My Diary 651 --- Observations and Thoughts in a Down Week
August 15, 2010
“How to invest in a down market” --- Market turmoil usually causes investors to question their own judgment and seek different approaches. That said, keeping oneself cool is pretty easy when the market is heading up and you're posting double-digit gains each year, but investing in a down market requires more than just stock picking and diversifications. One of my mentors, who had over 20 years experience in this industry, taught last week that a successful investor tends to keep his or her thoughts simple and follow a few fundamental principles. Inspired by his instruction, I would like to keep this diary short.
On the weekly basis, global equities dipped 4.07%, with -3.78% in US, -5.06% in EU, -3.5% in Japan and -4.76% in EMs. Elsewhere, USTs took a further step back with 2yr closed largely flat at 0.529% and 10yr down 14bps to2.67%, a new 16-month low. The spread (809bp) between 10yr Greek debt with German bunds continued to rise, growing above 800bps, the first time since June 28. The Portuguese-German spread rose to 284bps. 1MWTI fell $5.31 (-6.7% wow) to $75.39/bbl, the lowest level in a month. The Dollar index climbed 3.14% from 80.40 to 82.95. EURUSD continued its recent tumble, edging down 4.02% to 1.275, while JPYUSD also weakened0.81% to 86.20
Looking back, with 2Q earning season approaching its end and 458 companies already reported (+76.2% surprised the street on the upside), it is naturally that investors’ attention switched back to the economy for direction of the market. In that regard, renewed worries this week about the US economic outlook, along with the speculation of a more pronounced slowdown in China and a more dovish tome from BOE, have raised concerns about the global economic recovery. And with the Eurozone's public finances already stressed, the last thing it needs is less robust global economic growth, as global demand is one of the few sources of Eurozone growth going forward. In any event, these developments highlight the interdependency among the world's key economies. They also highlight the rotating nature of sovereign risk in debt markets.
There is no surprise to see shrinking risk appetites together with a tanking market. Several market indicators suggested the market direction may continue move to the south side – 1) VIX added +20.7% with rebound above its 200DMAV. The next to watch is its 50D MAVG at 26.65 vs. current level at 26.24; 2) Gold moved +0.79%. This is particular negative especially given the rising USD; 3) The falling 10yr UST yield indicates the continuous shift of liquidity away from the higher beta equity markets into the safer bond market; 4) DXY went +3.13%. The next level to watch will be its 50DMAV at 84 vs. current level of 82.92.
On the fund flow side, according to EPFR Global, as much as USD4bn was withdrawn from the US equity funds for the week ended 11th August while the global bond funds took up USD4.6bn in inflow. This again highlights the cautiousness of global asset allocators on the market. Flows are clearly favoring EM. Flows into EM equity funds totaled USD20bn over the past 3 months. In contrast, DM equity funds saw outflows of USD40bn over the same period. The trade also benefits from increased deflation concerns in DM. Over the week there was USD1.64bn put in EM equity funds It is interesting to note that despite such impressive inflow data for EM equities, MSCI EM fell 3.01% and MSCI AxJ fell 2.45%. One factor could be attributed is the falling currencies with ADXY down 0.89% on the back of a rebounding USD.
Market Thoughts and Outlook
Last week, the disappointing economic data are coming largely from the US, with Europe still surprising on the upside, and Asia moderating in line. Two US data points stand out –– a fall in core retail sales, and higher unemployment claims. Core retail sales are flat over the past 3 months, likely in response to weaker jobs growth. The market’s principal concern is whether businesses are reversing course and turning more defensive, which would pose a fundamental threat to the recovery. Domestic department-stores in the US, like JC Penney and Kohl’s lowered their profit guidance, citing an “uncertain” outlook for consumer spending. No doubt that US growth rates are dipping down again. The issue is by how much. Slower growth comes from the ageing inventory cycle in manufacturing and dramatic fiscal tightening in developed markets, not sufficiently offset by an expansion in private demand.
On the back of weaker recovery momentum, the Fed held the rate unchanged as expected and hinted on deflationary risks. The Fed also said that they would use the proceeds from expiring MBS to buy more Treasuries. While this would mean more liquidity in the system, it also highlights the health status of the economy which the market has bigger concern of. Further easing is clearly possible if US data continue to disappoint. Meanwhile, the Bank of England reduced its growth forecast, and continues to expect inflation to fall below target from its current elevated level. The theme of central banks on hold is strengthening and it argues for even lower yields and flatter curves. It is also important to note that the current risk backdrop is also being negatively impacted by perceptions about China. On China, the data showed investment and consumption moderating, a slowing in IP growth, and mixed readings on inflation (CPI was up, but PPI was down).
Given the poor US& China economic data and the see downside risk to the demands, commodities sold off heavily this week, especially oil. Moreover, the supply dynamics also seem unattractive as non-OPEC production rises and alternative fuels compete for market shares. These are likely to keep oil prices under pressure. The risk of underweighting oil is a hurricane disrupting oil supply. The rally in agriculture continued this. In addition to the Russian droughts and export bans, the flooding in China is now threatening food supply, especially for grains. Thus, we keep U/W oil while OW agriculture and CPI plays in China.
For the asset market, equities, commodities and credit have now been effectively in a range for almost a year. I think, if without much upside on the economy, investor interest is likely to focus more on the income component of returns instead of on capital gains. This greatly favors longer-duration bonds, carry trades and spread product in fixed income, and high dividends, preferred, and utilities within equities. It favors most EM asset classes over DM. Sector wise, global Telecoms and Utilities now offer dividend yields of 5% and 4% respectively, well above the average 1.7% dividend yield of cyclical sectors. The search for yield is also witnessed in HY bond markets. Despite HY spreads widening this week, investors continue to buy into HY bond funds, a sign of the strong demand. The market readily absorbed the mammoth supply of USD22bn this week, which is the highest on record and > 4X the YTD issuance pace.
Good night, my dear friends!
