FYI | May 04 2011
GaveKal offered the following observations this week
In his April newsletter, legendary investor Bill Miller (of Legg Mason) reviews the performance of US equities since the beginning of the year and remarks: "The most surprising thing about this market is that only two of the S&P sectors outperformed the broad S&P 500 in the first quarter on a price basis: energy and industrials. Energy was ahead by almost 1,100 basis points, while industrials led by around 300 basis points. All the other sectors underperformed. The last time this happened was in the first quarter of 2000, as the tech bubble was in the process of peaking, when the only two sectors to outperform were tech and utilities…."
Interestingly, this narrowing leadership does not solely seem to be the hallmark of equity markets; in April, commodity prices fell (CRB index: -0.9%) in spite of a very weak US$ (-3% on a trade-weighted basis to a new post Bretton-Woods low), a surge in oil prices (WTI rose +6.5% to $113/barrel) and gold setting fresh new nominal highs 13 times over the course of the month.
This pull-back in the CRB in the face of impressive oil and precious metals strength is attributable to a) the -34% drop in sugar from the multi-decade high set in February; b) the -17% drop in cotton since the all-time record set in early March, c) the year-to-date retreat in copper, lead, zinc and wheat… So what could be the reasons behind this narrowing leadership in risk assets? And what should we make of it?
– The first and most obvious explanation is that we are now clearly entering into a different global central banking environment. The PBoC has been tightening for a while, ECB board members are trying to 'out-German' each other in the current leadership vacuum, the Fed is almost done with QE2 and QE3 will not happen and the BoJ, which had flooded its domestic banks with liquidity following the tsunami, now seems to be clawing back some of its US$275bn emergency cash injection. Thus, as central banks stop acting like a Bourbon Street bartender on Mardi-Gras, should we be surprised that every single asset class is no longer being pushed higher for the ride?
– Another potential explanation for the narrowing leadership in both equity and commodity markets could be linked to the likely deceleration in Chinese growth. In that regard, yesterday's Chinese PMI was just one in a recent series of Mainland numbers which seem to show that the slew of recent tightening measures (higher interest rates, anti-corruption drives, higher reserve requirements, accelerating pace of appreciation in the RMB…) is starting to have an effect.
– A third possible explanation is the one presented by Charles in our latest Five Corners, namely the fact that if one strips out China, central bank reserves have most likely started to shrink. In the past, this has always led to financial accidents (Mexico in 1995, Thailand in 1997, Russia in 1998, Argentina in 2001, AIG/Lehman in 2008…) as slowing central bank reserves highlight a deterioration in the global liquidity environment. And if the global liquidity environment is tightening, should we be surprised by the narrowing leadership of risk assets?
In "Is Oil the New Interest Rate", we argued that the current expansionary cycle was a challenging one as it was more likely to be laid low by a surge in oil prices (itself triggered by an OPEC very upset at the US' lack of support to Mubarak) than by interest rates.
Meanwhile, establishing the levels at which oil prices become too high a hurdle for an economic expansion to continue varies widely between countries. Today, there is little doubt that the news is positive: from great corporate earnings (of the 337 S&P 500 companies that have reported so far, 71% have delivered positive earnings surprises with EPS coming in at +24% higher than a year ago and sales +10% higher) to Bin Laden 'sleeping with the fishes'.
But we have to admit that the apparent narrowing of leadership of risk assets towards energy and precious metals leaves us feeling uncomfortable.
The above expressed views are GaveKal's, not FNArena's (see our disclaimer). All copyright GaveKal.
GaveKal is a financial services firm that offers institutional investors and high net worth individuals fund management, independent research on global macro-economic trends and events, and independent advisory work on China and its impact on the global economy.
For more information, visit www.gavekal.com
