Wall Street just got taken to the cleaners. Unless you were a clinical short-seller positioned perfectly last Monday morning, it’s likely you’re feeling pretty battered and confused after what turned out to be the worst start to a calendar year ever for the US stock markets. There are 51 more weeks to go in 2016…now what?
Here are some points to keep in mind as we battle through the storm:
Overvalued, with no place to go: Last week’s 0.5% on-shore yuan devaluation was nothing compared to the off-shore devaluation, where market forces caused it to fall by a much greater 2%. A continued downturn for the currency remains the inevitable path…and only when this is over, will equities to find their footing. Take last August’s example…the yuan’s devaluation caused the VIX stateside to touch 40 and equities worldwide to tumble; last week, a similar episode occured, with the VIX jumping to over 27 by Friday’s close, from 22.3 on Monday. Ripping the band-aid on the yuan’s value will hurt in the short term for many reasons – exporters to China will counteract, and global trade may face some hurdles…but at this point, there may be no alternative. So, brace yourself…until the currency valuation is sorted, this ride may not come to an end.
A bite out of Apple: Concerns around China are significant for Apple, given over ~60% of its revenue growth and ~75% of operating income growth, per some estimates, were derived from there as of late ’15. Apple is down around 30% from its peak in July. Even so, it still covers over 3% of the S&P 500’s market cap. As a result, a downturn in China will influence Apple, which will pressure the US markets.
The S&P 500 is actually outperforming: Note that the S&P 500 actually outperformed several of its developed peers last week; the Stoxx 600 was down 6.82%%, the Nikkei-225 was down 7.02%, Germany was down 8.32%; meanwhile, the S&P 500 was only down 5.96%. It may be a testament to the strength of the US economy and relatively insulated nature, given less than 1% of its GDP is derived from exports to China.
The 10-year yield fell…but only a bit: The 10-year yield ended at 2.12% on Friday, down around 14 basis points from Monday’s open. Being a favorite safe haven during rough times, the drop was expected…but just 14 basis points amid a 5 day, 6% collapse for equities globally in the first trading week of the year? That seems small. The reason may have been selling pressure from China or oil-producing nations to raise cash, which may have created a floor on the yield. As a result, gold may be a better barometer to watch investor fear, along with the VIX. On a side note, a continued US tightening as the year continues should pressure the 2-year T-yield upwards. As a result, the yield curve is likely to get extremely interesting given the numerous forces acting on both the long and short end. Watch this space.
Bear territory: The S&P 500 may be only off ~11% from it’s highs, but the average stock is already in bear territory, according to Bespoke Investment Group, highlighted by Barron’s. Mega-performers, such as the FANG stocks, can take credit for keeping the broader index from hitting the 20% down mark through 2015 and so far. As a result, their performance will be critical in determining whether the slide gets stemmed in the coming weeks.
Is QE’s influence going unnoticed? Data shows that during each QE round, equities did quite well. The 3rd round of QE ended in October 2014, and since then, the markets have actually not moved. Is the influence of QE-induced liquidity more on the markets than Wall Street thinks? If yes, the tightening cycle may be even rougher than expected.
What it means for you: The points above may be helpful to keep in mind as Wall Street opens on Monday. We’re dealing with an extremely complex situation where geopolitical events, commodity prices, China’s economic reorientation and currencies are playing a key role in driving equity prices. Until the yuan has a price discovery moment, don’t have high expectations.
