It is astonishing how many people believe that with a turn of the calendar page to a new year, underlying problems with the economy can miraculously disappear. One of the benefits at the turn of the new year is that portfolio managers can stop staring at a negative PnL number glaring in front of them, destroying their ego and confidence, and leading them to make decisions under duress as opposed to fundamentally sound ones. Most hedge fund managers, despite being dogged by high water marks that seem much further away at the start of this year, will still cheer as the new year gifts them with a 0 at the bottom line. A new year, a new game.
Other than the 7% rally seen over the last few days in S&P 500, what changed as the clock struck midnight? Let's get it straight, the global economic data is showing significant signs of weakness and we will likely get further bearish prints over the coming weeks as December data is gathered.
Nothing has changed on the macro front. We have seen a standstill in some exports and the market needs some resolution over the U.S./China trade war to see what the "new" arrangement is, if any at all. The Fed and dollar path have been set for now -- slow steady rate increases with rate hikes tweaked slightly lower, but vigilant of further market deterioration to see if the Fed really needs to stop, implying markets may need to move a lot lower before the Fed actually blinks.
So, what is the macro data telling us currently? On Monday, China's December Manufacturing PMI fell to 49.4 from 50 in November -- the lowest reading since February 2016. Both production and new order sub-indices fell in December. Trade indicators continued to weaken as well, with the imports sub-index dropping 1.2 percentage points to 45.9 and the new export order sub-index was at 46.6, vs. 47.0 in November.
Wednesday morning, South Korea's exports were released for December, missing even the most-pessimistic of analyst expectations. They declined by 1.2% year-over-year (yoy) vs an expectation of +2.5% yoy. Korean exports were hit by falling memory chip and oil prices amidst cooling demand. Exports to China dropped 13.9% in December alone.
South Korea, which is the largest exporter of computer chips, ships, cars, and oil products, is a good global indicator of trade and the underlying trend, hence it does not bode well for data to follow. There is a significantly high correlation between South Korea's exports and global earnings growth rates, alluding to more earnings downgrades to follow.
In a nutshell, the year has opened with the same theme evident at the close of the previous year -- weaker trade indicators combined with no resolution to the Trade War are contributing to slower growth, which is not a healthy environment for risk assets (equities, commodities etc.) in general. Brent oil at $50/bbl has fundamental support, given demand/supply indicators, as has copper at sub $6000/tonne, but if the worsening economic trend continues, prices can drift lower. It is important to remember U.S. shale companies are profitable down to $45/bbl WTI even, so the choking point may be a lot lower than one expects.
Value is apparent, no doubt about that. But how is one to believe the P/E ratios for any company when the "E" part of the ratio is constantly being adjusted down? Do we trust the earnings being forecasted by the sell-side analysts? Valuations are only meaningful if the broader trend shows positive momentum so one can buy into these companies with confidence. As the old adage goes "cheap can get cheaper." The ledgers are clear, portfolios are unwound significantly, but the outlook is still uncertain.
Long-short hedge funds can really take advantage of their "hedged" status by going short, as they are meant to outperform even in downward markets, but we know that all they do is lever 10x on the upside on outperforming markets.
Long-only and retail investors best wait for a better entry point, as once the storm passes, there will be an opportunity to play for. For now, it shall continue to be an aggressive seesaw ride, as traders navigate between bullish Trump tweets and bearish economic data.