Monday, 23 September 2013

More good news on shipping, more thoughts on the "no taper" decision, a short-term warning sign

It seems it’s not just seaborne freight that is sending positive signals. The Association of American Railroads (AAR) ... reported increased total U.S. rail traffic for the month of August 2013, with intermodal setting a new record and carload volume increasing overall compared with August 2012.

Not surprisingly, railroad stocks have also been performing pretty well of late…

…while bellwether global transportation companies UPS and FedEx are also trading at record highs. These observations also augur well for continued recovery in the global economy.

Regarding the Fed and its influence on markets: I stumbled upon a great article at Motley Fool which had a fascinating chart that I have inserted below. The chart shows cumulative returns on the S&P500 from 1994 to 2011 with and without the 24 hour period following FOMC announcements. This chart shows two things:

1)      Most of the market’s gain from 1994 to 2011 came within 24 hours of Fed policy meetings (I found the impact staggering!); and

2)      The Fed has been influencing markets since long before Jon Hilsenrath became a household name (i.e. the Fed’s market influence is NOT some new, post-crisis paradigm)!

There has been much hand-wringing over what would happen to the equity market once the Fed starts tightening (or even reduces the amount of easing on offer via tapering). Remember, the Fed has a mandate to control inflation and support employment. Bernanke made it clear last week that the Fed will continue to provide accommodation until the economy gets stronger. And a stronger economy might be good for equities…the last time the fed tightened monetary policy, from 2004-2006, US equities rose approx. 40%. And if the economy doesn’t improve in line with Fed expectations, the Fed will keep stimulating…which might also be good for equities.

This does not mean things go up in a straight line. Witness Friday’s swoon, attributed to comments from Fed President Bullard regarding the possibility of tapering in October. However, the very notion that the Fed will at some point throw its hands in the air, yank stimulus and let the economy tank is not only unlikely, it is clearly against its mandate. Again, today is not the time to allocate (or not!) investment capital based on worries over the Fed’s exit strategy.

If I sound positive it’s because I am, structurally. Short term I am a little more cautious. In a previous note I mentioned how two of the sectors that lead the market higher – homebuilders and financials – looked as though they had broken down. While both sectors have recovered somewhat since then, neither has confirmed the new all-time highs seen in the S&P500 (see chart below). Non-confirmations like this often serve as a prelude to a broader pullback (a.k.a. “volatility” in investment banking parlance). Such a pullback is likely to be more technical in nature, although some scary narrative (debt ceiling fiasco round 3 anyone?) will almost certainly be applied to it. I would be inclined to treat any such event as a buying opportunity.

S&P500 (white line, making new highs), Financials ETF (orange line, not making new highs), Homebuilders ETF (red line, not making new highs):

Now is not the time to worry about the Fed's exit strategy

The Fed’s decision not to taper asset purchases on Wednesday has clearly left the market with a more bullish disposition than it had going into the announcement. I think it’s important to remember that 1) the impact of QE is more psychological than anything else; and 2) $10bio per month is pocket change in the scheme of things. So I expect the exuberance of the decision to not taper to be ephemeral.  Likewise when the Fed does eventually begin to taper (late this year or early in 2014) the angst will likely prove temporary as well.

Still, DM equities caught a bid and EM equities ripped higher! The USD suffered its worst slump in 3 months (consider than FX markets turnover nearly $5 trillion per DAY, in the context of an expected reduction in asset purchases of $10 billion a month if you still doubt the effects were are talking about here are predominantly psychological!) This lent considerable support to gold, the commodity complex and EM and commodity currencies.

10yr UST yields dropped expectedly and are now challenging near term support. I expect bonds will rally/yields will fall further from here…2.50% on the 10yr looks like a reasonable near term target.

The Fed has received a barrage of criticism in the press over poor communications and lost credibility (here, here, here, here) which highlights more than anything how much people hate to be wrong. I remain surprised by just how convinced the market was that we would see a September taper, given anything the Fed had told us.

Bernanke specifically mentioned “Upcoming fiscal debates may involve additional risks to financial markets and to the broader economy”. So even though markets are more psychologically predisposed to take risk as a result of the no taper decision, markets will not move up in a straight line if “Debt Ceiling Fiasco Mk III” looks like a high probability.

Changing the subject, I want to share with you below some charts that lead me to conclude that economic surprises over the next year or so could well be on the upside rather than the downside.

The chart below is of the Baltic Dry Index, one of the more common benchmarks of shipping activity. The index measures a combination of different shipping prices and gives a benchmark of the cost of freighting dry goods (e.g. coal, grain, iron ore) by sea. It’s a popular benchmark because the theory goes, when economic activity picks up, more goods get shipped and shipping rates rise.

Right now this index is having its best run in two years. It is coming off very depressed levels so I would hardly get too excited about the absolute level of the index. However it is moving decisively in the right direction - which serves as evidence that that things globally might be getting better.

Coincident with the rise in the Baltic Dry Index we can see that volumes at some of the busiest ports in the world (Shanghai, Singapore, Hamburg, Los Angeles) are trending up nicely:

Shanghai container volumes:

Singapore container volumes:

Port of Hamburg container volumes:

Los Angeles container volumes: 

Further confirmation of the current state of shipping can be seen in the stock price of the Guggenheim Shipping ETF, which is clearing 2-year highs:

There chorus of negative commentary fretting over the Fed’s exit strategy is significant. And look, one day the Fed will raise rates. One day the bull market in equities will be over. 

However what the charts above tell me is that a recovering world economy is the right trade to focus on right now. Now is not the time to be allocating investment capital based on worries over the Fed’s exit strategy. Let’s maybe start to worry about that in another year or so.