Last week’s market roller coaster was a story for the grandkids, leaving even the most seasoned investors trying hard to recollect the last time they had witnessed such wild swings and borderline insanity on Wall Street. With a 1,000 point plunge in the first 5 minutes of trading Monday morning, an apocalyptic, darkness-forever scenario wasn’t hard to envision, but mid-week countermeasures by Chinese authorities ended up stabilizing the global equity ship; the Dow actually ended up by 1.1% – an unimaginable thought given the previous few days’ events. It’s fair to forgive investors for the mayhem. After all, the new age mix of a connected global economy, currency warfare, international bond holdings, electronic trading, and liquid ETFs isn’t easy to handle when turbulence occurs…getting the kids ready for school may not seem so difficult anymore.
On a serious note, given last week’s market action, here are the three points we’re reflecting on:
While China’s turmoil and currency volatility dominated headlines, US economic data remained a beacon of hope amid overseas darkness. Q2 GDP was revised upwards to 3.7% – higher than expected – from the earlier 2.3%. While some may attribute it to inventory growth, the main sales-to-inventory ratio remains around the average post-recession level of 3.9, according to Barron’s Gene Epstein – signaling things aren’t really out of line. Alongside, July’s business investment showed the largest gains in the past year, jobless claims stayed around 15-year lows, and the core personal consumption index (a measure of inflation) was up 1.2% YoY. Consumer spending, meanwhile, was up 0.3% last month again, led by durable goods, up 1.1% – another signal of a housing upturn. Last week, we highlighted that auto sales, household net worth and consumer confidence was also looking pretty robust; all signs point to an underlying economic soundness and recovery. And while several of these improvements have come later than the usual expansion, they’re coming at a time when the world economy needs some serious stability and reassurance.
Investors are taking note. Take gold – an ultimate safe haven worldwide. It actually fell by 2.4% amid last week’s equity chaos. While we’ve heard the argument that the drop was caused by funds selling to get cash, it still shows that amid richly priced markets, the panic remains subdued; another sign was through the US utility sector, which also fell by over 4% last week. This doesn’t usually happen when the world is collapsing.
Treasury yields, however, signal some complexity. 10-year yields finished at 2.18%, up from 2.04%. Usually, in times of equity sell-offs, the opposite would occur as investors rotate out of stocks into safer bonds. The upside was largely attributed by Wall Street to China’s liquidation of a chunk of their $3.5 trillion foreign reserve (WSJ data) to raise dollars to aid their devalued yuan – we agree. Effectively, China has attempted to subdue local markets and create inflation – in essence, exporting deflation – something the entire developed world has been combating post-recession. As a result, this presents a fix for the US Fed – which has been looking to normalize rates while the world remains in a low demand, low growth, low inflation environment. The CME FedWatch is now predicting a rate hike probability of only 28% – far lower than the 60+% some days ago. The rate of change matters – and while we’re only talking about a 25 basis point increase, that’s effectively double the current 0.14% Fed Funds rate (NY Fed data). As a result, we think the uncertainty around interest rates until September’s Fed meeting will continue to hamper any market upside.
And finally, we consider oil. After reaching recession-level prices, WTI crude spiked up by over 17% in the past week on reports that inventories had been drawn down greater than estimates; short covering likely was a factor in the rebound. Again, while current WTI prices are only at $44.5/barrel, it’s the rate of change that matters, and the rebound will certainly draw investors’ attention – given the previous bottom was in the low $40s earlier this year. Schlumberger’s acquisition of Cameron mid-week was another catalyst, in our opinion. Given this may open the doors for more energy sector consolidation, M&A premiums will add to stock prices, and may even provide some breathing room for companies, leading to hopefully less layoffs, asset sales and insolvencies. In any case, several analysts have identified a 6-9 month lag in low oil prices leading to consumption boosts; we’ve been bullish for the same reason on consumption for a while now, and the recent WTI bottom lines up well with the upcoming US holiday season. Alongside, US BLS data shows that the mining, quarrying and oil and gas extraction sector employs only about 1% of the US workforce, furthering our thought that the benefits of low oil may be felt by consumers far more than the downside by firms. Could the equity catharsis have been the bottom for oil? It’s an enticing question; several nations and the US energy sector stands to benefit if yes. The fundamentals still don’t support a massive upside given supply – or demand – isn’t going to change overnight, but in any case, we think consumers will help the markets in the coming months.
What it means for you: It’s hard to expect any significant returns from the US markets in the coming weeks given increasing global policy divergence, continued liquidity splashing around, a lack of growth and demand worldwide, and China’s navigation towards a hard or soft landing. However, the US provides an incredibly compelling risk-reward ratio, including fair valuations, sturdy balance sheets, and downside protection with stable dividends from blue-chip firms; the S&P 500 earnings yield is at a 5.3% vs the long-term average of 4.9%. Overseas, we’re looking to markets that can feed themselves. India, Mexico, and Eastern Europe all boast a diversified economy with aspirational populations aiding domestic consumption, services and manufacturing. Brazil and Malaysia are now on our radar, given that unrest against current policy makers may lead to changes and reforms. At the end of the day, the big picture shows that a majority of the world’s population still remains below the middle class; as innovation, connectivity and consumption increases, staying invested has proven to be a sound approach to managing your money. Take advantage of the bargains, keep an eye on other asset classes, and watch for the bulls to feed on underlying economic strength as they fight some revenge-hungry bears on Wall Street next week based on Asia’s cues.
