As equity markets revert to their new normal BTFATH, Japanese-Yen-pinned reality, we thought a gentle reminder of the longer-term state of the real (not financial) economy would prod more than a few into the realization of just how 'encouraged' they should be by the nominal high after nominal high that is gloated over day after day...
Day two of the bounce from the biggest market drop in months is here, driven once again by weak carry currencies, with the USDJPY creeping up as high as 104.50 overnight before retracing some of the gains, and of course, the virtually non-existant volume. Whatever the reason don't look now but market all time highs are just around the corner, and the Nasdaq is back to 14 year highs. Stocks traded higher since the get-go in Europe, with financials leading the move higher following reports that European banks will not be required in upcoming stress tests to adjust their sovereign debt holdings to maturity to reflect current values. As a result, peripheral bond yield spreads tightened, also benefiting from good demand for 5y EFSF syndication, where price guidance tightened to MS+7bps from initial MS+9bps. Also of note, Burberry shares in London gained over 6% and advanced to its highest level since July, after the company posted better than expected sales data. Nevertheless, the FTSE-100 index underperformed its peers, with several large cap stocks trading ex-dividend today. Going forward, market participants will get to digest the release of the latest Empire Manufacturing report, PPI and DoE data, as well as earnings by Bank of America.
The rally is running out of steam, and there is a real possibility of a trend change.
Following yesterday's major market drubbing, in which the sliding market was propped up by the skin of Nomura's (and BOJ, and Fed's) teeth at 103.00 on the USDJPY, it was inevitable that with Japan returning from holiday there would be a dead cat bounce in the Yen carry pair, and sure enough there was, as the USDJPY rose all the way back up to 103.70, and nearly closed the Friday gap, before starting to let off some air. However, now that US traders are coming back online, Japan's attempts to keep markets in the green may falter, especially since it only has a couple of ES ticks to show for its efforts, as for the Nikkei which dropped 3% overnight, it has now lost all US "Taper" gains.
"We downgrade the US equity market to underweight relative to other equity markets over 3 months following strong performance. Our broader asset allocation is unchanged and so are almost all our forecasts. Since our last GOAL report, we have rolled our oil forecast forward in time to lower levels along our longstanding profile of declining prices. We have also lowered the near-term forecast for equities in Asia ex-Japan slightly. Near-term risks have declined as the US fiscal and monetary outlook has become clearer. Over 3 months our conviction in equities is now much lower as the run-up in prices leaves less room for unexpected events.... Our US strategists have also noted the risk of a 10% drawdown in 2014 following a large and low volatility rally in 2013 that may create a more attractive entry point later this year."
With no major macro news on today's docket, it is a day of continuing reflection of Friday's abysmal jobs report, which for now has hammered the USDJPY carry first and foremost, a pair which is now down 170 pips from the 105 level seen on Friday, which in turn is putting pressure on global equities. As DB summarizes, everyone "knows" that Friday's US December employment report had a sizeable weather impact but no-one can quite grasp how much or why it didn't show up in other reports. Given that parts of the US were colder than Mars last week one would have to think a few people might have struggled to get to work this month too. So we could be in for another difficult to decipher report at the start of February. Will the Fed look through the distortions? It’s fair to say that equities just about saw the report as good news (S&P 500 +0.23%) probably due to it increasing the possibility in a pause in tapering at the end of the month. However if the equity market was content the bond market was ecstatic with 10 year USTs rallying 11bps. The price action suggests the market was looking for a pretty strong print.
In the last 3 years, the volume of options quotes (not trades) in the first few seconds of the US equity market's open has exploded. From around 1 million quotes in the first second of the day in 2011, Nanex' detailed animation shows that volumes are now reaching 4 million quotes. Does this quote spam look like it provides liquidity? Wondering why the opening price action in US equity markets has become incredulous in recent months - with vertical dump-and-pumps - wonder no more... 'efficient' markets indeed...
We have asked (and answered) this question a number of times in recent weeks. Ignoring for a moment the bubble-trajectory, hope-expectations, and investor sentiment, as ex-Morgan Stanley-ite Gerard Minack notes, equity markets in 2013 appeared to completely ignore macro fundamentals. For 2014, as we warned here, the dream of moar multiple expansion may be over. With the Fed desperate to convince the world that strong language is just as effective as 100s of billions of dollars in liquidity provision, we suspect the 'wedge' between hope and reality will compress (significantly)...
Risks surrounding the looming release of the latest jobs report by the BLS later on in the session failed to weigh on sentiment and heading into the North American open, stocks in Europe are seen higher across the board. The SMI index in Switzerland outperformed its peers since the get-go, with Swatch Group trading up over 3% after the company said that it expects good results for 2013 at operating profit and net income level. At the same time, in spite of stocks trading in the green, Bunds remained better bid, with peripheral bond yield spreads wider as market participants booked profits following the aggressive tightening observed earlier in the week amid solid Spanish bond auctions, as well as syndications by Ireland and Portugal. Fake Chinese trade data failed to boost Chinese stocks, which dropped anoter 0.7% and is just 13 points above 2000 as Shanghai remains one of the world's worst performing markets since the financial crisis. The yoyoing Nikkei was largely unchanged. All eyes today will be fixed on the headline streamer at 8:30 when the latest nonfarm payrolls report is released.
Last week, Grant Williams reviewed the equity markets in an attempt to see how equity investors managed to scamper through 2013 with the friskiness of puppies when all about them lay doubt and potential disaster. His answer - of course - quantitative easing. This week Williams takes a deep dive into bonds and bullion in an effort to comprehend how the bond market managed to navigate the same 12-month period and see what can be learned about 2013 in order to forecast for 2014. The effect on the Fed’s balance sheet is plain to see - a very steady, predictable line; and markets love steady and predictable. So what happens when the 'predictability' ends...? The guardians of the global economy are relying on numerous logical fallacies to continue their path to oblivion...
Just over a year ago, in one simple graphic, we showed why Bridgewater, which currently manages around $150 billion, is the world's biggest hedge fund. Quite simply, its flagship $80 billion Pure Alpha strategy had generated a 16% annualized return since inception in 1991, with a modest 11% standard deviation - returns that even Bernie Madoff would be proud of. And, true to form, according to various media reports, Pure Alpha's winning ways continued in 2013, when it generated a 5.25% return: certainly underperfoming the market but a respectable return nonetheless. However, Pure Alpha's smaller cousin, the $70 billion All Weather "beta" fund was a different matter in the past year. The fund, which touts itself as "the foundation of the "Risk Parity" movement", showed that in a centrally-planned market, even the best asset managers are hardly equipped to deal with what has largely become an irrational market, and ended the year down -3.9%.
Chinese borrowers are facing rising pressures for loan repayments in an environment of overcapacity and unprofitable investments. Unable to generate cash to service their loans, they have to turn to the shadow-banking sector for credit and avoid default. The result is an explosive growth of the size of the shadow-banking sector. The PBOC thought it could control this by limiting liquidity but underestimated the effects of its measure. Largely because Chinese borrowers tend to cross-guarantee each other’s debt, squeezing even a relatively small number of borrowers could produce a cascade of default. The reaction in the credit market was thus almost instant and frightening. Borrowers facing imminent default are willing to borrow at any rate while banks with money are unwilling to loan it out no matter how attractive the terms are. Should this situation continue, China’s real economy would suffer a nasty shock.
If one listens to Goldman's chief economist Jan Hatzius these days, it is all roses for the global economy in 2014... much like it was for Goldman at the end of 2010, a case of optimism which went stupendously wrong. Goldman's Dominic Wilson admits as much in a brand new note in which he says, "Our economic and market views for 2014 are quite upbeat." However, unlike the blind faith Goldman had in a recovery that was promptly dashed, this time it is hedging, and as a result has just released the following not titled "Where we worry: Risks to our outlook", where Wilson notes: "After significant equity gains in 2013 and with more of a consensus that US growth will improve, it is important to think about the risks to that view. There are two main ways in which our market outlook could be wrong. The first is that our economic forecasts could be wrong. The second is that our economic forecasts could be right but our view of the market implications of those forecasts could be wrong. We highlight five key risks on each front here." In short: these are the ten things that keep Goldman up at night: the following five economic risks, and five market view risks.
Equity markets appear wholly dissatisfied with this morning's 'good' news and are unsure whether this taper-on data is confidence-inspiring or liquidty-sapping. The ADP print appears to confirm a hgher probability of another $10 billion taper. Bond yields jumped higher, the USD jumped higher, gold dropped, and stocks are limping to the day's lows...
Unintended consequences may have developed from QE policies that are not fully understood. They may materialize more clearly during the withdrawal process. Any of a number of obstacles could push the Fed ‘off course’ from the smooth landing that its baseline scenario suggests:
- Certainly, expanding the balance sheet by over $3 trillion has had a significant impact on valuations, market functioning, and asset allocation, so those effects could cause some market turbulence as they revert back to normal.
- Emerging markets, which benefited heavily in the early years of QE, have recently shown some disruptions, such as, slowing economic growth, weakening currencies, and capital outflows.
- Political and social concerns about income and wealth inequalities have grown due to the use of asset prices as a policy tool.
- Structural unemployment from long-term joblessness and technological advancement cannot be addressed through easy money.
- Politics is still polarizing, which in turn creates on-going economic headwinds.