Black Monday

[sb9]

Looks like market rally this morning has lost steam.....may be we should summon Morgan Stanley to come and grab bargains here, if they see that way.

[arc]

KW: Thank you , that is interesting and a good perspective on the bigger picture. I am going to start making a note of these "side factors" that relate & interrelate with stock price action and think of just how to incorporate it into the ai-model im working on.

Bobcat: Yes gold price action and indeed all precious metals will be interesting to see what they do in the next few weeks.

[RTM]

So along with your summary below KW, you would then expect companies to significantly reduce their dividends ? As if they do not...and PE's are reduced significantly, won't it follow that if divies remain the same, the % return becomes "unusually" high ? Have I got this right ?

In a nutshell, the root cause is the current currency war that nations are engaged in. The Chinese economy is slowing down, property and equity markets have crashed, and the Chinese Govt is devaluing the currency. This has triggered a big outflow of capital from China as the Chinese seek to protect their fortunes - which had been happening all year (and which is showing up most obviously as Chinese buyers of international property) but it has accelerated in the last few weeks as a result of the recent Chinese devaluation of the Yuan.

In order to convert Yuan to foreign currency China needs to buy foreign currency - which means selling US Treasuries. A flood of US Treasuries hitting the market pushes the price of them down and causes interest rates to rise (and most of the worlds borrowing is linked to the 10 year rate on US Treasuries). This is the opposite of Quantitative Easing - lets call it Quantitative Tightening. So while the US was looking to raise interest rates themselves they cannot as China is now dictating their fiscal policy - if they raise interest rates they are tightening into a tightening (way too much too soon, will damage the US economy). Depending on how much US Treasuries China is dumping, the US may even have to reverse course and start buying them = QE4 - the exact opposite of what they want to do. Best bet is the US sit tight and do nothing, and hope that China can in some way restrict the amount of capital flight (which is apparently happening as China crack down on shadow banking and illegal money transfer agents) so that the US can regain control of their own interest rate setting.

Bad news for Australians and Aucklanders though - if China does restrict people from taking money out of the country, you can kiss goodbye to the property boom.

There are other things going on such as the currency carry trade that is unwinding as a result of the devaluation, that could pose even greater risks down the line, but no-one knows how that will actually play out.

So no - this is not a stock market hiccup, there are serious issues at the heart of it, that are concerning those who control the money. Which is why this is not being communicated to the average punter - only a keep calm, and buy the dip message. For what Qantitative Easing did to drive up the share market, Quantitative Tightening will drive it back down. There is a lot of liquidating of assets to be done, before the public patsies get wind of any problems, and start to sell too.

And while the average business will keep on trucking on - it is likely that the days of paying 20 times earnings for an average business is over, if we return to historical valuations that business will be repriced to 10 times earnings. Every stock is at risk of having its P/E compressed significantly - this is called a bear market, the time when price finally meets value :-)

[BlackPeter]

No, the yields will go back to normal. At the moment yields are very low. Most Australian REITs are sitting on 4-5% yield - they should be around 7-8%. The rest of them will reduce their dividends because the economy is slowing - see recent Australia GDP and Retail Sales figures. Companies exposed to the slowing economy will cop a double whammy - falling earnings and P/E compression. Falling dividends will be compensated somewhat by rising yields. We have enjoyed a very low risk environment for equity so dividend yields have been low (low risk, low return) - as its risk on now those yields need to rise. Prior to this correction/bear market I thought it would happen naturally as interest rates rise, but now it looks as though it will happen via price falls. Which means I have some thinking to do about how long I want to stay invested in my AREITs :-(

NZ companies have always traded on low P/Es (to reflect lack of growth opportunities) and high yields. There will likely be some adjustment but overall I think the NZ market is better insulated. May be better to ask someone who remembers what NZ companies P/E and yields used to be 25 years ago to determine how much change will occur.

Hi KW, interesting theory. However just wondering - if you propose that stock yields will return back to normal, what happens with the interest rates? If interest rates stay low, than why would than anybody still hold bonds or leave money in the bank account to get 1 to 3%, if they can get 8% yield from their shares?

The reason for stock yields going that low (PE that high) in the first place have been the low interest rates. People just bought stocks because they promised higher interest rates, and the buying demand increased stock prices and dropped stock yields.

If you now propose that stock yields go up again, than either interest rates need to go up together with them, or otherwise the same thing will happen again (people moving into stocks and pushing prices up, yields down). Personally I am not sure which of the scenarios it will be, but I don't think that anybody would like the low PE / high interest rate scenario. Most industrialised countries (including US) would not be able to afford paying say 4 to 6 % interest on their debts - i.e. if interest rates would go that high, than we would look at some serious (and I mean SERIOUS) market crashes (and I am not even sure, whether the BEAR could help us in such a scenario).

IMHO - better hope everybody keeps interest rates low and PE's high. I am however sure that the FED's of the world are quite in agreement over this goal and happy to use their tools in sync.

Always an optimist, but I guess time will tell ....

[Daytr]

Speaking of optimism, I have put my toe in the water for the first time in the Indian market & bought the index this morning.
I remember from my gold days how much the price of fuel impacted the average Indian as they use a lot of diesel for power generation and fuel for cooking etc. With such a low oil price you would think its putting more money back into the average Indian's pocket.
Its a real speccy punt, but it looks like a reasonable level on the chart as well.
So far so good, up 1% ;-)

[nextbigthing]

Without wanting to go down the conspiracy theory path, I wonder how much the US and China will try and use this as an opportunity to gain financial superiority at the expense of the other, and what implications this will have for us as investors. Similar to OPEC not cutting production to hurt the 'frackers'.

If we can work out what one side might be up to, then there's obviously the potential for huge gains.

[couta1]

Couta...are you taking the Michael or what..I hope so.

Definitely not, grab yourself a modern translation and have a read of said chapter, if you have trouble with understanding then send me a pm but I'll give you a major headstart, Babylon equals the world financial systems and markets.

[Bobcat.]

In the USA, it's illegal to export oil. There's moves afoot to change that. Fracking, etc has meant the USA is now self-sufficient (in fact with a surplus of oil, with 4.6mb of US inventory announced today against an expected 0.32mb), which is why the price per barrel for US crude is less than for Brent oil.

Much of the rise in US job numbers these past two years have been in the Energy industry, mainly due to fracking. There have been a lot of layoffs lately and so there's political pressure to begin exporting oil. That being the case, and with a Bear market, we could easily see it fall to under $40/b and stay there for quite a while. That together with low commodity prices should in theory help economies recover...but we haven't seen much recovery over the past twelve months of falling commodity prices, have we.

There is something seriously broken, and with very little room to further lower interest rates to stimulate growth, Central Banks may (for the first time ever?) no longer have all the monetary tools required to fix it...hence the currency wars. It's getting to be dog-eat-dog.

Deflationary? Inflationary? Either way, precious metals silver and gold will come into play again...especially once people realise that interest rate rises are off the table.

Who's your pick for the next devaluation? I'm picking Japan...again. The Yen has strengthened quite a bit lately (about 5% against most major currencies this past month) - no wonder their exporters are finding it tough.

[RTM]

I had thought that printing lots of money (QE) in USA etc ultimately led to high inflation, or at least some inflation, unless it was accompanied by corresponding increases in productivity / output.. And that that inevitably led to increasing interest rates. Yet we don't seem to be seeing much inflation at all in the USA.....maybe I just need to wait a bit longer and it will happen ???

My post was predicated on the assumption that interest rates are rising - see my previous post. But no-one is suggesting 4-6%. Estimates are around 200 basis points (from China treasury/carry trade impact) or 25 points if US acts.
Except Australia, where interest rates will be going down as it slides into recession and we all know what that means for stock market prices, company earnings and yields.

But the end of QE means we are supposed to be heading back into an environment where interest rates will rise as the US tries to return to a more normal fiscal policy. The hiccups at the moment are because China is interfering with that slow normalisation process, and derailing all the emerging economies as it tries to fix its own problems by devaluing its currency. Which just starts a currency war, which no-one wins.

PS. Read today that if China devalues again, commodity prices could drop another 25% :-)

[Baa_Baa]

Look up 'Competitive Currency Debasement'.