Overview
Markets declined sharply towards the end of the week. Emerging markets were hit, in particular, which comes as no surprise to me – I have been bearish for quite a while. Traders blamed the declines in emerging markets to the weaker Chinese PMI data and the situation in Argentina. Quite frankly, I’m surprised that investors were surprised that the Chinese economy was slowing – all the indicators were there to be seen for quite some time. The potential default of a wealth management products in China (mentioned above) is a much more serious issue. Last week, I reported that the decline in the 10 year yield to 2.82% was a concern for the equity markets. This week, the US 10 year bond yield declined further to 2.72%, a signal that investors are seeking the safety of the bond markets, which is clearly a further bearish signal, in particular as the FED is likely to continue with its tapering programme next month. Indeed, bond yields of the major developed markets have also declined.
As I stated last week, I believe that risks are rising and that it was time to take profits on equity positions, whilst buying protection (the VIX) and wait for a better time to re enter markets. US earnings, in particular of some of the leading companies, have been lackluster to weak. Furthermore, valuations are no longer cheap. I cannot see the upside potential at present, though I believe that risks are rising. At some stage, the ECB will be forced to act, which may be a trigger to re enter markets. I continue to believe that emerging markets will continue to decline across all asset classes (equities, currencies and bonds) and that the higher beta names are particularly vulnerable. Its time for wealth preservation, rather than play the risk on equity trade. The VIX having been trading around just 12 a few days ago rose to 18, which is no longer the bargain it was.
I continue to believe that the US$ will outperform this year. Sterling is strengthening, but will be impacted by problems in the EZ and the BoE is in no hurry to raise rates. The A$ looks vulnerable to problems in China. The Yen has strengthened in a flight to safety trade. However, I believe that Japan faces significant problems and do not consider that Japan is the safety trade that it has been historically. In calendar Q2 this year, the sales tax doubles in Japan which will be a significant headwind for domestic consumption. As a result, I believe that the Yen, which has rebounded, will weaken in coming months.
The decline in the US 10 year bond yield (inspite of the tapering programme), which was one of the triggers that made me suggest that investors take profits, has declined even further this week. Emerging market issues were also a concern. The market is talking about Argentina. However, the much bigger problem is the so called Chinese “wealth management products”, most of which are junk and unrepayable. The problem is that the sheer amount of these products that are out there – it will be no easy task for the Chinese authorities to manage.
As a result, I remain bearish.
US
US job openings rose to the highest in 5 years in November, once again suggesting that December’s extremely poor non-farm payrolls data was a one off number, distorted by particularly bad weather.
Markit reported that US PMI declined to 53.7 in January, lower than the reading of 55.0 in December. An unchanged reading was expected. Output and new orders declined.
Weekly jobless claims came in at 326k, lower than the 330k expected and near the lowest in over a month.
The US index of leading indicators which indicates the outlook for the next 3 and 6 months rose by +0.1%, slightly below the forecast of +0.2%, though still indicating growth. Novembers index was much stronger, having been revised higher to +1.0%.
Congress needs to agree to increase the US debt ceiling. Congress did pass the budget deal, which suggests that the debt ceiling will be increased, though with the usual political theatrics.
The US house price index rose by just +0.1%, lower than the +0.4% expected and the rise of +0.5% in October.
December existing home sales rose by +1.0% to an annualised pace of 4.87mn units, slightly below forecasts of 4.93mn, though better than the downwardly revised rate of 4.82mn units in November.
Europe
EZ overnight interest rates have been rising materially. Banks are being forced to borrow from each other as LTRO funds are being repaid. Mr Draghi did say that he would act if rates increased which suggests that another LTRO is likely fairly soon.
The German ZEW investor confidence index declined unexpectedly to 61.7, from 62.0 in December and below the rise to 64.0 expected. It was the 1st decline in 6 months. However, the current and future expectations components were better, which makes the headline number difficult to understand.
Better manufacturing PMI data in the EZ. The index rose to 53.9, from 52.7 in December and higher than the rise to 53.0 expected. As usual, the German manufacturing data (56.3, as opposed to 54.3 in December and the 54.6 expected) was particularly positive, with factory output rising to a 32 month high. German manufacturing companies reporting increased output and new orders. French manufacturing PMI rose to 48.0, from 47.8 in December and better than the rise to 47.5 expected. However a number of companies reported that they would seek to reduce employment further and that selling prices were lower. The services sector rose to 48.6, higher than the 47.0 in December and better than the forecast of 48.1. Whilst both indexes remain in contraction territory, it is slightly better news, though France still has a long way to go. Services PMI in the EZ also rose to 51.9, from 51.0 in December and better than the rise to 51.4 expected. The composite index rose to 53.2, from 52.1 in December and better than the 52.5 expected.
Whilst Spanish data has been improving recently, unemployment remains a problem. The jobless rate rose to 26.03% in the 3 months to December, slightly higher than the 25.98% in the previous Q. As expected, GDP rose by +0.3% in Q4 Q/Q, though was -1.2% lower on the year Y/Y. However, both imports and exports declined by -0.6%, though household demand rose by +0.4%. Spanish bond yields continued to decline, though sold off towards the end of the week.
The IMF has raised its UK’s 2014 GDP forecast to 2.4% which, based on current data, looks to be on the conservative side. The manufacturing sector in the UK, whilst small compared with the service sector, is improving. Businesses expect capex to rise sharply this year according to the CBI , the UK’s business federation. New orders are improving are are at the highest level since April 2011, according to the CBI survey.
UK unemployment declined sharply to 7.1% in the 3 months to November to the lowest level since April 2009, as compared with the 7.4% rate in the 3 months to October and much better than the 7.3% rate expected. Unemployment fell by 167k, the largest decline since 1997. The unemployment rate is expected to decline to 7.0% or lower this Q. The much better data has forced the BoE Governor to signal that the BoE’s forward guidance policy of linking interest rates to unemployment would cease. He did add that the BoE had no plans to raise UK interest rates “immediately” and that the BoE would look at a number of indicators, rather than just the unemployment rate. The BoE is in no hurry to raise rates.
Japan
Japanese industrial production rose by +4.8% Y/Y in November.
The BoJ left its policy unchanged. It stated that inflation would rise to its 2.0% target in the fiscal year beginning April 2015. CPI, excluding fresh food, rose to +1.2% in November Y/Y, though the BoJ expected the rate to remain at these levels “for some time”. A number of analysts believe that the BoJ will increase its asset purchase programme later this year.
Basic wages declined by -0.6% Y/Y in November (the 18th consecutive monthly decline) and with rising inflation and a doubling of sales tax in April to 10.0%, consumption will decline, which will negatively impact GDP. I cannot see how the current BoJ policy will work in these circumstances.
The unemployment rate remained at 4.0% in October, with the number of people seeking employment as compared to the number of jobs available rising to the highest since 2007.
China
Chinese GDP slowed to +7.7% in Q4 2013 Y/Y, lower than the +7.8% in Q3, following lower capex and factory output. The economy grew by +2.0% in Q4 Q/Q, below the increase of +2.2% in Q3.
Industrial production increased by +9.7% in December Y/Y, as compared with +9.8% in November.
Retail sales rose by +13.6% Y/Y, in line with estimates.
Whilst the economy is cooling, new home sales increased to US$1.0 tr last year, an 11.0% rise on the previous year. The PBoC has been trying to reduce the pace of property price increases, though to date, has had little success. To cope with rising short term rates the PBoC had to inject further funds into the system. Whilst the PBoC wants to curb lending, it has realised that it cannot be to aggressive and cause a systemic risk in the financial sector.
Bloomberg reports that China’s working age population declined for the 2nd consecutive year, due to the one child policy. This problem is set to continue for many years and will prove a material headwind to growth.
The preliminary HSBC Chinese manufacturing PMI reading came in at 49.6, below December’s 50.5 and the forecast of 50.3. It was the 1st decline to below the 50.0 neutral level in 6 months.The new orders component declined to 49.8 and the employment component also declined. The report cited weaker domestic demand. The data indicates that the manufacturing sector is contracting, which should not come as a surprise.
Chinese authorities are trying to prevent a default of a US$500mn wealth management product to the coal sector in the Shanxi province. The bank (ICBC) that issued the bonds stated that they would not provide a backstop. This is a major issue as a significant amount of these wealth management products remain outstanding (guestimated at around US$1.7 tr), a large number of which are clearly unrepayable.
Other
Australian CPI rose to 2.7% in the 3 months to December, higher than the 2.4% expected. The Australian Central Bank was expected to reduce rates, though the higher inflation rate will make it difficult to do so. In addition, home prices continue to rise, which restricts the RBA from cutting rates too quickly. The weaker A$ contributed to the rise in inflation. The A$ rose on the news, but declined following the weaker Chinese PMI data and the news of a potential default of a wealth management product, as described above.
Kiron Sarkar
25th January 2014
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