- Technical Outlook: Mixed.
- Fundamental Drivers: Overview of what’s need to sustain global bull market.
- US: Earnings metrics, Fed policy.
- State Of Likely Crisis Flashpoints: EU, Japan, China.
Technical, Fundamental Market Drivers And Lessons For The Coming Week And Beyond From The US, Europe, Japan & China, For Traders & Investors in Stocks, Forex, Commodities, and Other Global Markets
First we look at overall risk appetite as portrayed by our sample of global indexes, because the EURUSD has been tracking these fairly well recently.
Overall Risk Appetite: Sample Global Weekly Chart & Key Take-Aways
Our sample of weekly charts for leading global stock indexes suggests a mixed technical picture, with the US locked in a tight 5 week trading range but retaining its upward momentum, while Europe and Asia have pulled back in recent weeks under the combined weight of the Crimean situation and China slowdown fears exacerbated by what's becoming weekly corporate bond defaults and weak data.
Weekly Charts Of Large Cap Global Indexes With 10 Week/200 Day EMA In Red: LEFT COLUMN TOP TO BOTTOM: S&P 500, DJ 30, FTSE 100, MIDDLE: CAC 40, DJ EUR 50, DAX 30, RIGHT: HANG SENG, MSCI TAIWAN, NIKKEI 225
KEY: 10 Week EMA Dark Blue, 20 WEEK EMA Yellow, 50 WEEK EMA Red, 100 WEEK EMA Light Blue, 200 WEEK EMA Violet, DOUBLE BOLLINGER BANDS: Normal 2 Standard Deviations Green, 1 Standard Deviation Orange
01 Mar. 22 20.49
1-3. Goldman Sachs' David Kostin predicts 1,900 year-end close for the S&P 500, which reflects a modest 3% gain from current levels. For that target to rise, Kostin says 3 things must increase further:
2- The expected forward earnings growth rate, and/or
3- The P/E multiple that investors will accept
Said Kostin: "Given the high starting point of all three metrics, it is hard to identify any one of these that will climb significantly during the coming year." See here for details.
We'll know more about these in the coming weeks with the start of Q1 2014 earnings announcements. Alcoa's (NYSE:AA) on April 8th marks the official start of earnings season.
4-5. We'd add to that list:
4- Belief that there will be continued low interest rate: Maybe yes, maybe not, but if not, we're in trouble. Remember that one of the two pillars of the rally since 2009 have been continued easy monetary policy (stimulus & low rates). Even if the US tightening is gradual enough to avoid damage (?), China is also tightening as part of its own reforms. We'll have more on that below. The other pillar has been….
5- No crises in any of the major economic zones. The EU may be most at risk, but there are real concerns about Japan and China, as detailed below.
None of these supports can be assumed to continue.
Let's look at each of them.
4. Are US Rate Hikes Really Coming Soon?
That's a good question. Even if Janet Yellen actually meant that the fed intends to begin rate hikes in mid-2015 (we read assorted comments from Fed and non-fed sources suggesting otherwise) the Fed is clearly improvising as it goes.
Why Rate Hikes Could Come By Mid-2015 Or Sooner
There's a growing opinion both within and beyond the Fed, that US labor participation is closer to capacity than previously thought, because it's in fact more structural than cyclical, because long term unemployment is more the result of factors such as an ageing workforce and the effect of technology on jobs, rather than of inadequate stimulus. If so, the Fed's ability and responsibility to raise employment is greatly reduced, and the time for a gradual tightening of normalization of US monetary policy - a crucial time for the global economy and for markets - could come sooner than expected. This opinion would gain followers if hours worked and re-engagement rates of the short and longer-term unemployed as well as headline employment numbers, continue to improve while the long term jobless remain unemployed.
Why Rate Hikes Won't Come By Mid-2015 Or Sooner
The FOMC's bias is dovish, Yellen will be cautious, especially given that even the optimistic forecasts for US GDP hitting ~3% are hardly suggestive of robust growth.
Last week Goldman Sachs economist Jan Hatzius said that he still believes there won't be any rate hikes until early 2016 (versus the approximate April 2015 date implied by Yellen's comments last week) because:
--As long as inflation stays well below the Fed's 2% goal, the Fed has even less motivation to raise rates until the recovery looks stronger.
--There's a risk of tightening financial conditions (as well as falling risk asset prices) when markets believe a rate hike is coming, which in turn could hurt growth and cause the Fed to defer a rate hike.
--Liquidity Trap Slows Rate Hikes: Hatzius' second point is a restatement of Richard Koo's belief that the Fed is stuck in "liquidity trap," in which withdrawal from QE means rates rise faster than they would have if the fed had not engaged in QE. In essence, Koo says that while QE lowers rates and improves growth faster; its withdrawal causes rates to rise faster, which slows the ultimate recovery.
5. No New Economic Crises In The EU - Or In Other Major Economies 5a. EU
Given that the EU has made few material steps towards preventing another crisis, that's not a great assumption, although the EU has been good at muddling through thus far and delaying hard decisions about who pays for the sins of the past. Recent events have not been encouraging. Last week the EU showed yet again that it's unable to create a credible bank backstop or strong central banking authority (both critical for surviving the next banking crisis). See our special report for full details.
The euro-zone needs a real (fast acting, well-funded) banking union to prevent doubts about the solvency of national governments from undermining confidence (and thus access to interbank financing) in their banks. Unless the resolution fund has the backstop of further European funding, that cannot happen. Those banks remain vulnerable to being cut off from interbank lending that could kill off otherwise stable banks.
Meanwhile, even that safety net won't be in place this summer, when the ECB's bank stress tests are scheduled to take place. Member states (and bank depositors, bond and stockholders) are on their own.
How much cash is needed? FT.com's Walter Munchau wrote here that he estimated that , "the European banking sector needs to raise its capital by at least €1tn." He went on to write:
A detailed study by financial economists Viral Acharya and Sascha Steffen came up with an estimate of €510bn-€770bn for the shortfall. But this range relates to only 109 banks out of the 128 that would be subject to ECB supervision. I doubt the ECB will come up with a number anywhere near this high. It would require lots of public money. The EU is not prepared for that.
Time to test Draghi's OMT program and see if it actually works? Spain refused it, fearing what outside auditors would find. This could be an interesting summer in the EU.
The EU faces other threats too. There's deflation, growth ranges from tepid in Germany In December, the Bundesbank predicted growth of 1.7% for 2014and 2% in 2015 for Europe's "growth engine" and down from there elsewhere. In the US, currently looking at 3% per year, sub 2% growth is considered a precursor to recession. Then there are the unknown consequences if the exchange of economic sanctions between the West and Russia escalates. We'll leave such speculations for another time, as Europe already has enough imminent threats already.
Last week Reuters' Anatole Kaletsky argued that Japan was the most likely next big sovereign debt crisis. His key points:
· Japan is still the world's third-largest economy, with a gross domestic product equal to France, Italy, Spain, and Portugal combined. Therefore a Japanese economic crisis can trigger financial crises across the whole of Asia - as it did in 1997.
· Abenomics was initially a promising program because it seemed to pierce the complacency of previous governments with its "three arrows" of radical economic policy - monetary expansion, fiscal stimulus, and structural reform.
· By last October, however, two of these three arrows were veering off course. Structural reforms in labor regulation, corporate governance, competition policy and pension management had already been abandoned or delayed sine die in the summer. When Abe bowed to the longstanding demand from Japan's powerful Ministry of Finance for a doubling of Japan's consumption tax, his fiscal "arrow" was transformed into a boomerang, threatening the hopes of economic acceleration in 2014 and 2015.
· This boomerang will hit Japan on April 1, when the consumption tax jumps from 5 percent to 8 percent, and again in October 2015, when it will rise again, to 10 percent. The result will be a fiscal tightening worth roughly 2.5 percent of GDP this year, plus another worth 1 percent in 2015,according to IMF estimates confirmed by unpublished projections from the Ministry of Finance. This fiscal squeeze - almost exactly equal to those in Britain in 2011 (2.4 percent) and Italy in 2012 (2.2 percent) - will cut Japan's economic growth from 2.5 percent in 2013 to 1.4 percent, according to official forecasts.
· He goes on to argue that those forecasts could well be too optimistic, and that if the tax hikes produce a recession, Japan has no compelling options for escaping it. See here for the full story.
The recent fall, loosening of the trading band of the Chinese Yuan, and the CNY's drop was the big China news this week. Key take-aways:
· The PBOC is clearly willing to suffer some currency volatility in order to punish speculators, and also provide some help to struggling exporters and also a boost to China's GDP that comes from a cheaper currency and more competitive exports.
· The drop in the CNY is in line with the China slowdown story that gets reinforced with each new China data release. In recent weeks we've seen across the board declines in most measures of growth and economic activity such as manufacturing PMIs, industrial production, exports (-18% y/y in February), inflation, new bank loans, credit growth, fixed asset investment, retail sales, property sales, etc. See here for details.
For those who haven't followed the China slowdown story, here are the basics:
1. Much of the slowdown is self-induced as China seeks to cut back on its own excess credit bubble. For years it has relied on easy credit to fuel growth, with the predictable result of causing a lot of bad debt as cash was recklessly thrown at unproductive investments. The details were somewhat different than those that caused the credit bubbles in the West, but the basic motives were the same. A few in power stood to gain in the short term at the expense of those stuck with non-performing loans.
2. China has little choice but to cut its debt levels (238% debt/GDP, rivaling Japan's) and accept the near term blow to GDP. The alternative is to let the credit bubble expand and invite a bigger wave of defaults that it may well not be able to control.
a. No "Bear Stearns" Moments: Private sector loan defaults have begun, but so far the credit bubble reduction seems under control. So far, none of the defaults has undermined market confidence in overall credit risk and caused a liquidity crunch, as was the case with Bear Stearns.
b. No Lehman Brothers Moments: Nor have any of the defaults created uncertainty about whether the central government stands ready to do what it must to preserve stability in the financial system, as was the fear when the US let Lehman Brothers die.
c. In the words of David Pilling, Financial Times Asia Editor, China's leadership is attempting to perform a "controlled explosion," in which its credit bubble collapses slowly, bringing down unproductive projects without dragging the entire economy down into recession or worse.
Ramifications of China Crisis
Basically this means that anything for which China was a key customer could suffer. In a Bloomberg View column, Patrick Chovanec, chief strategist at Silvercrest Asset Management, wrote that
"China has become the world's largest automobile market, its largest oil importer, and its largest buyer of gold. Although foreign banks have relatively little direct exposure to Chinese financial markets, capital flows into and out of the mainland are potentially large enough to have a significant impact on asset classes not normally associated with China. A financial train wreck would send tremors through global markets."
We would add that given the modest economic recoveries in the US and parts of Europe (other parts remain stagnant), and struggling EM economies, a steady drop in demand from China risks tipping other economies into recessions that make China's slowdown of ~7.5% growth look like boom times.
We don't see a material further escalation coming in the near term. While we believe Russia wants all of Ukraine, as well as firm control over its weakest neighbors, it is more likely to use the Crimea example and other forms of coercion to achieve its goals before opting for outright invasion to achieve its goal of rebuilding the former Soviet empire. More on this in the future.
To be added to Cliff's email distribution list, just click here, and leave your name, email address, and request to be on the mailing list for alerts of future posts.
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.