Markets fall despite Fed patience

The Federal Reserve left monetary policy unchanged on Wednesday.

While the Fed noted in its monetary policy meeting statement that economic activity has been expanding at a “solid pace”, it also said that it “can be patient in beginning to normalize the stance of monetary policy”.

Investors did not seem to take much comfort from the Fed statement though. Markets mostly fell on Wednesday. The S&P 500 fell 1.4 percent, US 10-year Treasury yields fell 10 basis points to 1.72 percent and oil plunged 3.9 percent.

In Europe, the STOXX Europe 600 managed to close up 0.1 percent. However, Greece’s 10-year bond yields rose 87 basis points to 10.35 percent, Italy’s 10-year yield increased six basis points to 1.59 percent and Portugal’s climbed 15 basis points to 2.59 percent.

Markets fall as US durable goods orders show decline

Markets fell on Tuesday.

The S&P 500 fell 1.3 percent amid concerns on the economy. A report on Tuesday showed that orders for US durable goods declined 3.4 percent in December after falling 2.1 percent the prior month.

The STOXX Europe 600 fell 1.0 percent, ending an eight-day rally that had taken it to a seven-year high. Greek stocks fell 3.7 percent, extending declines since Sunday’s elections to 6.9 percent.

The Shanghai Composite Index fell 0.9 percent after closing at a more than five-year high on Monday.

The US dollar fell against the euro and yen while the US 10-year Treasury yield fell one basis point to 1.82 percent.

Among commodities, copper fell 3.2 percent but gold, natural gas and oil rose.

Markets rally on ECB bond-buying announcement

Markets rose last week, and not for the first time, investors have a central bank to thank.

On Thursday, the European Central Bank announced after its monetary policy meeting that it would be buying 60 billion euros of sovereign bonds and other debt securities every month from March through September next year in an effort to avert deflation.

Stocks rose on Thursday on the decision, helping markets to finish the week up. The MSCI All-Country World Index rose 2.1 percent last week for its biggest weekly gain of the year. The Standard & Poor’s 500 Index rose 1.6 percent. The STOXX Europe 600 jumped 5.1 percent to the highest since December 2007. The Nikkei 225 Stock Average rose 3.8 percent. The MSCI Emerging Markets Index rose 3.5 percent.

The euro fell 3.1 percent against the US dollar last week while European government bonds rose. Germany's 10-year bond yield hit a record low of 0.345 percent while Italy's 10-year bond yield touched a record low of 1.413 percent.

The euro could decline further this week after the Syriza party won the elections in Greece on Sunday. Led by Alexis Tsipras, the Syriza party had campaigned against fiscal austerity and promised to renegotiate Greece's debts, a move that could risk getting the country expelled from the euro bloc.

ECB launches trillion euro QE

The European Central Bank announced its quantitative easing programme on Thursday. Bloomberg reports:

Mario Draghi led the European Central Bank into a new era, committing to a quantitative easing program worth at least 1.1 trillion euros ($1.3 trillion) to counter the threat of a deflationary spiral.

The ECB president shrugged off determined opposition led by German officials with a pledge to buy 60 billion euros every month through September next year in a once-and-for-all push to put more cash into circulation and revive inflation. To assuage critics, the region’s 19 national central banks will make 80 percent of the purchases and take on any risk they carry.

Markets reacted positively to the announcement. The S&P 500 rose 1.5 percent while the STOXX Europe 600 jumped 1.7 percent.

The euro declined 2.1 percent to $1.1363 as Italy’s 10-year yield fell 14 basis points to 1.55 percent, Spain's 10-year yield declined 13 basis points to 1.41 percent and Germany's bund yield fell eight basis points to 0.45 percent.

US auto loans fuel concerns

There have been increasing concerns that US auto loans may become a source of problems for the financial system. From the Wall Street Journal earlier this month:

Borrowers who took out auto loans over the past year are missing payments at the highest level since the recession, fueling concerns among regulators, analysts and some in the car industry that practices that helped boost 2014 light-vehicle sales to a near-decade high could backfire.

“It’s clear that credit quality is eroding now, and pretty quickly,” said Mark Zandi, chief economist at Moody’s Analytics.

One problem is that many of the auto loans are subprime, that is, being made to borrowers with low credit scores. Honda’s US sales chief John Mendel said in an interview last week that competitors are doing “stupid things” to boost auto sales, including making 84-month loans that reduce monthly payments while making it tougher to repay faster than cars lose value.

However, Bank of America Merrill Lynch’s Michael Hanson said in an October note to clients that auto loans are not a threat to the financial system, being a much smaller proportion of household debt than mortgages.

Still, they are an additional risk to a financial system that is still reeling from the Swiss bombshell last week.

Europe risks Lehman Brothers moment while Chinese shares plunge

Desmond Lachman asks whether Greece will trigger a Lehman Brothers moment for Europe.

In September 2008, United States policymakers made the costliest of policy miscalculations by allowing the Lehman investment bank to go bankrupt. That mistake triggered the worst global economic recession in the post-war period.

Judging by recent statements by German and French political leaders, it appears that it is now the European policymakers’ turn to make a major economic policy blunder. Since, ahead of the January 25 Greek parliamentary elections, those leaders are clearly signaling that they stand ready to cut Greece loose from the Euro should Greece choose not to comply with its European commitments...

Sadly, it is all too likely that, as was the case when U.S. policymakers allowed Lehman to go bankrupt, European policymakers are now underestimating the all too real risks of a Greek exit.

The reality, though, is that markets and financial institutions have become highly leveraged and a Lehman Brothers moment can potentially be triggered by a number of events. For example, even the decision by the Swiss central bank last week to abandon its cap of the Swiss franc against the euro is causing significant losses among financial institutions. From Bloomberg:

The $400 million of cumulative losses that Citigroup Inc., Deutsche Bank AG and Barclays Plc are said to have suffered from the Swiss central bank’s decision to end the cap on the franc may be followed by others in coming days.

“The losses will be in the billions -- they are still being tallied,” said Mark T. Williams, an executive-in-residence at Boston University specializing in risk management. “They will range from large banks, brokers, hedge funds, mutual funds to currency speculators. There will be ripple effects throughout the financial system.”

And it is not just Europe. The 16th Geneva Report on the World Economy in September last year identified the debt trajectories of emerging economies, especially China, as a source of concern and “which could host the next leg of the global leverage crisis”.

Indeed, after a strong rally that some say has been fuelled by margin financing, Chinese shares plunged on Monday, with the Shanghai Composite Index falling 7.7 percent, the biggest fall in more than six years, after the China Securities Regulatory Commission said on Friday that it had suspended three brokerages from opening new margin trading customer accounts for three months after an inspection found rule violations.

Stocks rise, oil rebounds, Russia downgraded

Markets appear to have stabilised somewhat after the shock Swiss move on Thursday.

Bloomberg reports the market action on Friday:

The Standard & Poor’s 500 Index (SPX) jumped 1.3 percent at 4 p.m. in New York, trimming a third weekly decline to 1.3 percent. Energy shares led gains as oil surged 5.3 percent. Goldman Sachs (GS) Group Inc. dropped 0.7 percent after reporting the lowest annual trading revenue since 2005. The franc weakened after soaring 23 percent yesterday and the Swiss Market Index (SMI) retreated 6 percent. Ten-year Treasury rates added 12 basis points to 1.83 percent. The Bloomberg Dollar Spot Index rose 0.3 percent and the euro slid to an 11-year low.

The improvement in US investor sentiment was matched by that in consumer sentiment. A report on Friday showed that the University of Michigan preliminary consumer sentiment index rose to 98.2, the highest since January 2004, from 93.6 in December.

Investor sentiment in Europe also mostly improved.

Italy’s 10-year yield reached a record-low 1.64 percent. Switzerland’s 10-year yield turned negative for the first time, reaching minus 0.031 percent...

The Stoxx Europe 600 Index climbed 1.1 percent to the highest since 2008, as the SNB move fueled speculation the ECB will act.

Greece was a notable exception.

Greece’s three-year note yield jumped 89 basis points to 11.07 percent.

Russia is also facing similar prospects after getting its credit rating downgraded by Moody's.

Russia’s credit rating was cut to the lowest investment grade by Moody’s Investors Service as plunging oil prices and the worst currency crisis since 1998 drag on growth.

Moody’s lowered the country to Baa3, one step above junk, from Baa2. The credit grade matches those of Standard & Poor’s and Fitch Ratings. The rating, on par with India and Turkey, is on review for a further reduction, Moody’s said in a statement.

Markets in turmoil on end of cap on Swiss franc

Markets were hit on Thursday by the Swiss central bank's decision to abandon its cap of the Swiss franc against the euro.

Bloomberg reports:

The Swiss National Bank roiled markets worldwide with its unexpected decision to abandon the franc’s cap against the euro, knocking down what an official just two days ago reaffirmed as a pillar of policy.

Europe’s shared currency slumped 1.9 percent against the dollar before recouping much of the decline as traders reflected on the decision, which also saw the SNB deepen negative deposit rates. SNB President Thomas Jordan defended the move, saying surprise was necessary. The franc surged as much as 38 percent versus the greenback and gained against all 174 foreign-exchange values tracked by Bloomberg. Volatility jumped to a more than one-year high.

Questioning the outlook for bonds and equities

In his latest weekly commentary, Corey Hoffstein, Chief Investment Officer and Chief Technology Officer of Newfound, questioned two widely-held beliefs in the investment world.

First, he looked at the expected direction of bond prices.

For the last several years, analysts, market commentators, and speculators alike have been claiming that interests rates must rise at some point, and when that day came, any investor that held long-duration bonds would be in for a world of pain.

It takes less effort to prove something false than it does to prove something true... To prove something false, you only need a single contradictory example.

With 30 Year U.S. Treasury Bond yielding 2.69%, rates going up does seem like the obvious conclusion...

Looking abroad, however, we can find our single contradictory example. Germany’s 30-Year Bunds are currently yielding 1.25% and fell as low as 1.05% on Wednesday...

Then he looked at equity as long-term investments.

... It is commonly held that stocks will appreciate over the long run... We simply ask: how do Japanese equities fit into this belief model?

Japan’s GDP is nearly unchanged for the last 20 years and the Nikkei 225 has been similarly unchanged for those that bought-and-held over that period. After 20 years, Professor Norihiro Kato suggested that Japan might, perhaps, be the world’s first “post growth” society, focused less on consumerism and growth and more on quality of life. No amount of stimulus will be able to reboot that sort of cultural change.

However, Japan has often been considered an exceptional case because of its declining workforce. As Tony Kelly, economist at National Australia Bank, wrote: “Japan's population is already declining, and with its society also ageing the drag on the workforce is potentially even greater.”

Indeed, with an ageing population, stimulus may make things even worse by burdening society with more debt.

However, Japan will not be an exceptional case for much longer. From a recent report from the McKinsey Global Institute on global growth: “The demographic tailwind that powered the world economy over the past 50 years is declining in most countries and even becoming a demographic headwind against growth.”

Rising deflationary risks in the US

Sober Look says that there is rising deflationary risks in the United States that may deter the Federal Reserve from raising interest rates.

It notes that intermediate-term market-based inflation expectations have fallen to 2009 levels, when deflation was a serious concern.

Meanwhile, energy prices have been falling, and not just for oil. Natural gas, coal and even uranium prices have also fallen.

While there may be positive effects from the fall in energy prices, it also says that some industries in the energy sector will be severely disrupted, resulting in debt restructuring, consolidation and job losses.

Apart from energy prices, wage growth has started to fall. The employment report for December showed that average hourly earnings fell 0.2 percent.

Also, the PriceStats CPI trend (online-price-based CPI-tracking model) has fallen to 2009 levels.

Sober Look concludes:

Putting it all together points to rising risks of deflation in the US. There is absolutely no way the Fed can raise rates in this environment. In fact some Fed officials are quite open about taking any 2015 rate hikes off the table.

Oil could fall to $40

West Texas Intermediate crude oil fell below $50 a barrel last week. Goldman Sachs thinks that it could fall further in the next few months. Bloomberg reports:

Goldman Sachs said U.S. oil prices need to trade near $40 a barrel in the first half of this year to curb shale investments as it gave up on OPEC cutting output to balance the market...

“To keep all capital sidelined and curtail investment in shale until the market has re-balanced, we believe prices need to stay lower for longer,” Goldman said in the report. “The search for a new equilibrium in oil markets continues.”

West Texas Intermediate, the U.S. marker crude, will trade at $41 a barrel and global benchmark Brent at $42 in three months, the bank said. It had previously forecast WTI at $70 and Brent at $80 for the first quarter.

While much of the decline in oil prices has been attributed to increased production, Jim Hamilton at Econbrowser thinks that falling demand has also had an impact.

[O]f the $55 drop in the price of oil since the start of July, about $24, or 44%, seems attributable to broader demand factors rather than anything specific happening to the oil market. That’s almost the same percentage as when I performed the calculation using data that we had available a month ago.

So what’s been happening on the supply side of oil markets is important. But so is what’s been happening on the demand side.

Stocks erase loss for year

Stocks rose on Thursday.

The S&P 500 rose 1.8 percent, the STOXX Europe 600 jumped 2.8 percent and the MSCI Emerging Markets Index gained 1.9 percent, all erasing year-to-date losses.

Oil was mixed though. Brent fell 19 cents but West Texas Intermediate rose 14 cents.

Markets fall as Gross says good times are over

Markets fell on Tuesday.

The S&P 500 lost 0.9 percent, its fifth consecutive decline, the longest losing streak in 13 months. West Texas Intermediate oil fell 4.2 percent while the yield on US 10-year Treasuries fell seven basis points to 1.96 percent.

The STOXX Europe 600 fell 0.7 percent, its third consecutive decline, amid concerns over the possible exit of Greece from the euro area. The MSCI Emerging Market Index fell for a fourth day, declining 0.8 percent.

Bill Gross thinks that there are more losses in store for assets in 2015. In his Investment Outlook for January, Gross says: “When the year is done, there will be minus signs in front of returns for many asset classes. The good times are over.”

As goes January, so goes the year?

In a recent blog post, Corey Hoffstein, Chief Investment Officer and Chief Technology Officer of Newfound, looked at whether market performance in January provides any useful indication of its performance in the rest of the year.

At the end of every January there is an onslaught of articles talking about the old adage, “as goes January, so goes the year.” The translation is that the performance in January is a good indicator of how the year will turn out...

Let’s set up the basics: using S&P 500 index data going back to 1951, we can calculate that in 75% of years, the directional return – positive or negative – from the year mirrored the directional return of January...

... A strong January gives the full year’s return a solid head start, but it says nothing about performance in the following 11 months.

What’s a simple way to test this? We can look at the probability that February through December is positive given that January was positive... What is this probability? Close to 70%.

If that seems high it is because...markets, historically, have tended to go up. In fact, the raw probability that February through December was positive over the same time frame is 75%.

In other words, there is no extra information in January’s return that helps us forecast February through December. And nor would we expect there to be from any theoretical foundation.

Strategists see more gains for US stocks in 2015 as bonds look pricey

After three consecutive years of gains, the Wall Street Journal reports that Wall Street strategists forecast more gains for US stocks in 2015:

The U.S. central bank is expected to raise short-term interest rates this year for the first time in nearly a decade, but strategists still expect U.S. stocks to end the year with gains...

Wall Street strategists see the S&P 500 rising 8.2% this year, based on the average forecast of banks and money-management firms polled by research firm Birinyi Associates. Accelerating economic expansion in the U.S. and strong corporate-earnings growth will continue to power the rally, they say.

High valuations are a concern though.

To be sure, some strategists are concerned about the stock market’s relatively high valuation, saying that it leaves stocks vulnerable to a sharp pullback if earnings disappoint or if the economic outlook darkens.

Still, bonds, the traditional competitor for the investor’s money, is not looking cheap either. CNN reports on Sunday:

Stocks are pricey...

Bonds are the obvious alternative. There’s just one problem: If stocks look a little scary, bonds look worse.

“Every time you hear someone say we're at record low yields, what they're really saying is we're at record high bond prices,” says Burt White, chief investment officer of LPL Financial...

The advice for 2015 is to keep your portfolio overweight stocks and underweight bonds.

Developed stock markets rise for third consecutive year

Stocks had another positive year in 2014, especially in developed markets.

Stock markets in the United States, Europe and Japan all rose for the third consecutive year. The Standard & Poor's 500 Index in the US rose 11.4 percent last year, the STOXX Europe 600 Index rose 4.4 percent and Japan's Nikkei 225 Stock Average rose 7.1 percent.

Stocks had a positive year despite ending on a weak note. The S&P 500 fell 0.4 percent last month, its first December decline since 2007. The STOXX Europe 600 fell 1.4 percent last month, its first December decline since 2008. The Nikkei 225 fell less than 0.1 percent.

Markets finished down in December despite hitting multi-year highs earlier in the month. The S&P 500 hit an all-time high on 29 December. The STOXX Europe 600 hit its highest level in almost seven years on 5 December. The Nikkei 225 briefly rose above 18,000 on 8 December for the first time in seven years.

While stocks in the developed markets did well in 2014 as a whole, stocks in emerging markets were mostly weak. The MSCI Emerging Markets Index fell 4.6 percent in 2014.

China's stock market was an exception to the weakness in emerging markets. The Shanghai Composite Index rose 52.9 percent in 2014 to close at the highest level since January 2010.