Headlines:
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First week hangover: don’t blame it all on China
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Coming up: more slowdown evidence
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L’Europe en danger! Et ses femmes!
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Brexit is hard to do
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Markets: sauve qui peut! Every stock for itself!
First week hangover
2016 has got off to what can only be described as a rather poor start but I am sticking to my headline last week that we may well all be ‘doomed but just not yet’. China is currently getting most of the blame but, in fact, the real causes are problems carried over from last year:
- The slowdown in growth is global and not only the fault of China’s manufacturing
- The central bank with most clout remains the US Fed even if others are more deluded.
- China has almost nothing to do with the Syrian crisis threatening Europe.
- All markets have become fragile and exposed to stampedes
Alas, the hangover follows what was not even that much of a party. Much of 2015 went by with the Fed’s signalling its desire to remove the proverbial punchbowl and finally doing so just as Santa was expected with his proverbial rally. So, it should really be no surprise that things look grim right now and, unfortunately, there appears to be no equivalent to PG Woodhouse’s ‘Jeeves famous hangover cure’. Hangovers are wretched but they do eventually fade and I remain convinced the major stock markets will end 2016 not so far away from where they started, albeit they are more likely to take a few nasty tumbles on the way and from which not all may recover fully by next December. Having said that, last week’s rout in equity markets included the worst ever start to the New Year in the US and has given new material to the soothsayers who routinely come out with such bonmots as ‘Santa Rallies’ and ‘Selling in May’. The latest sooth is ‘as the year starts, so it proceeds’ and this may well prolong the hangover for the more nervous. Why not take a look at Chart 1 and judge for yourself?
Chart 1 S & P 500 in 2016?: Pick a number between -40% and +30%
Source: Pension Partners via Financial Orbit
Coming up: more slowdown evidence
Two charts from last week highlight the current challenges to the global economy and provide a framework for assessing data to be published in the coming weeks. Chart 2 from Caixin/Markit came out on Wednesday showing China’s Manufacturing, Services and the combined Composite PMIs for December. These surveys are widely regarded to be as close to being independent as any data from China.The shock was that the Services PMI had for the first time ever fallen below the 50 level that delineates expansion and contraction.Taken to extremes, which inevitably it was (especially by the new archetype gung-ho investor, Mrs Wong), this could mean that the whole Chinese economy was contracting in December. So, forget the official GDP growth rate of 7% and the switch to Consumption! It is going to become increasingly difficult for the authorities to massage the next batches of data and so this week we can expect further softening in both Exports and Imports. Later in the month Retail Sales and Industrial Production in December may also be reported as softer but the authorities will probably try to tough it out with reporting 7% GDP growth in 2015 as a whole.
Chart 2 Caixin China Output PMI: Services pooping the Party
In contrast, at first sight the December US Labor Market numbers seemed very encouraging when they first came out on Friday: 292K new hires in the month, previous months revised higher, another nudge higher in the Participation Rate and also in Average Hourly Earnings. However, the doomsters have since been busy deconstructing the data. Chart 3 tells a similar story to the UK in so far as almost all recent new hires are in the Services sector, where many jobs are lower paid, unskilled and less productive. Indeed, average hourly earnings did not increase month on month from November. Perhaps even more worrying is that of the 292K incease in the December Non-Farm Payrolls 281K represent an annual adjustment because of the Festive Season that may or may not be accurate. This week Industrial Production is almost certain to be soft again but there may be some cheer in Retail Sales, which are due for a good month after struggling over the last few months. In other words, whether the US is even close to growing at 2% per annum depends almost entirely on shopping.
Chart 3 US cumulative new jobs by sector: low skill, lw pay
Here in the UK, Industrial Production may actually be better as the ONS seems to report good and bad numbers in alternate months but the year on year headline for Manufacturing Output is still set to show a deterioration. Also due for an uplift are British Retail Consortium sales in December (shopping again!). The MPC meets this week but the only question is whether Ian McCafferty will fall back in line with his colleagues and vote to hold Base Rates (probably not). The most interesting announcement will be the NIESR’s rolling 3-monthly GDP estimate (not a forecast) which will cover Q4. The previous two rolling estimates came out at +0.6% which suggests an estimate for Q4 of no worse than +0.5%, which sets up a potential clash with the ONS’s first cut when it is published later this month. Chancellor Osborne will have to put up with the latter’s numbers but will not welcome any further downward revisions for previous quarters. His downbeat ‘poisonous cocktail’ speech last week, however, should be seen as a political rather than economic warning. Protocol prevents his giving hints to the MPC but Tory MPs need a wake-up call on Brexit risk and, of course, he must ensure that he gets none of the blame if his upbeat message of only one month ago turns out too optimistic. It should always be remembered that Mr Osborne is usually (but not always!) at least two moves ahead of everyone else.
Meanwhile in the EZ, mixed data suggests that although its economy is no longer getting worse significant recovery remains elusive. This week, with Italy and Spain taking centre stage, should add to this picture following last week’s Unemployment (slightly better), CPI (under pressure again), Industrial Production (stalling) and PMIs (slightly better).
L’Europe en danger! Et ses femmes!
One thing that can be said for the EZ elite is that they take holidays very seriously. Sadly, there has been no avoiding the shocking accounts of muggings and sexual assaults in parts of Germany but who would guess that all the major problems are still festering. Greece is not and, to be fair, probably cannot, comply with the bail-out conditions, Italy and France are trying to neutralise the Stability and Growth Pact, Germany is still trying to block the Single Bank Resolution, Portugal and Spain are without stable governments, Denmark wants no more integration, there is a North-South dispute over gas pipelines from Russia, the Bundesbank is trying to subvert the ECB’s monetary policies und zo weiter. The Brexit negotiation is a minor irritant by comparison.
However, there is no doubt the Syria crisis represents the greatest threat to Europe and it has already undermined the Schengen agreement on free movement and returned high wire fences to Eastern frontiers. Migration generally brings direct economic benefits to all concerned: more jobs, more public spending but tax receipts taking over from initial social benefit outlays but this time the problem is so many migrants’ arriving at once. This point is made in a most civilised way in the following extract from an article by Klaus Brinkbäumer, Editor in Chief of DER SPIEGE:
9:26 p.m. – 25 Dec 2015 · Details
No migrant leaves his or her home casually, frivolously or even with any kind of pleasure at all. It is a far-reaching decision and all who pull up roots know it, even those who are still in their formative years. The migrants who come to us merit empathy — and what choice do those people have who come from war-torn Syria? What would we do in their situation?
There is proof for everything — for almost every thesis as well as for its antithesis. Regions that have integrated many migrants in the past are prosperous today, but integration only works if the state doesn’t lose control, and Germany at present has lost control. Of course there is a basic human right to asylum, but without an upper limit — enforced, if necessary, with border controls — it will be almost impossible to find a way out of the crisis.
The political and social disruption is only just beginning and it is hard to be optimistic. Much is being made of the rise of extremist political parties but I would suggest that the most sinister long-term threat is to the status of women unless ‘multiculturalism’ is made more sympathetic to them.
Chart 4 Brexit voting intentions
Source: YouGov via The Times
Brexit is hard to do
Full disclosure: both my head and heart are in favour of the UK staying in the EU. Heart is easy to explain as my father was an immigrant, my wife and I between us have family and friends in 8 other EU countries and I spend up to 2 months every year in Italy and France. Head (from an economic stance) is slightly more difficult if the post-Brexit outcome is merely a ‘Swiss/Norway plus’ deal in a free-trade zone although I boggle at the logic of still being bound to most European Treaties without being able to participate in future decisions. The extreme solution of joining some sort of ‘Anglo-Saxon’ English-speaking trade group (specifically with multiracial US, Canada, Australia and New Zealand) seems even more illogical as well as politically fanciful and economically reckless. At least our European partners value our trade! Nevertheless, it may well be that fear of migrants from Syria, Somalia, Afghanistan and Pakistan rather than Europe itself will tilt the balance in favour of Brexit, which would ironic in a number of ways, not least because we would need to increase trade with many such countries.
Chart 4 from pollsters YouGov shows referendum voting intentions to be very finely balanced with a narrow split between both men and women. The party political differences are as one might expect, which means people in London, the North and Scotland want to stay while those in the English shires want to leave. There is a more fundamental polarisation between those educated to ‘A’ Level and above (stay in) and those below (out) and also those aged under 30 (stay in) and over 50 (out). There is less polarisation by social class: AB and CI would prefer to stay while C2 DE want to leave. As with most referenda the onus will be on those who want a change and xenophobia as opposed to lofty superiority traditionally does not go down well in the UK. A sub-plot may well develop in which it becomes a matter of confidence in David Cameron personally, which should stay the hand of many Tory Eurosceptics. I would like to think the pointlessness of Brexit might swing the balance.
Markets: Sauve qui peut. Every stock for itself
OK, let’s get China and last week’s 10% belly flop out the way first. Foreigners are still not allowed to get much involved directly via the domestic stock exchanges and most are too smart to want to. With major shareholders subject to restrictive lock-in regulations, the wild swings are all about ‘Mrs Wong’ and the authorities clearly do not know what to do about her, given the absolute priority of keeping the Communist Party in power. The international repercussions are to undermine confidence in global growth and corporate earnings while the clumsy devaluation of the renminbi is more of an issue for China’s trading partners amongst the Developing Economies. It is all very unsettling but investors will just have to get used to it while Mr Xi decides how much he wants to ‘embrace the markets’ as The Economist mischievously put it back in July or, as now seems more likely, prop them up!
Chart 5. Xi ha!
Source: Bloomberg
Some Emerging Markets are easier to get into than others but none look attractive right now and this highlights the problem of investing in broad asset classes and geographical markets. Where to get a positive return is proving increasingly hazardous for Japanese investors who are inclined to repatriate when risk is in the air but the resulting boost to the yen is counterproductive, especially for exports to China and other Developing Economies. European equities were fashionable last year but neither exports nor domestic demand are growing fast enough to encourage hopes for much further progress, albeit earnings multiples are still relatively modest compared to the US. In the UK the FTSE 100 looks a rather unhappy cocktail of beaten-up overseas resources companies and UK standard bearers in sectors facing margin squeezes and/or enforced structural change. The FTSE 250 has so far proved to be a more solid representative of UK plc and the wider economy but even it failed to escape last week’s sell-off.
Chart 6: M & A to the rescue?
Inevitably, one has to look to the US for investment ideas but even this is not clear-cut. Valuations are historically very high especially when considering the prospects for future growth. After two soild years earnings of S & P 500 companies probably fell by at least 4% in 2015 and the outlook is still not encouraging. Share buy-backs no longer look so attractive to corporate executives nor does holding on to their stock options. There may be a silver lining in the form of M & A deals although even these may involve significant equity swap elements. It is only once one starts digging deeper that slightly more hopeful signs appear. If one strips out the energy and materials sectors, average corporate earnings turn positive with Consumer Dicretionary, Healthcare and IT topping the bill. This is yet another reason not to invest only in asset-classes and market indices.
Even better is to seek out individual companies that have a new story to tell and/or are temporarily off many investors’ radar screen. These stocks should be able to move independently of the general market or their sector but also be sufficiently liquid to enable short-term trades. This approach is applicable elsewhere but the US and the UK offer the most accessible opportunities. This ‘stockpicking plus’ strategy is the principle on which we recently launced our DAN-Trade equity product. Of course, there will always be great companies to buy and hold for the long-term but that too is becoming increasingly subjective-and risky!- in the current skittish markets.
Meanwhile some investors will continue, when all else fails, to rely on the Fed to bail us all out. Plus ça change …….
Chart 7 When you wish upon a star…….
Source: WSJ Survey of Economists via WSJ
Alastair Winter 