From oil plunge to China’s trade figures

<p>As stocks hit a fresh record high relative to bond yields – measured by the S&P 500/US 10-year yield ratio at 1061 – the contrast […]</p>

As stocks hit a fresh record high relative to bond yields – measured by the S&P 500/US 10-year yield ratio at 1061 – the contrast between these two markets becomes palpable. This is not the first time we see a new a high in the stocks/yields ratio, but plunging oil prices are certainly making this phenomenon less of an aberration and more of the new normal… but until when?

Surging equity prices are normally a sign of improved investor confidence, while falling bond yields, accompanied by tumbling commodities suggest the contrary – disinflationary (or deflationary) pressures and slowing economic growth. If stocks were correct, then demand is supposed to be soaring and bond yields are rising or at least keeping steady – not falling across the board from two-year to 30-year yields; and from Australia to Canada to the US.

Today was supposed to be a quiet day – the start of US earning season – until oil prices plummeted, with US crude oil tumbling 4.8% to reach $45.85 and bent oil collapsing 5.4% to $47.16, per barrel, both at new five-year lows. Energy stocks could not tolerate the latest damage, sending the broader indices down across the board.

Beware of tonight’s China’s trade figures

Another shoe to drop in the ensuing sell-off in yields and equities could well be tonight’s release of Chinese December trade figures: due at 2 am London/GMT and expected to show the trade surplus falling to $49.0bn from $54.5bn; and more, importantly, imports falling by 6% following a 6.7% decline. Thus, regardless of any continued increase in exports, most likely to be around 6%, additional weakness in Chinese demand would highlight the broadening risk for emerging markets.

Chinese imports a risk for EM

We noted late last year that the three principal risks to emerging market currencies were; i) further USD appreciation; ii) broadening weakness in Chinese economy; and iii) a rebound in US bond yields.

The most pressing and realistic of these is a combination of the first two risks. Emerging markets are burdened by servicing their USD-denominated debt owing to the appreciating value of the US dollar.

We are closely awaiting tonight’s release of China trade figures after Chinese imports fell for the fifth straight month over the last nine months. With China serving as the biggest source of demand for Latin and Asian EM, any pullback in imports, or a weakening yuan (or both) could become a veritable challenge for EM sentiment.

Once these EM dangers materialize, it will be no longer possible for stocks to maintain their levitating prowess relative to bond yields. Even stock buy-backs won’t be enough.


SPX Yields Ratio Jan 13


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