This note was originally published at 8am on April 14, 2015 for Hedgeye subscribers.
“It is very queer that the unhappiness of the world is so often brought on by small men.”
-Erich Maria Remarque, “All Quiet on the Western Front”
Aside from January 2nd, yesterday had the lowest volume in U.S. equity markets for the year. Was it complacency? The calm before the storm? Or, was it simply a non-event and just a quiet day in the markets?
At the start of this note, we used a quote from the classic World War I novel, “All Quiet on the Western Front” written by German World War I veteran Erich Remarque. Far be it from us to compare stock market operating to operating in the brutal trenches of World War I, but certainly many of us do feel like we are getting up and going into battle every morning, even if in an obviously more figurative and proverbial sense.
So, as you dug into your Bloomberg and Excel trenches yesterday, how did you interpret the almost 11% ramp in equity volatility? Is it possible that the world’s omnipotent central bankers are Remarque’s “small men”? Is it possible that in their attempt to manage the global economy, they will ultimately lead to its demise?
Those questions will largely be answered in hindsight for most stock market operators. But in the meantime, keeping our eyes on the minefield ahead is as important as it has ever been in the last five or more years. As the Chart of the Day below shows, volatility can and will pick up dramatically.
Back to the Global Macro Grind...
Right now, “quiet” is the best euphemism for the morning news in global macro markets. Probably the most disconcerting news(at least for those of us who hope for continued stock market complacency) is coming out of Greece. Rumors are now running rampant that Greece may default on its debt if it can’t reach a deal with its main creditors (read: the Troika) by the end of the month.
Now to be fair, the Greek Prime Minister’s office adamantly denied that it would pursue the strategy of defaulting on its debt. Conversely, the IMF, who is a key creditor, seems to be leaking to every major newspaper that Greek negotiations are not working out and that there is real potential of a default. So, what is the truth in this Greek tragedy of a negotiation?
Like most negotiations led by bureaucrats, discerning the reality versus negotiation posturing is difficult at best. Certainly, the markets do not seem overly concerned about adverse outcomes. This is a bit surprising given how heated the rhetoric has become combined with the fact that Greece has more than 315 billion in Euro denominated debt outstanding.
Currently, about 78% of that debt is owned by the Troika – EU owns 61%, ECB owns 8%, and the IMF owns 9%. Perhaps they are comfortable that a Greek default will have no systematic effects. (Of course, many said the same about Lehman Brothers, when those negotiations failed.) Certainly for the Greek government though, there is no going back after a default. As IMF Managing Director Christine Lagarde very accurately stated:
“Defaulting, restructuring, changing the terms has consequences on the signature and the confidence in the signature.”
Inasmuch as the outlook for Greece is bleak and the consequences for a Greek default are real, in much of Europe things actually appear to be getting better on the margin. Later today at 11am (ping firstname.lastname@example.org for details), we will be walking through the case to remain bullish on Germany.
The German finance ministry bolstered this case, albeit marginally, when they upped their outlook for growth in 2016 to 1.6% from 1.5% in 2015. At the same time, they emphasized that overall government debt to GDP should fall to around 70%. Clearly, those aren’t GDP growth rates that get any of us overly excited. But much like a company, we do like the set-up of a country that can beat top line expectations.
China, on the other hand, seems to be faced with the opposite scenario of German. GDP appears poised to miss expectations and debt is set to accelerate. On the Chinese debt front there are actually two important points to highlight:
- According to a Bloomberg report, margin debt in China, when adjusting for the relative size of the markets, is double that of the NYSE. With the Shanghai Composite trading at 20x earnings and GDP slowing, that is a tad disconcerting; and
- According to a BofA index, leverage for Chines companies is at the highest level since 2004 and debt relative to assets is that the highest level since 2007.
By any measure, that is a lot of speculative debt for a country whose growth is slowing.
So, even if things are all quiet on the Western front, they may not be on the Eastern economic front in Asia for long.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.85-1.98%
Oil (WTI) 47.65-53.98
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research