JAN-FEB 2016 INVESTMENT JOURNAL: NIPPONESE NEGATIVES
- US Fed leaves rates unchanged
- Bank of Japan drops rates below 0%
- US wages in uptrend
- Ten year Japanese Government Bond trades below 0%
US stocks finished February close to flat (-0.2%) after an early-month sell-off and recovery. For the year, stocks are still in the red following an ugly January, with international developed markets faring the worst, down close to 9%. As stock market risk has risen, other asset classes have benefited from a flight to safety. Bonds have returned 2% in 2016, and Treasury Inflation Protected Bonds (TIP's) have returned close to 3%. Gold, the other safe haven asset, made a comeback, returning 17% this year after a multi-year sell-off that may be coming to a close. Commodities in general are still weak, with oil prices still struggling in the face of a global supply glut. Economic weakness in China is also putting broad pressure on hard asset prices:
The last year has been a rollercoaster ride for investors as the US stock market has provided the first major downdraft in several years. Global economic weakness and a strong US dollar have been the main drivers behind these stock swings. The Federal Reserve's decision to tighten monetary policy in December of 2015, just as the economy started to show real signs of a rough patch, caused stocks to sell off more than 10% this year, reaching their lowest point on February 11th. Stocks have since made an initial recovery, but investors are skeptical, as company earnings expectations for the year are declining into the second quarter, and GDP estimates for the first quarter are currently at only 1.9%.
These signs of economic sluggishness have had many market prognosticators claiming that the US is already in recession (or headed in that direction quickly). Others have stated that the downswing in gas and other commodity prices should help provide stability, as it puts more cash in consumers' pockets to spend elsewhere. The US Dollar's move higher against other currencies during late 2014, and continued strength to this point, has been a major headwind for multinational firms. Any shift in guidance from the Federal Reserve that suggests a slower timeline for the tightening of monetary policy, or even another round of Quantitative Easing, would lead to a weakening in the US Dollar that would provide some relief to those large corporations. Since the US is the only developed economy in a tightening phase (which put the upward pressure on the Dollar), a closer alignment with the rest of the world should be manifested in currency markets. In the meantime, US stocks retain their performance crown versus all other major asset classes over the last several years:
The Federal Reserve met in late January and decided to keep its key interest rate unchanged, signaling that it's taking a time-out before resuming its effort to normalize interest rate policy. The lack of movement was widely expected. Fed watchers noted that one key phrase had been removed from the post-meeting statement that was present in the December minutes. The phrase "The committee...is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective." was replaced with inflation is "expected to remain low in the near term" but still rise to the 2% in the medium term. Though the change is subtle, it implies that the Fed is retreating from the implied projection of 4 quarter-point rate hikes in 2016.
In Japan, the Bank of Japan shocked markets around the world by taking the aggressive step of cutting interest rates below zero on January 29th. This policy essentially means that banks will have to pay for the privilege of "parking" money at the central bank, and in theory this should motivate the banks to lend more. The move represents a last resort for the country that has struggled with weak growth for a quarter-century. This move was also widely interpreted as being a damper on the pace at which the U.S. Fed increases interest rates, since now the European Central Bank and the Bank of Japan have gone the opposite direction as the U.S. in their respective interest rate policies.
We also learned in January that capital outflows from China surged $158.7 billion in December to an estimated $1 trillion for all of 2015. The large scale of the outflows is a sign of the battle being waged among policymakers trying to manage the yuan amid slower economic growth and falling Chinese stock markets. The entire year's estimated trillion-dollar total is greater than 7 times the prior year's $134.3 billion, according to Bloomberg Intelligence data. December's outflows increased by almost $50 billion over November after China's central bank stated that it would refocus the yuan's moves against a wider basket of currencies than just the dollar, which we highlighted in last December's Investment Journal. This is a very important development that investors should be monitoring closely, for it suggests that deflation is nowhere near ending as China is poised to methodically devalue its currency over time.
In early February, the release of US jobs data showed the unemployment rate dropped from 5.0% to 4.9%, despite a weaker than expected addition of 151,000 jobs in January. The data also showed wage growth accelerating at a 2.5% annual rate. This continues a recent trend of rising wages that has not been seen since the entire post 2008-09 crash period:
All in all, the report suggests America's jobs market is holding its ground in the face of mounting concern about the health of the world economy.
The real shocker in February again had its epicenter in Japan, as the 10 year government bond yield traded below 0% for the first time in that nation's millennia old history on February 9th. The graphic below from the Financial Times shows how quickly longer term bond yields moved in reaction to the surprise move by the BOJ:
Investors clearly did not anticipate this monetary stimulus, and were blindsided. Japanese stocks plunged over 5%, but the Yen, counterintuitively, rose to a 15 month high against the US Dollar (another case of unanticipated reaction). Japan's stimulus program, called "Abenomics" after their Prime Minister Shinzo Abe, has relied on ultra-loose monetary policy to push down the value of the yen (i.e. zero percent interest rates are unattractive to foreign investors, who will sell yen to invest elsewhere). Instead, the yen's rise has thwarted hopes of an export led recovery, and now Japan finds itself squarely in the cross-hairs of the Chinese, who will not tolerate a weaker yen because they desperately need their export industries to become more competitive. This is what many call a "beggar thy neighbor" trade policy, and it is all part and parcel of a global currency re-alignment that will have a profound impact on capital markets and economies globally over the next several years.
As a reminder, note below that the US has the highest government bond yields of any developed country AND a strong currency. Who says the US can't join the negative rate club, pushing bond yields lower in the US?!:
As February drew to a close, US GDP for the fourth quarter was revised upward to +1.0% growth by the Commerce Department, better than the +0.7% gain initially reported. For the year, the economy grew a very modest +2.4%, the same as in 2014. The report was a surprise to Wall Street, which had expected a downward revision.
One long-standing indicator of stock market health is the amount of money borrowed by investors and speculators for stock purchases - called "margin debt". The amount of outstanding margin debt reached a peak last April and has declined steadily ever since. Originally devised in the 1970's by market analyst Norman Fosback, the margin debt indicator has a good record of identifying Bull and Bear markets when compared to its own 12-month moving average. The identification is even more accurate when the margin debt breach is more than a one-month aberration. Unhappily for the Bulls, margin debt has now remained below its 12-month moving average for 5 consecutive months:
In closing, we learned in February that a long-standing issue facing the world's third-largest economy - Japan - has finally manifested itself in a visible way. The official population of Japan as of Oct. 1 is 127.1 million, which is down by 947,000 or -0.75% from the previous census in 2010; this is the first-ever decline since the census started in 1920! Even during World War II the population rose. A UN report last year projected that Japan's population would fall to about 83 million by 2100. The average number of children a Japanese woman will bear in a lifetime - just 1.42 as of 2014 - is far below the replacement rate of 2.1. It doesn't help that Japan keeps a tight lid on immigration, which business leaders are calling to be loosened, but Prime Minister Shinzo Abe is showing no signs of changing existing policy. The Japanese census figures are likely to further Japan's decades-long stagnation. From a government standpoint, further stimulus packages are likely. The declining Japanese population is particularly visible in many rural prefectures. While Tokyo's population grew +2.7% from 2010 to 2015, the population in 39 of Japan's 47 prefectures declined. All in all, another Nipponese Negative!
Thanks for reading our Journal. We hope you and yours have a great month, and don't forget to wear some green and celebrate all things Irish on St. Patrick's Day. Éirinn go Brách!
©2016 Stratford Advisors, Inc. All Rights Reserved.
This publication is intended solely for information purposes and is not to be construed, under any circumstances, by implication or otherwise, as an offer to sell or a solicitation to buy or sell or trade in any securities herein named. Information is obtained from sources believed to be reliable, but is in no way guaranteed. No guarantee of any kind is implied or possible where projections of future conditions are attempted. In no event should the content of this market letter be construed as an express or implied promise, guarantee or implication by or from Stratford Advisors, Inc., or any of its officers, directors, employees, affiliates or other agents that you will profit or that losses can or will be limited in any manner whatsoever. Past results are no indication of future performance. All investments are subject to risk which should be considered prior to making any investment decisions. The firm may hold for its clients, Principals or employees, positions in any securities mentioned herein, and may buy or sell such securities at any time without prior notice.