It’s always amusing to hear market commentators find a scapegoat for the sell off rather than observe the warning signals leading up to it. I mean take your pick: Emerging market currency wobbles, softer US growth, Fed continuing to taper, or Weak China PMI? Over the last few weeks we have seen a clear break in Developed Market Equities and risk assets, rally in US Treasuries, and USD/JPY falling? Notice a trend? All over owned positions carried over from 2013.
Given the currency moves seen in Argentina, Turkey, and South Africa alongside broad EM weakness, it’s easy to blame EM for this sell off. Given the huge imbalances that have built up over the years, a combination of weaker currency moves and higher interest rates is needed to make the necessary adjustment. This theme has been ongoing for some time, so what spooked the markets now?
Dare I say, could it be that markets were extremely complacent coming into 2014 and investors are left long with no catalysts to drive it higher for now? Investors are long DM Equities, cyclicals, and anything geared to US and Global economic recovery; I like to describe investors coming into 2104 positioned as “lazy longs”. A sense of apathy driven by lack of alternatives but desperate not to be left out given the bullish sell side predictions for this year.
2014 is all about seeing the earnings recovery the market has very well priced in already given the 50% P/E rerating seen over the past year. We are in the midst of q4’13 reports and company earnings have not been stellar, with no upgrades seen. Less than a third of European companies have reported so far, where 51% missed and only 21% met and 28% beat earnings expectations. Even the macro data has been a bit soft for the US, and China HSBC PMI print for January came in at 49.5 from 50.5 in December, the first deterioration in 6 months. Don’t forget the carry trade: the Japanese Yen. This is the daddy of all carry trades and the market has been extremely short of it coming into 2014 and long the Nikkei index. The Nikkei is down 10% and Yen has strengthened 3%. If the unwind momentum continues, this will hit other risk assets as well. The market lacks catalysts and put protection that expired worthless since December/January expiration and not rolled forward given how futile an exercise it was to do so all last year; the market is a bit exposed right now.
Another contributing factor to the current sell off has been the Bond/Equity ratio charts at elevated levels short term. Given the performance seen last year, pension funds are extremely solvent and probably needed to “rebalance” a bit by selling Equities and buying bonds into month end which hits the large cap stocks as is futures driven.
There has been no change in fundamentals or the bigger picture. The Great Rotation trade is alive and well, just timing is a bit off. Investors have been caught in a game of musical chairs, and the music has stopped temporarily. Choose your entry point carefully. Energy and Basic resource Equities are still not the place to invest, for now.
