MID JANUARY 2016 MARKET COMMENTARY - FFG€¦ · Currently the VIX is spiking higher and...
Transcript of MID JANUARY 2016 MARKET COMMENTARY - FFG€¦ · Currently the VIX is spiking higher and...
January 20, 2016 [Edition 1, Volume 1]
WORST START EVER 2016 is fast becoming the year of the Bear
January has seen some of the
largest liquidations in stocks that
we have ever seen for the first
month of the year in history, but is
it all a co-incidence? Or are
there greater forces at work?
“Animal Spirits” maybe? The
world is reeling from a greatly
depressed oil market which is
largely caused due to excess
supply in the market from key
players in OPEC, namely Saudi
Arabia who are targeting sales of
12 million barrels a day as well as
the fresh supply coming on line
from Iran who have been
released from the shackles of
international sanctions. We are
now seeing levels in oil not seen
since the 90’s and this creates
tremendous pressure on oil
producing countries to promote
growth, especially since
breakeven prices for production
are often at levels higher than
the current price of $28.8/Barrel
*below WTI Crude Futures
MASH-UP OF CHARTS AND MARKET COMMENTARY
MID JANUARY 2016 MARKET COMMENTARY
MARKETS YTD
JSE ALSI(-2.73%)
JSE FIN 15(-2.29%)
JSE RESI 10(-4.51%)
JSE IND 25(-2.60%)
JSE TOP 40(-2.94%)
JSE GOLD(+2.76%)
Data: moneyweb.co.za
“The problem with the oil
market is part of a far
greater issue with
commodities and
commodity producing
counties as a whole.”
M A S H - U P O F C H A R T S A N D M A R K E T C O M M E N T A R Y
“spreads are widening
and the banks who
supplied the capital to
these producers now sit
with a liability.”
This oil glut in the system is
wreaking havoc with many oil
exporting country’s currency
exchange rates. A clear
example of this currency
devaluation off the back of oil
deflation can be seen when
looking at the USD/CAD – Oil
represents one of Canada’s
primary export markets and
therefore we see that their
currency has also not been this
week in over a decade. The
next casualties of the Saudi
lead devaluation are smaller
and high cost producers, who
are currently being driven to
the brink of bankruptcy. Many
of them will fail and their assets
will be sold at fire sale prices.
The effect of this is currently
being seen in High Yield Energy
Green – USD/CAD
Black – WTI Crude Futures
Data: Tradingview
Credit (1) markets where spreads
are widening and the banks who
supplied the capital to these
producers now sit with a liability
on their balance sheet as much
of this high yield debt will default.
This event may possibly be the
catalyst to end this particular
credit cycle.
On the right we see a very
alarming chart illustrating the
yield spike on HY Energy Bonds
and startling, although not
surprising the ability for borrowers
to service their debt dropping to
levels lower than what it was
during the 2008 financial crisis.
(1)HY Credit Spreads
Data: Reuters
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“record prices in
late 2011 evaporate
into prices last seen
in the 1990’s”
The problem with the oil and
credit market is part of a far
greater issue with HY Credit and
commodity producing counties
as a whole(2).
We are possibly going to start
seeing some banks balance
sheets hemorrhage due to the
fact that producers can no
longer afford to pay the debt on
their loans – This will be an
important theme to watch as we
progress further on into the year.
The Commodity Super Cycle(3)
has seen record prices in late
2011 evaporate into prices last
seen in the 1990’s and with such
depressed prices, mining and
exploration companies(4) and
the countries that depend on
them for economic growth suffer.
The JSE: Resources Index is Down
54.98% from 5 years ago
World demand for commodities
has dropped thanks to the
slowing down of manufacturing
(5) Global PMI
Is nearing 50, which would
suggest that the global economy
should start to shrink if we go
below the 50 line.
(2)HY Metals & Mining Vs Energy
Data: Bloomberg
(3)Bloomberg Commodity Index
Data: Bloomberg
(4)Orange - JSE: RESI Index
Blue – Bloomberg Commodity
mash-up of charts and market commentary
(5)Global Manufacturing PMI
Data: JP Morgan & Markit
China is also struggling with
internal issues around its currency
peg to the US Dollar and the
impact of having to sell off its war
chest of US treasuries every
month in order to maintain this
artificial peg to the Greenback(6)
The initial “Shock Devaluation”
experienced by the market in
August 2015 of the Chinese Yuan,
left the markets in complete and
utter disarray and caused a great
amount of fear in the market and
general risk-off sentiment in stocks
China has since August slowly
continued to devalue its currency
in order to help its economy
transition into an economy that is
consumption driven rather than
production driven. This
devaluation is causing somewhat
of a capital flight from Chinese
Investors who are moving money
out of the country at record
amounts which is placing a stress
on its foreign reserves.
(5)View of Global
Manufacturing PMI’s
We note that the world is
producing less with
Emerging Market
Manufacturing actually
contracting in 2015
China also produced
much less in 2015 than in
2014
Only the Eurozone seems
to have ramped up
manufacturing
production in 2015
“Global PMI
Is nearing 50,
which would
suggest that
the global
economy
should start
to shrink.”
BELOW CHINESE CONSUMPTION
SHOWING CLEAR SIGNS OF GROWTH
(BLUE) RELATIVE TO NET EXPORTS (GREEN)
AND CAPITAL FORMATION (ORANGE)
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Data: the Economist
The Left shows that China has lost
more than $700 Billion in foreign
FX reserves in order to maintain
their currency peg to the US
Dollar.
Data: Bloomberg
To the left we see how China is
fighting capital flight in its country
as investors buy Dollars to guard
themselves against a much more
muted Yuan devaluation
Date: Bloomberg
Note that the fact that China is
liquidating its reserves, does not
necessarily mean its dumping its
treasury holdings onto the
market, which would have very
adverse effects on US Sovereign
Bond Yields and the economy at
large.
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THE STORY OF THE DOLLAR A new normal of monetary policy divergence
Mid December saw the US Federal Reserve adjust its guidance for its Federal Funds Rate upward by 25 bps,
which marks the end of an era of ultra-lose monetary policy from the US Central Bank; which until then had
been engaged in ZIRP (Zero Interest Rate Policy) as well as Quantitative Easing and Planned Open Market
Operations to manipulate the long end of the treasury yield curve lower, making servicing its debts cheaper.
Data: Tradingview
FED FUNDS (Blue) DXY Dollar Index (Green)
Now one would question whether or not 25 bps is sufficient to warrant a move to the upside in the US Dollar?
The correlations between these two indicators are striking and one would assume that eventually the Dollar
would rally further if demand for the Green Back is introduced into the system via stock market liquidations
(risk-off behavior) or demand for higher yielding US treasuries
A general gauge for bearish sentiment is the implied volatility measure of the S&P500 – AKA the VIX.
Currently the VIX is spiking higher and traditionally what happened since FED monetary stimulus efforts, was
that traders and investors would sell these VIX volatility spikes as a sure way to make money off of a dip in the
S&P500. This trade was however predicated on the fact that central banks (specifically the FED) were actively
involved in propping up financial markets via stimulus and would always come to the rescue of the market if
it fell. This created massive amounts of complacency in the financial system where investors falsely expect the
market to always go up.
We are currently seeing the lowest levels in the S&P500 that we have seen in over a year, the FED has for the
time being stopped all of its efforts to prop up the market and is now trying to engage in monetary tightening
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“This created massive
amounts of complacency
in the financial system
where investors falsely
expect the market to
always go up.”
Data: Tradingview
S&P500 (Blue) VIX (Red)
Above we note the dips in the
S&P500 and corresponding VIX short
Vol trades that much of the last
decade have been about.
Data: Pension Partners
To the left we see the major indices
of the World in their local currency
from highest to weakest YTD return
as well as their distance from their 52
week high and whether price lies
above or below the all-important
long term 200 day simple moving
average
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So in the US we are seeing the start of tightening monetary policy when growth is tepid and inflation low
(which begs the question how long will it last?). The result of the loose monetary policy of the US Fed has
caused the Price to Earnings (PE) ratios of companies to become inflated. The higher PE ratios create a
market expectation of future profit growth, but because this inflation of companies stock prices has been
largely artificial due to the worldwide search of yield and that the stock market has pretty much been a one
way bet; Companies now face the very real risk of missing earnings estimates, due to the fact that the Fed
has removed the punch bowl, so to speak.
In the EU, China and Japan we are experiencing the exact opposite with each Central Bank engaged in
some form of stimulus or policy intervention in order to generate inflation in their economies and get
consumption up and the consumer spending. This further incentivized by historically low interest rates, and in
the EU even negative interest rates!
This policy divergence will facilitate an investment carry trade towards high yielding economies away from
low yielding economies, where investors borrow in a low interest and invest in an economy which can offer a
greater yield than what they have to pay on their borrowed money.
In a local context, South Africa has since 2009 enjoyed the benefits of this positive carry trade and with our
inclusion into the Citi world bond index in 2012, we have seen great inflows into our country as a direct result
of the kind of return investors could make on money borrowed at near zero rates and put to work in our local
economy, but more of that a little later.
The tightening of FED monetary policy also means that all interest payment on Dollar denominated debt is
increasing, due to the fact that the Dollar is currently very strong and getting stronger relative to most other
countries. Below we look at a study from the Bank of International Settlements to see which countries are
exposed to higher Dollar debt servicing costs.
mash-up of charts and market commentary
“The tightening of FED monetary policy also means that all interest
payment on Dollar denominated debt is increasing, due to the fact
that the Dollar is currently very strong and getting stronger relative to
most other countries”
It is very encouraging to see that US Dollar denominated debt is not as large for South Africa as it is for many
of the other Emerging Economies, like China, Russia, Brazil and Turkey. So the current weakness of the Rand is
not necessarily placing an added strain on our economy in the form of debt repayment as it would be with
countries like Brazil and Russia, who have like South Africa also been battered by the current commodity rout.
Below we see the breakdown of Non-financial debt and we can see that where South Africa is concerned
most of our debt is for investment or hedging purposes in the form of debt securities, with very little in the form
of outright loans. Whereas Russia and Brazil are in a far worse situation with regards to their liabilities.
mash-up of charts and market commentary
mash-up of charts and market commentary
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The previous 6 currency blocks (South Africa, Brazil, Russia, Turkey, Mexico and China) represent the Emerging
Markets (EM) Currency Exchange Rates relative to the US Dollar.
We can see that currently the strong Dollar is effecting massive pressure on domestic EM currencies and with
China continuing to devalue its currency to counter US Dollar strength since the FED began to tighten its
monetary policy by ending Quantitative Easing and raising interest rates. Such competitive devaluation helps
countries such as China who are net exporters of goods, but for countries like South Africa who do not
produce many finished products the weaker Rand is a curse, as the country now starts to import inflation via a
stronger Dollar.
Yesterday the Core CPI (Inflation numbers came out for South Africa) and we are already starting to see the
effects of the Rand weakness on our inflation numbers.
Consumer prices in South Africa went up 5.2 percent year-on-year in December of 2015, up from a 4.8
percent rise in the previous month and the biggest increase in a year. This due to the higher costs for food.
Factors that could further increase inflation in 2016 include Eskom tariff hikes and power shortages, the
Drought of the 2015 farming season, the weak Rand, higher costs of imported products including cars,
technology, broadband infrastructure, etc. We are getting some relief at the fuel pump in the coming
months due to the low oil price, but again Rand weakness makes this relief very muted.
The problem with inflation running away as it has been is that the South African Reserve Bank has as part of its
economic mandate the duty to guide inflation between the 3%-6% band and as inflation tracks higher the
SARB have little other choice but to hike the interbank repurchase rate or REPO rate higher in order to try and
stabilize our currency and credit markets, hopefully bringing inflation down.
mash-up of charts and market commentary
So locally with Inflation expectation set to rise, and interest rate increases being initiated by the SARB in order
to bring inflation under control. Unless the SARB change its inflation target mandate and move towards more
accommodative monetary policy in the aid of economic growth whilst ignoring inflation remains to be seen
We also have the looming worry of a possible credit rating downgrade of our sovereign bond market this
year, which would effectively drop us from Investment Grade into Junk bond status and out of the coveted
Citi World Bond Index. This event would wreak havoc on our bond and currency markets much like the
carnage witnessed in Brazil when they got junked in Sep 2015 by S&P
All the above issues are predicated by a strong Dollar and weak demand for raw materials. We have seen
Rand Hedge stocks outperform local counters and so far this year it has been the Gold Miners who have been
relishing the limelight. The thesis around this meteoric rise in gold stocks has been very simple. Rand weakness
causes the price of Gold in Rand terms to be higher and those miners who have little exposure to offshore
mining operations benefit directly from enhanced earnings in Rand terms as the price of Gold remains flat
and the Rand weakens. However if gold were to rise then these Mining stocks may come to the rescue for
South Africa and the Rand.
Another thought of note is that in a high interest rate environment we should see pressure exerted on bonds
and on our local property markets.
There are many analysts that suggest the Dollar may not strengthen further and that EM currencies are
currently greatly undervalued but it is still early days to be calling a bottom in the Rand, although that may be
the trade of the decade if one could accurately get it right.
mash-up of charts and market commentary
Our saving grace at the moment for our economy is consumer spending which is seeing quarterly increases
although this will come under threat if inflation rears its ugly head.
Above we see consumer spending take a dip when inflation breaks out of the 6% band
SUMMARY
The world is not in a happy place at the moment, and South Africa has little or no effect on the world
economy at all, so we are going along for the ride.
There are great systemic risks in the market brought about by asset bubbles that have formed through the
attempts of Central Banks to artificially prop up financial markets through unprecedented monetary policy.
The problem is that as we saw with Sub-prime defaults in the USA, that the world markets are so correlated
and intertwined that it makes it very difficult to hedge against these risks that seem so far away.
The safest way to save money in troubled times has always been cash and with interest rates on the rise, it
opens up new opportunities for money market rates to improve and possibly match or beat inflation, if the
SARB gets it right.
The long term prospect for local stocks is looking grim, but it is in such times that asset managers show their
true value in creating alpha in falling markets through tactical asset allocations and portfolio diversification
Over the long term the global markets should stabilize and find a floor and continue to grow especially if the
Asian consumer comes online, the Fed may abandon their current forward guidance and opt for more QE in
order to save the market again, but this remains to be seen and is not something one should be betting on
the short term.
Locally we are at risk of a credit rating downgrade, but this can be averted with prudent fiscal and monetary
policy. We await our new budget to see what direction treasury will take to tackle our domestic issues.
In the long term emerging markets still offer significant value for investors with a stomach for volatility and
patience.
mash-up of charts and market commentary
Markets are cyclical, and we can’t expect them to always go up, we are definitely entering a new market
landscape of prolonged lower growth and possible recession
Investors sticking to a tried and tested investment strategy that looks to produce inflation beating returns over
the long term and not selling in a panic when markets drop, need coaching on matching their expectations
to the new returns reality that we are moving towards.
Fees will come into focus and its best to opt for solutions that save investors in fees and reward investors for
good investment behavior; like investing through the cycle.
Start becoming more self-sufficient; capture rain water, maintain a veggie garden, go solar, go green and
invest in your children’s future
The Document has been prepared solely for informational purposes, and is not an offer to buy or sell or a solicitation of
an offer to buy or sell any security, product, service or investment. The opinions expressed in this Document do not
constitute investment advice and independent advice should be sought where appropriate.