On the Turmoil in Global Markets; China Capital Flight; Eggs and Diabetes Risk!

From: aditya rana
Date: Sat, Jan 30, 2016 at 2:06 PM
Subject: On the Turmoil in Global Markets; China Capital Flight; Eggs and Diabetes Risk!


The popular notion of the “January effect”, implying a positive start to global stock markets as investors rush to invest, was in a for a rude awakening with the global stock market index declining by 6% over the month (with one of last year’s underperformer Turkey being the top performer at +2.5%). This performance was worse than 96% of the months on record. Fears of a renminbi devaluation and capital flight out of China, collapsing oil prices and a global recession weighed on markets. Looking deeper into these factors we can try and make an assessment of what were the real drivers and how relevant they might be as the year progresses. Three notes from astute observers of global markets: Anatole Kaletsky of Gavekal Dragonomics; Paul Kasreil, former chief economist of Northern Trust; and, Christopher Wood of CLSA provide interesting insights into these factors. To highlight the key points:

Anatole Kaletsky:

-The rout in the Chinese stock markets during the first four days of the year triggered the global market meltdown, but the Chinese stock market matters little to the rest of the world and the real fear was the risk of an aggressive devaluation of the renminbi leading to massive capital flight.

-This scenario seemed plausible for a few weeks last summer, and remerged during the first half of January, but abated during the second half of the month as market fears about China stabilized.

-The market then focused on the collapsing oil price, and began to move in lockstep with oil prices. However, the market seems to have got this relationship wrong and the correlation of oil prices and the world economy is almost certainly to turn negative over a time horizon beyond the short-term.

-As oil prices stabilize at the lower end of a $25-50 range, the world economy and non-commodity businesses should benefit as low oil prices increase real incomes, stimulate spending on non-resource goods and services, and increase profits for energy-using businesses.

-The third fear about a recession in the world economy or the US seem unfounded as well. History shows that oil prices are not a useful leading indicator of economic activity – every global recession since 1970 has been preceded by rising oil prices and a 30% fall in oil prices and almost always been followed by accelerating growth and rising equity markets. The market belief that “this time is different” usually takes hold at the peaks and troughs of boom-bust cycles.

-The real danger to the global economy arises not from the underlying fundamentals, but through the powerful force of “reflexivity” – where financial market expectations influence economic events. While the negative influence of this phenomena through consumer and business confidence should be offset by the collapse in oil prices, the more worrying impact is its impact on the financial system itself – i.e. bankruptcies of small energy companies which are creating pressure on the banking system and leading to tightening of credit for healthy businesses and consumers. In addition, fears of a Chinese devaluation that has not happened (and very likely never will) are creating pressure on EM credit markets.

Paul Kasreil:

-Having argued in early December that the imminent Fed preemptive rate hike was not justified as it would happen in the face of significant slowing of US economic activity, low and declining inflation (except for house prices), and low inflation expectation based on market indicators.

-As expected, the Fed rate hike in December forced a massive monthly reduction in Fed-created bank reserves of US$ 179 billion (see chart below) which adversely affected the total amount of “thin-air” credit (sum of reserves and bank credit) in the system.

-Thin-air credit contracted at an annualized rate of 4.5% in December 2015, compared to a growth of 4.7% during the previous month. The 3-month annualized growth slowed to 3.0% versus 7.2% in November, and a long-run median growth rate of 7.25% (see graph below)

-This was driven by the 51.4% annualized reduction in reserves which more than offset the 9.1% annualized growth in bank credit during December (see chart below).

-However, during the first three weeks of January, while bank credit has continued to grow at a robust pace, bank reserves have also risen substantially (see chart below) leading to a rise in thin-air credit. This is because the Fed only needs to reduce the supply of reserves relative to the demand for reserves once to effect a Fed rate hike, but once that has taken place the Fed does not have to continue reducing the supply of reserves. So if the Fed’s December rate hike will not be repeated for some time then bank reserves are not likely to decline.

-In sum, the US economy is unlikely to crash anytime soon as the Fed is unlikely to raise rates again until the economy is on a sustained 2.5%+ trajectory and there are some faint signs of inflationary pressure. The earliest this could happen is mid-2016.

Christopher Wood:

-There is no real consensus amongst investors about the exact nature of Chinese capital outflow as it could be driven by capital flight, unwinding of renminbi carry trades or repayment of dollar loans, and there is no real time data to monitor these flows.

-However, looking at the numbers based on data as of September 2015, dollar loan repayments over the previous year totaled US$397 BN (with total claims declining from a peak of US$ 1.5tn to US$1.1tn), while the total capital outflow based on BOP numbers was US$ 534bn. This suggests that three quarters of the capital outflow during the 12 month period preceding September 2015 was repayment of dollar borrowings.

-The reason that this breakdown is important, is that the more the capital outflow is driven by payment of dollar borrowing the more positive it is for China and the rest of Asia. Other signs of capital flight remain subdued – with interbank rates at 2.36% being largely unchanged from August 2015 (see graph below). In addition, renminbi deposit growth has remained stable at 12.4%YoY in December, down slightly from 13.4% in November but up from 9.1%YoY in December 2014.

-Where there has been a clear decline is in foreign currency deposit growth, declining from 30.8%YoY in December 2014, to 3.2%YoY in December 2015, and accounting for only 3% of deposits in China. This has been driven mainly by corporates shifting their foreign currency deposits offshore, while households have actually increased their foreign currency deposits onshore.

-Lastly, the PBOC is maintaining its commitment to keep the renminbi stable against a basket of currencies, which has been broadly stable since the start of 2015 (see graph below), with the index being up 0.5% during 2015, and declining by 0.6% in 2016.

-Interesting analysis which points to oversold markets and the likelihood of a rally in markets over the coming months, as market concerns about the three factors dissipate and the focus shifts back on the stability in global economic activity.

-Regarding Chinese capital outflows, estimates from Goldman based on monthly data from SAFE and the PBOC, are that the total capital outflow for 2015 was US$ 620bn (US$449bn in August –December). As CLSA points out, most of this is due to repayments on dollar loans which actually bodes well for China going forward. The estimated US$1tn of the great renminbi carry trade of previous years (betting on a one way appreciation of the currency effected through US$ loans, FX transactions and trade flows) is well on the way to being unwound and thereby reducing systemic risk for China.

-As mentioned in previous newsletters, the key variable to watch in China to gauge the overall health of the economy and financial markets is money supply, which continued to grow at a robust 13.1% in January.

-Despite the stomach churning 22% fall in the Shanghai composite this month, keeping the course if you are long, and adding gradually if your are underweight, has the potential to payoff over the course of the year as the market refocuses on the underlying economic fundamentals which have been stabilizing since the lows of last September.

-The much decried state support for the stock market, has served the useful purpose of exhausting the selling pressure emanating from an unwinding of margin debt which has now fallen 61% from its peak in June 2015 and is currently at the lows of September last year. As observed in previous large scale government led bailouts of other markets, once the selling pressure exhausts itself it does not take much of an improvement in the underlying economic fundamentals to trigger a sharp rally.

-Please also note that the Chinese stock market had two bull markets (the 60% rise until June 12 and the 21% rise from August 26) and a bear market (the 44% fall from June to August) all in the space of a year in 2015! Despite the volatility it posted a 9.4% gain for the year, and was the second best performing major stock market in the world in 2015 in dollar terms(after being the best performing global market in 2014 by being up 53%). Patient investors with a long-term holding period should be amply rewarded.

-With global central banks having their fingers close to the panic button (including the Fed), the likelihood of a full blown crisis is low and the strategy of buying on dips and taking money off the table after rallies still very much holds. While the Fed is unlikely to reverse course unless the current crisis worsens, please note that the surprise decision to introduce negative rates yesterday by the BOJ caused a 2% rally in global markets. The ECB is expected to announce further easing measures at their March meeting.

Egg Consumption Increases Risk for Type 2 Diabetes:

PRCM 12/1/2016:

Djoussé L, Khawaja OA, Gaziano JM. Egg consumption and risk of type 2 diabetes: a meta-analysis of prospective studies. Am J Clin Nutr. Published online January 6, 2016.

-Consuming three or more eggs per week increases an American’s risk for type 2 diabetes, according to a meta-analysis published in the American Journal of Clinical Nutrition. Researchers analyzed 12 cohort studies that encompassed over 200,000 participants and their egg consumption and risk for type 2 diabetes.

– In the United States, those who consumed the most eggs experienced a 39 percent higher risk for diabetes, compared with those who consumed the least. In studies conducted outside the United States, egg consumption was not associated with diabetes risk. Other dietary habits may contribute to the elevated risk, including common consumption of processed meats with eggs.

Apologies for no newsletters during the previous fortnight as I had to make an urgent trip to India to attend to an important personal matter. I will be also travelling for the month of Feb, for the Chinese New Year break and then back to India so the next newsletter will be sent out on March 5 – but I do hope to be able to send out a brief market update if warranted.

Wishing my readers a happy, prosperous and healthy Year of the Monkey!




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