Stocks are in uncharted territory with volatility spikes
and drops in all of the major equity indices to start the New Year. It
has been ugly, with $2.5 trillion in market capitalization being wiped
out in the first four trading days of 2016, and may signal a dramatic
rise in cross-asset volatility for the rest of 2016.
Why is this all happening? Plain and simple, the path to Federal Reserve
monetary-policy normalization will be painful. With divergent monetary
policy, there is less scope for suppression of market volatility. The
Fed is beginning to tighten and drain liquidity from the markets,
utilizing reverse repurchases to provide a soft floor under short-term
interest rates.
Getty Images
A trader works on the floor of the New York Stock Exchange.
The Fed said in its minutes that "even after the initial
increase in the target range, the stance of policy would remain
accommodative. Gradual adjustments in the federal-funds rate would also
allow policy makers to assess how the economy was responding to
increases in interest rates."
The statement suggests that the Fed will
be data dependent and use current economic activity to determine the
timing of the next rate increase.
One of the ancillary effects of this path to normalization
is the effect on energy. Dollar strength has put pressure on all
dollar-denominated asset classes including the most important
geopolitical commodity: Crude.
Crude oil has remained below $40 and is
now headed toward $30, which has not happened since 2008. The drop has
been steep, but even more important is the velocity at which prices
moved. WTI in recent trading broke through the lows from 2008 which
immediately drew everyone's attention. Crude oil volatility will
continue to affect equities in the U.S. and Europe. If China allows for
faster currency depreciation than the financial markets expect, this
will increase the downward pressure on crude.
Eventually, lower energy prices along with lower input
costs for corporate America will be a tailwind for equities. But
sovereign wealth funds that are from oil-producing states need to have
oil much higher to meet their budgetary needs domestically. This market
dynamic will drive the trajectory of global equities.
The level of sovereign wealth funds assets
under management as of last week was at 7.2 trillion, with 4.4 trillion
originating in commodity and oil-rich nations. With falling crude
prices, the pressure on these sovereign wealth funds continues to mount.
The need has arisen to repatriate the capital from sovereign wealth
funds with spillover effects occurring for global equity markets. When
markets move fast they leave no prisoners, it creates a global margin
call; investors sell what they "can," not what they "want."
So what does this mean for the average investor? Be alert
and defensive as the market corrects. One thing for sure is that we will
continue to witness volatility in the capital markets for a prolonged
period of time. A 20 percent to 30 percent correction in equity prices
would be a healthy move after the recent run-up over the last few years.
There will be continued earnings contraction in S&P 500 companies with a stronger U.S. dollar impacting manufacturers adversely.
The strong dollar will exacerbate lower
prices for commodities in addition to crude oil. All of this will bring
out the "doom and gloomers" including those who claim this is 2008 all
over again. Wrong! Remember, bull market corrections are fast and
vicious and it will look worst at the bottom. This is not 2008, it is a
cyclical correction in a long term bull market. Be ready to put money to
work as stocks go on sale throughout this year.
Commentary by Jack Bouroudjian, CEO of Index Futures
Group LLC, a registered independent broker, and CIO of Index Capital
Partners, a registered commodity-pool operator. He was also a three-term
director of the Chicago Mercantile Exchange and founder and advisor of
UCX (Universal Compute Exchange). Follow him on Twitter@JackBouroudjian.
For the latest commentary on markets in the U.S. and around the world, follow @CNBCopinion on Twitter.
3 reasons for concern about the Chinese economy
By PAUL WISEMAN
January 8, 2016 3:46 AM
.
WASHINGTON (AP) — A
scary sell-off in Chinese stocks is magnifying concerns about the health
of the world's second-biggest economy.
The Shanghai Composite Index on
Thursday tumbled 7 percent in 30 minutes before trading was suspended.
The damage quickly rolled around the world: Stocks plunged in Tokyo,
Hong Kong, London and New York. The Dow Jones industrial average
finished Thursday down a steep 2 percent. On Friday, the Shanghai Index
closed up 2 percent.
China's stock markets have
little connection to the rest of its economy. A big reason Chinese
shares are sinking is that Beijing is trying to undo some of the
measures it took to prop up stock prices after the Shanghai market
collapsed in June. Yet China watchers say there are reasons to worry
about the Chinese economy.
Among them:
___
A WEAKENING CURRENCY
The Chinese government alarmed
world markets in August by suddenly pushing down its currency, the yuan,
by about 2 percent. Pessimists feared that the devaluation signaled
desperation: Maybe Beijing had grown so worried about the country's
economic prospects that it had decided to give its exporters more help
by lowering the yuan's value, which makes Chinese products more
affordable in foreign markets.
The government said it was
merely responding to signals from the market: The yuan, closely linked
to a surging U.S. dollar, had risen too high. After the August
devaluation, the yuan stabilized for three months. Then it started
sinking again. It's dropped more than 4 percent against the dollar since
the end of October. On Thursday, the yuan hit its lowest level against
the dollar since 2011.
The Chinese economy has been
"weakening for years," says Derek Scissors, resident scholar at the
conservative American Enterprise Institute. "That hasn't changed. What
has changed is they pushed the yuan down.
"There's a heightened risk that
the Chinese are going to be more aggressively predatory on trade," he
said. "Everybody who competes with China — their profits are now in
jeopardy."
Scissors says he thinks the
Chinese authorities are actually just catching up with reality, not
trying to give their companies an unfair edge. The yuan, he says, is
still overvalued.
"If you left it alone, it would probably fall another 5, 6, 7, 8
percent," says Yukon Huang, senior associate at the Carnegie Asia
Program.
Chinese authorities want to keep
the yuan from going into free-fall. But investors who fear that the
currency has further to fall are likely to sell investments that are
denominated in yuan, thereby putting further downward pressure on
China's currency and stocks.
___
A TOUGH TRANSITION
China's economic slowdown is
partly deliberate. The country's super-charged growth of the past
quarter-century was built largely on massive investment in real estate
and factories, much of it increasingly wasteful and inefficient.
The government is trying to
guide the economy toward slower but more sustainable growth built on
spending by Chinese consumers. It's also nudging the country away from
overdependence on manufacturing toward more reliance on services
industries.
Overhauling a sprawling and
enormously complex economy was always going to be daunting. And a report
Wednesday, seized on by global investors, suggested that the transition
might not be going so well, at least not yet: The Caixin China General
Services Index fell last month to its second-lowest level in records
dating to 2005.
The index showed that far from
picking up the slack from faltering manufacturers, Chinese services
businesses are barely growing. Moreover, the report noted that services
firms weren't hiring fast enough to offset factory layoffs.
___
ECONOMIC MISMANAGEMENT
Chinese policymakers, long
admired for their stewardship of a fast-growing economy, have worsened
things by communicating poorly, meddling clumsily in the markets and
backsliding on reforms.
"The ongoing rout in China's
stock and currency markets reflects a sharp erosion of confidence in the
economic management skills of Chinese policymakers, coupled with rising
concerns about the state of the economy," says Eswar Prasad, professor
of trade policy at Cornell University.
The government's heavy-handed
attempts to stop a freefall in the Shanghai stock market dismayed those
who had hoped China was moving toward a more open financial system.
Chinese authorities banned investors from betting against stocks,
suspended trading in hundreds of companies and poured money into the
market. At first, the desperation measures seemed to work. Yet stocks
plunged again once the government began to back away.
What's more, the authorities
have repeatedly confused investors about their policy toward the yuan,
thereby unnerving the markets.
"You have to explain what you're doing," Huang says. "The Chinese economic managers are not good communicators."
The uncertainty coincides with
persistent doubts about China's economic statistics. Even Premier Li
Keqiang has conceded that Chinese figures for economic growth are
"man-made."
Officially, the Chinese economy
grew about 7 percent last year. Some economists suspect the actual
growth rate might be 6 percent or lower.
"I wouldn't be surprised to see
it decelerate to the 4 percent range this year," says Daniel Meckstroth,
chief economist at the Manufacturers Alliance for Productivity and
Innovation.
China needs $5 trillion to save its economy — and it might not work anyway
By Linette Lopez
2 hours ago
(Reuters) Visitors
run away from a wave caused by a tidal bore that surged past a barrier
on the banks of Qiantang River, in Hangzhou, Zhejiang province, China,
August 30, 2015. At this point, it's pretty much consensus that it's going to take some doing to get China's economy back on track.
The
country is dealing with a falling currency, an incredibly volatile
stock market, and thinning corporate margins in sectors that used to
drive the country's growth.
These are huge structural problems that will require both brilliance and cold hard cash to solve. The question is, how much?
According
to Charlene Chu of Autonomous Research, who is widely considered one of
the best (if not the best) China analyst in the world, it's going to
take more money than you could possibly imagine.
"Larger
credit injections are possible, but we would need to see CNY37.5trn in
net new credit in 2016 to achieve the same magnitude credit impulse as
in 2009," Chu wrote in an email to Business Insider.
That is $5.7 trillion. $5.7 trillion!
Those
numbers are based on her firm's internal calculation of China's Total
Social Financing (TSF), a metric the government developed to track how
much money is flowing through the economy.
This
is obviously a huge bazooka the government would have to pull out, but
the stimulus measures the government has been applying over the last
year and half or so aren't really doing the job.
"Other
monetary policy levers are either approaching exhaustion, or have
limited effectiveness in staving off the deflationary wave China is
contending with from the slowdown in secondary industry and
overcapacity," Chu said.
"Interest rate cuts can help ease the
debt-servicing burden, but aren't enough to address this. RRR cuts are
primarily an offset for capital outflows and to help financial
institutions in need of liquidity."
Now Chu doesn't actually think China's financial institutions will extend that much credit in 2016. What's more, she isn't sure if a $5.7 trillion shot in the arm would even be enough for China.
"What would adding further credit on top of what is already the biggest corporate credit boom the world has seen do?" she wrote.
View gallery
.
(Autonomous Research)
As
the yuan depreciates, cash is leaving the country at a stunning rate.
In December alone China spent $108 billion of its $3.4 trillion
foreign-exchange-reserve stash trying to keep the yuan from depreciating
faster than it has. The country has stepped up already tight capital
controls to keep its house in order, according to the Financial Times.
"That
leaves China's authorities with only one monetary lever: the currency,"
Chu said in her email. "Hence, it is difficult to see how the CNY
doesn't weaken significantly from here. The questions are what magnitude
of move, when, and what path does it take? All of that largely depends
on the situation with capital outflows and growth."
And that is an entirely different, thoroughly complicated, potentially dizzying matter.
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