New article from Tatton Investment Management: More sellers than buyers

18 August 2017

Last week had news that felt like it should affect markets. Risks were obvious and it was unsurprising that risk assets came under pressure. As we wrote, it was perhaps more surprising that there was such little reaction.
 
Still, historically, the prospect of war tends not to have too much impact. That’s probably because potential conflicts often do not become actual. It’s only the long-term consequences of actual war that create destruction of wealth. The Korean War was 1950-53, the Cuban Missile crisis ended in 1963, and the Vietnam War main phase 1968-75.

Therefore, this week’s moves have been interesting. As I write, equity markets are trading some 2.5% down from the recent highs. In itself the sell-off is just revisiting last Friday’s lows. However there is no obvious rationalisation – war is not more imminent, the end of the Q2 earnings season has continued to be relatively upbeat, economic data continues to signal steady growth.
Indeed, copper has hit a new 3-year high and palladium has hit its best level since the bursting of the tech bubble.
 
As an indicator of global growth, metals prices may be imperfect and more typically seen as a reflection of China’s demand for resources. China’s data did show signs of slowing. As Dow Jones Newswire said, “the deceleration in growth, from a rise of 0.9% on the month in June to just 0.6% in July, is relatively minor. “
 
“But consumer-loan growth and tightening mortgage restrictions have already put the lid on rallies in top-tier coastal markets like Beijing and Shanghai. If prices in the interior begin falling outright, or if housing investment weakens again in August, it may be time to start hedging bets on China growth plays. Some vulnerable stocks include mining firms and U.S. construction-equipment maker Caterpillar, which has been testing new highs this year as global growth rebounded.”
 
“Some slowdown in the interior is to be expected. Credit has been gradually tightening in China for months. Steel prices are up, buoyed by mill-capacity cuts. That is fantastic for steel producers but bad for downstream industries like construction, which buy steel. Steel sector growth accelerated in July, while most other sectors decelerated.”
 
“The biggest bullish factor for Chinese construction remains intact: Massive housing inventories, which depressed construction growth for years, are still falling. Vacant, unsold housing floor space in China fell 10 million square meters in July to the lowest level since February 2014. Vacant floor space is down 20% on the year.”
 
“Nonetheless, China's housing market looks close to an inflection point. If August data shows sales and investment weakening again, or the fall in inventories levelling off, sentiment on China may deteriorate”.
 
Blaming China’s economic data for a turn in global equities may be missing the point. Perhaps more likely is just a near-term case of more sellers than buyers. The pressure from China’s regulator on the likes of Anbang Insurance to cease their buying spree is intense. Lipper fund flow data for last week showed marked selling by US investors, in certain cases the biggest outflow in 33 weeks. Meanwhile the strength of the Yen (and its coincidence with the timing of falls in the S&P500) suggest that Japanese holders have continued their selling from last week.
 
As we’ve mentioned before (and discuss in more detail below), Central Bank commentary is raising the probability that quantitative easing support for long-term assets will start to be removed soon. The Fed’s minutes for its last meeting told us as much. Next week, the Fed holds its annual powwow at Jackson Hole (Wyoming), courtesy of the Kansas City branch. Yellen will give a speech regarding financial stability, a topic in which QE plays an important part. Draghi will also attend and speak.
We feel reasonably sure that they’ve already reached a conclusion that the start must be made, knowing that markets will wobble as the reality of support removal will sink in.
 
Political incompetence hasn’t helped. The US market has certainly not been helped by Trump’s diminishing support, evidence by the collapse of the Economic Advisory Council. The President still has Gary Cohn’s passive backing, with Cohn still being seen as a likely replacement for Yellen at the Fed. If Trump loses the Goldman Sachs ex-chief, that would be significantly worse.
We take a closer look below at the UK’s issues regarding Brexit negotiations.
 
The confident phase that took equity markets to highs a month ago feel as though it’s passed for the moment. Holidays have inevitability compressed liquidity which surely has led to the pickup in volatility, and next week is still holidays for many so we should expect it all to feel a bit risky in the next few days.

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