Athena Wealth Management August 2015 Investment Research Report
Summary In August, general markets experienced a significant drawback amid concern higher U.S. interest rates and China s economic slowdown pose threats to global growth. MSCI World dropped 6.81%, and MSCI EM index slumped more than 9%. The best performed market should be Russia which increased 3.84% and the worst was China, dropped more than 12%. The risk appetite shrank which the investors prefer the risk free asset, rather than risky assets. The Treasury bond yield dropped to around 2.2%. Corporate bond spreads continued to widen. The oil price rebound in August but the other commodities continue its weak trend. 1 Fig. 1 Equity market comparisons
Fed rate decision would be the main focus in the markets. We did consider the first rate hike will happen within the year, even Fed held on rate in September meeting. The US dollar will keep strong, which means the commodity price is hard to reverse the downtrend in short future. We are pessimistic on the commodity driven economies. Also, many Emerging Markets are also showing signs of continued weakness. Some of them are suffering heavily from low prices and weak demand for commodities, others from lower demand for intermediate goods from China. Many EM are also in a prolonged de-leveraging process as excessive credit creation proved unsustainable. Therefore, we hold the negative view on the emerging market equity. On the other hand, the shift from Emerging to Developed assets continued. We did hold the neutral view on developed market equity as it could have better fundamentals, but still volatile on the Fed decision. ECB is likely to extend the easing policy which could be negative to the euro dollar. 2 Fig. 2 Fund Flow by asset Class Source: Commerzbank
This Month s Hot Topic: Another Stock Crash? 3 August is remarkable month. Global market rout intensified as market is concerning China s aggravated economy. Investors are trying to assess whether this round of crash is just a short-term correction signal or reflect deeper problems. Market starts to question the similarities between current equity market and past market crashes like 1929, 1940, 1987 and 2008. Let us look at them one by one. There are several basic conditions that align and lead to a stock market meltdown or correction: deeply oversold condition, inability to rally much and the market down on successively higher volume. The NASDAQ is currently off about 10% from its high, almost the identical amount of the first leg down prior to the 1987 crash. Based on one measure, the last time the Dow was this oversold was in Aug 2011 when the Dow Jones was off 11% from the high and then fell an additional 6.5%. The current oversold reading is very similar to 1987 pattern. Fig.1 Weekly equity flow (27/07-31/07) Source: Mark Minervini's Official Blog Fig. 2 S&P 500 1940 vs.2015 Extreme Oversold Reading Source: Bloomberg
Fig. 3 Rolling 3 Days Sum of Standard Deviations Below 50-MA Source: Bloomberg Another similar pattern is 1940 stock crash. We can see a pair of analogue charts of the S&P500 as below showing this similar extreme oversold situation. Currently, the S&P 500 has closed more than four standard deviations below its 50-day moving average for the third consecutive session. From the history of the index, it only happens two times while the first time is in 1940. 4 Fig. 4 Similarities Between China's Stock Market Crash And 1929 Source: Zero Hedge China also cannot avoid from it, even it has been a major contributor to economic growth and low global inflation for more than two decades but now market worries the new crash will first happen in China as its Black Monday is worryingly similar to Wall Street's 1929 crash. The similar pattern and only bank stocks support the market. In spite of Chinese authorities and regulators are doing everything to shore up the stock market, there s a better than 50% chance their efforts will fail and that a devastating crash could send global markets back into a 2008-era financial crisis.
Eurozone Market Fig.1 Eurozone Majors Manufacturing PMI 5 In the Eurozone, 6 out of 13 macro-economic figures releases disappointed. Consumer prices in August were 0.2% higher than a year earlier, keeping pressure on the European Central Bank to consider additional stimulus measures to bring inflation closer to its target near 2%. Draghi left the door open for a QE extension while the QE per-issue limit was raised to 33%. Going forward, we expect the recovery to continue, although momentum will differ across countries. Fig.2 Eurozone Inflation Rate
Fig. 3 Luxury demand by countries 6 Fig. 4 EUR/USD Common supportive factors include lower oil prices and the somewhat weaker euro, while the stimulus stemming from lower interest rates, easier bank lending conditions and reduced fiscal headwinds vary between countries. Importantly, lower interest rates have reduced debt-servicing costs significantly. We hold the neutral view on the overall European equity but negative to the luxury sector. Although it is undervalued, the sector will continue suffered from the china economic slowdown. We expect the sovereign yield would keep in lower level as the ECB tends to continue the easing environment.
7 U.S. Market U.S. labour market showed the mixed data. The job growth slowed in August, but the unemployment rate dropped to a near 7-1/2-year low and wages accelerated. Nonfarm payrolls increased 173,000 last month after an upwardly revised gain of 245,000 in July. However, the jobless rate fell two-tenths of a point to 5.1 percent, its lowest level since April 2008. On the Fed rate hike at the September meeting, Wall Street opinion makers can't agree on anything. Not only is there no consensus about whether the Fed will end its seven-year-old policy of zero interest rates, but views on the fallout from such a move is wildly disparate. Fig. 2 Markets pricing no September rate hike Fig. 1 U.S. labour market
But, analysts are a bit surer there'll be a hike before year end. Even if uncertainty were removed after the September meeting, markets are unlikely to calm down quickly. Looking at previous rate-hike cycles, markets remained bumpy for a few weeks after the first hike as market participants try to assess the impact of higher rates. On the other hand, we did compare the recent equity market to the 2011 assuming that higher rates would make the impact like systematic risk. As result, we hold the neutral view on US equities in short run, but more negative on the economic sensitive industries. Moreover, we believe that fixed income would likely underperform in the upcoming few months. Fig. 3 S&P500 index Comparison between 2011 and 2015 8
China Market Today s markets are driven by both market sentiment and government policy, particularly for China. Fig. 1 China PMI 9 The slowing economy growth in China is a fact; no one can deny this. Chinese manufacturing fell in August to the lowest in more than six years, following weaker-than-expected reports on investment, industrial output, retail sales and exports in July. This is also reflected in the performance of China equity market. Followed dramatically drop of the Shanghai composite index, what the government can do is further easing. This time, they cut the key rate and relaxed the reserve requirement ratio together, aiming to support financial stability and economic growth just like it devalued the Yuan in middle of August. Fig. 2 PBOC monetary policy change
Fig. 3 Historical RRR and Benchmark Interest Rates Movement 10 Fig. 4 China Yuan Movement Currency devaluation is common way to lower the value of currencies to support economy. U.S. had done before by using QE to cause the value of the U.S. dollar sliding and benefit the manufacturing sector. The trouble is that other countries become exporting their products in a relative high price but current situation is that China is no longer having the big appetite for everything everyone wants to sell and even devalues yuan to stimulate its economy. We can also see that Europe remains bogged down with its debt problems, and the U.S., while stronger than it was in the recession of 2008, still isn't particularly vigorous and the Fed no longer wants to keep interest rates low. That s why the panic come from and boomed for the foreseeing economy slowdown.
Others- Emerging Market Fig. 1 Brazil GDP Battered by the commodities fall and weakening global demand, a blow to the emerging market. We believe the weak trend of emerging market will continue. 11 BRICS The BRIC countries were the ones that had been expected to assume leadership of global growth in the next century but now, it is not the truth. China s growth is a question. Russia, with its dependence on oil, looks to have no way out and ruble already suffers from this since 2014. Only India can be saying as a rare beacon of growth and stability among major emerging economies. Its GDP expanded 7 % in the second quarter, down from 7.5% the previous quarter. But it was a lights-out performance compared with fast-fading former BRIC star Brazil, whose GDP shrunk by 2.6 % from a year earlier. Brazil real even depreciated 29% this year, becoming the worst performing currency against dollar. The Workers' Party corruption even leads to Brazil call on President Dilma Rousseff to step down, making Brazil economy more unstable. Brazil's domestic political and economic crisis raises market concern of the market crash. Fig. 2 Brazil s budget balance
Next 11 countries Fig. 3 Goldman Sachs N-11 Fund Goldman has proposed the term Next 11 countries, including Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, the Philippines, Turkey, Vietnam and South Korea, in order to fill the void left by shrinking investment returns from BRICS. Now, those countries are looking even worse for investors than the BRICS. MSCI Inc. s Next 11 equity gauge has tumbled 19 %this year. Foreign capital continues rushing out, with the Goldman Sachs fund shrinking by almost half as losses deepened to 11 %since its inception four years ago. 12 Fig. 4 Market concern of next country a risk
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