jueves, 11 de febrero de 2016

jueves, febrero 11, 2016

Up and Down Wall Street

Markets Suffer as China Depletes Reserves

In trying to prop up their currency by selling foreign-exchange reserves, the Chinese are stoking volatility in global stock markets. Also putting pressure on shares: asset liquidations by sovereign wealth funds.

By Randall W. Forsyth
In keeping with the current practice of starting with a scriptural reference, today’s lesson comes from the Book of Genesis, in which Joseph won the pharaoh’s favor by interpreting the Egyptian ruler’s dreams.

Joseph advised that, during seven years of plenty, surplus grain should be stored to prepare for seven years of famine. So, when the lean times arrived, Egypt had ample seed to feed itself and to sell to its neighbors, setting up Joseph as the commodity guru of his time.

Whether this biblical lesson took hold in international finance is hard to say. But some nations that had gone through the fat years of rising oil and other commodity prices did amass huge stores of financial assets in what’s known as sovereign wealth funds. These included oil exporters in the Middle East and Norway, plus Asian powerhouses with big surpluses, such as China, Hong Kong, and Singapore.

Central banks of countries with large trade surpluses also built up big caches of foreign-exchange reserves, although it wasn’t Joseph’s example that they followed. In some cases, as with China, the central banks bought up foreign currencies (mainly dollars) to prevent their own from rising too much.

Some countries also were traumatized by memories of the 1997-98 emerging market crisis, during which a number experienced painful devaluations and what they saw as humiliating bailouts by the International Monetary Fund. To prevent a recurrence, they built up war chests to defend their currencies and economies against future onslaughts.

Whatever their motivations, sovereign wealth funds and central banks acquired large sums of assets during the lush times, no doubt having a positive impact on stock and bond prices around the globe. Now, however, the process is working backward, as they are being forced to sell some of those assets, with the opposite effect.

The suddenly straitened circumstances of oil exporters are making them recycle their petrodollars in reverse, selling stocks and bonds of Western nations that they had accumulated in the past in a kind of vendor financing. Saudi Arabia is even having to borrow in international bond markets and is mulling the sale of shares in its national oil company, Aramco. That would help cover the shortfall in revenues from crude oil in the low-$30 a barrel range, as well as increased expenditures, including for its military.

China, meanwhile, has seen its currency reserves plunge dramatically in recent months. Capital flight has forced the Chinese monetary authorities to spend their rapidly shrinking foreign-exchange reserves to prevent their currency, the renminbi or yuan, from depreciating too rapidly.

This, writes John Brady, who has his highly sensitive ear to the ground as managing director at R.J. O’Brien, a major Chicago futures broker, is the “single largest cloud overhanging the markets.” That’s because the shrinkage of China’s foreign-exchange reserves represents a significant tightening of financial conditions.

Not long after this column goes to press (or the 21st century electronic equivalent), China will release the most important datum, in O’Brien’s view: a tally of its currency reserves. This will show how much the nation’s monetary authorities have spent to offset the exodus of capital seeking to escape the Middle Kingdom, in many cases evading the barriers set up to bar or limit its exit. This number is even more important than the January U.S. employment report released on Friday (about which, more later), he contends.

In the past six months, China has burned through $800 billion in foreign-exchange reserves, which stood at $3.3 trillion as of December, and the total is estimated to have fallen another $120 billion in January. “Street economists, along with the IMF, have written that $2.8 trillion is the lowest acceptable level for China’s forex reserves, so anything below the $3.2 trillion number expected this weekend may add to an increased sense of urgency, as an approach of $2.8 trillion will be seen as undermining global confidence in the People’s Bank of China’s ability to resist currency depreciation and to manage future balance-of-payment shocks,” Brady writes.

For that reason, hedge funds and other investors have been piling into bets that China will be forced to give up its prideful attempt to prop up the yuan, as The Wall Street Journal reported last week. That, of course, contradicts Republican presidential candidate Donald Trump’s assertion that China is deliberately lowering its currency, as noted here previously (“Trump Is Wrong on China,” Nov. 14). Presumably, these hedge-fund managers are also “really, really smart” and “really, really rich,” and yet they come to the opposite conclusion from the Donald, incredible as that may sound. More important are the global implications of China’s vainglorious attempt to try to stem the tide against the yuan by spending billions in foreign-exchange reserves. As Brady explains:

“The spending of forex reserves is in itself a monetary tightening (sell U.S. dollars/buy Chinese yuan/removing yuan from the system), and the Chinese economy isn’t in that part of its economic cycle where it can withstand a dramatic or quick tightening.” Expectations about Federal Reserve interest-rate increases have shifted, he notes, with barely even money on a second hike by the end of 2016. “But it is the pace of reserve liquidation that has the highest potential to keep market volatility and repricing higher than otherwise,” he adds.

And, should you need reminding, higher volatility almost invariably means lower asset prices.

SOVEREIGN WEALTH FUNDS HAVE BEEN LIQUIDATING ASSETS at the same time as the central banks of China and other nations, also with significant impacts on capital markets.
Their sizes give an indication of their potential effects. Norway’s is the largest at about $825 billion, as of last month, according to Statista.com. It’s followed by Abu Dhabi, at $773 billion; the China Investment Corp., at $747 billion; SAMA Foreign Holdings of Saudi Arabia, at $669 billion; and the Kuwait Investment Authority, at $592 billion.

Given the opacity of many of these organizations, estimating their flows is tough, but JPMorgan economist Nikolaos Panigirtzoglou makes a valiant effort. (Thanks to our colleague Chris Dieterich for bringing this to light in his Focus on Funds blog on Barrons.com.)

Lumping together liquidations of the central banks and the sovereign wealth funds of oil-producing nations, Panigirtzoglou estimates that they sold $90 billion of government bonds, $50 billion of public equities, $7 billion of corporate bonds, and $15 billion of cash instruments in 2015.

For 2016, assuming an average oil price of $35 a barrel, Panigirtzoglou estimates that their shortfalls will be covered by liquidations of $220 billion of assets and borrowings of $20 billion.
That would imply the sale of $107 billion of government bonds, $80 billion of public equities, $12 billion of corporate bonds, and $19 billion of cash instruments.

In the equity sphere, he finds, sovereign wealth funds are overweighted in financial and consumer-discretionary stocks and geographically in European markets. Not surprisingly, market watchers infer a connection in the steep drop in European banks, notably Deutsche Bank (ticker: DB), some of which are trading below their 2009 crisis lows. U.S. financials also have taken a battering of late, on concerns about their energy-loan exposure.

THE MARKET TOOK A PUMMELING on Friday from all sellers. The January jobs report provided an inverse Goldilocks effect: some disappointments, but none bad enough to elicit a reaction from the Fed. Nonfarm payrolls rose by 151,000, short of forecasts of a gain in the 190,000 region, and short of the downwardly revised increase of 262,000, originally estimated at 292,000. But the separate household survey showed a 0.1 percentage point downtick in the headline unemployment rate, to 4.9%, although the broader “underemployment” rate held steady at 9.9%.

Broad equity measures shed about 2% on Friday, but the Nasdaq Composite got clobbered by 3.3% as investors saw the bad things that can happen to high-beta, high-multiple tech names. What may be happening, according to Jim Paulsen, chief investment strategist and economist at Wells Capital Management, is that the old leadership groups have become the laggards, and vice versa.

For instance, he notes that the S&P financial, health-care, consumer-discretionary, and technology groups have gone from the top of the leader board last year to the bottom in 2016.
Meanwhile, last year’s low-beta sluggards—consumer staples, telecoms, and utilities—have come into favor in what’s shaping up to be a year of living dangerously.

Perhaps the allure of these defensive groups is being burnished by the further fall in bond yields, with Treasury yields down to 12-month lows (despite steady sales by central banks and sovereign wealth funds). Their dividends also look a lot more secure than those in the energy sector, a situation underscored by the payout cut announced last week by ConocoPhillips (COP).

The 394 dividend reductions in 2015 topped the 295 in 2008, according to Bespoke Investment Group. And this year may be worse, given the deterioration in the high-yield bond market.
“When the credit markets are willing to lend, companies have jumped at the opportunity to borrow and increase their payouts. The flip side is what we are seeing now, and when the credit markets start to turn off the spigot, some companies find they don’t have the cash flows to support their payouts,” Bespoke explains.

Then again, the group rotation may simply be a manifestation of the biblical injunction that the first will be last and the last will be first. Here endeth the lesson.


0 comments:

Publicar un comentario