A funny thing happened on the way to 2014
Even on New Year’s eve the S&P looked more or less healthy, market pundits from the talking heads on CNBC to your local real estate agent or hairdresser spoke of 2014 being another good year for US equities, maybe not quite as good as 2013 but still good. Yes, we knew tapering had begun but shrugged that off, we knew the stories about Chinese “dodgy loans” but that was just dismissed as Western bias, we had seen how EM markets had lagged but that just meant good value to be had, we were even aware of political turmoil in the EM world from Kiev to Bangkok, but we all knew then that these kinds of things usually blow over and create buying opportunities. Yes and we even knew P/E multiples had become a tad stretched but felt revenues and capex would finally pick up and allow earnings to grow again.
Then as the clock struck 2014 that funny thing happened and we stepped through the looking glass into an alternative world where up now means down and yes now means no and what was good became bad .
News from China has gone from mere here say to substantive evidence of a bloated shadow banking system showing some real leaks. Defaulting farmer trusts are a case in point as well as alerts of coal mine loans. Equally telling is that 30% of Chinese millionaires are now known to have either left China or have installed their families abroad and estimates show 60% of the rich intend to leave…largely for the West. Further, PMI data has suggested the economy is now contracting. And in the West we are all hoping the bad NFP print was just an anomaly, but if it wasn’t? Worldwide, several countries appear on the brink of dysfunction, the Ukraine being one, Argentina another and Thailand, once again. But now we see that the beginning of tapering, we also begin to see these countries in a less flattering light, they aren’t pretty anymore are they?
Then we have had a slew of lackluster earnings results and warnings. Roughly 90% of US companies that have issued an earnings outlook so far this year have warned of problems. That rate is a record. That does of course mean an easier hurdle on announcement day, but can the lower the bar game be played ad infinitum? Has 2014 brought revenue like rain after a drought…not so far, it was just hope not logic.
So we have China loan problems and bad macro data, bad jobs numbers from the US, a terrible streak of company earnings warnings and various unstable EM countries.
The trouble spots such as Argentina and Turkey are arguably isolated, EM being not just one block but a diverse set of unique economies that we should interpret as such, on their own individual merits. The trouble with this is twofold…maybe three or four fold actually. First, all rose on the sea of low rates and cheap money that Ben Bernanke provided. All will therefore fall if that cheap money is withdrawn and even if it isn’t withdrawn, all will show the same signs of cheap money fatigue.
Then there is the universe of ETF’s, the darlings of an investor universe too lazy or frightened to pick individual countries, they buy the lot. It’s a bit like that “Storage Wars” reality show which I find quite addictive…the abandoned unit is opened up with a crow bar and you bid on the lot, lock stock and barrel, without knowing what is really inside. Then, when Argentina collapses and investors decide to dump their EM ETF as it contains a rat, they also sell Brazil and Malaysia at the same time.
In this way passive ETF’s have become a vehicle of contagion, a double edged sword.
But the real clincher isn’t the data, it’s the price action.
In the past few days the S&P has fallen by large amounts. The downward momentum has taken out key levels and on Friday night closed at the low. Given there have been few shorts left, further downward momentum may suck some back in. There are undoubtedly buyers of dips waiting in the wings, indeed judging CNBC that remains the consensus view. But how strong will the conviction of buyers be when they think twice about earnings, valuations, macro data and geopolitical risks? My guess is their conviction will be weak and this may allow negative sentiment to gain the upper hand. Levels may test support which I see at 1760 or so. Once below 1760 the gaps lower look lower and lower. Once the negative momentum starts sucking in new shorts and becomes self-reinforcing these gaps may be filled. Some seem to hope the Fed will cancel their already announced taper at the last second…fat chance I say…they have almost zero credibility left and they probably know better than most that they can’t chicken out again.
One little disclosure, I am now square in S&P futures terms, no shorts as of the time of writing but will be watching momentum carefully.