Good Morning. Markets are looking at a wobble but it has to be said that the warning signs for stocks were there for all to see. Are stocks the last asset to take a hit after bonds, gold and the USD surge on risk off? The issue here is that we are seeing an early impact on vols and there lies the key in many assets, including stocks. Data overnight was pretty shocking and Japan looks in real trouble with its economy now and finally the currency is just starting to price some of it. I think a few algo’s will need re-programming on the JPY against risk. I still think we can buy the dip, even though I think stocks may have a weak finish to the weak. Aussie data was also dreadful and the issue for me in both the Japanese and Aussie PMI data was the spill-over to services. If we see this across the EU and UK, we may have a bigger growth problem than we thought. It will also be interesting to see how the US data holds up. Right now it’s hard to argue against the USD or gold or bonds. Portfolios need some diversification of rebalancing to lessen the impact if things do get heated and vols create a VAR event. Could be a frisky end to the week and it’s a Friday so “Be careful out there”..
Keep the Faith..
09:00.. Eur PMI Mfg (Prelim) Cons: 47.5 Prev: 47.9
Eur PMI Services (Prelim) Cons: 52.2 Prev: 52.5
09:30.. UK PMI Mfg (Prelim) Cons: 49.7 Prev: 50.0
UK PMI Services (Prelim) Cons: 53.4 Prev: 53.9
10:00.. Eur CPI Core y/y (Final) Cons: 1.1% Prev: 1.1%
EUR Core CPI mom Conms: -1.7% Prev -1.7%
Eur CPI y/y Final Cons: 1.4% Prev:1.4%
Eur CPI mom Final Cons: -1.0% Prev 0.3%
13:30.. Canada Retail Sales m/m Cons: 0.1% Prev :0.9%
Canada Core retail sales mom Cons: 0.4% Prev: 0.2%
14:45.. US PMI Services (Prelim) Cons: 53.0 Prev: 53.4
US PMI Mfg (Prelim) Cons: 51.5 Prev 51.9
15:00. US Existing Home Sales Cons: 5.44mln Prev: 5.5mln
Speakers:..
08:30.. Riksbank Publishes Minutes From Feb.11 Meeting
11:30.. Riksbank’s Ohlsson on Economic Situation and Policy
14:35.. Fed Speaker: Kaplan (Neutral) in Dallas. Text: no.
15:15.. Fed Speaker: Brainard (Neutral) & Bostic (NV, Neutral) on Panel Policy Forum. Text: Brainard.
17:00.. ECB Speaker: Lane (Very Dovish) at Booth Policy Forum in New York. Text: Yes
18:30.. Fed Speaker: Clarida (Dovish) on Panel at Booth Forum in New York. Text: yes
BoE Speaker: Tenreyro (Dovish) on Panel in New York
Fed Speakers: Mester (Hawkish) MonPol Panel with Clarida (Dovish). Text: yes.
Details 21/02/20
That Philly Fed number: Vols set to rise and if so, look out. PMI day.
The Philly Fed index has been a tad volatile recently but nothing like we saw yesterday with the headline rising nearly 20 points this month to 36.7, smashing expectations of a drop from 17.0 to 12.0, and the highest index reading since February 2017.
More importantly, this was the second highest print on record. I don’t usually pay a great deal of attention to this but what an earth is going on here? With the disruption to the supply chains for US manufacturers there is a fair chance that some if not all, have turned to local manufacturers to get some supplies. This is the only explanation that makes sense; that US firms are using domestic manufacturers as a substitution for Chinese producers on the goods that the US can produce. US capacity utilization is 77% so plenty of spare capacity there. Otherwise this data is useless. But this could be an important point that keeps the US less impacted from all this but at what cost to the consumer? Again, increased costs will hit margins for American firms and thus corporate earnings and that worries me.
The USD remained bid throughout the session yesterday and again overnight and commenting on the monthly report, the Philadelphia Fed said that “the survey’s current indicators for general activity, new orders, and shipments increased this month, suggesting more widespread growth. The firms reported expansion in employment, although at a moderated pace from January. The survey’s broad future indexes also showed improvement this month, indicating that growth is expected to continue over the next six months.” No wonder the USD remains bid as the US remains the cleanest dirty shirt. But that does not exclude the chances of a stock market sell-off and I think we may actually be at risk here. Even if we are, the USD is a safe haven now and will probably still do well and again, I note with some interest that USDJPY has held up as stocks fall, AUD remains weak and the USD is generally still bid. Bonds took off and US yields took a 5bps hit in the 10yr space. 2s-10s hit 13bps yesterday and hit 11bps overnight as demand for the long end continues unabated. Gold ripped up to $1633 and the close above $1612 last night opens up a new leg higher; stay long.
But what worries me here is the warning signs of impending higher vols and that is something that can really move markets after years of vol suppression. JPY, commodities, gold and Bonds are all suggesting a big surge possible in vols and it is this that could hit stocks at some point. If this does take hold, we could be looking at a VAR event. Again, I think we need to start monitoring the credit space for any signs of stress. Vol suppression has been so extreme that it is in itself a bubble and a bubble that could burst. The vol “tail” has been waging the underlying “dog” for a while now. Talking of crowding, the ratio of the S&P500 technology to energy sector is now the same as during the tech bubble. At the very least; is this chart about to converge now? (Value over growth).
Maybe so but the issue is that this would create havoc in the vol/VIX markets and all stocks are open to that exposure. Looking at relative value may still be extremely expensive and we saw a fair bit of rotation in the last few sessions as investors do NOT want to give up on equity holdings still. Remember that leverage will play a huge part in any significant shock. The market is not only long cash but long equity calls too! Keep a close eye on what growth/momentum vs value are doing and if there is indeed a sharp reversal, it may be time to reassess everything. If you want/have to stay long equities, then owning gold, bonds and cash is certainly going to help. My fear is that investors all own the same stuff and this crowding is building a potential ticking bomb.
It is also a real possibility that while the US economy is still stronger than most, the global slowdown will impact the US economy. Even now there are early signs with the January Cass Freight Shipping Index bringing more bad news for the global economy.
The Cass Freight Shipping Index is down 9.4% year-over-year, the largest decline since 2009 and this is for January, before the Coronavirus disruption. However this is countered by the resilience in US Consumer confidence and spending. The US still attracts even though I would think global shipping is being massively disrupted and the end of this is nowhere in sight yet. Can stocks really ignore this? The trouble is that it seems most investors are against giving up on stocks while the Fed is threatening more easing and June Fed now stands at 17bps of cuts (as of late yesterday). Stocks are seeing some rotation but no capitulation (YET).
Bonds, commodities, gold and vols are starting to suggest something is not as it was. Correlations are breaking all over the place and the volcano is smoking. How long can this divergence (below) last?
I am sorry as I really don’t know but it may well be unsustainable. I still think the market is hoping that earnings forecasts remain where they are; but I can’t see that. PMI data is starting to roll in and it is not getting off to a good start and I note with some interest the spill-over now from manufacturing to services in the data from last night! Aussie PMI manufacturing marginally missed but the reason the AUD is lower this morning is that services dropped precipitously lower from an expected rise to 52.4 to 48.4. In Japan, Manufacturing PMI was a stinker coming in at 47.6 after 48.8 last and Services a very disappointing 46.7 after 51.0 last. Japan’s economy is in really bad shape and the JPY may yet be an accident waiting to happen and some re-programming of established algo’s that buy JPY on negative moves in stocks may be needed now. Stay short JPY in some form. EU and UK PMIs may also need monitoring and it will be interesting to see if the US numbers follow this afternoon. If they hold then further USD strength will be seen but in addition to that, we have stocks lower again, keeping the USD in demand as the safe haven of choice now.
To date, it is clear that investors have largely taken the view that the impact from the global supply chains will be temporary, hopefully short-lived, and that most of the weakness should be reversed with a strong rebound in the quarters that follow. Good luck with that if this thing breaks loose outside of China and breaking out it seems to be! It is certainly striking that despite fears of slower growth, stock market capitalisation has continued to rise relative to the size of economies. Central banks have driven this; not earnings. But central banks are running out of options; no more so than the BoJ and ECB. Doing more of the same is not a viable option now. Higher wages and tighter margins are not going to help earnings and this global trade blackout is certainly going to matter.
Are equity markets underestimating the potential impact of the virus and the hit to supply chains? Bonds aren’t and nor is gold. It is suggested that Chinese tourism alone now accounts for 0.4% of Global GDP, and the number of “missing workdays” in China will be roughly equivalent to the entire US workforce taking an unplanned break for two months. How can that not matter? This slowdown is going to hit fragile companies and defaults look set to rise.
Talking of slowdowns; China car sales plunged 92% during the first two weeks of February as the coronavirus outbreak kept buyers away from showrooms. It was even worse in the first week, when nationwide sales tumbled 96% to a daily average of only 811 units, the China Passenger Car Association said in a report released earlier this week. Deliveries this month may slide by about 70%, resulting in a roughly 40% drop in the first two months of 2020, the association said. This is likely to spread across Asia as/if the virus starts to spread and this auto sector was already on its knees. EU PMIs are coming in as I type.
Meanwhile, problems down under mount up as Australia’s hottest and driest year on record has slashed crop production, with summer output expected to fall to the lowest levels on record, according to official projections released Tuesday. Australia has started to import wheat, and that is likely to continue for the foreseeable future. We have swine fever killing the global pig herd, various bird flu issues, plagues of locusts rampaging across Africa and parts of the ME and the worlds food suppliers are feeling the heat. Global food prices may be set to soar. In fact, cases of African Swine Fever have now been identified “in 50 countries”, and U.S. pig farmers are deathly afraid of what would happen if this disease starts spreading there. As a result of this crisis, pork prices in China have gone through the roof, and many families are no longer able to eat pork at all. Never before in the modern era, have we seen so many major threats to global food production emerge simultaneously. People get very angry when they get hungry or are priced out of the staples. But across the developed world, consumers, governments and corporations have all borrowed and spent on a grand scale, abandoning financial prudence in favour of a euphoric fantasy (encouraged by central banks) that the cycle of expansion would never end. It will one day.
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Strategy:
Macro:.
Short AUD @ .6875 at .6917 (average .6896).
Short USDJPY @ 109.95.. stop above 110.35 Stopped yesterday
Short EURJPY @ Tight stop above 120.20. Stopped last night
Long USDJPY @ 111.45 with tight stop below 110.80.
Macro Long FTSE250 20,900
Brought to you by Maurice Pomery, Strategic Alpha Limited.
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