As noted in the Fed’s ‘Normalcy Bias’ Burden post back on December 16th, many factors were out of alignment for any hope of a bullish economic outlook and bullish equity markets in 2016. While the selloff has been both immediate and vicious, we had also noted in the late-November Santa’s Back!! that once the seasonal portfolio manager window dressing was over at the end of last year we remained very skeptical of the economic outlook and equities into this year.
Even allowing that we had no more insight than anyone else on the degree to which the bearish tendencies would be so aggressive right from the top of the year, the immediate technical breakdowns signaled the likelihood of further weakness right from the US opening on January 4th.
The tripartite confluence of impacts from different areas conspired against any upbeat expectation for the global economies and equities markets. Those include still weak data that we are surprised anybody else is surprised to see. We have been highlighting the atypically downbeat expectations from the typically more upbeat OECD (Organization for Economic cooperation and Development) for many months.
That is especially pernicious regarding weak world trade that OECD Secretary General Angel Gurria highlighted as only weakening to the current degree five times over the past 50 years. And in each instance it coincided with a marked downturn in global growth (More below.)
Fed solution or problem?
And then there is the Fed. It is not necessarily a mistake for the Fed to want to get back to ‘normal’. That includes pushing up the US base rate from the ZIRP (Zero Interest Rate Policy) ultra-low yields. However, we are not the only ones who have questioned whether the FOMC might have missed the rate hike window back in late 2014. If the economic cycle was already turning down into this period, the current rate hike attempt might be misguided. Is this just the Fed’s ‘Normalcy Bias’? (More on that below as well.)
The last factor is the geopolitical disarray stemming to some degree from US President Obama’s weak US foreign policy stance. We discussed that in our Monday, January 4th Special Alert post on www.Rohr-Blog.com, and refer you to that for more details. Suffice to say that the real problem is that these factors seem to be sustained now.
Key multiple negative factors are finally aligned. We are always quick to point out that one negative factor alone is rarely enough to foment a down trend in equities. At present however, the magnitude of each negative and the degree to which they are not likely to be addressed any time soon (other than a possible volte face by the Fed) means there was suddenly no reason to feel good about either the global economy or equities.
The underlying weakness brewing throughout last year in the wake of the lack of any meaningful structural reforms since the 2008-2009 Crisis is not surprising. As we noted since last January’s www.Rohr-Blog.com posts It’s Lack of Reform, Stupid (Part 1 & 2 on the 19th and the 24th), the political class has taken all of the extended QE as a giant gift allowing it to avoid any of the tough choices necessary to support the extended global recovery. We highlighted the looming negatives for the global economies and equity markets in our May 2nd Extended Perspective: Tail Risk is Back!, and accentuated that after the August 19th release of the previous meeting’s FOMC minutes in out MyTradingBuddy blog post Is ‘tail risk’ now real risk? (Obviously a rhetorical question.)
Will 2016 be 2007 Redux?
And since the ensuing mid-late August markets meltdown, we remained bearish on the global economic outlook and equities. In a www.Rohr-Blog.com Will 2016 be 2007 Redux? post on December 8th we refer to a key global economic indication as the “OECD Trade Fade”. After the strong early November US Employment report it was a fairly striking to see the OECD (Organization for Economic Cooperation and Development) Semiannual Economic Outlook the following Monday morning (November 9th.) It was quite downbeat, mirroring the slippage into atypical negative outlooks in all of its recent monthly Composite Leading Indicators (CLI.)
And two areas which seem most crucial to the anticipation out of 2015 into at least the early part of 2016 are economic weaknesses we have noted previous. The first is the telling sharp contraction in international trade. The second is the political class’ lack of desire or ability (take your pick) to provide the structural reforms necessary to complement the previous and ongoing massive Quantitative Easing programs of so many central banks.
Especially of note is the slideshow (enlarge to full screen) and the video of the Outlook presentation. Of particular interest in the press conference video discussion by Secretary General Angel Gurria and others is the focus from approximately 03:00 on the extreme weakness of global trade (we have noted previous), and (from 05:15) the fact that structural reform we have been so focused on all year is the only policy lever left after monetary and fiscal tools have been mostly exhausted.
Scary historic context
▪ That global trade weakness is increasingly important in the context of the likely impact on overall economic activity. Global trade that had been growing slowly over the past few years now it seems to have gone completely stagnant, growing only 2.00% in 2015. The rule of thumb is that trade grows at double the rate of global economic growth.
And here’s the rub:
Over the past 50 years there were only five years where trade growth was 2.00% or less. Each of those coincided with a marked downturn in global growth. 2016 may turn out to be the exception, but the historic context is not propitious, especially as future growth is expected to be subdued. Even the extended outlook into 2017 and 2018 is not very strong. And that is the sort of thing on which businesses base investment and hiring decisions. There is also little chance that the political class in the US will engage in any constructive compromise on badly needed structural reforms into an election year.
Further OECD indications
Compared to the major semi-annual OECD Economic Outlooks the monthly CLI releases have a peculiar editorial tendency. As we have noted on many previous occasions, the titles of monthly updates attempt to be upbeat no matter what the actual data may show.
The headline for this Monday’s latest Composite Leading Indicators (November’s indications with the typical two month delay) was “Composite leading indicators continue to point to stable growth momentum in the OECD area.” Yet even a cursory review of the actual graphs of the future economic indications shows that this is simply not the case.
The US is clearly in a cyclical downturn since as far back as late 2014, and weakening further at present. The same is true for the UK along with Japan. Of course China is still weak, and commodity economies like Canada and Russia are commensurately still suffering, even if India and Brazil might be bottoming.
While the Euro-zone seems to be recovering, that is not of much comfort for two reasons. The Euro-zone is starting from a very low base on both economic growth and inflation, and the recent data has not been very inspiring. And in any event, we have the same question as previous on that: With so many other major economies weakening, are we really going to rely upon Europe to lead the way higher?
The Fed’s ‘Normalcy Bias’
So all of the reasons we have for being negative toward the global economy and equity markets are already out there in the anticipatory analyses at many junctures last year. That was all also exacerbated by what we see from the US central bank as the Fed’s ‘Normalcy Bias’ Burden (posted to the MyTradingBuddy blog after the December 16th FOMC announcements and press conference.) Needless to say, the equities did not like that either. Note the reaction from that Thursday morning into the end of the week’s previous test of the 1,990 area.
And what else have we heard since that time? Repeated indications from the Fed’s minions on their determination to put through an additional four 25 basis point rate hikes this year. While they will claim they are data dependent meeting to meeting, the strong indication they are very much inclined to see things as ‘normal’ once again in the face of obvious indications things are not so normal is disconcerting.
Cleveland Fed head Loretta Mester even went so far as to say that there is no need to see further signs of inflation to feel comfortable hiking rates. This seems as out of touch in the current context as Ben Bernanke’s lack of desire to raise rates when the DJIA exceeded the 11,750 Dot.Com Bubble 2000 all-time high back in October 2006. You can review much more on this in the December 16th Fed’s ‘Normalcy Bias’ Continues post.
Less hawkish FOMC minutes?
▪ The recent FOMC minutes released last Wednesday actually showed a bit more flexibility in the form of some members’ dissent than had been expected. Yet that is not of much assistance to markets when Federal Reserve Vice Chairman Stanley Fischer goes on CNBC that morning with the view that there will still likely be at least three further FOMC rate hikes this year.
As both Richard Bernstein and Jim Grant (two people whose economic analysis and trend assessments we respect) have noted in recent CNBC appearances, the Fed’s current path in the face of the deteriorating global economic situation is “unsettling.” Grant has noted since right after the December 16th hike that it is “likely to need to be reversed.” Bernstein was also a key focus in our www.Rohr-Blog.com December 8th ‘Redux’ post. And his message was much the same last week: global manufacturers like China are too pressured domestically to close industries and cut employment. They are engaging in a currency depreciation ‘war’ instead.
The Fed’s new scale?
Grant even went so far in his CNBC appearance last Wednesday (unfortunately for which no video clip is available) to say, “(paraphrased) …this is as if the Fed has a new diet program with its own unique bathroom scale. And that consistently displays your weight as being 10 pounds less than what you actually weigh.”
Instant success!! Another very nice metaphor for the ‘normalcy bias’ the Fed is afflicted with at present. Just because the Fed says ‘normal’ doesn’t make it so any more than a faulty scale means you are making weight control progress.
Critical markets indications
The additional gap lower last Monday morning to start the year also left the March S&P 500 future below both the major 2,020-10 range breached on Monday’s gap lower and the far more critical lower support at the late 2014 into early February 2015 1,975-70 congestion by Thursday morning. Each of the previous slides below that lower area (in both August and September) saw further weakness below interim supports in the 1,960 and 1,930 areas to at least the 1,900 area and sometimes well below.
And that is what has transpired. However, there is one more technical threshold that will likely indicate whether or not the equity markets are in a complete meltdown, or can possibly at least stabilize for an upside reaction. That is the lower major 1,865-60 support.
We always prefer when a critical area is reinforced by several major technical factors. In this case that range is not only the late September pullback low, and a major Fibonacci 0.25 retracement (from the 1,068 October 2011 low to the highs.) It is also the major weekly up channel support for the entire trend since the 666 cycle low back in March of 2009. As such, as far and as fast as the US equity markets have dropped the first part of this year, whether they will now enter an extended meltdown phase will be determined by what transpires late this week into next; at least for the near-term.
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