The rout that refreshes?

Posted on Posted in Newsletters

Those of you who follow the stock market, even casually, know that we’ve had a nasty two days in global equity markets, with the MSCI All-Country World index tumbling -3.5% in just 48 hours. Today was the sharpest one-day drop since last June, and the biggest weekly decline since late 2011. Moreover, the selling was global and indiscriminate, with virtually no country or sector spared.

After two days of continuous, across-the-board selling, it’s natural to wonder if the dip is merely a pothole that will do little damage, or the beginning of a large sinkhole that sucks everything down -10% or more. Although you should know by now that we’re loath to make directional predictions on the stock market, we will admit that as of today, we remain firmly in the pothole camp.

It’s not at all clear why sellers have been so active recently, which itself is a good sign. True market-moving news is both significant and unexpected, and we have heard neither this week. It appears that the trigger (or excuse) for the selling was the release of the “flash” HSBC China manufacturing PMI (Purchasing Manager’s Index). This is modeled on an index originally developed in the US and represents a survey of purchasing managers in manufacturing companies, asking them whether conditions are improving or deteriorating. The data are aggregated to produce a number, where 50 represents “no change,” anything under 50 indicates contraction and anything above 50 means expansion.

The result came in at 49.6, slightly under 50 and a drop of 0.8 from November. The naïve takeaway is that manufacturing in China is now contracting, which can’t be good. But there are several reasons why this should not be market-moving information:

  1. It’s only one month of data, and we had 5 months over 50 preceding it.
  2. It’s a preliminary result, not based on the full survey, which comes later this month.
  3. The report came out yesterday, so why was the lion’s share of the decline today?
  4. It’s one of two different PMIs from China, and historically the less accurate one because it excludes the largest state-owned enterprises.
  5. All PMI surveys are heavily influenced by sentiment, as they are based on interviews with humans, not hard data. They can thus be depressed if the purchasing managers are in a negative mood for some reason.
  6. All data coming out of China have to be taken with a grain of salt.

So if the China PMI wasn’t the cause of the market rout, what was? One can only speculate, but it appears from trading data that it was mainly the short-term and high-frequency traders that sold, mostly through futures rather than actual stocks. Longer-term holders, including mutual funds, endowments, pension funds and even individuals mostly stood pat. This suggests that the “hot” money was simply taking bets on what might happen, not on new information, of which there was none.

You may have heard that the decline started in emerging markets, and was accompanied by a drop in many emerging market currencies. This is probably just a “risk off” effect: when traders become worried about the market, they sell their riskiest assets first. This is exactly what happened yesterday, but today, even stodgy stocks were hit hard. Selling begat selling, which shows that even professional traders can behave like sheep.

We’re not going to speculate on whether the selling is mostly finished or there is still more to come. But on a longer-term basis, we would like to point out that emerging markets have been struggling since the spring of 2011, and have dropped -23.8% in price since then. This is a bear market by definition, and one that has lasted nearly 3 years. It’s about time it ended, and perhaps this week’s rout, which started in just those markets, will mark a real turnaround in the emerging markets. If so, it can truly be called the “rout that refreshes.”

Enjoy your weekend and don’t let the market’s gyrations get you down.

       Adam

Dr. Ken Waltzer MD, MPH, AIF®, CFA, CFP®
Founder and President – Kenfield Capital Strategies (KCS)

Adam Bragman
Director of Business Development – Kenfield Capital Strategies (KCS)

Kenfield Capital Strategies℠ (KCS) is a registered investment adviser. Our services include discretionary management of individual and institutional investment accounts, along with comprehensive financial, estate and tax planning services.

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