Finally, mercifully, the bounce arrives, like a cool change after a scorching hot day. Stocks jumped in the US overnight, finishing up around 1.5%.
Oil rallied more than 2%…not much given the recent beating, but it’s better than another kick in the teeth.
With the market momentarily OK about the ongoing currency debacle in China, gold sold off nearly 1.5%.
In other words, a complete reversal of what you’ve seen in 2016 so far.
The Aussie market looks like having a good day, driven mainly by a big bounce in the miners.
This is a short squeeze, and not necessarily the end of the rout. As I pointed out yesterday, market sentiment is changing. Gone is the confident ‘buy-the dip’ mentality. The preference for traders and strategists is to now ‘sell the rally’.
I’m seeing this sentiment emerge in comments via the financial media. Slowly but surely, greed is giving way to fear.
Reading the financial news is helpful for this very reason. It helps you to gauge the psychology of the market.
For example, the bears are getting much more airtime these days. Albert Edwards is a Societe Generale strategist and noted bear. He hasn’t changed his tune in years but all of a sudden his views are in demand.
The Financial Times recently reported on a conference in London headed by Edwards, and quoted from his most recent weekly report:
‘Investors are coming to terms with what a Chinese renminbi devaluation means for Western markets. It means global deflation and recession. The coming carnage is an indirect result of the failure of the Fed’s QE. It may not have done much to boost US growth, but it certainly inflated global asset prices into the stratosphere. The one area though, where US QE did unambiguously boost growth was in emerging markets (EM) as surplus money poured into these supposedly superior investment opportunities, leading to massive EM foreign exchange intervention to hold their currencies down. This turned ineffective US QE into very effective EM QE in terms of boosting EM economic growth. A commodity bubble and the resultant US shale investment boom were all consequences of the Fed’s QE. The illusion of prosperity is shattered as boom now turns to bust. But I do hope this time around the Queen won’t ask, as she did in November 2008, why nobody saw this coming!’
Edwards is exactly right. But being exactly right in a big picture sense doesn’t necessarily make you money in the market. Big picture events take years to play out.
It reminds me of how I play chess. I’ll focus on an outcome that I’m trying to achieve and I don’t see what my opponent is doing. Just as I’m about to set up for a glorious check-mate — bang! — I lose my queen.
In this instance, the opponent of the bears is the Fed. What happens if the Fed turns around and says interest rate rises are off the table, and that restarting QE is a possibility?
While it would be a disastrous policy in the long run, I’d bet that it would get Wall Street excited for at least a few months.
Funnily enough, the Fed was behind last night’s rally, with a hint that further interest rate hikes might not happen. From Reuters:
‘The continued rout on global oil markets has caused a “worrisome” drop in U.S. inflation expectations that may make further rate hikes hard to justify, St. Louis Federal Reserve President James Bullard said on Thursday.’
While the Fed has a powerful influence on the market, it cannot stand in the way of the primary trend. The events of 2008 are a good example of this. Each time the Fed lowered rates the market rallied for a few weeks, only to fall to new lows.
The market finally bottomed in March 2009. Without the Fed’s help things would have been a lot worse. The point is, when the market is bearish, it doesn’t really matter what the Fed does. Bearish sentiment will prevail until the selling is done.
Which brings me back to Edwards’ initial point. Investors ARE coming to terms with what a Chinese currency devaluation means. They’re probably coming to terms a lot more slowly than he thinks, but this is what a change in sentiment is all about. It reflects the slow realisation that a situation (China’s currency issues) is not as benign as first thought.
That is, China’s outflows represent a tightening of credit in the world’s second largest economy. These outflows are not just about Chinese capital trying to escape a slowing economy, or a clampdown on corruption. It’s about a massive unwinding of leveraged carry trades, which represents THE DISAPPEARANCE of money.
What do I mean by that? Well, in the same way that banks create credit (or money) by approving a loan, money disappears when that loan is repaid. Put simply, a lot of speculators who punted on China are now repaying their loans.
No one really knows how long this unwinding has to run. The financial system, with its web of derivatives and associated leverage, is incredibly opaque.
This lack of insight, this ‘uncertainty’, is the stuff of panics. On the way up, ignorance is bliss, on the way down it creates fear and loathing…if not in Las Vegas then certainly in New York.
My guess is that the Chinese devaluation story is a trend that is only just getting started. My UK Markets and Money colleague, Ben Traynor, who attended the Societe Generale conference in London recently, gives us a hint as to why:
‘…the Institute of International Finance has reported a massive unwinding of Chinese companies’ dollar debts during the last few months of last year.
‘“This prescient action means that many Chinese corporates have taken the signal from the initial August devaluation seriously and readied themselves,” says Albert in his Global Strategy Weekly note.
‘“Hence China is now in a better position to transmit a massive deflationary shock to the West without damaging its own corporate sector.”’
In other words, expect more currency weakness out of China. But we’re getting ahead of things. A relief rally is underway. Enjoy it. If you want some ideas on how to play it with some ‘shockproof’ stocks, check out my mate Sam Volkering’s presentation here.
But keep in mind that the primary trend might be in the process of changing. If that turns out to be the case, you’ll need to change your strategy too.
For Markets and Money