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By Oren Laurent
President, Banc De Binary
Investors looking to cash in on the current equities rout will no doubt be scratching their heads in utter confusion. 2016 was supposed to herald a time of equities stabilization, with the all the anxiety of the December 16, 2015 rate hikes a thing of the past.
There was tremendous volatility in currency markets and equities markets ahead of the rate hike with no clear indication which way markets would go. By the time liftoff took place, all the variables had already been factored into the markets and a period of stabilization was expected heading into the New Year.
But then all hell broke loose and Chinese bourses crumbled within the first week of trading. Two days of 7% declines rocked the Shanghai and the Shenzhen Composite Index and this had a devastating effect on global equities markets. From Hong Kong to Paris, London to New York, markets have been reeling. The latest such catastrophe took place on Wall Street on Friday the 15 January, 2016. It was then that all of Wall Street’s major averages plummeted on the news of crude oil weakness and widening cracks in the Chinese economy.
Wall Street Stocks Crumble
Wall Street stocks have fluctuated wildly as investors try to gauge market sentiment on a day-to-day basis. As oil prices breach new lows, confidence in the global economy plunges. This has resulted in steep selloffs across all major averages including the following:
• The S&P 500 lost 2.16% to close at 1,880.33
• The NASDAQ shed 2.74% to close at 4,488.42
• The Dow traded 2.39% lower to close at 15,988.08
The declines on Wall Street were matched by declines elsewhere. In France, the CAC 40 closed 2.38% lower at 4,210.16 and in Germany the DAX closed 2.54% lower at 9,545.27. In London, the FTSE 100 index shed 1.93% to close at 5,804.10. All of these declines are the net effect of China weakness and oil price declines coupled with a bearish tidal wave that has swept the world. As it stands, economic analysts, investors and traders alike are uncertain where the current bottom in the market is. Every time it appears as if the price of oil has hit a support level, it gives way and new lows are recorded. The big shock on Friday was when the $30 support level gave way under massive oversupply and slack demand.
Weakness in Equities Causes Gold Rush
But it isn’t only ongoing supply concerns that are dogging markets; it’s the latest report from the EIA. According to the Energy Information Administration while crude oil inventories are declining, gasoline and diesel inventories are rising in the US. This does not bode well for what is supposed to be growing domestic demand. Gold has been rallying on the back of weak equities demand, but even the gold price has retraced from its 9-week high of $1,112 per ounce. The precious metal is now trading at $1,090 per ounce.
The pull/push factors driving gold are strangely correlated. For example, the price of gold is inversely correlated with the strength of the USD. As the dollar gains ground, the gold price plunges. But at the same time gold tends to rally when equities markets are weak. We have a situation now where equities markets are weak as a result of interest rate hikes in the US, weakness in China and historic lows for crude oil. The Shanghai Composite Index closed the trading session on Friday 3.55% lower at 2,900.97. These sharp declines have become commonplace in China despite government intervention. One of the problems in China equities markets is over-valuation. While western countries’ stock markets like the US, UK, Germany, Switzerland and Canada typically trade at under 20 times earnings, Chinese equities trade at 57 times earnings. We are now in the midst of the equities bubble meltdown in China and it doesn’t matter what the authorities in Beijing are trying to do to arrest the declines; there is simply no appetite for maintaining over-valued stocks on the Shanghai Composite and the Shenzhen Composite indices.
Catching a Falling Knife in a Bear Market
Speculators and short-sellers have gained the ascendancy of late. There is substantial weakness in equities with sentiment heavily bearish. But when will markets bottom out? For analysts this question is as perplexing today as it was when the commodity price rout began. The problem is that nobody knew the extent of the weakness in the Chinese economy. We are seeing widening cracks all the time.
Not only is the Peoples Bank of China enacting quantitative easing measures to further stimulate the economy, but there are moves afoot to weaken the CNY to kickstart Chinese export growth. These policy measures do not go unnoticed by other emerging market economies: now we are seeing reciprocal measures being adopted to make China’s competitors more competitive with the world’s second largest economy.
That major banks and financial institutions have called $20 oil a real possibility has not helped matters. At current prices, there is still substantial room for oil prices to drop and for every downward revision in prices, we can expect equities to follow suit. How low can equities markets go? This is a question that even the sharpest minds refuse to put a number on. Suffice it to say, January is considered the month that investors must get through before any clarity is gained on equity prices. The good news about falling share prices is that value stocks become available.
Tech stocks on the NASDAQ and mining stocks on the Dow become far more affordable and the inevitable turnaround is bound to occur sooner or later. For the time being, advisors have the perfect window-period to rebalance financial portfolios before the rush to buy equities kicks in. For example, if you’re the type of investor whose portfolio is heavier in Treasuries, CDs and savings you may wish to consider diversifying into equities now that prices are cheap. We are not at the bottom yet, but we are getting close. The end of January appears to be a good starting point.
Please note that this column does not constitute financial advice.
