Monday, August 03, 2015

The Market's Macro Story in Three Charts

Every so often, it is worthwhile to step back and canvas the macroeconomic picture from a global perspective.  Above are three charts that tell a distinctive macro story:

1)  Deflationary pressures - In a world of expanding global economic growth, we would expect to see greater utilization of raw materials, driving the prices of commodities higher.  What we've been seeing instead (top chart) is a collapse of commodity prices, particularly in the wake of concerns regarding growth in China.  Over the past year, emerging market stocks have notably underperformed those of developed markets, just as periphery equity markets in Europe have underperformed core markets in response to concerns regarding Greece.  One would like to see the emerging markets of the world as engines of growth, but instead the commodities markets suggest that those regions have become burdened by deflationary pressures, even as debt burdens have mounted.

2)  Flight to safety and USD strength - Given the QE dynamics abroad and greater economic growth in the U.S., the U.S. dollar has soared as commodities have fallen (middle chart).  Among equities, SPY is not far from its highs, despite the weakness among commodity-related shares, while emerging market equities (EEM) are flirting with multi-year lows.  USD strength has set up an interesting dynamic among stocks, whereby companies that import raw materials have benefited and companies that depend upon export sales for growth have been hurt.  The interplay between the boost to the U.S. economy from falling raw material prices and the drag on export sales from the strong dollar, as well as the global economic weakness, have contributed to an abundance of caution from the Fed regarding interest rate hikes.

3)  The challenge to rising interest rates - Most of 2014 saw falling long-term interest rates in the U.S. (rising prices; bottom chart), whereas most of 2015 has seen a rise in rates in anticipation of Fed rate hikes. Most recently, we've seen a bounce in bond prices (lower yields), in response to weaker domestic data (Friday's ECI a case in point) and continued commodity weakness and concerns over global growth.  To the extent that a debt/deflation dynamic abroad keeps a lid on global economic growth and incentivizes greater central bank activism abroad than domestically, it is difficult to imagine a Fed wanting to raise rates in any meaningful way, as higher rates would encourage further flows into the dollar and add to export-related headwinds.  

So what does it all mean?  One dynamic seems clear:  if it's burdened with debt, it underperforms.  Whether it's domestic equities in China, high yield muni bond funds in the U.S.with exposure to Puerto Rico, peripheral bonds/credit in Europe, or the Brazilian Real, high debt has led to poor returns and considerable volatility.  The winning investments have been those furthest from debt-deflationary dynamics.

Further Reading:  How Investors and Traders Win By Failing