"This slightly more positive data is welcome, but there is no room for any complacency whatsoever." Olli Rehn, European Economic Commissioner
Our Monthly Macro is a recurring post that appears on the first Tuesday of every month and recaps the high level macro developments of the previous month. We highlight the global themes that we believe are the most important and discuss why they matter for investors. This month’s piece will focus on a few themes that show the ongoing tug of war between confidence and uncertainty. We’ll discuss equity market complacency, Syrian tensions and green shoots in the European and Chinese economies.
Complacency Set To Reverse
Stanford and the University of Chicago together publish a series of indexes measuring the uncertainty in economic, policy and equity market outcomes. Their Equity Market Uncertainty Index looks at a universe of US news publications going back to the mid-80’s and extrapolates the level of uncertainty (or lack thereof) based on the prevalence of key words and phrases found throughout the publications’ content. As shown in the chart below, equity market uncertainty is flirting with all-time low levels that have historically preceded major corrections in the market. Confirming this metric is a recent study from SentimenTrader.com showing that equity market investors have nearly 6 times more money invested in leveraged mutual funds positioned for a market rise than they do in leveraged mutual funds positioned for a market decline. This is another contrarian indicator warning that the cyclical bull market could be overdue for a correction. That said, both indicators are also a perfect example of how improving confidence can be a self-fulfilling prophecy of relentlessly higher asset prices regardless of fundamentals.
WHY IT MATTERS: Short term moves in the market are almost always driven by shifts in sentiment which are most likely to occur when extremes are reached. We are beginning to see signs that complacency in the market is beginning to reverse. Stocks sold off slightly in August, and many institutional traders (the “smart money”) are positioning themselves net short as we head into the month of September. There are a number of potentially negative triggers culminating this month, including Syria, the debt ceiling, Fed tapering and a slowdown in housing data. Sentiment is one of the inputs into our quantitative model MarketVANE, but we might not wait to get a model signal before doing a little bit of trimming at the margins in risk assets.
By now we are all well aware of the tragedy that occurred nearly two weeks ago in Syria. Most of the world believes President Bashar al-Assad's regime was responsible for the chemical weapon attack that killed well over 1,000 people including hundreds of children. This event was the latest chapter in an ongoing civil war that has already claimed over 100,000 lives. Had these lives been ended with bullets and bombs they likely would not have dominated American headlines like they have over the past two weeks, but Assad’s use of chemical weapons has prompted a global debate over whether or not intervention is now warranted – and the US has been at the center of that debate. As we write this post it appears President Obama is garnering key support from Congressional leaders for a military strike in Syria. The details of the strike’s timing, nature and objective are still to be fleshed out, but at this point some sort of intervention is looking all but certain.
WHY IT MATTERS: This issue obviously matters for many reasons. It’s impossible to fathom the tragedy that countless families have experienced over the past two years in Syria. Speaking in economic terms, the largest potential impact of the Syrian Showdown relates to Iran and the Strait of Hormuz. Iran is a strong ally of Assad in the Middle East, and over the weekend the head of Iran’s Revolutionary Guard warned that if the US attacks Syria “the reactions will go beyond Syrian borders”. The biggest threat the Iranians could pose to global markets is to shut down the Strait of Hormuz which connects the Persian Gulf to the Arabian Sea and serves as a way of passage for roughly 20% of the world’s oil. Any disruption to this choke point would almost certainly cause an immediate spike in oil prices from their already elevated levels (WTI crude oil is approaching $110/barrel).
More Green Shoots In Europe & China
And now we come to the tug of war. Despite the tensions in Syria and concerning levels of complacency in equity markets, August brought with it a slew of economic data pointing to a stabilization and impending rebound in Europe and China – a huge boon for investor confidence. Business activity in the Eurozone, as measured by the Markit composite purchasing manager’s index, grew at its fastest pace in over two years as the 17-nation currency block posted data showing that it has emerged from a longstanding economic recession. Investor sentiment across the region surged in response, and money began flowing in earnest into European ETFs and mutual funds. Meanwhile, Chinese industrial profits rose 11.6% over last year as factory production, retail sales and fixed-asset investment all surged. These developments, naturally, have brought forward numerous analysts and political figures calling the end of the European slump and Chinese slowdown.
WHY IT MATTERS: Europe and China have been two of the primary sources of concern for investors over the past two years. It’s far too early to sound the “all clear” for either of these two regions, but a continuation of these trends would be extremely positive news for the global economy and the bull market in equities. It would also likely mark a turning point in relative strength as the leadership baton would be passed from the US stock market to international developed and emerging markets. As the opening quote of this post suggests, the positive changes are very welcome but there are still so many potential sources of systemic risks in both these regions that there is no room for complacency to creep in. A lot of work still has to be done.
Author David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.
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