There is no craving in the investor’s heart more persistent or more passionate than the longing to lay a firm hand upon something sturdy. As large pieces of our markets swayed together in violence, we grabbed a hold of any sort of news in an effort to make sense of it all.
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On Monday last week, we witnessed the S&P 500 tumble to 1867 points only to surge 6.7% - topping out at 1993 by Friday. In similar fashion we were awestruck as U.S. crude oil lurched beneath $38.00 a barrel only to snap back 29% five days later to $49.00.
Most of us are still completely shell-shocked while we stare at steep losses that took just six trading days to produce. Many an investor has had enough, tired of the market mechanics, the recycled news, the liquidity vacuums, program trading, and the volatility out of context.
Yet, this is also the time where an investor – acting like a trader – tramples the gravel beneath his feet, seeing nothing. In contrast, the investor – acting like an investor – recognizes in those same stone the archives of antiquity.
Markets have taken on a life of their own and news can and does get twisted to fit the action.
China & the Official NBS Manufacturing PMI
On September 1, China released its official NBS manufacturing PMI - faltering below the psychologically important 50 level, although the number (49.7) was precisely in line with expectations. As things go, the default strategy of late is to panic, and as such, the S&P 500 plummeted 2.9% on the heels of this seemingly bad report.
The Official NBS Purchasing Managers Index (PMI) is collected as a survey given to a diverse group of entities throughout various parts of the country. Given its very nature, a PMI will be affected by participants sentiment and thus, require much objectivity. The Official NBS PMI does survey a large swath of China’s economy however, given the objectivity factor of the participant it seems to be a great lagging indicator as opposed to one that leads. Additionally, a PMI requires a seasonal adjustment, which is complicated to do.
I was in China for most of June and witnessed the beginnings of the stock market rout. The distractions were epic and I can’t imagine any survey participant filling this out with any hope or lucidness of mind.
Confusing China’s Equity Market for China’s Economy
Headlines declaring, “China’s economy is slowing” is all the rage and this isn’t entirely inaccurate.
China’s economic backdrop has been frustratingly challenging for 18 months as real GDP growth has slowed steadily since the second quarter of 2007. In addition, China is methodically transitioning from industrial, export driven growth, to a consumer domestic demand driven economy. Evidence of that can be found in the steady growth of economic numbers relating to gasoline consumption, service, and activities. A country that has experienced a tripling of its GDP in 12 years’ time will someday experience shifts (i.e. demographic shifts, higher wages) that will be uneven and could take decades to complete. Although China does have its share of challenges, conflating its recent stock market woes to its economy can be very misleading.
In the last 52 weeks, the Shanghai Shenzen CSI 300 stock index rallied from 2,350 to 5,380 and back down to 3,365. During the same time period, the Shanghai Stock Exchange Composite Index rose from 2,234 to a peak of 5,380 before surrendering itself back to 3,160 where it sits presently. Even in the best of circumstances, any market that doubles in value in such short order will eventually be followed by trouble.
Despite sluggish growth, a two-year commodity rout, and a forming corporate debt bubble, equity markets rocketed skyward as millions of new investors were given the opportunity for cross-border equity flows between Hong Kong and China. Chinese citizens were very eager to dump poorly performing real estate and commodity holdings, opening easy-credit margin accounts, in favor of equities which, despite troubles in their economy, had attractively cheap P/E multiples.
New investors chasing riches with leverage never ends well. It’s really that simple what happened in China.
The Federal Reserve
In June 2006, the Federal Reserve raised the Fed Funds rate by 0.25% to 5.25%. Since then it’s been downhill all the way, with the current rate of 0% - 0.25% secured firmly in place for nearly seven years. Beginning in 2009 through 2014, the central bank has purchased both mortgage backed securities (MBS) and U.S. Treasuries in an effort to stimulate growth.
Given the Fed’s inability to lower interest rates below zero, it adopted “forward guidance” communication. Keeping rates low for “some time,” by 2009 had transformed to “an extended period”, and from 2011 the Fed submitted a date before which monetary policy would not be tightened.
Although we have no idea how this will all end, it’s truly amazing – borderline incomprehensible – to think what the Fed has accomplished so far. As this long chapter of loose U.S. policy comes to an end, a few thoughts on various and sundry details of the Fed and what was, what is, and what to expect.
- The Fed realizes full well that QE 1, 2, 3 was a monetary experiment of epic proportion and, at some point, market confidence in unorthodox or otherwise temporary policies would eventually decline.
- The Fed is probably a lot less concerned about the recent global market rout than one would expect. They have placed market volatility in its proper context.
- Yuan devaluation/weakness is unlikely to deter the Fed. While the 3.5% move doesn’t seem that big – and compared to floating currencies it’s not, as the Euro/US$ is down 15% on a year-on-year basis.
- Newswires continue to spill ink over the timing of the initial hike yet give very little credence to its pace. Data dependency is everything!
- Higher interest rates could beget lower commodity prices for the sole reason(s) that investors are less likely to hold them as the opportunity cost of doing so is higher on a relative basis. Likewise, miners/producers are more likely to increase production as the opportunity cost of leaving unearthed below ground is higher. It’s truly that simple.
- The current U.S. interest rate yield curve is hinting that the Fed will soon lower its medium-to-long-term interest rate forecast.
We never see the entire stretch of the road from any one point. And, investing is not a long straight path; one where the untrodden portion is clearly marked. Investing is a winding and undulating lane.