• Weekly comments for January 11, 2016

    There is only one aspect that has been central to this week's market moves: bad debt contagion from China. Chinese banks are only a few percent integrated to international finance, but still a contagion of bad Chinese debts will take several transmission channels:

    1. Commodities: in order to raise cash, Chinese corporations/trading houses will dump whatever liquid asset they are holding. This is why copper is in distress mode.



    2. Cheap steel will continue flowing out of China, helped by devaluation. This will hurt the rest of the world.





    3. Large US Banks were hit hard yesterday, a clear fear of contagion. The TED spread is also at its highest in the past few years. And the British Pound was sold on Friday. Why is the BP important? Because British banks are believed to be the most linked to Honk-Kong banks.











    How will China be able to take back the control over its failing markets?

    Three steps:

    1. Stop capital outflow from HK. I think that it is already taking place or at least anticipated: the CTick has turned negative (money is not coming into US equities anymore) and the US real-estate market that profited from Chinese investments is feeling the contagion.





    2. Continue to raise US$ (sell US Treasuries) in order to patch holes in the state controlled banks that cannot meet their international obligations and whose international lines of credits are cut.

    3. Inform their citizens that the Yuan devaluation is good and will continue: it will help exports, import inflation and boost equities. Of course, they will also try to decrease interest rates, but both devaluation and rates are only long-term tools.

    China will act over the week-end. Will they be able to manage a general Chinese equities bounce on Monday? That would greatly help to stem the negative heard behavior that took place in the last thirty minutes of trading on Friday.



    The problem is the "everything has to go" mentality that started to grip investors. This behavior is taking place in Semiconductors and Biotech (in poor AAPL too,) which have been leaders during the bull market of the past few years.





    What will it take to get a good buying opportunity?

    Sure, China must rise from the dead. Not sure that the Chinese herd behavior will be turned around.
    It will take more than to "suicide" a few non-patriotic sellers.

    We probably also need a real reversal in the energy sectors. We are not there yet for oil, but Nat Gas has been attracting good money in the past few days.





    And with it, Nat gas companies might be bouncing here. I believe that this will be the best buying opportunity even probably this coming week... depending on the general mood.





    Gold has also attracted good money, pulling the gold miners partly out of the grave.





    Not sure I want to buy this sector here. Much depends on the US$, which indeed has been down in the past days, but this is probably just a reversal of the US$/Yen and US$/Euro carry trade. The Yen has attracted money, but still some large players are betting on a reversal of this trend. This means that they are betting that US equities will bounce soon.



    Conclusions:

    Not sure that contagion can be contained.

    Tactically speaking, the fact that some large banks' earnings at the end of the week will correspond to an options expiration day could fuel a buyable oversold bounce. If this occurs, I guess that it will be anticipated by a few days. The big question is to point to the right oversold conditions.

    Will S&P at $1850 be an objective target for a possible bounce?

    Let's not forget that due to forced regulatory selling, the worst dumps usually occur in an already oversold market. This is the reason why the end of the day on Friday was so negative: regular investor threw in the towel... will margin investors be forced to do the same on Monday?

    I do not know, but just to be sure, I closed my only long position at the end of the day on Friday.
    I had expected a late afternoon bounce in anticipation for a Monday reversal, but we had a weak bounce during lunch and the rest is history.