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There was a trend in the first quarter that ended today–volatility

posted on March 31, 2016 at 7:50 pm
hurricane

And I expect it to characterize the second quarter as well. In fact, volatility is the defining characteristic of this market for even longer periods than a quarter. Not only did the markets finish March pretty much where they began the year–inspite of the worst beginning to a year for the Standard & Poor’s 500 stock index EVER, but March 2016 ended at virtually the same place markets were in March 2015. (And I’m not just saying that because my new book Juggling with Knives posits an Age of Volatility. You can read my argument for yourself by buying a copy at Amazon, of course:  http://www.amazon.com/Juggling-Knives-Investing-Coming-Volatility-ebook/dp/B016TX4ETY/ref=sr_1_1?s=books&ie=UTF8&qid=1459452897&sr=1-1&keywords=juggling+with+knives )

And it’s not just U.S. stocks. Although domestic stocks are a very good place to start.

The S&P 500 was down 12% for the year by mid-February. The index finished the quarter up 0.9% (as of 2:30 p.m. New York time today) after a 6.9% rally in March.

Global stocks were up 7.1% in March but finished the quarter down 0.3%. That’s just about flat. Shanghai stocks didn’t do nearly that well but did show a remarkably similar degree of volatility. The market composite rose 12% in March to cut the loss for the year to a mere 15%.

The S&P 500 was down 12% for the year by mid-February. The index finished the quarter up 0.9% (as of 2:30 p.m. New York time today) after a 6.9% rally in March.

Global stocks were up 7.1% in March but finished the quarter down 0.3%. That’s just about flat. Shanghai stocks didn’t do nearly that well but did show a remarkably similar degree of volatility. The market composite rose 12% in March to cut the loss for the year to a mere 15%.

Oil was down 9% and then up with energy stocks advancing 9.5% in March. Chesapeake Energy (CHK), one of the biggest losers in the sector at the beginning of the year and back into 2015, rose 58% in March.

The dollar was up and then down with the Bloomberg Dollar Spot Index recording its worst month since 2010 with a 3.8% drop in March. Gold saw its best three-month gain since 1986 in the first quarter.

If you look at the causes for the volatility in the first quarter I think it’s reasonable to look for more of the same in the second quarter.

We ended 2015 with the Federal Reserve signaling that it would raise interest rates in 2016 but we spent the first quarter vacillating among opinions on when those rate increases might take place and how big they might be. That’s about where we are as we head into the second quarter. (With the added wrinkle that the Fed’s June meeting is likely–but not certain–to settle the debate on when the next interest rate increase might take place.)

We spent much of the quarter trying to figure out when oil and natural gas prices might bottom, stabilize, and then start to recover with a huge market disagreement about whether oil prices had to go back down into the low $20s after rallying to $40 a barrel or so. Sound familiar?

We ended the fourth quarter of 2015 with an “earnings recession” of two straight quarters of drops in S&P 500 earnings–and we begin 2016 with forecasts for another two quarters of declining earnings.

And, of course, we still have no idea of whether economic growth in China has bottomed or is still headed lower.

I’d expect that at some point–maybe in the second half of this year–we might be able to see reasonably strong trends in many of these areas. But next quarter? Seems unlikely.

Which won’t, of course, mean that traders and investor won’t develop strong opinions on the answers to these questions or that those opinions won’t be strong enough to drive financial markets. It’s just that I can see any strong opinions facing a equally strong shift in conviction in the opposite direction before the end of the quarter.

Yellen speaks–and today 1 is louder than 3 on Fed policy

posted on March 29, 2016 at 7:56 pm
Federal_Reserve

At a speech in front of the Economic Club of New York today Federal Reserve Chair Janet Yellen pretty much quashed speculation that the Fed might raise interest rates at its April meeting. That possibility had been raised by comments from three Fed members, James Bullard, head of the St. Louis Fed, Patrick Harker (Philadelphia Fed) and Dennis Lockhart (Atlanta Fed)–members who don’t vote currently on the interest rate setting Open Market Committee. Yellen’s speech put that possibility back in the drawer–odds of a March increase fell to 0% on the Fed Funds Futures market–and made it clear that while U.S. economic numbers might suggest the need for a sooner rather than later interest rate increase, other factors that the Fed is watching don’t. Yellen also sounded less convinced than those Fed members that the recent uptick in inflation will prove to be a durable trend.

The basic thrust of Yellen’s talk was to re-emphasize the global issues that the Fed is watching and that signal caution on any increase in U.S. interest rates. She emphasized  that further appreciation of the dollar–likely after any additional increase in U.S. interest rates–would lower inflation and depress U.S. exports and hurt U.S. manufacturing. She noted that the Fed would like to see stable global commodity prices and a bigger contribution to U.S. growth from the housing sector.

Yellen repeatedly emphasized the need to “proceed cautiously,” and added that “caution is especially warranted.” A footnote to the text of her talk stated that “uncertainty and greater downside risk” when the Fed’s policy rate is so close to zero “call for greater gradualism.”

As you’d expect after such a strong reiteration of the Fed’s willingness to wait, the dollar fell, retreating 0.02% against the euro, and oil climbed.

The April 1 report on March job creation could, of course, put renewed heat under the debate about Fed intentions. But Yellen certainly did her mighty best today to roll back any expectations of an increase before June.

And, if we see any weakness in the April 1 job report–new job creation below the consensus expectation of 207,000 net new jobs for the month–I think we could see a revival of the “one or none” argument that drove the rally in stocks and oil from their February lows. That argument posits that the Fed won’t raise rates more than once in 2016. At its March meeting the Fed lowered expectations for 2016 to two interest rate increases in 2016 from the four increases signaled in December.

Is the emerging market rally ahead of itself or is this time to buy?

posted on March 18, 2016 at 7:50 pm
StocksUp

Earlier today I posted that the more dovish than expected news from the Federal Reserve on Wednesday, March 16–a signal that the Fed was looking at two interest rate increases in 2016 rather than the four it had projected in December–had, in the shorter run, set off a rally in those asset classes that benefit from a weaker dollar–commodities including oil and gold, for example, and emerging market debt and equities. Today that trend remained in effect although, this being a Friday after a good run to the upside, pre-weekend selling has taken some of the strength out of that rally. As of 1 p.m. New York time the Dow Jones Industrial Average was up 0.5% and the Standard & Poor’s 500 stock index was ahead 0.49%. In the oil markets West Texas Intermediate was holding even and Brent benchmark crude was up 0.6%. Emerging market stocks, as measured by the iShares MSCI Emerging Markets ETF (EEM), were higher by 0.78%.

However, in the longer run, I noted, the global economy is still looking at a tightening of the supply of dollars. The Federal Reserve, after all, didn’t say it was about to cut interest rates or that it had decided not to raise rates at all in 2016. It announced that it would move more slowly–but that it still intended to raise interest rates. That means that a sluggish global economy is still looking at the Federal Reserve to tighten the supply of dollars–and thus to make them more expensive–in 2016, probably beginning at the Fed’s June 16 meeting. The Fed’s caution on raising rates is a reminder that the world economy runs on dollars and that the Fed, the central bank for the United States, recognizes that because of the dollar’s role as the dominant global currency it is the central bank for the world too. As much as the strength of the U.S. economy might argue for interest rate increases, the weakness of the global economy, the Fed said on Wednesday (actually fairly clearly for the Fed) isn’t ready for higher U.S. interest rates. A hike in interest rates and a stronger dollar would amount to a tightening of monetary policy for the world–and the world economy, in the Fed’s estimation, isn’t strong enough for that.

In the longer run then, the Fed’s move yesterday isn’t a big plus for all the asset classes that are up today and were up even more yesterday. The Fed’s worry about the effects of a U.S. interest rate increase should remind us that the stronger dollar that is likely to follow on such a move (all things being equal, which, of course, they never are) will act, at a minimum, to depress the prices of commodities denominated in dollars such as oil, copper, and gold.

But that effect isn’t the big worry in the current global economy. During the days when interest rates on the dollar ranged from 0% to 0.25% companies in developing economies borrowed in dollars to meet working capital requirements, to build factories, and to expand marketing efforts. In Brazil, for example, borrowing in overseas markets by non-finance companies reached a record $137 billion in 2014, the Bank for International Settlements reported in September 2015. That’s a 10-fold increase in the last decade.

Brazilian companies have been alone in this trend. In 2014 Indian companies borrowed $20 billion overseas, bringing total outstanding overseas borrowing to $200 billion. Much of that, an estimated 50%, is unhedged and rises or falls in value with the Indian rupee. That $100 billion in unhedged overseas corporate borrowing is equal to roughly 5% of India’s GDP.

In China unhedged overseas corporate debt came to $1 trillion at the end of 2014, UBS estimates. That’s equal to roughly 10% of China’s GDP.

This unhedged debt burden gets really heavy when the local currency plunges against the dollar. The Brazilian real fell 32.9% against the U.S. dollar in 2015, making every dollar of corporate debt roughly one-third more expensive to pay back. Other big currency drops in 2015 hit the Argentine peso (34.6%), the South African rand (25%), the Turkish lira (20%) and the Russian ruble (17%).

The corporate sector isn’t the only part of developing country economies exposed to the effects of high U.S. interest rates and a stronger dollar. Any country running a current account deficit and thus dependent on external cash flows to balance its accounts also feels the effect. A Brazil, a Turkey, or an India, for example, needs to attract overseas capital–and that gets harder when the local currency is tumbling and when local interest rates lag those in the United States.

Some developing country central banks tend to fight this problem by raising their own interest rates, a study by the Dallas Federal Reserve Bank, found. Mexico’s central bank raised its benchmark interest rate 0.25 percentage points on December 17, following hard on the heels of the Fed’s December 16 0.25 percentage point increase. Raising domestic interest rates does work to defend the local currency, the Mexican peso in this case, but higher domestic interest rates do take a bite out of domestic economic growth. Central banks are most likely to raise interest rates–and take the potential punishment to the domestic economy–if their national economy is dependent on overseas cash flows to balance the current account. The list of countries likely to take that uncomfortable deal, according to the Dallas Fed, includes Turkey, South Africa, Peru, Mexico Colombia, Brazil, Chile and India. I’d note that this list uses data from 2014. I think if you factor in the collapse in oil prices, Russia and Nigeria would be members of this group.

All this means, of course, that any move by the U.S. Federal Reserve to raise U.S. interest rates comes with a built in multiplier that increases the slowdown to global growth (from any slowdown in U.S. domestic growth) because of the potential drag from these coincident developing economy interest rate increases.

The other multiplier here operates through the mechanism of sovereign debt and national credit ratings–and it’s here that we pick up another big effect from the global slowdown in economic growth. The slowdown in the global economy has brought especially big drops in economic growth for developing economies dependent on demand from China and/or global commodity prices. A country such as Brazil, which had clawed its way to its first ever investment grade credit rating during the boom years has seen itself plunge back to a below investment grade credit rating. Countries that have to compete in the global markets to raise money to fund their government operations then have to pay more when their debt is graded as “more risky” and when investors have a choice of buying higher yielding and safer U.S. debt. (Safety, or perceived safety, goes a long way in the debt markets these days–how else explain the propensity of the currency and bonds of the heavily indebted (understatement alert) Japanese government to climb when investors and traders think global financial markets have turned riskier.)

None of these longer-term drags on emerging financial markets and their economies went away with the Fed’s dovish surprise on Wednesday, March 16. Their effects may have been postponed. And the drags may have decreased in magnitude with the decision, at the moment, to move to two increases in 2016 from four.

What’s difficult to calculate right now is what degree of drag was already accurately priced into crushed prices in emerging markets–in which case the explosive rally of the last two days is fundamentally justified. On the other hand, there’s the strong possibility that fundamentals have nothing to do with this rally and that it is all based on speculation and momentum.

In the last month or so as emerging market asset prices plunged, I’ve heard more and more talk of the drop in those prices setting up the trade of the decade. I’m not discounting the potential truthiness of that talk. But I sure would like to figure out whether we have one more plunge ahead as the fundamentals of the Fed’s interest rates bite home or if now is the time to buy into these assets (and as a trade or as an investment?) And I’d like to figure out which emerging markets carry the most and lease risk  (and of what sort) so I can figure out what I might want to own or not.

I’ll take a stab at answering some of those questions in a post tomorrow, Saturday, March 19.

In the shorter term a dovish Fed sets off an emerging market rally

posted on March 18, 2016 at 6:05 pm
global_economy

In the short-run (however, long that might be) financial markets have decided to jump on the “dovish Federal Reserve” band wagon.

Thursday, the dollar was down again and (as of 2 p.m. New York time) showed its biggest two day loss since 2009. The euro had climbed to $1.1320 today from a close of $1.1224 Tuesday.

Everything that normally goes up with a weak dollar was up. The West Texas Intermediate crude benchmark climbed to near $40 and was up 3.77% as of 2 p.m. Emerging market stocks had climbed by 2.2% (as measured by the iShares MSCI Emerging Markets ETF (EEM) as of 2 p.m. in New York on Thursday. As if to demonstrate how in favor the riskiest assets are Brazil’s Sao Paulo market was ahead 5.97% for the day as of 2 p.m.

In the short-term this all makes sense. The Fed’s decision to leave interest rates unchanged at Wednesday’s meeting of its Open Market Committee and its signal of its intention to raise interest rates just twice in 2016 instead of the four times it planned back in December does promise the world that the Fed will raise rates very, very gradually and that the Fed will remain in the easy money camp along with the Bank of Japan, the European Central Bank, and the People’s Bank of China for longer than financial markets anticipated back in December. And I suspect that there’s a very sizable group of traders that believes the Fed will pull back even from its plan for two interest rate increases in 2016.

Easy money from the Fed means a weaker dollar means rising prices for commodities priced in dollars, means substantial relief for companies in developing countries with large amounts of dollar-denominated debt and means welcome help for central banks in those economies trying to walk the line between raising interest rates to defend their own currencies and risking an even greater slowdown in economic growth from those higher interest rates.

In the short-term a Fed that is moving more slowly toward raising rates is a big plus for all these asset classes. And that’s reflected in market action of the last two days.

In the longer run (however shortly that might arrive), the Fed’s caution on raising rates is a reminder that the world economy runs on dollars and that the Fed, the central bank for the United States, recognizes that because of the dollar’s role as the dominant global currency it is the central bank for the world too. As much as the strength of the U.S. economy might argue for interest rate increases, the weakness of the global economy, the Fed said yesterday (actually fairly clearly for the Fed) isn’t ready for higher U.S. interest rates. A hike in interest rates and a stronger dollar would amount to a tightening of monetary policy for the world–and the world economy, in the Fed’s estimation, isn’t strong enough for that.

In the longer run then, the Fed’s move Wednesday isn’t a big plus for all the asset classes that are up in the last two days. Instead it’s a signal of how vulnerable these asset classes are to any increase in the strength of the dollar and any increase in U.S. interest rates. The only reason not to be worried, in the longer run, about the Fed’s move Wednesday, is if you believe the Fed will,  because of global economic weakness, decide to put off even the two interest rate increases it signaled for 2016 yesterday.

But that’s another perspective and another blog post.  The next one up, in fact.

Not this time–Draghi’s central bank magic goes flat today

posted on March 10, 2016 at 7:37 pm
currency

The longer the financial markets thought about the actions announced by the European Central Bank today, the less impressed markets were. The STOXX 600 Europe Index had climbed as much as 2.5% during the day, but after peaking around 1 p.m., the index finished down 1.7% for the day. The French CAC 40 ended lower by 1.7% and the German DAX was off by 2.3% at the close.

The problem was that European Central Bank President Mario Draghi undercut, as far as the market was concerned, more forceful than expected action with his comments to reporters. The bank announced another 10 basis point cut to its overnight deposit rate to a negative 0.4% (as expected); raised the amount of assets it aims to buy each month to 80 billion euros from 60 billion (10 billion more than expected) and that it would add corporate debt to its potential purchases.

Nothing startling there but more than expected.

But Draghi then said that the central bank is done–at least for a while. “From today’s perspective, we don’t anticipate it will be necessary to reduce rates further,” he said. The package “is an adequate reaction to a weakening of the growth and price-stability prospects,” Draghi added. “We think the measures we took today are adequate to address the change in economic conditions that occurred since our last monetary policy meeting.”

Which seems puzzling since he also noted that inflation is expected to remain negative (deflation in other words but without saying the “d word) in the coming months but will pick up later in 2016. (Inflation in February was a negative 0.2%.) The central bank lowered its inflation forecast for 2016 to 0.1% from the 1% forecast in December. Inflation will climb to 1.3% in 2017 and then 1.6% in 2018.

Last time I checked the math 1.6% is still less than the 2% target the bank has set as a goal for its program of asset purchases. And the bank is now projecting that inflation will remain below that target through 2018.

The European Central Bank also cut it forecast for economic growth in the EuroZone to 1.4% in 2016. That’s below the 1.7% growth in GDP the central bank forecast in December. The EuroZone economy will grow by 1.7% in 2017.

So let’s see–inflation lower than the target and economic growth tepid into 2017. Yep, I can see why the European Central Bank announced that it was done for a while.

On the news the euro climbed to $1.1207 against the dollar–after falling by as much as 1.6% earlier.

The most important take-away to me from today’s announcement and the market reaction is that traders and investors are becoming increasingly skeptical about the ability of central banks to stimulate higher growth and to generate higher inflation.

The bag of tricks announced today by the European Central Bank didn’t contain anything new and the same old, same old–even more of the same old, same old–doesn’t have the old magic that it once did.



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