What Is Happening To Equities?

Depression

moving

in

from

the

east
Markets

remain

by

and

large

in

a

depressed

state,

following

on

from

a

sell

off

on

Friday

after

the

Non-event,

Non-Farm

Payrolls.

Whilst

it's

not

entirely

clear

what

the

catalyst

was

for

the

US

sell

off,

we

can

surmise

that

the

low

ball

Non–Farm

number

gave

investors

pause

for

thought,

as

they

considered

the

possibility

that

the

Fed

has

raised

interest

rates

prematurely.
With

many

Asian

markets

closed

or

on

short

working

for

the

Lunar

New

Year

the

baton

passed

from

the

US

close

straight

to

the

European

open.

European

markets

initially

rallied

on

Monday

morning

but

then

turned

tail.

That

negative

price

action

fed

back

into

US

index

futures

and

US

equity

markets

opened

lower

once

more.

As

I

write,

10

minutes

into

Mondays

US

session,

the

Dow

is

off

by

1.5%

or

some

240

points,

whilst

the

tech

heavy

Nasdaq

Composite

index

(which

was

hard

hit

last

Friday)

is

down

by

a

further

1.9%.
These

type

of

downside

moves,

followed

by

short

sharp

countertrend

rallies

are

typical

of

a

bear

market.

Which

as

I

noted

in

late

January,

in

what

are

the

markets

telling

us?

,

is

where

many

equity

indices

find

themselves.

At

that

time

we

characterised

the

market

moves

as

a

correction

rather

than

a

crash

and

I

think

we

can

still

consider

that

to

be

the

case.

Although

the

longer

the

downtrend

continues

the

more

tenuous

the

distinction

becomes.
Recent

performance
Of

course

as

equity

markets

and

other

financial

assets

sell

off

from

their

peaks,

traders

and

investors

naturally

start

to

consider

at

what

point

these

same

instruments

might

be

considered

to

be

"

good

value

"

or

put

another

way

are

approaching

a

bottom

,

from

which

they

could

bounce.

Chart

shows

the

6

month

%

performance

of

selected

Futures

contracts

(source

Finviz.com)

As

we

can

see

European

stock

indices

have

been

particularly

hard

hit

over

this

time

frame

with

the

Dax

and

Euro

Stoxx

50

indices

down

by

21.7%

and

22.67%

respectively.

By

comparison

the

S&P

500

and

Nasdaq

100

(a

more

concentrated

measure

of

tech

stock

performance

than

the

Composite

index

mentioned

above)

are

down

by

10.10%

and

12.3%

as

of

the

close

of

the

05/02/2016.The

narrower

Dow

30

industrial

index

has

fallen

by

just

7.17%

during

this

time.

The

exception

to

the

out

performance

of

US

equities

has

been

the

Russell

2000

small

cap

index,

which

has

slumped

by

18.73%

over

the

last

6

months.

I

also

note

that

the

VIX

Index,

effectively

a

measure

of

the

levels

of

fear

and

greed

in

the

market,

has

rallied

by

73%.

A

clear

indication

that

for

now

at

least

fear

has

the

upper

hand.

Why

are

we

correcting?
We

could

explore

many

different

reasoned

arguments

to

try

and

answer

this

question.

However

it

is

said

that

a

picture

speaks

a

thousand

words

and

in

this

case

two

pictures

can

do

that

very

eloquently

indeed.

The

pictures

in

question

are

two

charts

prepared

by

analysts

at

the

French

bank

Societe

Generale

(PA:SOGN).
Chart

one

plots

global

equity

prices

against

global

equity

earnings

since

Dec

2011.

itemprop="image"

itemscope

itemtype="https://schema.org/ImageObject">

src="https://d51-invdn-com.akamaized.net/1455027511_0.png"

alt="price

versus"

data-link=""

width="450"

height="300"

layout="responsive">

itemprop="url"

content="">

itemprop="width"

content="450">

itemprop="height"

content="300">

Chart

two

plots

the

level

of

global

corporate

debt

against

global

profit

growth

(EBITDA)

itemprop="image"

itemscope

itemtype="https://schema.org/ImageObject">

src="https://d51-invdn-com.akamaized.net/1455027569_0.png"

alt="debt"

data-link=""

width="450"

height="300"

layout="responsive">

itemprop="url"

content="">

itemprop="width"

content="450">

itemprop="height"

content="300">

Carried

away
It's

quite

clear

that

equity

prices

have

run

well

ahead

of

earnings

since

the

summer

of

2012

it's

also

clear

that

earnings

peaked,

if

we

can

call

it

that,

around

December

2014

and

have

moved

lower

on

a

shallow

incline

since

then.

The

gap

between

the

two

lines

in

chart

one

could

be

said

to

represent

the

unrealistic

expectations

about

equity

valuations,

which

investors

and

traders

have

held

since

the

summer

of

2012.
What's

more

as

we

can

see

in

chart

two,

profits

have

effectively

moved

sideways

since

January

2011,

whilst

at

the

same

time

levels

of

corporate

debt

have

risen

sharply.

Despite

the

fact

that

many

corporates

have

been

stockpiling

cash

in

this

period.

In

summary

equity

investors

had

been

prepared

to

pay

more

to

own

less.

Both

in

terms

of

earnings

streams,

profitability

and

residual

valuations.
Investors

haven't

had

some

kind

collective

hysteria

over

the

last

five

or

six

years

but

their

heads

have

been

turned

by

Quantitative

Easing

and

the

flows

of

cheap

money

that

have

artificially

boosted

many

asset

values

to

levels

well

ahead

of

their

historical

averages.New

challenges

ahead
Now

that

US

QE

is

a

distant

memory

and

the

Fed

has,

for

better

or

worse,

began

to

tighten

rates.

Investors

that

chased

valuations

in

haste,

have

the

opportunity

to

repent

at

their

leisure.

They

must

also

wrestle

with

the

prospect

of

a

double

whammy

over

the

cost

of

debt

servicing

going

forward.

Higher

US

interest

rates

will

make

dollar

debts

more

expensive

to

service,

this

might

be

offset

by

negative

interest

rates

in

the

Eurozone

and

Japan.

However

the

spectre

of

deflation

can't

be

ruled

out

in

either

economy.

Deflation

works

in

the

opposite

way

to

inflation

and

actually

raises

the

real

value

of

outstanding

debts.

Making

them

more

expensive

to

pay

back.

Falling

expectations

about

global

growth

in

2016

/2017

have

also

weighed

on

investor

sentiment

and

will

have

a

trickledown

effect

on

analysts'

earnings

forecasts

for

both

Developed

and

Emerging

Markets.Dividends

under

pressure
One

of

the

reasons

that

investors

own

equities

is

to

receive

dividends,

which

are

if

you

like

are

their

share

of

the

company's

success

or

the

reward

for

ownership.

The

reinvestment

of

dividends

has

been

the

cornerstone

of

success

for

many

long

term

investors.

In

an

environment

where

decent

returns

available

from

bonds

are

few

and

far

between

equity

dividends

also

take

on

an

added

importance

for

income

investors

too.
When

we

consider

that

25%

of

all

government

bonds

in

the

JP

Morgan

Government

Bond

Index

had

a

negative

yield

as

of

the

end

of

January

and

just

this

morning,

the

yield

on

Japanese

Government

10

year

bonds

went

negative

for

the

first

time.

We

can

see

that

dividends

matter.
Against

this

background

then

it's

worth

noting

comments

by

the

Economist

magazine

in

a

recent

series

of

articles

on

the

importance

of

dividends.

They

note

that

dividend

reinvestment

has

accounted

for

two

thirds

of

the

real

returns

seen

in

US

equities

since

1900

and

that

70%

of

the

dividends

paid

in

Australia,

Britain,

France,

Germany

and

Switzerland

came

from

just

20

companies

in

each

country.
That

may

not

be

an

issue

in

and

of

itself.

Save

for

the

fact

that

these

dividends

are

under

pressure

in

key

sectors

such

as

Mining,

Oil

&

Gas

and

Industrials

(this

is

particularly

true

for

the

UK

&

Australia).
The

Banking

sector

was

thought

likely

to

be

able

to

make

up

any

short

fall

as

it

emerged

from

a

multiyear

restructuring.

But

in

Europe

that

now

looks

unlikely

to

be

fulfilled

over

the

mid-term.

Which

will

place

additional

pressure

on

and

concentrate

investment

(risk)

in

sectors

such

as

Healthcare

and

Pharmaceuticals.
Chart

shows

the

concentration

of

Dividends

across

selected

markets

(source

Economist/

Soc

Gen)

itemprop="image"

itemscope

itemtype="https://schema.org/ImageObject">

src="https://d51-invdn-com.akamaized.net/1455027616_0.png"

alt="world"

data-link=""

width="450"

height="300"

layout="responsive">

itemprop="url"

content="">

itemprop="width"

content="450">

itemprop="height"

content="300">

Summary
Global

Macro

(top

down)

factors

will

dominate

the

investment

outlook

in

2016/2017.

But

bottom

up

issues

such

as

those

outlined

above

will

also

play

an

increasingly

important

role

.Traders

should

not

try

and

pick

bottoms.But

rather

should

wait

for

the

markets

to

tell

them

they

have

found

support.

And

when

in

the

market,

traders

should

exercise

caution

and

discipline

in

relation

to

order

sizes,

stop

losses

and

unattended

positions.

Written By: Admirals