Tower Private Advisors
- January forecasting the year?
- Getting carried away with emerging markets
- Weather-related economist ineptitude
Capital Markets Recap
My Excel spreadsheet is not hooking up with Bloomberg, so this view of markets is going to have to suffice.
Here’s one thing to take away, as highlighted by the yellow squiggle. Markets are down almost across the board for January, and that brings to mind an old investing saw: as goes January, so goes the year. Here are some paraphrased statistics and thoughts from the Chief Market Technician at Oppenheimer.
In any given year, the odds of a negative return are 33.72%, “[b]ut if January is negative, the probability increases to 58.06%.” Is it possible the results in January distort the rest of the year, could a negative January overwhelm the rest of the year? In fact, it does, on average, when January returns are negative, ”the February-December returns are +1.6% on average.” When January is positive, the February-December returns are a big 8.6%. So, while the odds are the worst of the two periods (January and Rest-of-the-Year) are behind us, we’re still in for a less than stellar year.
Stories having to do with the struggling emerging markets and their currencies dominated this week’s news. Here’s a sampling of the week’s news–
Wait, first, here’s why the heightened concern. In 1997, the emerging markets began to run into trouble, and investors dumped EM currencies. The ones I remember are the Thai Bhat crisis, which started a 58% sell-off in the MSCI Emerging Markets Index, and the Russian Ruble debacle, which took down Long Term Capital Management, in September 1998, and which marked the end of the big slide, but at that time there were a host of other country problems between those two, including Philippines, Indonesia, Singapore, Hong Kong, and South Korea. Hopefully, the EM countries have learned from that experience–a case The Economist makes in a top story this week. If not, we’re going to be in for a long slide; but I’d side with The Economist on this one.
Here’s what goes on in one of these–maybe any–currency crisis. Market participants sell a country’s currency in favor of another country’s currency. One of the countries getting beaten up is South Africa, so a nervous or opportunistic market participant would sell Rand and receive, say, Swiss Francs. That will push down the value of the Rand, making imported goods more expensive in Rand or South African terms, and the prices of imported goods weigh on a country’s inflation rate. A weak currency doesn’t encourge foreign capital to flow in, which is a problem if a country runs a trade deficit; i.e. it relies depends on foreigners to fund its trade deficit. So, the country getting beaten up will often try to defend its currency by selling foreign currency and buying its own. But to do so, it has to own foreign currencies–QUICK NOTE: the South Africans don’t have a giant vault of Swiss Francs; instead they would own Swiss government bonds–and that ownership is called foreign currency reserves. If a country doesn’t have a large foreign currency reserve, it’ll have a hard time defending its currencies. Turkey, for example, is a country that has a small trade deficit–it might even be positive–I’m not sure–and which has large foreign currency reserves, so it should be able to defend its currency. It, however, has a problem with protesters taking over government buildings–or is that Latvia? Moreover, market participants (can you say George Soros?) know what a country’s foreign reserves are…take your pick of metaphor: they find a scab and pick it or they look for the weak ones in the pack. It’s also possible–and South Africa might not do this as much as a speculator–to do these transactions in the futures markets.
Another line of defense–sort of like holding a knife to one’s throat and sawing back and forth–is to raise interest rates. So, in the excellent timeline of the 1997-1998 EM debacle available from PBS by clicking here, one will note many instances of beseiged governments raising interest rates. To review, the countries that attract foreign capital are those with 1) low inflation; 2) strong economic growth; and 3) relatively high interest rates. Selling foreign currencies attempts to address #1, while #2 usually takes a longer time to address. So what’s left is interest rates, and embattled countries will raise overnight lending rates–like our Fed Funds rate–in an attempt to attract foreign currency–raise those rates high enough, and you’ll draw foreign currency like flies to rotting food–but at a very high cost, throttling one’s economy. Imagine what would happen in the U.S. if our interest rates quadrupled overnight…they’d go from zero to…well…zero–bad example. Let’s say U.S. interest rates went from 0% to 4%. (Hong Kong raised the rate at which it loaned to banks to a freakin’ 300%(!) in 1997, which dropped its stock market by 10% overnight.) That, mind you, is the so-called risk-free rate; it’s the rate from which all others are determined. The interest rate on your home equity line of credit just went to 6% or 7%. Those phenomenal car loan rates? Say goodbye to 2.49% for 72 months…hello 7.49%.
Here’s what happened then:
There is another important difference. Then, Emerging Markets had enjoyed a two-year bull market. Now, Emerging Markets have been chopping around for two years, and valuations are getting pretty low. That should help stem the decline in EM stocks, although valuation is no defense against freaked-out panic selling, which we haven’t seen yet.
–Ooops, looks like I neglected the top stories. Let’s just say there was one top story this week, emerging markets.
There wasn’t a lot of market moving, but there were some pretty big misses, both in terms of what the dismal scientists were looking for and as compared to prior releases. Some of it was clearly weather related; some, probably related to year-end plant shutdowns. Keep in mind that, while economists will blame some of the softness on the weater–as they should–they apparently didn’t figure the weather into their own estimates, which were, in these cases, quite wide of the mark. In the weather-related category, New Home Sales fell by (-)7% in December, whereas economists expected a much milder (-)1.7% decline. Pending Home Sales fell by (-)8.7% in December versus economists’ consensus estimate of a decline of (-)0.3%. Initial Jobless Claims were also likely boosted by the weather, as they jumped by 5.7%, from a revised 329,000 to 348,000. Economists expected a drop of (-)0.3%. Durable Goods Orders fell by (-)4.3% versus economists’ estimate of +4.5%. Even after stripping out some of the notoriously volatile stuff (e.g. diesel locomotives), durable goods orders were well off expectations.
In the non-weather-related category, we got our first glimpse of Q4 2013 GDP. It was roundly positive, at 3.2%, right in line with economists’ estimates. Personal Consumption was up by 3.3%, and, notably, Government Spending was not a contributing factor in the quarter.
‘Fairly big week ahead. It’s the first Friday of the month, so we can look for Nonfarm Payrolls. You might recall that this was a big stinker in January, when only 74,000 jobs were created. It’s likely that weather will have been a contributing factor in next Friday’s report. With that report comes the all-important Unemployment Rate. As usual, Wednesday’s ADP Employment Situation report will attempt to upstage Friday’s report. It’s not a market mover. We’ll also get the Institute for Supply Management’s reports on the Manufacturing and Services sectors.
Gotta run…hot date with my younger daughter, Mimi, tonight…Hobby Lobby, Barnes & Noble, Coldstone Creamery. Should be fun.
Graig P. Stettner, CFA, CMT
Chief Investment Officer
Tower Private Advisors