November 2015 Global Macro Recap

While the ECB’s decision to expand Q€ on December 3rd was important, the markets will be watching the actions and wording of Dr. Yellen and the US Federal Reserve on December 16th.  The question of whether they will raise rates seems moot at this point – we are switching our expectations to yes to +0.25% to the targeted Fed Funds rate.  Domestically in the US, unemployment remains under control and the headline payroll numbers are coming in strong.  Meanwhile US inflation is subdued with comparable levels starting to take the decline in energy prices into account from a year ago.  This was all in our expectations.  However, what has changed from a month ago is the ECB disappointed the markets in terms of its increase in Q€ free money.  Draghi did announce a reduction in the deposit rate and increase to the term of the monthly bond purchases, but did not increase the monthly €60 billion purchase amount as expected.  For not exceeding the market’s dovish expectations for the first time in his tenure, Draghi saw the euro rapidly strengthen almost three eurocents against the US dollar.  This higher euro gives our Janet Yellen greater cover to raise rates as she can more effectively fend off claims that she is over-tightening against our manufacturing rivals in the Eurozone.  Yes, technically, the US dollar is under the purview of the US Treasury, not the Fed, but any bit of room will be welcome by her and her colleagues.  Fed comments into month-end and into December also supported her view of raising rates.  Not raising rates therefore will be a surprise, and I think a big one should it happen.  However, the current market conditions have that risk as only a 20% chance, so not likely.  Needless-to-say, her comments about future rate increases will be closely scrutinized, and with 2016 being an election year, I would be surprised if there is more than one, assuming that inflation stays low.  Overseas, the OECD cut global growth slightly from +3.0% to +2.9% in 2015 and +3.6% to 3.3% in 2016, primarily on lower growth in the US and Europe.  Lower global trade forecasts drove much of their decision-making.  Standard & Poors announced that it expects 2015 to have the highest number of corporate debt defaults since the market crash in 2009, concentrated in the energy sector.  Chinese bond defaults and financial markets investigations continued to make headlines and the central government expanded its program to recapitalize heavily indebted municipalities.  Japan flirted with technical recession again but reversions put Q3 GDP back to the positive side.  Brazilian GDP continued to contract, with the year-on-year number at -4.5%, the worst on record.  Low commodity prices on record global oil inventories and high stocks of grains and metals continued to undercut commodity producing nations.  Their plight seems to have no end.  I would guess that it will have to get worse before it gets better – some bond defaults or headline bankruptcies should mark the catalyst for the final leg down, assuming that happens.  Low interest rates have not been a panacea.  However, a “Santa rally” in US equities would be an appropriate if not slightly ironic end to the year. 

Adjusting Tone:  The chatter from the Federal Reserve on raising rates was quitechange in nonfarm payrolls  constant through November and into December, with only the token dovish words of caution.  In contrast, Chairwoman Yellen was almost pounding the table on her resolve that the US economy was ready for a rate hike, albeit a first step of only +0.25% followed by very slow rate increases thereafter.  The news flow was supportive in terms of employment, with October payrolls adjusted upwards strongly to gains of 298,000 positions and an expectation-beating 211,000 gain for November.  The headline unemployment rate stayed at 5.0% and the underemployment rate increased to 9.9% from 9.8%, but increases to participation rate and steady earnings growth of +2.3% year-on-year must all be comforting to Janet’s labor economist soul.  Inflation also looks steady, with the monthly core level forecasted to match September’s number of +0.2%.  Headline inflation is projected to stay low, if not negative due to lower energy prices – the AAA survey on December 1st said that US gasoline prices had fallen 25 days in a row to $2.04 per gallon.  Other measures appear to be more subdued, such as the current Atlanta Federal Reserve Q4 GDP forecast of +1.4% lowered in early December from +2.2% the week prior.  However, Q3 GDP was revised upward from +1.5% to +2.1%.  Retail giant and bellwether Walmart warned on slowing US sales growth for Q4 along with sales declines in China (-0.7%) and Brazil (-0.6%).  Existing home sales fell -3.4% month-on-month in October with the median home price lower for the fourth month in a row.  US Industrial Production unexpected fell -0.2% for October on utility and mining sector declines for the ninth month-on-month drop over the last ten months.  Household spending rose less than expected in October at +0.1% versus expectations of +0.3%.  All of this is not a good prognosis for the traditional holiday shopping season. 

nifty market capOf note to US financial markets is the narrowness of gains, with 2015 stock price increases concentrated in nine companies of the S&P 500 – Facebook, Amazon, Netflix, Google, Priceline, Ebay, Starbucks, Microsoft and Salesforce (see the Financial Times graphic to the left with the first four being Fang and the whole list as the Nifty).  Standard & Poor’s also downgraded eight US lenders, including presumed “too-big-to-fail” stalwarts such as JP Morgan Chase, Bank of America, Citigroup and Wells Fargo on capital requirement increases and a backing off by the Federal Reserve on its stated support in a crisis.  Perhaps another ominous note was struck by Fannie Mae and Freddie Mac starting a new home loan program allowing for only 3% down-payments – approaching those highly levered days of the 2000’s leading up to the financial crisis.  S&P has announced over $1 trillion in US corporate downgrades so far this year, a 72% increase from last year.  Upgrades are only $500 billion, 1/3rd of last year.  With the pain concentrated in the oil and gas industry, it won’t be resolved anytime soon.  But so far the equity markets have been ignoring these concerns, remaining supported on a cloud of QE (and Q€). 

Outside of the US in the Western Hemisphere, the news was notably more downbeat.  Brazil’s economy shrank a larger-than-expected -1.7% (not annualized) for Q3, dragging down the large country -4.5% over the last twelve months, the worst on record.  The government deficit is running at 9.5% of GDP, pushing gross public debt over 70% and putting more pressure on its debt rating.  S&P already has it running at junk while Moody’s has it still under review.  Perhaps it is no surprise that President Rousseff is under impeachment proceedings, further confusing the country’s direction and potential reform.  Brazil’s congress, although also leftist and handling the impeachment, has been resisting reforms by her finance minister.  Closer to home, Puerto Rico made a December 1st debt payment of $350 million by redirecting budget away from highway and infrastructure spending.  However, given that Governor Padilla has another payment of $357 million due January 1st, it is more suspect that the money well is now dry.  Will the US Congress or the US Supreme Court act?  We shall see but I believe that a number of banks, hedge funds and retirees are about to get handed a big loss.  In Mexico, the largest corporate bond default in twenty years is looming as construction firm Empresas ICA SAB missed making a $31 million interest payment due on December 2nd, putting $1.35 billion of debt at risk.  S&P estimates that bondholders will get between 10 and 30 cents on the dollar when all is done.  Why the collapse of its business?  The Mexican government which accounted for 90% of ICA’s revenue cut infrastructure spending to deal with its own fiscal situation.  Venezuela’s payment situation is so bad that more than a dozen oil tankers are waiting for monies before unloading their cargos.  Finally, Canada’s Q3 GDP grew only at +2.3% as September’s figure was a surprising -0.5% contraction, generally due to declines in the oil sector.  Q3 GDP is forecasted at a slower +1.5% annualized rate, similar to the US’.  Everyone is slowing for the holidays, I suppose.

Over-promise, Under-deliver:  Draghi finally flubbed his messaging with NovemberUS GDP Growth 2015 filled with hints of more negative rates and greater Q€ being met with disappointment on December 3rd when he did lower the benchmark deposit rate by -10 basis points to -30 bps but did not increase the amount of Q€ bought per month from the €60 billion target as expected.  He did extend the official buy-back period by six months which is an extra $360 billion worth as well as extend the buy-back universe into certain municipal securities but the market had been led to think otherwise.  Not that it is helping as the Eurozone grew only +0.3% in Q3 (not annualized) with Greece and Finland contracting (-0.5% and -0.6%, respectively).  France and Germany were above the average, carrying the zone.  Looking at Q4, Germany had good industrial production numbers for November at +1.8% month-on-month, retail sales for the Eurozone were down -0.1% month-on-month November (largely on a miss by Germany) and French unemployment rate inched higher in Q3 to 10.6%, close to a two-decade high.  Greece started to make news again with passing legislation to receive €2.1 billion in bank and government aid though there is a second round due by December 11th.  With a general strike hitting the country in protest in November, the government is reminded of the domestic pressure to not pass it.  We shall see where this standoff ends (though not in Greece’s favor in the end, for certain).  Portugal’s left-wing Socialist Party won the elections so we shall see how far they go in easing austerity over the upcoming months as well.  Meanwhile in Austria, the creditors of the Hpyo Alpa fund rejected the €1.2 billion offered by the state of Carinthia as insufficient (Carinthia is the Austrian state government that guaranteed €11 billion of bank loans but has an annual budget of only €2 billion).  Obviously the creditors are looking for further assistance from the central government in Vienna.  After all, the ECB is giving money away!  At least, they are in Germany which sold debt at the lowest rate ever – two-year bonds at -0.38% on November 18th.  Switzerland was not outdone as their ten-year bonds hit -0.41% at the end of the month.  With Swiss Q3 GDP growth at 0.0%, it seems clear that easy monetary policy is not really working.  On the plus side, UK Q3 GDP was +0.5% quarter-on-quarter with gains in consumption (both private and public).  In summary, Draghi is just playing the game out as long as he can though the rate of deterioration has been slow so far.

Russia stayed consistent with its tough rhetoric as it threated retaliation to the Eurozone after NATO formally invited Montenegro (one of the former Yugoslav republics) to join it.  Given that it and Serbia were subject to NATO bombing in 1999, this is quite a turnabout of circumstances.  We shall see what happens given that Russia is directly involved in a shooting war in Syria (and who knows about Turkey).   Perhaps this is why Russia stepped in to offer to restructure the €3 billion bond due with Ukraine to three annual €1 billion payments starting in 2016 instead of forcing a collapse of the IMF package already negotiated.  The offer is still pending so the alternative is the full payment by the Ukraine on December 20th.  Merry (Gregorian) Christmas!

The East is Red:  The Chinese stock markets may be well off their low but the Chinese government had to buy at least six percent of the tradable equities in order to stop the crashing, per the FT.  The amount was compiled based on public quarterly filings of the top ten holders of every stock, and therefore could be higher assuming there are purchases that do not fall into the top ten.  All fine for now but what will happen if/when they sell?  After all, bond defaults are still occurring, with the largest one in early November of China Shanshui Cement Group which failed to pay a two billion yuan ($315 million) note due – small beans in a 40 trillion yuan ($6.3 trillion) market but not helpful to a country dependent on this kind of employer.  Their additional US$500 million overseas bond also failed under cross-default provisions.  The company has filed for liquidation.  The Sinosteel default from October is still pending as the firm missed another payment deadline.  The OECD lowered Chinese growth to 6.2% for 2016 so no immediate relief is expected to the economy in transition.  On a lower level, the data is mixed.  October retail sales were up a better than expected 11.0% year-on-year, but industrial production missed by being up only +5.6%.  China new-home prices for October increased in 27 cities, twelve fewer than September.  Rail freight fell -16.3% year-on-year in October, a worsening from September.  China’s imports fell -8.7% year-on-year, an improvement over last month as weak commodity prices induce some opportunistic buying but exports were down as well, showing no improvement there.  Chinese foreign exchange reserves have continued to fall as well as overseas assets, such as US treasury bonds, though they still have a lot.

Of course a foreign adventure may be suitably distracting – besides the standoff in the South China Sea, China is in final negotiations with the tiny state of Djibouti for a permanent naval base.  Located between Eritrea, Ethiopia and Somalia and across the straits from Yemen, the government of Djibouti is considered by Amnesty International as one of the most oppressive in Africa.  The location strategically can block the Red Sea and thus the Suez Canal.   However, it will put the Chinese navy in the way of many pirate vessels, and since France and the US also have bases there, the strategic powers together.

Japan meanwhile also is trying to thread the solvency needle as an initial Q3 GDP of -0.8% was revised dramatically upwards to +1.0%, thus avoiding another recession.  Industrial output increased in October by +1.4% for the month and retail sales were up 1.8% for the last twelve months on good weather and Chinese tourism (personally vouched by me as I was there in late October and getting a hotel room was a nightmare).  Japan also sold one-year bonds for a negative yield showing the slow economy is still in full force.  Australia also came through with a higher than expected Q3 GDP growth of +0.9%, a pick-up from Q2 of +0.3%.  Net exports grew a surprising amount, given the slowdown in commodities trade with China.  Myanmar reported its first election where the opposition led by Aung San Suu Kyi earned a supermajority of seats over the governing military.  Now the junta faces a real question as to their continued leadership.  Let us hope that the transition will occur and be peaceful. 

Highs Reach New Highs:  OECD oil inventories as estimated by IEA have reached a new high of just under 3 billion barrels.  Record demand has been offset by record supply, reaching 97 million barrels per day in October, which is two million higher than a oil production 2015year ago and despite the slowdown in US production.  OPEC is responsible for 1.1 million barrels of the increase.  At their December meeting, the cartel declined to state a maximum production number, effectively allowing its members to pump as much as they want.  Not much of a cartel is it, then.  The US oil rig count continued its fall to 555 on November 27th but output is still climbing in some of the US shale plays as can be seen in the FT graph to the left.  US shale producers may be leading the way on defaults by sector for 2015 (especially in high yield) but I think that the slowdown will take longer than expected as there is too much money looking for any kind of yield still – and even assuming if Yellen raises rates as expected.  China is still planning to double its strategic petroleum reserve purchases next year but much of that is already contracted for and the country is actively increasing its exports of diesel and gasoline, which would further put negative pressure on oil.  And if the UN envoy is right, a truce may be called between Libya’s warring factions.  It may be short-lived but a respite could put more oil on the market.  And we still have not forgotten about Iran, which is ticking towards the end of its sanctions.

In other commodities news, metals prices continue to tumble with copper reaching six-year lows during November and nickel to its lowest level since 2003.  Glencore is still battling its detractors with the stock price falling 17% in the month, though still above its September lows.  Argentina’s election ushered in a new president who promptly pledged to reduce the export tax on soy, sending the beans down to their lowest levels in seven years as farmers are now more disposed to sell their stores.  US farmers on Corn inventoriesthe other hand are looking to store more grains than ever as low price make the option more attractive.  On-farm storage capacity is estimated to have grown 7% from last December to 13.1 billion bushels.  In livestock, a China – Korea joint venture plans in 2016 to build the world’s largest cloning factory in Tianjin, China to eventually produce over one million head of cattle per year.  To quote the lead scientist, Hwang Woo-suk, the beef will taste “delicious.”  Finally, the US government’s agency that oversees the futures markets, the CFTC, has decided that they will stop collecting data on the flow of money from index funds into the commodity markets, retreating from a practice they began a decade ago when those funds were blamed for soaring prices.  Market veterans may remember the frothing testimony by Michael Masters who was trying to get index funds banned from the commodities markets.  Of course, the fact that this hedge fund manager was trying to boost the stock prices of the companies in his portfolio stands out in stark manipulation.  At least he was obvious about it.

David Burkart, CFA

Coloma Capital Futures®, LLC
Special contributor to aiSource 

Additional information sources:  BAML, BBC, Bloomberg, Deutsche Bank, Financial Times, The Guardian, JP Morgan, PVM, Reuters, South Bay Research, Wall Street Journal and Zerohedge.