July 7, 2013, 8:03 pm
As we complete the first half of the year we have had the pleasure of witnessing a colossal shift that is taking place in global macro markets. We are possibly coming to an end of cheap US dollarliquidity;the end of an investment led China and emerging market growth which was supposed to rebalance the global economy;theend of the commodity bull market; the continuous recession in Europe and the surprising resilience of the United States (US)economy.
These are just some of the themes which have been driving markets over the first half of this year. Global fund managers have lost billions of dollarsbetting on the wrong side of many of these markets, besidesa notable few such as George Soros who at 82 years of age continues to benefit from larger macro trends.
Given the carnage, the markets will take the next few months to digest the following structural shifts before deciding on direction. In the meantime, I would like to point out to a few "global macro themes" that may continue over the coming year with the hope of providing investors with a sense of possible direction.
Stay LONG, the US
The US equity investors are set up for a Win/Win scenario on future economic data points. It can be argued that stronger data is healthy for the markets, as we witnessed this Friday the 5th of July, where the markets shot up after a better than expected jobs report. This move occurred while facing a steepeningyield curve as the US 10year treasury yield hit 2.7%. This proves that stocks are learning to live without Quantitative Easing (QE) led stimulus and will now start to focus on economic data points.
At the same time weaker data could also be "good" for stocks because they decrease the odds of "tapering" and the Federal Reserve (FED) will continue the process of cheap liquidity. We are not in the prediction business but we will continue to monitor US vs. global data and how markets react to the data going forward for possible clues for equities continuing their move higher.
So far in the US, equities have had a great bull run breaking above their all-time highs and remaining one of the top performing markets in the world. History from the 1950’s show that 6month runs are typically followed by further gains. The financial, healthcare and services sectors have led the way in the first half but however we could also see energy and technology being big beneficiaries over the next few years.
Stay long West Taxes Intermediate (WTI) futures andUS energy corporationsresponsible for doubling local oilproduction over the last decade. Alsostay long US Natural Gas futures and corporations thanks to the Shale-gas revolution where production in the US as a whole rose more than fourfold between 2007 and 2010.All theefforts made over the last decade are clearly bearing fruit to ensure that the US will be energy independent and a larger exporter over the next few decades.
The shale revolution is also supported by the Obama administration which continuous to battle global climate change, andmay have an unintended consequence of sparking a new demand for natural gas, which is fast becoming a staple in creating electric power.
According to the US energy department natural gas prices should double in the next 10 years. This structural shift, says the Department of Energy, has helped push up its gas output by 20% over the past five years, making the country the world’s biggest gas producer. British Petroleum (BP), forecasts that North American shale-gas output largely from the US, will grow by an average of 5.3% a year until 2030.
The US still enjoys remarkably cheap gas by international standards. In 2011 it had the second-lowest gas prices in the industry among rich and emerging countries, after Canada, according to the International Energy Agency (IEA). US factories paid a third of the German gas price and a quarter of the South Korean.
By the end of this year, BP predicts, the US will overtake Russia and Saudi Arabia to become the world’s biggest producer of liquid fuel, meaning oil and biofuels.
Be cautious short term
If we look at previous tightening cycles, it has been shown that when the Fed signals its position and intentions clearly, there has typically been a selloff within the first 3 months in the US market, but the market ends up higher 12 months later.
Therefore, given the fairly low volatility over the 6months and speculation about the end of QE and improved economic data, it has pushed US Treasury yields higher, but given this backdrop we should be cautious in the near term because there has not been a meaningful correction since the end of last year while valuation multiples have moved up quickly.
Emerging markets are weak for a reason
As markets try to digest this news, emerging markets (EM) have continued to do poorly as the US dollar liquidity has tightened, impacting near-term rates and worsening concerns about an economic slowdown. Emerging markets have deteriorated to a point where they trade at over a 25% discount based on 2014 forward price-to-earnings (P/E), compared to developed markets (DM): 9.3x vs. 12.6x.
Furthermore, there are some very positive long-term structural drivers behind the Fed’s intention to reduce easing, including improving housing, job and consumption figures. In addition, the tail winds from reduced wage pressure and increased competitiveness in the energy sector which should provide investors a good degree of comfort.
Stay away from the
metals market for now
As you all know the metals complex have got crushed this year, GOLD (- 28%), SILVER (-38%) and Copper (-16%) are all down this year to date. Therefore,as one of the consequences the metal producers are down more than 50% and producer countries such as Brazil who rely on them for exports have seen their markets deplete by close to 30%.
On the demand side of the equation the clear slowdown in China is having a substantial impact on these markets. And just how important is Chinese demand? "To offset a 1% decline in Chinese copper or aluminum demand, would require a 3% to 5% boost in the U.S. or European demand or a 15% to 20% boost in Indian or Brazilian demand. China’s slowdown will accelerate next year, driven by a collapse in the metal-intensive, investment-driven portion of growth. Demand for metals will fall far more sharply than headline GDP growth numbers would suggest, from double-digit to as low as single-digit growth and possibly to zero" in the case of iron ore.
On the supply side of the equation the extra production over the last few years has outpaced demand leaving major over-supply across the commodity complex. Technically, a lot of these markets are oversold and large dead cat bounces do occur from time to time but right now they are being sold yet again.
The trends for commodities are clearly down for now and we will wait for the markets to tell us otherwise. Just a cautious note for anyone looking to purchase GOLD, We are strongly advising clients not to catch a falling knife. The markets are telling us to stay away because there is still heavy selling in the metal and we could possibly see it head towards USD1000 OZ and below this year
Stay LONG, the US Dollar
For all of the above reasons we are seeing large capital inflows heading back to the US. This will ensure that the currency strengthens as the trends persist over time. The US dollar indexup over 6% has been one of the top performing currencies this year andshould continue to outperform against all other currencies going forward. We advise clients to stay clear of all commodity currencies notably the CAD, AUD and REAL and the other emerging market currencies which should all weaken against the US dollar.
Other central banks such as the European Central Bank (ECB), Bank of England (BOE) and Bank of Japan(BOJ) just highlighted that they are nowhere close to tapering or pulling back on their own QE programs andin fact these economies will continue to add more liquidity to their markets. The ECB has suggested it may cut interest rates further, while the BOE warned that markets were being too quick to bet on higher borrowing costs. And this is before you include the BOJ, which stands ready to pump more money into the economy if needed on top of its existing $1.4 trillion program.
All eyes on the FED
According to MFS global,in the past, bond market corrections have typically been relatively short-lived and not terribly painful, at least not by equity market standards. This time around, things could be a little worse for bonds. Low yields creates greater sensitivity to changes in interest rates. We all know the pain trade is coming (or perhaps is here already).
A steepening yield curve in almost every occasion is a response to an improved economic time. Effectively, the fixed income market is beginning to discount a strong economic upturn in the next half a year. Stepping back and looking longer term, if the Fed is tapering and eventually ending QE under the assumption that the economy is transitioning to a stronger growth trajectory, it need not be bearish on longer term for equities and corporate bonds, even if Treasury yields continue to rise. In other words, stocks could quickly find their footing if there are growing expectations that the economy and earnings which are about to be releases this month are on an upswing in an environment of easy money.
As the saying goes don’t fight the FED and the market trend because markets never lie
Commodity Futures I own: Long Natural Gas, WTI crude and Soy beans
Currency futures I own: Long US dollar index
US sectors and stocks: Short Metals and Mining, Long Energy, Financials and Technology
MarketsNeverLie (Pvt) Ltd is a private trading consultancy which manages discretionary portfolios and provides advice to investors on local and global markets. The founder, Stefan Juriansz partners with the Island and Investors.lk to help provide investors with unbiased advice and encourages investors to contact him regarding their investments. His trade ideas on global markets can be viewed on Twitter and StockTwits under his companyMarketsNeverLie (Pvt) Ltd.