Déjà vu

Last August, and again earlier this year, Chinese devaluation and the threat of a more serious decline in the Yuan (combined with USD strength) sowed the seeds of brief periods of significant drawdown in Global equity markets: the Global Index fell 12% in the month after last August’s trivial devaluation, and almost 14% in the weeks leading up to mid-February, when Yuan devaluation fears again re-surfaced.

Despite net outflows continuing apace through the first quarter – almost matching the entire outflow in the first 11 months of last year – and heavy Central Bank intervention, together with some tightening of controls at the margin, the Yuan actually strengthened in a move (vindictive, some speculators might say!) designed to head off speculative pressures and provide reassurance that all is well in the East. Another $1trillion in loans helped, but that’s neither here nor there in China these days. Move along, nothing to see here…

But we know differently. We know that you simply cannot grow credit $2.5 trillion annually with no corresponding nominal income growth; we know you cannot add capacity where there is already too much capacity; and that you cannot grow bank balance sheets at a rate annually equivalent to 40% of nominal GDP. Not if you want to keep your exchange rate fixed, you can’t.

And that’s where recent developments are interesting, the Chinese officially target the Yuan against the CFETs index – against a basket of 13 currencies (about one quarter USD weighted) and the Yuan has depreciated 1.3% since the end of March (5.9% year to date). From the mid-January low, the Yuan appreciated 2.1% against the USD through the end of March but has depreciated 1.2% versus the USD subsequently. They’ve unwound half the appreciation of the prior weeks.

Quietly, and under the radar, the Chinese have been letting the Yuan slide against the CFETs basket and, probably more importantly for the market, against USD.

Graph 1

This USD strength is seen in the broad USD appreciation in recent weeks: the next chart shows the percentage of currencies in the US effective exchange rate basket that the US has appreciated against in the last 20 days: the USD has appreciated against 80% of the currencies in its own basket.

Graph 2

We are seeing broad USD strength, broad Yuan weakness and, significantly, the Chinese quietly letting the Yuan slide against the USD.

This feels like déjà vu from our standpoint.

The global economy is already at low altitude, the median annual growth rate in our broad national sample is just 1.9% with over half growing less than 2% annually, and appears to be losing speed, again over half have growth slowing. Another round of Yuan/USD weakness into that mix is likely to precipitate just the same reaction as we saw last summer and earlier this year. Perhaps it’s time to seek out that tin hat again…

That time of year

It’s that time of year for forecasters to rejoice in the opportunity to produce forecasts for the year ahead. Economists like Christmas – it brings the gift of a spotlight for their year ahead projections. However, when those economic growth forecasts start landing in your inbox, it might be worth keeping the following simple charts in mind.

We look here at the US market (simply because it is the heartbeat of the market overall and is so influential, but the analysis holds equally elsewhere) and the annual relationship between the growth rate of the economy and the return on the S&P 500.

Chart 1 shows the annual nominal return for the S&P 500 from 1990 onward plotted against the annual nominal rate of growth in US GDP.

Quite strikingly, there is absolutely no relationship at all between annual nominal US growth and annual nominal US equity returns (look at those coefficients, zeroes everywhere).

2015.12.08.thattimeofyear

Let us torture the data a little to see if we can squeeze something useful from it. Chart 2 shows the annual rate of growth of real US GDP plotted against annual nominal US equity returns.

No change, still irrelevant. Where the economy goes the market does not follow.

2015.12.08.thattimeofyear2

So, with that in mind, perhaps it is time to give your economist a break this year. Not surprisingly, we will not be winging our economic growth forecasts to your inbox.

It’s not the economy, stupid.

P.S. Here is the same chart for the UK.

2015.12.08.thattimeofyear3

 

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