Accentuate the negative; another down day for the markets

By Buttonwood

MARKETS have a habit of turning on a dime and surprising the unwary commentator. But one tip your blogger can share after 30 years is to see how long the counter-trends last; if they peter out quickly, that is a sign the mood is set. That certainly seems to be the case in 2016. We have had brief rallies but within a couple of days, bearish sentiment seizes the upper hand again.

European stocks are heading for their eighth down day out of nine. Just as strikingly, look at government bond markets. The 10-year Treasury bond yield has fallen more than half a percentage point so far this year; Japanese 10-year yields went negative (they are now at the giddy heights of 0.01%); French yields are at 0.58%. But there are also signs of differentiation; Portuguese yields are up a percentage point over the last month and Greek yields have surged two-and-a-half points to 10.7%. The euro crisis was supposed to be behind us.

Another sign of the prevailing mood is that yesterday's testimony by Federal Reserve chairman Janet Yellen seems to have been taken in a bearish light. The testimony included the key sentence that

Financial conditions in the United States have recently become less supportive of growth, with declines in broad measures of equity prices, higher borrowing rates for riskier borrowers, and a further appreciation of the dollar.

At a different time, these remarks would be seen as bullish; the Fed is far less likely to increase rates than before. But instead, the market took the sentence to confirm the view of bears that all is not well with the American economy. The latest cut by Sweden, sending rates even further into negative territory, also seems to have dented confidence and Japan's move into negative yields has sent the yen higher, not lower, as the Japanese hoped. Faith in central banks is not what it used to be, as Free Exchange comments.

All that chimes with Albert Edwards, the ultra-bearish strategist at SocGen, who is in his element (even as his bank's share price plunges). He writes that

The US released 2015 Q4 productivity data last week which saw a plunge of 3% annualised qoq. Together with mildly improving wage inflation, unit labour costs surged 4.5% qoq annualised and 2.8% yoy. With corporate output prices growing a meagre 0.8% yoy, this represents a severe margin squeeze which we believe is often a good leading indicator for recession. Clearly the strong dollar is making the margin squeeze much worse.

It is hard to spot a US recession in the recent numbers. The Atlanta Fed, which has a nowcasting model for the economy, is currently pointing to annualised 2.5% growth in the first quarter.

Still, there is something going on in the global economy. This week has seen the release of December's industrial production numbers from four leading European economies; Italy was down 0.7%, Britain 1.1%, Germany 1.2% and France 1.6% (against forecasts for a 0.2% rise!). There seems to have been a collapse in global shipping. Maersk, the Danish group whose huge container ships can be seen from many a shoreline, said global trade was worse than during the 2008 crisis. The Baltic Dry index is down 98% from the peak. Clearly, that is a lot to do with excess supply of ships, but they aren't making any more ships and the index is down another 39% so far this year.

The fall in commodity prices is a big part of this; there is less need to ship bulky stuff. The Association of American Railroads isn't telling as gloomy a story as the Baltic Dry; nevertheless, carload volumes in the first five weeks of the year are 15.7% down on the same period in 2015.

Of course, many see the fall in commodity prices, particularly oil, as a good sign. Again, it is an indicator of sentiment that it hasn't been taken that way. Indeed, the story of the last 12 months is that the bad news has caught up with the equity market. Falling commodity prices, low bond yield, weak global trade, and signs of Chinese slowdown were all dismissed. Even weak industrial numbers were not enough to convince the optimists; services are much bigger than manufacturing, after all. But whistling to keep the spirits up hasn't worked. The fall in bank shares may be the sign that the rot has really set in. Even gold, which in recent years has been deader than a deep-fried dodo, is reviving. Now we know investors are worried.