Friday, 19th of October 2018
We are closing-out a nasty week… Another one, where fears of rising interest rates, brewing political conflict between the USA and Saudi Arabia and further commercial ‘misunderstandings between the USA and China are spreading jitters with the global investors that we are. China’s GDP figures for Q3 2018 showed that its economic growth slowed to 6.5% year-over-year to Q3 ‘18, amid concerns surrounding the ongoing trade war between Washington and Beijing. Should we be concerned? Well, applying 65% growth to the current GDP of about $12.24Bn we calculate that China is adding some $800 billion of GDP power per annum. The US must grow at over 4.20% in order to maintain its lead in GDP size vs. China. We thought it appropriate to show this chart of relative economic weights, where you can see that the Chinese growth is equivalent to adding a Switzerland or two Belgium’s each year… Also, it can give some perspective as to the economic importance of the brewing Saudi conflict- At $0.68T of GDP, the Saudi economy represents some 9 months of Chinese growth… But as we all heard elsewhere, size isn’t everything…
Gross Domestic Product (GDP) by Country 2017
Saudi Arabia in effect controls the oil matrix. They have the power to utterly disrupt the energy market via relatively small production variations. And, they help the West in containing Iran. Possibly these elements could be weighted to counterbalance the GDP size?
What else might be driving those rather violent moves? Goldman Sachs CEO David Solomon said on Thursday that he believes part of October’s steep stock sell-off was the result of programmatic trading. “There’s no question when you look at last week, some of the selling is the result of programmatic selling because as volatility goes up, some of these algorithms force people to sell,” said Solomon. “Market structure can, at times, contribute to volatility and one of the things that we’re spending a bunch of time thinking about at the firm is how changes in market structure over the course of the last 10 years will affect market activity.” The Goldman chief highlighted the rise of a number of relatively new market assets — such as passive index or exchange-traded funds — as examples of the new types of technology that are still being perfected. Clearly, there is a change in the decision-processes that are moving markets. There is also a cross-market contamination effect- Now that China is the second economy of the world, movements in its stock exchanges actually send ripples through the whole world (we thought it normal that the world followed the US…). The Shanghai Composite Index plunged 2.9% Tuesday, sending negative ripples through world markets. China stocks are now down 12% in October and 26% over the last 12 months. But U.S. investors feel insulated from China’s losses. Why wouldn’t they, with the S&P up 4.5% this year while Shanghai is down 25%? A study by CNBC using analytics tool Kensho found that U.S. stocks are more often weaker when the declines in Chinese stocks are large. Over the past 10 years, when Shanghai stocks fell 10% or more in a 30-day period, the U.S. stock market was up only about 30% of the time, and the U.S. indexes all averaged significant declines. For instance, the S&P 500 on average fell 4.8% when China was down 10% or more, and the Nasdaq was even worse with a loss of 5.3%. As Shanghai stocks went down, so did basic commodities, like copper, off 8.3%, and oil, off 8.5% on average in the 30-day periods. Crude oil was down nearly 70% of the time when Chinese shares toppled, and copper was down 78% of the time. Safe havens, however, averaged gains and gold rose by 0.6% while the dollar index was up 1.5%. Both were higher more than half the time. We wanted an integrated world? Here we are…The largest U.S.-listed exchange-traded fund tracking Saudi Arabian stocks sank Thursday as U.S. Treasury Secretary Steve Mnuchin said he was skipping an investor conference in Riyadh amid rising pressure to hold the kingdom’s leadership accountable for the disappearance of a Saudi journalist. The $219 million iShares MSCI Saudi Arabia ETF, ticker KSA, was down 1.6% in afternoon trading. Still up some 7.5% YTD…
For market professionals, the most significant thing that happened in early October was a flip in investor psychology. The correlation between stock prices and interest rates, as measured over the prior 52 weeks, turned from positive to negative—so higher rates implied lower stock prices. That’s happened only four times since 1989. Some strategists are confident the bull market will endure even if rates continue to rise. They reason that the Fed under Chairman Jerome Powell won’t make the mistake of raising rates too fast and snuffing out the expansion. The chief investment strategist at BMO Capital Markets said this week “periods of higher or rising rates have coincided with double-digit annual returns for the S&P 500, on average.” That may be. But if Oct. 10-11 taught us anything, it’s that bad weather can escape the radar’s notice, and hibernating bears can suddenly emerge from their caves. Well… We are watching very encouraging Q3 earnings, mostly beating expectations on both top-line revenues and on bottom line profits… you were worried about high P/E ratios? Well, as the “P” of the Prices is coming down and the “E” as in Earnings is rising, the ratio is falling doubly fast. Looking cheap yet? The other factor for establishing “cheapness” is the cost of capital, or simply, interest rates. Yes, these have risen some, and as per the Fed minutes released this week they are likely to rise some more. But the benchmark 10-year Treasury note yields 3.17% as we write, not significantly higher. But then, China US Treasury holdings are at their lowest in 14 months. China trimmed its holdings of U.S. Treasuries in August by about $6 billion, to the lowest level since June 2017. If they stop buying… couple this with The U.S. budget deficit which grew to $779 billion in Trump’s first full fiscal year as president, the highest since 2012 amid tax cuts and spending increases. The budget gap for the 12 months through September was 17% wider than the same 12-month period a year earlier. The deficit as a share of total economic output was 3.9% in fiscal 2018, up 0.4% point from the year prior. Clearly, the US would not qualify for EU membership… Smiles aside, the US Treasury will have to borrow this deficit just as China is buying less and the Fed will be selling more… Supply up, demand down… Prices of US$ bonds are likely to fall… That means yield will rise!
That said, let’s not forget that even when all else is lost, the future still remains.
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