Monday, January 25, 2016

The five 'C's for '16

A piece from one of the investment banks, written in reaction to what so far has been a truly awful start to the year for markets, highlighted the four things that would be needed for a market recovery: China, Commodities, Credit & Consumer. We'd add a fifth: Cashflow. As with so many things these days, these issues are all linked, but it will help if we look at them in turn.

(1) China - The wild policy mis-steps by the regulatory and economic powers that be in the first two weeks of 2016 thrust Chinese markets into a global prominence that is probably unwarranted, but nonetheless had a big effect on sentiment. China's opacity in economic and monetary factors hasn't helped and these has merely led to investors bailing first on the assumption that if you don't know something, it's because the reality is worse. This is obviously a simplistic argument but the policy confusion has hardly helped in clarifying matters since it seems to suggest disagreements, or worse, incompetence at a political level. Whether or not this is justified is academic, although even the IMF has started gently suggesting that China needs to improve its communication skills. How ironic that this should now be an issue so soon after the IMF added the Yuan to its SDR currency basket.

The slow-down in the Chinese economy is clear from even the published data (with 2015 GDP growth officially posted at 6.8%). The question remains as to what the government will do about it. Memories are fresh of the mid 2015 Yuan "devaluation" of 3% overnight which triggered the first wave of Chinese market panic selling. In 2016, the forecasts from some are suggesting that the Yuan could be allowed to depreciate by 5% or so from here to 6.90 to the USD. If so, such a move, if not already discounted by markets, could trigger a round of zero sum game competitive devaluations amongst all emerging markets, as well as further commodity price weakness.

So - for China to return to being a positive for markets rather than a negative - as at present - we'll need to see currency stability, policy stability and signs of greater progress on the success of the structural shift in the economy from and industrial investment led growth model to more of a consumer led one.

(2) Commodities - You might have noticed that the oil price has been a little weak lately. in 2015, the same applied to pretty much all other commodities too, as sluggish demand from developed nations and China combined with the usual peak in supply at exactly the wrong time. Stock markets have usually treated weaker commodity as a positive since it gives the consumer cost discount, and usually such price declines are subsequently followed by a pick up in demand. This time round, though, the rally in demand has been notable for its absence. On the supply side too, marginal producers have been hanging in there for longer than  expected so production cuts have been less significant.

So - for Commodities to return to being a positive for markets, demand will need to start rising (cf. China, above), supply will need to start falling, prices will need to recover. The correlation between stockmarkets and oil prices could remain fairly high for a while yet.

(3) Credit - It's all about the central banks. We saw last week how a few words in support of further easing from the ECB triggered a sharp change in sentiment. The central bank "put" which has served markets so well since 2008 is still in place. However, with interest rates as  low as they are, it's becoming difficult for central banks to hold the line single handedly since their policy drawer is emptier than it used to be. In the US, the Fed's rate increase in December demonstrated it's desire to start pushing the burden of supporting the economy back to more traditional measures: private sector growth and consumer demand. Whether or not they'll actually be able to do that in the face of a weaker global economy remains to be seen. Suffice to say all policy statements from any central banker will remain required reading for a while yet.

(4) Consumer - The consumer remains supportive of economic growth, helped by solid employment and low interest rates. Can it conti9nue?

(5) Cashflow - Ultimately markets reflect the earnings base of companies and expectation of growth for that earnings base. 2/3rds of the rise in the market since 2012 has been not as a result of stronger earnings growth, but simply as a result of investors being prepared to pay more for the same $1 earned: the P/E has risen. Without further expansion in that P/E, the growth in the market relies more heavily on earnings and dividends for support. Q4 earnings from the US fell by 6.4%, although in Japan and Europe they still rose. In 2016 US earnings are expected to grow by 5% (including oil stocks, but these are now only 4% of the total), excluding dividends. In Europe, Japan and some individual Asian markets the outlook seems better.

So of the 5 points above, China, Commodities, Credit and Cashflow all look uncertain to greater or lesser degrees. The Consumer is still hanging in there, supported by lower prices and low interest rates. The hope must be that the Consumer sees support coming in from elsewhere rather than ending up as the last man standing.

What does that mean for portfolios...? If you've got cash elsewhere and this provides you with a cushion against volatility then you can afford to sit tight and avoid looking at the TV. If you are more fully invested, then taking advantage of any occasional rallies to raise a bit of cash seems sensible. Such caution could be proved wrong (we've seen market bounce sharply off lows countless times since 2011, and then march on to set new highs), but if it is proved wrong, the consolation can only be that it was wrong for the right reasons!

e-mail: steve.davies@javelinwealth.com
contact: +65 65577186
Find us on Facebook: http://www.facebook.com/JavelinWealth
Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.

Sunday, December 13, 2015

Where's the Santa Rally...?

So far, December 2015 is looking a lot like Santa is having trouble launching his sleigh. We've had a commodity price slump, with oil prices down nearly 16% this month alone (and -35% for the year); high yield bonds drop as concerns increase about rising defaults from energy and commodity dependent companies (about 20% of the high yield index); a less accommodating speech from the head of the ECB (although he subsequently claimed he didn't really mean it); the odds-on likelihood of a rate increase from the Fed in the US this Wednesday. That's a lot for any month to absorb, let alone one in which liquidity reaches a seasonal low point.

This all means that the likelihood of global equity markets ending the year in the red is fairly high - we've only got two weeks to go...

But - is it really as bad as all that?

If you are an oil or a mining company, yes - it looks grim. The oil majors will be struggling to make much money with oil at $40 per barrel, and the oil minors - the shale oil specialists - will be struggling. The inability of Saudi Arabia and Iran to reach any sort of output deal earlier this month is unlikely to result in oil prices recovering any time soon.

Last week's announcements out of Anglo American about its plans to lay off 2/3rds of its global workforce show the degree to which even large companies are struggling to make mines pay at such depressed prices: copper, aluminium and iron ore have all fallen sharply this year as new output comes on stream at exactly the wrong time in the demand cycle.

The normal reaction to this is debt downgrades, dividend cuts or suspensions, falling share prices etc.


Note this from a mid-year IMF economic survey:

"While the dramatic drop in oil prices in the past year will mean significant losses in revenue for some exporting countries, consumers should be paying less for fuel—and have more money to spend. [However], what we’re finding is that the positive we were expecting is taking longer to come. Part of the reason for that is that there have been other shocks along the way that have gone in the opposite direction, [consequently] part of it is that the saving is being used to pay down overextended balance sheets, both by households, and by firms. So the boon from lower oil prices could take a while to come, once balance sheets have been repaired, but the repairing process is taking place faster than it otherwise would have thanks to lower oil prices".

So there will be losers (the oil exporters who need prices ranging from $70 to $120 per barrel to balance their budgets) and winners: the oil importers:

With Europe's flagging economies characterised by low inflation and weak growth, any benefits of lower prices would be welcomed by beleaguered governments. A 10% fall in oil prices should lead to a 0.1% increase in economic output, say some. In general consumers benefit through lower energy prices, but eventually low oil prices do erode the conditions that brought them about.

China, which is set to become the largest net importer of oil, should gain from falling prices. However, lower oil prices won't fully offset the far wider effects of a slowing economy.

Japan imports nearly all of the oil it uses. But lower prices are a mixed blessing because high energy prices had helped to push inflation higher, which has been a key part of Japanese Prime Minister Shinzo Abe's growth strategy to combat deflation.

India imports 75% of its oil, and analysts say falling oil prices will ease its current account deficit. At the same time, the cost of India's fuel subsidies could fall by $2.5bn this year - but only if oil prices stay low. (source bbc.com 19th January 2015)

 This would seem to point towards inflation remaining low for a while yet as lower commodity prices feed their way through. That means the ECB and BoJ will likely leave the QE taps on, whilst the Fed is likely to reassure markets that the first rise (or two) will be small, measured and directly linked to the data. The data looks like it will show steady, gradual improvements.

And for the markets...?

It may take time to come through, but the December Drop looks overdone and if so, could result in a January Jump. Maybe Santa got caught in a snowdrift...


e-mail: steve.davies@javelinwealth.com

contact: +65 65577186

Find us on Facebook: http://www.facebook.com/JavelinWealth

Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.