Observations on the Capital Markets – Week Ended March 14, 2014
China’s downbeat economic data raised fears as softness in Chinese economic data (below-consensus growth in industrial production, retail sales, and CPI) fueled concerns over the health of its economy.
The price of copper fell 5% on the week and is down 12% year to date, raising fears that the Chinese financial system is facing cascading margin calls like what happened to U.S. CDO (Collateralized Debt Obligations) prices in 2007-9 (lots of Chinese copper positions appear to be leveraged).
A referendum in Crimea about seceding from the Ukraine to rejoin Russia, only rumored at a week ago, took place Sunday March 16; the Russians report that 93% voted in favor of doing so. Regardless of how the people might have voted under other circumstances, the outcome is almost certain: Russia is effectively conquering/annexing Crimea.
The U.N. will not act. Russia has a veto on the Security Council. On Saturday, it vetoed a draft resolution against the Ukraine referendum (China abstained). Western diplomats continue to cry foul, but it’s hard to make a clear moral case against Crimean self-determination when the Kiev “government” was not elected.
Softer China data didn’t spook the markets. Russia’s troop buildup in Ukraine did.
Equities: The S&P 500 returned -1.9% last week. Utilities (+2.3%) rallied on the end-of-week flight-to-safety trade.
Among the world MSCI market indices, Europe returned -2.9%, slightly lagging Emerging Markets (-2.6%). Russia was down 7% for the week; it’s down 25% year-to-date.
Japan was also notably weak: MSCI Japan returned 6% for the week (blame yen strength and China fears more than Japanese economic data, which wasn’t bad).
Bonds: The 10-year Treasury yield almost exactly retraced its week-earlier 14 basis point (bp) rise, falling 15 bps to 2.65% as geopolitical fears trumped neutral/better economic data. The 10-year Treasury Inflation Protected (TIP) yield fell to 0.48%. Both yields are near the bottom of their year-to-date trading ranges, but not at year-to-date lows.
High yield bond spreads widened 17 bps (off cycle lows) to 396. (Note: HY bonds haven’t been all that volatile: rather, their yields have been relatively stable while Treasury yields—and thus spreads—moved.)
Currencies: The Euro gained a bit against the dollar; despite Ukraine developments; it’s up 1% ytd and approaching $1.40.
The Japanese yen rose almost 2% on the week; it’s up 4% ytd (but still down more than 15% since the beginning of 2013). The Chinese yuan continued to fall, dropping 0.4% last week; it’s down 1.6% ytd. While movements in the euro and yen are generally attributed to market forces, yuan weakness is attributed to the central bank ‘shaking out’ hot-money speculators who’d bet a rising yuan was a one-way trade.
Commodities: Oil fell 4% for the week on rising production and inventories; year to date it’s about flat. Gold was up 4%; it’s now up about 15% ytd.
The U.S. economic data’s message: wait for spring
- The employment data showed little weather-linked weakness. The “JOLTS” job openings report was essentially unchanged month over month not bad, considering the weather. Initial unemployment claims fell by 9k to 315k . . . good. After a lot of volatility in the fourth quarter, claims seem to be settling down at comfortable levels.
- Business data was less encouraging. Inventories rose faster than sales, pushing the inventory/sales ratios to cycle highs. Meanwhile, the NFIB survey (small business barometer) fell 2.7 to 91.4 on declining economic and sales expectations. Hiring plans and inventories are being scaled back. If sales don’t pick up when the weather recovers, this will become a Q2 drag.
- Consumer sentiment data has shown an uptrend, but the recent data has showed weakness. This week, for example, the U-Michigan indicator fell from 81.8 to 79.9. Retail sales rose, but recovered only about half of the January decline. Better sales when the weather improves is critical to the ‘growing economy’ story.
- Inflation remains quiescent. Year-over-year headline and core PPI (producer price index) inflation were 0.9% and 1.1%, respectively.
Ukraine update: what will Putin do next?
- The U.S. said “no” to a request for military aid from the Ukraine.
- Merkel dramatically toughened her language, calling for sanctions, but Putin appears undeterred by the threat.
- Foreign Transactions data TICS data showed Treasuries held in custody for foreign official/government accounts fell by $105 billion in the week ending Wednesday…while treasury yields were little changed. Russia apparently roughly had that amount deposited at the Fed. If so, did Putin get his money out before sanctions could be imposed?
- If Russia completes the annexation of Crimea and stops there, the situation will probably stabilize around the new status quo.
- If Putin moves troops into “mainland” Ukraine, as he has threatened to do, it would be a provocative escalation of the conflict.
- Think of the board game Risk: Crimea (like Australia in the game) is easy to defend: the new Crimea-mainland border would be short (only about 5 miles of land and 2 major highways) easy to defend. The border between “mainland” Ukraine and Russia would be over 500 miles long, a much more difficult proposition.
- I fear invading “mainland” Ukraine would dramatically increase the risk of a shooting war (very bearish for equities). To do so now seems unnecessarily risky to me—I hope Putin feels the same.
- Putin has a third alternative: There are regions in “mainland” Ukraine that might “spontaneously” choose to join Crimea in seceding from Kiev. I wouldn’t be at all surprised to see this happen in the coming weeks/months.
Data Sources: The Wall Street Journal, Financial Times, Bloomberg.