My Diary 640 --- Are We Out Of the Woods?

My Diary 640 --- Are We Out Of the Woods?

Sunday, June 13, 2010

“Are we out of the woods?” --- A few of colleagues in Beijing asked the question when they saw a good rebound in US stock indices (SPX +2.95%) on Thursday. My simple answer is “Not Yet”, and I will explain soon in details. Oh, by the way, today’s diary will be short as I have been away from HK for the whole week, and I have a lot of home cleaning work to be done this weekend. But I would like to ink down some of my observations and thoughts over the past week’s volatile markets.

Looking back, the US equity markets initially took a hit after the double whammy hit by the poor NFP number and the renewed concerns over Hungarian sovereign debt in the previous week. However, S&P 500 managed to find good support at 1040 level and recovered all of its lost grounds throughout the week driven by +VE economic numbers from across the world. It worth to note that Nasdaq, Russell 2000, BKX and Dow Transport indices all moved back to their 200D MAVG, while the Dow Industrial and SPX were still beneath such important technical level. There is no improvement in T/O from this rebound with Daily market turnover stayed more or less flat wow. One area of worry here is that the high beta indices like Nasdaq (+1.1%) and Russell 2000 (+2.37%) all underperformed the broader index of SPX (2.51%). Thus I need to see these high beta Indices to outperform so as to indentify the return of risk appetites.

X-Asset Markets Performance

On a weekly basis, global equity indexes rose 1.92%, led by US +2.5% and  EU +1.96%, but dragged by JP -2.79% and EM +0.4%. MXCN closed flat, +0.05% wow. Valuation wise, MSCI China is now traded at 12.9XPE10 and 25.1%EG10, CSI 300 at 15.1XPE10 and 32.4%EG10, and Hang Seng at 13.1XPE10 and 25.1%EG10, while MXASJ region is traded at 12.2XPE10 and +36.8%EG10.

Elsewhere, 2YR UST yields were flat at 0.73%, while 10yr added 3bp to 3.23%, despite the good response to the USD114bn 10/30 yr bonds. 1MWTI crude oil edged down $1.7 to $73.78/bbl on Friday, but climbed $2.27/bbl (or +3.17%) on the weekly basis. The rebound in EUR (closed at 1.2112, +1.21% wow) contributed to the weakness in USD and DXY -0.82%. JPY stayed relatively flat at 91.65, -0.27% wow. Credit side, TED spread continues to widen, rising 5.2bp to 46.8bp, +12.6% wow. The spread was 18.6bp on the first trading day of May. The measure of credit market stress has climbed in 15 of the last 17 trading days. In comparison, The VIX fell 6.69 points to 28.79, -18.86% wow. The VIX index recently peaked at 45.8 on May 20.

Looking across asset markets, it seems that global equity markets are trapped by two opposite forces – 1) on the +VE side, there is continued economic expansion around the world, very low interest rates and the diminishing threat of inflation; 2) on the -VE side, the Euro area economy faces mounting growth problems, an intensifying debt crisis and banking fragility that threatens to cause a credit squeeze. Interestingly, asset markets have taken a very different judgment here as witnessed by the credit spreads and equity volatility index. In general, Equity markets seem to be focused on the growth outlook, saying corporate earnings will survive government spending cuts and tax increases. In contrast, Credit investors perceive the inherent risk in banking systems and sovereign debt to be greater and more challenging in the future than equity markets do. Since the beginning of 2007, the North American HY Spread is nearly traded at perfect negative correlation with S&P 500, while inter-bank spread (TED spread) moved in sync with credit spread since March 2009. (Please see the attachment)

Market Thoughts and Outlook

Despite the slightly BTE initial jobless claims (453K), the WTE advanced retail sales(-0.8%) and the lukewarm comments from the Beige Book saying that the economy is only showing modest growth, the US markets chose to focus on 1) Bernanke’s comments saying that there would not be a double dip; 2) the strong China and Japan economic data; 3) ECB’s comments that they would continue to buy bonds after keeping the rate unchanged and revised up their GDP forecast from 0.8% to 1% for 2010; 4) the +VE response to the Spanish bond sales which led the Spanish 10 year yield -6.6bps to 4.462% and the rebound of EUR (+0.34%) and SX5E (+3.32%).

Macro wise, US retail sales unexpectedly dropped in May (-1.2% vs Cons=0.2%)  for the first time in eight months, indicating, signaling consumers boosted savings as employment slowed and stocks fell. The decrease in demand wasn’t broad-based, with 5 of 13 major categories showing decreases last month, led by a 9.3% plunge at building-materials, reflecting the end of a government appliance rebate. Interestingly, UoM Confidence index still ended up slightly BTE at 75.5 vs. Cons=74.5 and 73.6 in April. There seems a gap between the consumer confidence, real consumption spending and unemployment figures.

In contrast, China’s May economic data looks very mixed with CPI @ 3.1%, FAI @ 25.9% and Retail sales @ 18.7%. It shows that economic growth was not as bad as expected, especially the May export data. Inflation pressure was slightly WTE, PPI (+7.1%) in particular. In general, street economists think this strong rebound in export cannot sustain and that export growth will decline to 10-15 % in 2H10. Based on my own observation, macro tightening policies are gradually showing the impact, with IVA grew by 16.5% yoy in May in real terms, slowing from 17.8% in April. This is consistent with slowing yoy growth in the PMI sub-index for production, which declined to 1.3 in May (from 1.7 prior).  Regarding the market liquidity, PBOC net injected RMB166bn into the domestic market in this week and SHCOMP Index closed up 0.64% wow to 2569.9 points. However, it is interesting to see that GEM index sparked by 9% compared to the sluggish performance of SH50, down by 0.59%. Meanwhile, the central bank raised the auction yield in three month bill and 1 year bill by 4bp and 8bp. The concern of another RRR hike is still there. Looking forward, I expect the market may experience a vacuum period of news flow as the policy makers may put on hold any further tightening policy in order to re-assess the effects of previous policies and the economic data for the first half year. The potential pressure comes from the ABC IPO issuance, but I think it has been well-known by the market now.

Regarding energy markets, WTI oil prices fell 2.15% on Friday as an unexpected fall in May retail sales in the US and easing industrial output in China revived concerns about the economy and oil demand.  Looking forward, I expect that the oil spill in the Gulf would likely cause significant political risk and policy uncertainty about the future of energy policies in the US. It is interestingly to watch how the investors and corporate management will respond to the potential changes in the regulatory policy in a crucial area. This compounds policy uncertainties that exist in the financial sector. These are certainly the kinds of policy uncertainty that are no doubt weighing on investors willingness to invest and industry's willingness to invest and hire.

Good night, my dear friends!