Investors here in the US have been the beneficiaries of a reversal of fortune of sorts as themes that have roiled markets and driven volatility dramatically higher in the first six weeks of the year have subsequently become tailwinds, for the near term.
For example, China’s near complete equity market collapse over the past 10 months has quite unexpectedly and dramatically been brought to a halt. More impressively, that halt has been followed by a sharp reversal higher. Over the past three weeks the Hong Kong Hang Seng Index has risen a blistering 10.13%. The Shanghai Shenzhen CSI 300 Index, a more pure barometer of Chinese equity pricing, has risen 4.38% .
Crude oil, both WTI and Brent, have reversed higher as well in the period adding 35% in a matter of weeks. Over the previous year crude WTI had fallen 73% before finding a bottom on February 11th at $26.21./bbl. Crude WTI closed at $35.92./bbl on Friday.
Another contributor to the risk off trade that gripped markets at the outset of 2016 was fear of a pending US economic slowdown. That fear was in part due to concerns over the impact of first move towards normalization by the Federal Reserve in nearly eight years. At the December FOMC Meeting, the committee voted to raise rates by 25bps. Further, indications by select Federal Reserve officials that more tightening was on the way in 2016 unnerved investors, many of whom were not engaged in markets before the Financial Crisis. Meantime, US economic expansion appears to have been able to weather a weak Q4, the first rate rise and global volatility with a degree of resiliency that few expected.
Fears of a slowdown in US economic activity as measured by the Q4 Chicago PMI, Pending Home Sales, PMI Manufacturing, ISM Manufacturing, Construction Spending, GDP, payrolls and most every other economic measure also stirred fear in investors fueling a sharp rally in the global demand for US Treasuries while simultaneously triggering a massive reset lower in equity prices. However, more recent economic data has suggested that the weakness borne out in Q4 was not carried over into 2016.
So, where do we go from here? Q1 earnings season starts the first week of April. That should provide some context as to the state of the US economic expansion - away from pure economic data. With guidance and expectations severely pared back over the past quarter, upside surprises should be the norm. Crude oil is likely near a top at these levels and will likely roll over to establish near term support in the $32/bbl range. The energy sector will continue to reduce exposure to exploration and R&D resulting in a robust defense of dividends. Global equity markets and EM remain challenged by the US interest rate landscape and by still tepid global demand growth. Yet, based on painful discount and earnings compression, investors will increasingly allocate capital to the space. The US economy looks to be gaining some momentum in which case a second move on rates is highly likely before the end of Q2.