It was a broadly lower week for the global equity markets with the global index falling -1.4%. The U.S. markets were relatively resilient despite the poor growth number reported on Friday and Japan managed to gain +1.5% on the back of further yen weakness. However, Europe was off close to 2% while emerging equities were down close to -4%. Hong Kong was off over -2% and we saw sizable losses in most other markets. Falling commodity prices hit commodity exporters particularly hard. For example, Brazil was off -5.6% this week, pushing its year-to-date loss to -11.8%.
As equities dipped bonds rallied. The yield on the 10-year fell 0.12% to close at 2.10%. Intermediate-term government bonds notched up a +0.7% gain while 30-year Treasuries advanced +1.9%.
Two Steps Forward, One Step Back
The main economic report of the week was the 2nd quarter GDP report on Friday. This was actually the second estimate on the number. Initially growth was thought to be +0.2%, but this new estimate shows that growth actually contracted at a -0.7% annual rate (economists had expected a -0.9% number). As you can see in the chart below, the contraction in the first quarter mirrors the contraction in the first quarter last year.
The reason for this contraction is also similar to last year’s – weather. Or at least that is the excuse. Interestingly a big reason for the swing between +0.2% in the first estimate (guess) and the latest number are imports. Roughly 80% of the differential is explained by a deteriorating trade balance.
Other measures of growth are not so bad. For example, gross domestic income measures incomes for both consumers and corporations. This number grew by +1.4% in the first quarter and is up +3.6% year-over-year. This stronger report jives with other measures like weekly jobless claims which are hovering around multi-decade lows (chart below), and pending home sales which are back to 2006 (pre-bubble levels).
However, the outlook for this quarter remains murky. About the only major outfit to get the first quarter call right is the Atlanta Fed. Their model predicted a contraction, and they see growth of only +0.7% in the second quarter. This stands in stark contrast to the +3.0% estimate from most economists.
The next big measure for the U.S. economy will be next Friday’s payrolls report. This will set the tone for the markets going into the June 16/17th Fed meeting and the usual summer doldrums.
Another Record Ready to Fall?
There is a saying in the investment community that the stock market isn’t a call option on the economy. This means that the market and the economy don’t necessarily have to move together, and is that ever true the last couple years. Once again growth has basically flat-lined, but the market in the U.S. proves to be surprisingly resilient if you measure it by the lack of a 10% corrections.
And this resiliency is making history. David Bianco points out that it has now been 916 days since the last 10% correction for the index, or 3.6 years. The hiccup we had last year over Ebola and ISIS resulted in a bit over a 9% correction. We haven’t even had a 5% correction so far in 2015 despite growth falling in the first quarter.
To put the 916 days in perspective, the chart below shows the intervals between 10% corrections doing back to 1960. This is the third longest on record.
Impressive stuff. So do we get our 10% hit this year? Soft economic growth hasn’t done the trick. Lackluster earnings have been shrugged off. A decent selloff in the bond market didn’t seem to matter. Maybe the Fed does the trick at the next meeting or two. Or possibly the catalyst comes from overseas?
China – How Do You Keep the Plates in the Air?
The nuttiness continues in China. The local market lost -1.0% this week which seems pretty subdued, but this obscures very volatile trading. Things started off strong Monday after the so called ‘Mutual Recognition of Funds’ announcement. This new plan will allow Hong Kong based asset managers to offer investment products to Chinese mainland investors (and visa versa). This is simply another step in opening up the Chinese investment market. The new plan launches on July 1st.
However, things took a turn for the worse on Thursday and the A-share/H-share market were clipped for -6.7% and -2.8% respectively. The losses are attributed to an increase in margin requirements as well as a report that the Chinese central bank drained liquidity via targeted repo operations.
But the news could probably have been anything. The market has been on such a tear lately that it really didn’t need much reason to correct. I hesitate to use the word fundamental as it relates to the Chinese market, but the fundamental factors that have been driving Chinese shares haven’t really changed. These include the opening up of China’s wealth management industry, the high probability of more monetary support, and underinvested foreign investors. On the last point, the large index provider FTSE launched two transitional emerging markets indexes with A-shares accounting for a roughly 5% allocation. While not an official change, it does point to the likely trend of more index providers including local shares in widely traded indexes. There is widespread speculation that MSCI will decide as early as next month to begin including “A shares” in its global indices.
But valuations in China are clearly a challenge in parts of the market. The chart from Goldman below shows the valuation of the NASDAQ against various Chinese indexes. While the market as a whole doesn’t look too expensive (MXCN at 11.8X forward earnings), the Shenzhen market (CSI300 at 18.0X) and the tech/start-up heavy ChiNext index (58.3X) look rich (or ridiculously rich).
So we have a battle between rich valuations and a macro picture that could get more stimulative. One thing is for sure, we are likely to see more of the 6% swings this year. But would a crash in the Chinese market tank the economy? The Economists notes the following:
“The tradable value of the Chinese market is about 40% of GDP; in mature economies it is typically more than 100%. This suggests that the immediate fallout from a crash would be more limited. But a healthy economy needs a healthy stock market. It would be a setback for China’s development if the rally turns to a rout and investors lose faith.”
You suspect the Chinese authorities know this and will bend over backward to prevent it from happening. But how do you slowly deflate a bubble? The Fed is pondering just the same question.
George Washington, Thomas Jefferson, and…..Bill Gross. Come Again???
Bill Gross is one of those names in the investment industry that everyone has heard of. He co-founded PIMCO in 1971 and helped build it into a $2 trillion firm. Then his tenure turned into an episode of Desperate Housewives and he left to join Janus. Well, part of his legacy will now be on display at the Smithsonian. The Bloomberg keyboard below will join two Beanie Babies in the shape of a bull and a bear as well as a pair of fuzzy dice representing his blackjack background (I know, that doesn’t make sense).
While it is tough to make out in the picture below, Gross taped his username and password to the keyboard in the upper right. Nice.
Have a good weekend.