The S&P 500 posted a 6% gain over the past two trading sessions after staging a dramatic 11% free fall that started late last week. Last Monday, U.S. crude oil prices settled below $39.00 – the first time since 2009 – only to snap-back Thursday with an 11% bounce. It was the biggest single-biggest percentage gain for WTI since March, 2009. Adding to market volatility, the U.S. dollar fell nearly 2% against most major currencies and interest rates spiked higher and not to mention large swings in iron ore, copper, and palladium.
Experts of all sorts were quick to spread blame to fears around Chinese growth and, to a lesser degree, a lack of clarity as to when the Fed’s symbolic rate hike will take place. Ironic, that the two biggest overshadows for the markets – China and the U.S. Fed – are old news, a bit recycled, and still very unresolved. Yet, the markets managed to free-fall and stage an impressive recovery nonetheless.
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Underneath it all, the trading action since last week seemed both construed and contrived; it felt as though we were living through an extended “flash crash” where a few smartly timed money pools relying not on fundamentals but vulnerability, knew precisely how and when to knock the market down. They realize that at a perfect point and time, selling will beget more selling, and they certainly took no prisoners as they produced a waterfall - pushing the Dow Jones Industrial Average within 80 points of its 200-day moving average, before realizing perhaps “enough is enough”, or “someone may get wise to our scheme” before they opened the curtains and lifted levers to reverse course.
We follow fundamentals yet are increasingly albeit temporarily ruled by sentiment. As panic is not a wise investment strategy nor is the belief that week-to-week trading is anything but a charade. We attempt to have balanced investment portfolios yet are up against a wily foe who can increasingly turn rivers into a desert; fruitful land into a salt waste. Trading is a technology business!
New Markets Require a New Praxis
I’m not a speaker of dark riddles and cynic wisdom. Rather, I wish to question the current fashion in-place; where investors are traders and traders are everything but!
Gold portrayal as a “currency-driven asset” came to life since its early July low on shaky emerging market economic developments and credence to a potential delay to the U.S. Feds impending rate hike. Yet, in relation to the stunning moves in other assets (i.e. energy, oil) gold’s move was not impressive and leads me to again maintain that its downside risks will be cushioned to the extent of how it begins to act as a “commodity” and not a “currency”. In my view, demand news from India and China will trump interest rates.
Financial “talking heads” normally don’t talk much about equity valuations unless there’s a correction! Personally, this makes sense as valuations require some objectivity and equities can persist at perceived cheap or expensive valuations for a long time. For the last 12 months, equity valuations have been driven higher as earnings estimates were dwindling due to a rising U.S. dollar and dropping energy prices. However, the stock market remained in a very narrow and deliberate range for seven months as frothy valuations were justified as fundamentals suggested dollar strength and energy woes were both deemed one-off events and the excess would eventually work itself out of the system.
Currently, valuations are not high and in some cases well below their ten and 20-year averages – including some of my long-term favorites: Health care (16x current vs. 19.5x 20-year average), financials (12x vs. 13x), and materials (15x vs. 16.5x). Investing solely on valuations makes huge assumptions, but at the minimum, it acts as a downside hedge as it’s riskier to beat down an already beaten stock.
Presently it matters little whether news is good, bad, or mixed – crude prices are presently taking their cue from financial market volatility. My January on-air prediction of an average WTI price of $48.00 is comical – given the severe highs and lows yet, it still makes sense to me. Crude has taken the brunt of the “commodity collapse” justifications however, in my mind, crude’s languishing is chiefly about supply and lower oil – no matter what you’ve heard or read about it – remains a net economic virtue. What’s little advertised is global crude demand has been strong – almost double 2014. That sturdy demand has been met with a flood of supply issues including OPEC producing 2 million barrels a day beyond its quota, upside production surprises by Russia, Iran, Saudi Arabia, along with the lowering of cost-curves in the U.S.
The news from China has been blinding; everyone seems to be an expert and it’s difficult indeed to come to grips with issues including their alleged investment, real estate, and credit bubbles that are evidently near bursting. I am concerned with China as it begins its ten-year journey from an industrial producer / exporting economy to one that is consumption, consumer, and service oriented. Near-term, China will need to combat severe deflation, persistent capital flight, a slowdown in savings deposit growth, along with a higher wages and a labor market at full capacity.
China had a nice run, while we’ve had a fairly lackluster recovery. Perhaps both are due in part to our outsourcing to China. It will be fascinating to watch another societal/economic transformation take place and I hope the landing will be smooth. Yet, I won’t lose sleep over it as I’d gladly argue that China’s impact on the U.S. economy is much smaller than most think. In short, we’ll have lost our factory. That has happened before.