Sunday, January 10, 2016

Global equities have shock decline in the first week of 2016

Equities were consistently down country by country, product area by product area, market cap from big to small, and highly rated to lowly rated in the first week of 2016.  The phrase "across the board" fully applies.  What is happening will take some time to shake out.

That something like this is happening in the first week of the year is no big surprise, but this year the impact is dreadful.  From approximately November 15 of any year until year end, institutional equity market trading is significantly influenced by portfolio positioning, the need to manage perception of that positioning, tax management for the year closing, and the balancing of gains and losses to give the best possible appearance to investors.  Once the new year opens, all of those concerns are off the table and unbridled trading based on expectations, research and, more now than ever, perceived trading trends that can get magnified by volume, each of those attributes are now running the books.

There are today some major events that are driving trading.  Those seen here are as follows:

---Credit liquidity - with the rise of trouble on the not so distant fringes of the high yield market, fixed income investors are unsettled.  They know that smaller players in the commodities and materials sector could be coming under greater pressure, and they know that weakness in one area can pull liquidity from other sectors that are less severely affected.  With the Dodd Frank bill adoption of the restrictive Volcker views in some market making areas, the big financial institutions will now be much less of a backstop for the system in a crisis.  With rates already pressed so low and bond buying by central banks at some point reaching a limit, there is less of a cushion should weakness trigger a broader market selling. What happens in that event is the question.

---Regional economic downturns - the focus of most financial media coverage is on the big powerful broad regions, meaning China in particular for good reason, but Europe and the U.S. as well of course. There are regional economic downturns underway that relate to these blocs, but they are less discussed.  One is the southeast Asia decline that is underway, and throw into that South Korea as well.  Companies in those countries trade heavily with each other.  They are certainly impacted by what is going on in China, but they interact with each other in a significant way.  The region seems to be slowing down and the currencies are lagging in a major way over the last quarter.  Other regions subject to decline underway now are Russia and the Middle East.  Europe is pressured by the migrant crisis and its impact on state services and tourism, while winter sets in and the strong dollar tourism boost may diminish at just the wrong time.  These regional undertows are not trivial.

---Commodity price declines - it is not a secret that commodity prices are declining broadly, but the extent of the declines is becoming alarming.  China was leading a rise in global demand for everything.  Producers of oil, metals, and agricultural products all built up capacity, much of which is coming on line now.  Producers need to cover the cost of their investments so they keep producing even as prices decline.  It's simple to explain but it is not simple to fix this deflationary trend.  It hurts, or will hurt, corporate profits, lending flows, and future capital investment.  This can happen gradually or it could happen in a disorderly way.  Investors are concerned.

---Global political uncertainty - this is always somewhere on the table, but with recent events in the Middle East it is more urgently watched.  This kind of unknowable concern cannot be traded, but it can slow down investment and it can add caution to what would be a more efficient trading world.

There is no view here about what will happen near term.  By any historic measure of recent years, we should certainly expect to see a bounce back in equities in the coming week but whether it will be meaningful or just volatility driven, is something that is not clear, if it materializes at all. Fundamentals in the U.S. economy remain unchanged, as in relatively positive with some modest erosion based on global events, but the guess here is that investors will be focused on discrete buying and selling, as my little retail hand will be, and waiting for some kind of  "all clear". By the time that comes, opportunities will have been missed or hopes will have been crushed. Why did I once like this?    

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