump in crop prices and recent weakness in the dairy and hog markets.

Net farm income will drop to $58.3 billion from $91.1 billion in 2014, marking the largest percentage decline since 1983, including when figures are adjusted for inflation. The projected decrease would mark the second consecutive drop after incomes reached nominal record highs in 2013, according to the USDA. (…)

The government said their revenues could drop more than 9%, wider than its February forecast for a 5% decrease, because of lower milk and hog prices.

The softening outlook for farm incomes comes amid a continued downturn in the U.S. agricultural economy triggered by record corn and soybean crops in the past few years. U.S. growers this autumn are expected to produce bumper harvests again, which has kept prices depressed for the two commodities. (…)

Mr. Justison said falling crop prices have significantly reduced cash flow for many Midwestern growers, forcing them to carefully scrutinize what once were regular purchases. “We’ve pretty much stopped buying machinery,” he said.

The farm-industry slump is hurting large agricultural-equipment suppliers and seed makers. Last week, Deere & Co., the world’s largest seller of tractors and harvesting combines, said its profit in its July-ended third quarter tumbled 40% as weak crop prices curb farmers’ appetite for new equipment. (…)

Trade suffers biggest fall in 6 years Figures fuel debate on whether globalisation has peaked

(…) The volume of global trade fell 0.5 per cent in the three months to June compared with the first quarter, the Netherlands Bureau for Economic Policy Analysis, keepers of the World Trade Monitor, said on Tuesday.

Economists there also revised down their result for the first quarter to a 1.5 per cent contraction, making the first half of 2015 the worst recorded since the 2009 collapse in global trade that followed the crisis.

Global trade actually rebounded 2 per cent in June, according to the World Trade Monitor but its authors warned that the monthly numbers were volatile and the more revealing pattern lay in the longer term figures. (…)

In the three months to June, global trade grew just 1.1 per cent from the same quarter of 2014, according to the new Dutch figures. The International Monetary Fund expects the global economy to grow 3.5 per cent this year. (…)

The slowdown in global trade has led some to proclaim that globalisation has peakedwith technological innovations such as 3D printing creating more disruptions.(…)

World Struggles to Adjust to China’s ‘New Normal’ China is in the midst of a tectonic shift in its giant economy that is rattling markets world-wide. The slowdown deepening this year is part of a bumpy transition away from an era powered China’s seemingly unstoppable rise; now debt has swelled to more than twice the size of the economy, and some industries are reeling.

(…) Instead of them, China is pushing services, consumer spending and private entrepreneurship as new drivers of growth that rely less on debt and more on the stock market for funding. (…)

Retail sales are still climbing, up 10.5% in July from a year earlier, although the rate of growth has slowed. A string of U.S. companies, from Apple Inc. to Gap Inc., have singled out China as a growth market in an otherwise sluggish world. Chinese consumers are spending like never before on movie tickets, toothpaste, jeans and cars.

“My life is actually getting better,” said Zhu Baolian, a retired package-handler at Beijing’s Capital International Airport. The 58-year-old said the government recently fattened his pension by 250 yuan a month, about $40, giving him more spending money. “I eat well. The quality of our food and other things is improving,” he said.

The problem is that consumer spending isn’t robust enough to replace the heavy industry and investment in infrastructure and property that powered China’s nearly 10% average annual growth for the past three decades. For that to happen, a series of wrenching changes would have to take place, from giving migrants better access to social services to breaking the dominance of state-run banks and companies in many industries. (…)

China now is exporting volatility. The CBOE Volatility Index, a measure of risk in the U.S. stock markets sometimes called the fear gauge, has surged over the past week, tracking the cratering Shanghai market. This is in contrast to previous Chinese share routs that barely registered abroad. (…)

As troubles mounted this summer, divisions within the party elite began to rise, according to Chinese officials and government-connected scholars. China’s central-bank governor, Zhou Xiaochuan, and its finance minister, Lou Jiwei, preferred more-limited stock-market intervention, said officials with knowledge of the situation, but were overruled by Premier Li, who demanded forceful actions to support the tumbling market.

Senior party members close to one of Mr. Xi’s predecessors urged him to pay renewed attention to the economy, these people said. An unusually blunt commentary in People’s Daily, the party’s main newspaper, this month criticized unnamed retired leaders for interfering in the government and sowing division. Their attempt to retain influence “not only puts new leaders in a bind but hinders them from having a free rein to do bold work,” it said.

Investors who during good times saw Beijing’s tight control of economic levers as assurance their business interests were safe now worry that authorities could be understating problems.

Mr. Li, in his statement on Tuesday, said that as the government takes “more reform measures to encourage market vitality and improve people’s living conditions, China has the ability and conditions to achieve its annual economic growth target, which will be a big contribution to the global economy.” (…)

But China also finds itself somewhere between a poor and rich country. This is a historically difficult position—dubbed the “middle-income trap” by economists—that South Korea escaped but that has held back much of Latin America.

“China is right there, where a lot of countries start to struggle,” said Peter Robertson, an economist at the University of Western Australia, adding that the “trap” often features conflict between a political system and economic reality over how a nation’s wealth is distributed. (…)

Questions over Li Keqiang’s future amid China market turmoil

(…)Among party officials and politically connected people in Beijing, the hottest topic of conversation is whether Mr Li will take the fall for Beijing’s perceived mismanagement of the stock market crash and the country’s broader economic slowdown. (…)

But even if Mr Li is blamed by the party elite for his handling of the crisis, most analysts and serving officials believe his removal from power would be too damaging to party prestige and credibility and that he is almost certain to remain in office, at least until the next five-yearly party Congress in 2017.

Mr Li is already regarded by most analysts and political insiders as the country’s weakest premier in decades, thanks largely to Mr Xi’s aggressive concentration of power in his own hands. (…)

Devaluation Stunner: China Has Dumped $100 Billion In Treasurys In The Past Two Weeks
 
Asia Consumer Spending Won’t Come to Rescue

(…) Household spending on consumption fell more than 4% year-over-year in the three months ended June in Indonesia and Malaysia, two of Southeast Asia’s linchpin economies, according to statistics compiled by CEIC Data. In Thailand, growth in consumer spending slowed to 1.3% year-over-year in the second quarter from 4% in the first. (…)

High-frequency data show retail sales in Indonesia fell 5.3% year-over-year. Sales fell more than 13% in Singapore, a typically volatile market, its fourth straight month of contraction.

Meanwhile, farmers in Asia have been particularly hard hit by falling commodities prices and have less purchasing power as a result. (…)

Consumer spending accounts for 56% of gross domestic product in Indonesia, 58% in Thailand and 52% in Malaysia. China’s rapid development raised hopes the world’s second-largest economy would transition toward consumption-led growth from one driven by manufacturing and construction. But consumer spending accounts for only 38% of GDP, compared with 41% 10 years ago.

There are some bright spots. In India, where private spending contributes around 57% of GDP, consumers are expected to remain a sturdy pillar of growth as the government works to connect more of the population with electricity, bank accounts and decent roads. Household and business spending grew 6.3% in the 12 months ended March, statistics show. (…)

Brazil’s Economy Shows More Signs of Weakness

(…) In 2015 through July, Brazil has lost nearly a half-million jobs, according to the Labor Ministry. Joblessness hit 8.3% in the second quarter, according to the Brazilian statistics agency’s three-month unemployment calculation. That is the highest level since the series began in 2012.

The country’s main consumer confidence measure sank to 80.6 points, the lowest since that series began in 2005. (…)

China is Brazil’s biggest trading partner (…)

Ruble Near Record Lows
BHP Billiton’s credit ratings fragile, agencies warn

(…) Both agencies said even with BHP’s sharp cut in capital spending and plans to pare costs beyond the $4.1-billion already slashed in the 2015 financial year, funding the dividend from cash flow would be a challenge if commodity prices worsened.

“This would place further pressure on credit metrics and the rating,” Moody’s said.

EARNINGS WATCH

A strategist wrote yesterday that “as long as earnings continue to grow, pullbacks such as the current one can be opportunities for investors with longer-term horizons”. The surprise is the first part “as long as earnings continue to grow”. The reality is that they are no longer growing and are set to drop 3.3% YoY based on Thomson Reuters’ methodology and calculations.

Furthermore, TR’s most recent data reveal that:

  • Negative preannouncements have increased from 62 on Aug. 14 to 81 on Aug. 25. So 19 negatives against only 3 positives during the last 6 working days.
  • Q3 EPS are now expected to decline 3.3%, a little worse than the –3.1% expected on Aug. 14.
SENTIMENT WATCH

(…) Tuesday, amid the six-day decline in stocks, J.P. Morgan Chase & Co.’s Dubravko Lakos-Bujas cut his year-end view by 100 points to 2150 from 2250, blaming technical deterioration and continued strength in the U.S. dollar.

“We remain cautious in the short term given outstanding global risks and higher degree of technical market deterioration, but view a deep correction as unlikely,” wrote Mr. Lakos-Bujas.

Mr. Lakos-Bujas is the first among 21 strategists followed by Birinyi Associates to have lowered his year-end price target during the recent market downturn in which the S&P 500 has shed 11% over six sessions. Still, even with Mr. Lakos-Bujas’ downward revision, the average year-end gain among strategists Birinyi tracks stands at a little higher than 8%.

Craig Johnson, a technical market strategist at Piper Jaffray and one that Birinyi does not follow, back pedaled on his year-end target for the S&P 500 Monday when he slashed his 2015 view by 215 points to 2135 from 2350. (…)

(…) In dissecting the duration of and damage from previous stock market declines, the strategist finds that this current one looks like it’s close to its finale. Since 1988, the MSCI All Country World total return index has suffered a drop of more than 10 percent on 16 occasions, averaging a 20 percent decline over a span of 18 weeks., By comparison, this retreat has lasted for 14 weeks, during which time the index has given back 19 percent.

Though timing the market is a tricky task indeed, Laidler points out that investors who manage to buy the trough can look forward to an average 12-month return of more than 20 percent:

Trading Tumult Exposes Flaws in Modern Markets Monday’s mayhem exposed significant flaws in the new architecture of Wall Street, where stock-linked funds—as much as shares themselves—now trade en masse on U.S. markets.

Many traders reported difficulty buying and selling exchange-traded funds, a popular investment in which baskets of stocks and other assets are packaged to facilitate easy trading. Dozens of ETFs traded at sharp discounts to their net asset value—or their components’ worth—leading to outsize losses for investors who entered sell orders at the depth of the panic.

Products built to provide insurance for investors came up short. As a result of trading halts in futures tied to the S&P 500 index, it was difficult for investors to get consistent prices on contracts linked to them that offer insurance against S&P 500 declines.

Elsewhere, the value of the most widely tracked Wall Street gauge of investor anxiety, theCBOE Volatility Index, or VIX, wasn’t published until almost 10 a.m. Monday, half an hour after stock trading began and after the Dow Jones Industrial Average had already posted its largest-ever intraday point decline. That made it difficult for investors to easily gauge the fear in the market. (…)

Circuit breakers, which are designed to pause trading in single stocks and ETFs during big moves, were triggered nearly 1,300 times Monday. (…) But Monday, they sometimes exacerbated problems by preventing prices from returning to normal levels quickly, according to traders, investors and market observers. (…) The declines in these and other ETFs were notable in that they exceeded the declines in the prices of their underlying holdings. (…)

Today, there are more than 1,400 ETFs trading in the U.S. markets. (…)

Dennis Houlihan, a financial adviser based in Fort Wayne, Ind., said issues like those on Monday have implications that go far beyond portfolio losses for individual clients.

“On days like yesterday, it’s up for debate if there was a larger, more systemic issue in the market,” said Mr. Houlihan. “I think you are going to lose generations of investors.”

NEW$ & VIEW$ (25 AUGUST 2015): Sentiment Watch.

China Cuts Rates China cut its benchmark lending rate to 4.6% and reduced the cash levels banks are required to keep as China’s stock-market tumble has sent its main stock index down 22% in the past four days.

China also did away with its ceiling on most bank deposits.

The People’s Bank of China said in a statement on its website that it also cut bank reserve requirements for rural banks by an additional half a percentage point.

  • CHINA PBOC CUTS INTEREST RATES
  • CHINA PBOC CUTS REQUIRED DEPOSIT RESERVE RATIO
  • CHINA PBOC CUTS 1Y DEPOSIT RATE BY 25 BPS
  • CHINA PBOC CUTS 1Y LENDING RATE BY 25 BPS
  • CHINA PBOC CUTS BANKS DEPOSIT RESERVE RATIO BY 50 BPS
China stocks plummet again as Beijing sits on sidelines
Beijing capitulates after spending $200bn to prop up equities

Beijing’s leaders appear to have belatedly decided it is too expensive and ultimately futile to fight gravity in the equity market, especially as the government is now intervening separately on a massive scale to stop its currency from devaluing further.

Since the People’s Bank of China devalued its currency and introduced a new “market-oriented” foreign exchange price-setting mechanism on August 11, it has had to spend as much as $200bn of the country’s foreign exchange reserves to prevent the renminbi from falling more than it wants, according to people familiar with the central bank and its market interventions.

That was more money than the PBoC had spent over the past two years to keep its currency in the desired range against the dollar, these people said.

The scale of the intervention in both equity and currency markets has led many to question whether the Chinese authorities are in control of the situation or whether they have made a series of policy blunders. (…)

CHINA’S HARD-LANDING TRIGGERS A REASSESSMENT OF THE PROSPECTS FOR GROWTH

(…) there are two groups of emerging market economies that look particularly vulnerable.

There are the commodity rich nations, such as Sierra Leone and Angola, which have met China’s insatiable demand for natural resources. And there are also the East Asian economies, such as South Korea, Malaysia and Vietnam, which export semi-manufactured and finished goods to China. Data suggest that China’s slowdown has already hit commodity producers hard, and they will continue to suffer — with crude oil prices hitting new six-year lows. (…) (Chart from BCA Research)image

Pointing up Abe Aide Hamada Says BOJ Should Ease If Economy Fails to Grow
Bear Grip Tightens on Emerging Stocks as Half of 30 Markets Wilt

Fifteen of the 30 largest equity markets among emerging economies extended losses yesterday from their peaks to 20 percent or more, fulfilling traders’ definition of a bear market. China and Russia have led the pack, tumbling more than 30 percent each. The remainder are either in a correction, or on the brink.

Investor Confidence Plunges Amid Emerging-Market Rout

Investors are even less confident about emerging-market equities than they were at height of the financial crisis in 2008, an index showed yesterday. That may be a signal that a market rebound is coming, argues Sentix, the data compiler.

The polling group’s gauge of sentiment in emerging-market equities fell about 20 points to minus 27.75 in August, the lowest since it began in early 2007.

The sharp decline in the index “is an enormous glimmer of hope as the appearance of fear is usually a precursor of a turn in price developments,” said Sebastian Wanke, senior analyst at Sentix. He said the sharp drop in the mood index in late 2008 preceded a rebound in emerging-market equities. (…)

Hmmm…

Chicago Fed: Economic Growth Picked Up in July

Led by improvements in production-related indicators, the Chicago Fed National Activity Index (CFNAI) rose to +0.34 in July from –0.07 in June. Two of the four broad categories of indicators that make up the index increased from June, and three of the four categories made positive contributions to the index in July.

The index’s three-month moving average, CFNAI-MA3, edged up to a neutral reading in July from –0.08 in June. July’s CFNAI-MA3 suggests that growth in national economic activity was at its historical trend. The economic growth reflected in this level of the CFNAI-MA3 suggests limited inflationary pressure from economic activity over the coming year.

The CFNAI Diffusion Index, which is also a three-month moving average, moved up to +0.06 in July from a neutral reading in June. Fifty of the 85 individual indicators made positive contributions to the CFNAI in July, while 35 made negative contributions. Forty-four indicators improved from June to July, while 40 indicators deteriorated and one was unchanged. Of the indicators that improved, 12 made negative contributions. [Download PDF News Release]

The next chart highlights the -0.7 level. The Chicago Fed explains:

When the CFNAI-MA3 value moves below -0.70 following a period of economic expansion, there is an increasing likelihood that a recession has begun. Conversely, when the CFNAI-MA3 value moves above -0.70 following a period of economic contraction, there is an increasing likelihood that a recession has ended.

The next chart highlights the -0.70 level and the value of the CFNAI-MA3 at the start of the seven recession that during the timeframe of this indicator. The 1973-75 event was an outlier because of the rapid rise of inflation following the 1973 Oil Embargo. As for the other six, we see that all but one started when the CFNAI-MA3 was above the -0.70 level.

CFNAI and Recessions

Financial Conditions Force Fed to Tiptoe to Rates Liftoff

(…) During the first two quarters of the year, real GDP increased 0.6 percent and 2.3 percent, respectively, for an average growth rate of 1.4 percent for the first half. With the economy on such thin ice, it isn’t clear how resilient households — or businesses — can be to a profound and prolonged market slump.

As of August 18, the Atlanta Fed’s GDPNow forecasting model estimates third-quarter GDP growth to be 1.3 percent. Keep in mind that the Atlanta Fed has the hottest hand in forecasting, having accurately predicted the first- and second-quarter GDP growth estimates. If the bank is correct again, third-quarter growth would be at essentially the same pace as during the first half.

Policy makers are cognizant that one 25 basis point increase will not derail the economy. However, they are sensitive to the fact that, if the market prices in a string of rate hikes, it would cause a significant tightening of financial conditions, and they do not want this given their hesitancy over the broader outlook. The key to the Fed successfully achieving liftoff will depend on it successfully telegraphing to the markets that the post-liftoff path of policy will be extremely shallow — more gradual than the roughly 100-125 basis points per year that it has previously signaled.

In short, the Fed can probably successfully pull off a September liftoff if it can convince the markets that it is a “one and done” approach for 2015. Policy makers can accomplish this through their forward guidance language, as well as through the dot plot.   

SENTIMENT WATCH

It is really amusing how everybody is able to explain the market rout after the fact…even though the facts were all there for everybody to see. Now, the guessing game on what is needed to turn things around:

  • David Rosenberg:

Gaining traction is going to take some sign of confidence returning to China since more than 80% of this year’s U.S. market selloff has occurred since the devaluation – since that time, more than $5 trillion paper wealth has been wiped off the value of global equities (…)

Quite clearly, the state-directed attempt to turn the Chinese equity market has unravelled and it may be this sense that the authorities have “lost control” that is the principal cause of this sudden dramatic loss of global investor confidence, and we are reminded by the domino effect to other regions just how interconnected the world is today (…)

The capitulation is definitely in.

Here’s what we need:

  • We need reassuring moves out of China. (…) Of all central banks, only the PBoC has anything left in its arsenal.
  • We need to see oil prices show signs of bottoming out
  • Technically, we need to see an outside positive reversal. (…) Credit spreads are usually a good leading indicator.
  • Break-even inflation rates bottom out
  • Less panic by global policymakers would be helpful too. (…) efforts to stimulate demand, not further manuipulate or distort asset prices.
  • ISI:

• The EM market plunge of almost -60% in 1997-1998 ended when the Fed cut the funds rate.
• The S&P decline of almost -20% in 2011 ended around the prospect of more QE.
• Last year’s S&P decline in Oct of -7% ended Oct 19 — “Monetary policies around the world edged toward easing, from BoE to China.” Oct 26 — “Policymakers are leaning toward easing, eg, Abe, China, Fischer, and Draghi.”

“I’m not a buyer that this is 1998. Nor am I am a buyer that that’s 2008. And in 1998 you had a lot of fixed exchange rates. Now you have fewer of those. And 2008 was about the payments and settlement system. This is not about the payments and settlement system. This is an old-fashioned repricing of two things.”

He added: “I’m not a buyer that this is the crisis of all crises. Yes, this is a very unpleasant repricing, very unpleasant. And it’s going to go quite deep, but it’s not going to derail the economy in a major way.”

El-Erian said he believes a December rate hike is still possible: “I think December is still on the table, and for the following reason. The economy will benefit from lower commodity prices, particularly oi. And the economy will benefit from lower interest rates. And that’s going to fuel some underlying strength that the economy does have. The big question is how much damage are we doing to the wealth effect, and to what extent will external demand collapse? We cannot answer that question yet. So I would think December is still a possibility, but September is unlikely to happen.”

(…) Today the story is much different. Governments learned from the last crisis, and have more macroeconomic and policy tools at their disposal. Their currencies already float, and none are running current-account deficits with fixed exchange rates. Their foreign-exchange reserves are larger (though Malaysia’s have just fallen below $100 billion for the first time in five years), and their banking systems stronger, with larger domestic-deposit bases. Their currencies have not come under attack—low oil prices are dragging down the ringgit, while concerns over long-term competitiveness are hampering Indonesia—and their economies better able to handle foreign-investment inflows. Big emerging-market firms look slightly less healthy; many have taken on large and growing piles of dollar-denominated debt, which have become less affordable as the dollar has risen in value. But these debts do not yet look a plausible source of widespread systemic financial risk. 

The worry, though, is that governments have equipped themselves well to fight the last war. A panic-driven crisis may not loom, but emerging-market currencies the world over have taken hits from low commodity prices, China’s slowdown and an impending American interest-rate hike. Yet in fact, Asia’s currencies are faring relatively well: the Russian rouble, Colombian peso and Brazilian real have all fallen more than twice as much as the rupiah and ringgit. Low global demand has kept export growth low this year; a weakening yuan will make things worse. Last month Indonesian exports were down almost 30% year-on-year, a sluggishness mirrored across the region. Indeed, some now reckon that emerging markets will try to stimulate external demand through devaluation, as Vietnam did last week. That, in turn, suggests a different risk: that much of the world economy will try to cope with economic weakness by selling to the American consumer. Yet the sorts of global imbalances that result from competitive depreciation are dangerous, as the 2000s demonstrated. Americans might borrow too much as they attempt to play the role of engine of economic demand. Or they may simply tire, leaving the world without a source of economic locomotion.

(…) “U.S. economic trends are still very much driven by domestic phenomenon and data points continue to intimate growth as opposed to developments overseas that are creating turbulence and distressing investors,” he writes. “Specifically, American employment, plus consumer and capital spending (ex-energy) remain on track.”

The two key sectors to look at to gauge the health of the American consumer and economy—automotive and housing—still look healthy, according to Levkovich )…)

Levkovich points to three indicators that are at levels close to the previous market bottom in October and suggest that a rebound could be imminent:

  • The share of stocks listed on the New York Stock Exchange trading at or below their 200-day moving average is within shouting distance of the October 2014 level.
  • The ratio of 90-day to 30-day implied volatility is more than two standard deviations below its longer-term norm.
  • The put/call ratio exceeds the level it was at last October.

“In this context, investors should be sharpening some pencils to find the corn being thrown out with the chaff,” he concludes.

(…) But there is nevertheless reason to think any weakness will ultimately prove temporary.

It is worth reflecting on just how aggressive a 10-per-cent stock market repricing is. It is the equivalent of concluding that one 10th of every company’s future earnings stream has suddenly and forevermore vanished. Even a full-bore recession doesn’t usually have an effect that corrosive. Confused smile

To the contrary, global leading indicators continue to point to mediocre economic growth. The Chinese slowdown – while certainly consequential for the world – is unlikely to induce a recessionary nadir at the global level. Meanwhile, the latest bout of low interest rates and low commodity prices are both accretive to global growth.

Second, Chinese concerns warrant a more careful parsing. Recent stock market problems in the Middle Kingdom hardly matter to the rest of the world – the market is small relative to its host economy. China’s stock indexes remain higher than they were in mid-2014 and mainland shares are largely domestically held. The currency story is also no great shakes given that the currency has stabilized at just 3 per cent lower against the U.S. dollar.

China’s debt problems are a legitimate concern and the main reason for China’s economic deceleration. Recent news of shadow-finance entities requesting government bailouts merely adds to the list of supplicants. Fortunately, the national government remains both inclined and equipped to rescue beleaguered parties. To be sure, China’s economy will continue slowing, but a “soft landing” is still more likely than a crash.

Third, it is surprisingly normal for stock markets to swoon by 10 per cent or more. This happens every few years, and markets normally then reclaim the lost ground in short order. When framed in the context of the U.S. presidential cycle – a classic technical indicator – the bellwether S&P 500 usually experiences a decline very similar to this one somewhere in the year before an election, before surging back to new highs later that year.

Fourth, stock market valuations were fine before the correction took place. There is always a searing debate on this subject, given the wide range of metrics that exist, but classic measures such as the price-earnings ratio and more advanced ones such as the risk premium between stocks and bonds argue that equities are a reasonable buy.

Fifth, policy-makers generally do what they can to restore tranquility to financial markets. Chinese policy-makers almost certainly have more up their sleeves. The European Central Bank may yet do more in light of the euro’s revival. Possibly most important, the Fed is now unlikely to tighten rates in September – eliminating one of the original catalysts for the stock market correction.

In the end, identifying financial market bottoms is highly imprecise, and some markets – including Canada’s – may experience an especially sluggish revival due to persistently undershooting commodity prices. But with these caveats firmly in place, this looks more like a temporary correction than a permanent new trend.

The usual cheerleaders are out reassuring everybody that all is fine. Not a word on profits. And valuations were fine before! Sarcastic smile

  • Bearnobull:

Nobody can really forecast what will happen next and how markets will react. We can, however, re-assess the risk/reward equation. The growth scares of 2010, 2011 and 2012 brought the Rule of 20 P/E to between 15x (1425 on the SPY) and 16.4x (1575), while the 2014 mid-October drop stopped at 18x (1750). The “Lower Risk” area for the Rule of 20 P/E is between 15 and 20 with the low end generally reached in cases of extreme pessimism (actual recession or perceived high recession risk), conditions which currently do not exist in the USA.

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My sense is that 17x (1640) would be a solid floor making 18.0-18.5 (1750-1800) a reasonable mid-point where potential upside reward would begin to exceed downside risk. This leaves another 5-8% of downside before a better risk/reward ratio surfaces.

This assumes that EPS do not deteriorate (TTM $108) and that core inflation remains fairly stable around 1.8%. A meaningful decline in inflation would normally have a positive impact on P/Es if deflation fears remain muted. Shorter term, headwinds will remain strong, likely offsetting positives from lower energy and commodity prices on the OECD economies.

  • China is slow and slower with questionable leadership.
  • The Fed seems clueless with few visible ammo left. This is Jackson Hole week.
  • Earnings will continue soft for another 3-6 months.
  • Inflation not a problem. Deflation?
  • Currencies?
  • Emerging markets?

Based on today’s pre-opening indication (1940, +3%), the Rule of 20 P/E is 19.7, back in “lower risk” territory but not very comfy. BTW, the support has been redefined…

SPY Channel

Just kidding I have been writing about markets losing confidence in central bankers. Jared Dillian does not help with this:

(…) the current Board of Governors is composed of
Yellen
Fischer
Powell
Tarullo
Brainard
And maybe Landon
And now Kathryn Dominguez.

Vassar Undergrad (82), Yale PhD (87), taught at Harvard, got tenure at Harvard (which is damn near impossible for an assistant professor to do, so quite an
achievement), and then went to UMich.

I have never said that Fed people are dumb. They are unquestionably brilliant. They just have no real world experience! If the two nominations go through, this
is what the board will look like:
Professor
Professor
Professor
Professor
Lawyer
Lawyer
Banker (buddies with Obama)