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Yardeni: Another Panic Attack or the True End of Bull Market?

Yardeni: Another Panic Attack or the True End of Bull Market?
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Tuesday, 19 January 2016 10:55 AM Current | Bio | Archive


Given the mauling the bull market has taken since the start of the year ...  the question is whether this panic attack is simply the latest in a long series of panic attacks followed by relief rallies that have characterized this bull market or whether it marks the end of the bull market.

While I remain in the secular bull camp, we have to admit that this selloff has been one of the grizzliest of the lot. That’s because it follows a significant underlying technical deterioration of the market since its record high on May 21 of last year.
 
While the current 10.9% correction covers 73 calendar days since last November’s high, it has amounted to an 11.8% decline over the 239 days since the May 21 high. Of course, this year’s freefall is reminiscent of last August’s plunge. Both were triggered by sharp declines in the Chinese stock market and weakness in China’s currency.
 
I am currently in London meeting with our accounts all week. At the end of last week, I met with some of our accounts in New York City. The level of anxiety among them was very high, more so than during the previous corrections of the latest bull market. That’s because there is much more concern now that the plunge in commodity prices, particularly the price of oil, has resulted from a hard landing of China’s economy, which could trigger a global recession that may already be weakening the US economy. Everyone agrees that a US recession made in China would be unprecedented, but that scenario certainly has gained lots of anxious converts since the start of the year.
 
Debbie and I were early in seeing the end of the commodity super-cycle in late 2013. During 2014, we characterized it as the latest debt-inflated bubble that was bursting as we monitored the drops in the CRB raw industrials spot price index and the price of a barrel of Brent. However, we’ve been relatively sanguine that while global economic demand was slowing, it wasn’t falling into a recession. The problem, we thought, was simply too much supply from commodity producers who had overestimated the long-term prospects for demand, especially from China. The bursting of the commodity super-cycle bubble was really the bursting of the China bubble.
 
The fear now is that the problems for the producers of commodities are feeding back to depress demand. That’s because they are facing a credit crunch, which is widening the yield spread between corporate junk bonds and 10-year Treasuries. The average yield on high-yield corporate bonds has jumped by 400bps since June 24, 2014 to 9.16%. Even investment-grade yields are up 76bps to 3.60% since April 17, 2015. With credit conditions tightening and prices falling, producers are slashing their capital outlays, which means their problems are spreading to the industries that are in their supply chain.
 
In my meetings in New York, a few accounts raised the specter of the 2008 financial crisis. They noted that back then it was widely believed that the subprime mortgage problem would be contained. Instead it turned into a global contagion. This time they fear that the collapse in oil prices will have a similar contagion effect on credit and stock markets, with negative consequences for the global economy as energy-related capital spending takes a dive. There is also concern that the negative wealth effect on oil exporters will depress demand for luxury goods, and that their sovereign wealth funds will be forced to sell their stocks to maintain their governments’ social welfare commitments. One fellow observed, “It’s hard to imagine that a 75% price collapse in a key commodity like oil isn’t going to have lots of adverse consequences.”
 
All good points. Nevertheless, in our opinion, this isn’t 2008 all over again. We also still doubt that the global economy is heading into a recession that drags down the US economy as well. We remain in the secular stagnation camp on the outlook for world economic growth.

Let’s see what the latest data show — starting with the good, then the bad, and ending with the ugly:
 
(1) Global oil demand. It is encouraging to see that the price mechanism is working, at least on the demand side of the oil market. While supply has yet to fall, lower oil prices are boosting oil demand, which we view as a sign of life in the global economy that so many are giving up for dead so quickly. Data compiled by Oil Market Intelligence show that world oil demand over the past 12 months is up 2.4% y/y through November, the fastest pace since July 2011.
 
Despite all the concerns about the outlook for emerging economies in a world of secular stagnation with weak commodity prices, non-OECD oil demand is up to 3.5% y/y using the 12-month smoothed data, the best reading since October 2013. Leading demand higher among the emerging economies are the two biggest ones, i.e., China and India. Granted, some of that may reflect stockpiling of strategic oil reserves. In addition, oil demand has turned weaker in Latin America in recent months, especially Brazil.
 
(2) Industrial commodity prices.
During the summer of 2014, we started to write regularly about the decline in the CRB raw industrials spot price index. Though we’ve used the CRB in the past as one of the best real-time high-frequency indicators of global economic demand, as noted above, we believed that some of the weakness since mid-2014 reflected too much supply. In any event, while the recent firming of this index has only been happening for two weeks, it may be an encouraging sign — especially in the face of the ongoing plunge in oil prices.
 
(3) U.S. consumers. Also responding positively to lower oil prices are U.S. consumers. Gasoline usage is the highest since the end of 2008, and vehicle miles traveled rose to another record high during October. Yet as we noted last week, it is puzzling to see that the windfall to consumers at the gas pumps, which amounts to over $100 billion at an annual rate, has been matched by a similar increase in personal saving rather than an increase in spending on other consumer goods and services.
 
As Debbie reports below, retail sales were weak in December. However, warmer-than-usual weather and early discounting by retailers during the holiday season may have distorted yearend results. Debbie estimates that inflation-adjusted retail sales rose 4.3% (saar) during Q4, up from 4.1% and 2.6% the prior two quarters.
 
Nevertheless, investors were unsettled by December’s weak retail sales report as well as news that Walmart said it will close 269 poorly performing stores in 2016. Of the 16,000 employees to be affected, 10,000 will be in the US. The company aims to place them in nearby Walmarts. That follows news that Macy’s will also be closing some stores. Online sales during November accounted for a record 25.5% of the types of merchandise sold by department stores. This development may be starting to weigh on retail store employment, which fell 12,300 during December.
 
(4) U.S. production. While Debbie and I continue to expect that consumer spending will drive U.S. economic growth and keep the US out of a recession, clearly some of the merchandise that consumers purchase comes from abroad. If the Chinese currency continues to weaken, that will make Chinese goods more attractive for U.S. consumers. The strong trade-weighted dollar is already weighing on U.S. exports. That’s all challenging for U.S. manufacturers. So is the slashing of spending by energy companies.
 
Industrial production fell 3.5% (saar) during Q4, depressed by the weak output of utilities during the unseasonably warm quarter. Manufacturing output, however, rose, but by only 0.5% (saar), weighed down by a 16.3% plunge in energy materials output — which includes coal, by the way. With less coal, shale oil, and fracking sand to transport on the rails, no wonder that Michael Ward, the chief executive of the CSX railway, said last week that the U.S. is in a “freight recession.” That certainly helped to unsettle investors.
 
(5) Chinese social financing. The cover story of this week’s The Economist is sarcastically titled “Everything’s under control: China, the yuan and the markets.” The magazine opines: “For well over a decade, China has been the engine of global growth. But the blistering pace of economic expansion has slowed. The stock market has been in turmoil, again. Although share prices in China matter little to the real economy, seesawing stocks feed fears among investors that the Communist Party does not have the wisdom to manage the move from Mao to market. The rest of the world looks at the debts and growing labor unrest inside China, and it shudders. Nowhere are those worries more apparent — or more consequential — than in the handling of its currency, the yuan.”
 
In one of my meetings in NYC last week, one fellow asked what would happen if the Chinese sharply devalued their currency, which has been gradually depreciating since late 2013. I answered that it would be very bad news for other emerging economies. The Emerging Markets MSCI stock price index (in local currency) has been falling along with the yuan over the past year. A weaker yuan could boost imports into the US, but would mostly lower the dollar cost of everything that China has been sending our way, thus boosting the purchasing power of US consumers.
 
China clearly has become a very big concern for investors. Everything actually may be out of control in China, as suggested by the above-cited cover of The Economist showing a panic-stricken President Xi Jinping riding a flying dragon that seems to be in a death dive. It may be that the transition from an export-led manufacturing economy to one based on services for domestic consumers isn’t going smoothly. There may be too much excess capacity in the old economy impeding movement toward the new economy.
 
The biggest problem of all is that so much of China’s growth has been debt-financed, as we’ve previously monitored by focusing on bank loans. They totaled $14.6 trillion during December, doubling since January 2011. They’ve been mostly financed by a similar increase in M2, reflecting the very high savings rate in China. The problem is that the bank loans financed too much excess capacity in manufacturing. Furthermore, the y/y increases in both bank loans and M2 have slowed dramatically. However, some of that may be occurring as the government has implemented measures to encourage more borrowing in the bond market. That was very noticeable in December’s “social financing” data.
 
Meanwhile, last Thursday, investors were spooked when Intel issued a financial projection for Q1 that was lower than analysts expected. Intel executives attributed its low expectation largely to the possibility of lower sales of personal computers in China, a huge market for many U.S. technology suppliers. “Our team on the ground in China has gotten fairly cautious about what’s going on,” said Intel’s chief financial officer during a conference call with analysts to discuss its Q4 results.
 
(6) Pessimistic indicators. While I view the alarmist cover story about China in the latest issue of The Economist as a contrary indicator that China isn’t about to crash and burn, we do worry about another reliable indicator of trouble ahead, i.e., the curse of the tallest buildings. The 1/12 Washington Post reported: “The Shanghai Tower in China was officially crowned the second-tallest building in the world last week. The same day, as if on cue, the country’s stock market had tanked.
 
“Shanghai Tower is not just a skyscraper. It’s a ‘mega-tall’ building — yes, that’s a technical word — that stands more than 2,000 feet high, a spiraling steel spire with 106 elevators and indoor sky gardens. The building is a testament to China’s rapid transformation into a global economic superpower as well as a symbol of its lofty ambitions for the future.”
 
Actually, the super-tall skyscraper index is warning about a global recession. A 1/14 Bloomberg article is titled “World’s Supertall Skyscrapers Double in Five Years to 100: Chart.”

Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research. To read more of his blogs, CLICK HERE NOW.

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EdwardYardeni
Given the mauling the bull market has taken since the start of the year ... the question is whether this panic attack is simply the latest in a long series of panic attacks followed by relief rallies that have characterized this bull market or whether it marks the end of the bull market.
stock market, investors, panic, bull
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2016-55-19
Tuesday, 19 January 2016 10:55 AM
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