Gavekal Capital: 2014-08-03

Friday, August 8, 2014

Four Simple Charts to Follow the Global Stock Market Correction

One way in which we can measure the intensity of a corrective phase in the markets is to calculate the percent of stocks that are trading within various tiered ranges of their 200-day high. The way we do this is to create four buckets of stocks:

  1. Percent of stocks trading within 10% of their 200-day high (dark blue line)
  2. Percent of stocks trading between 10-20% of the 200-day high (red line)
  3. Percent of stocks trading between 20-30% of the 200-day high (light blue line)
  4. Percent of stocks trading further than 30% from the 200-day high (black line)  
If we observe that bucket 1 is obviously becoming smaller while buckets 2-4 are becoming bigger, then we know that stocks are moving into a corrective phase. When bucket 4 is the largest bucket, then most stocks have suffered deep losses, and it's usually not until the black line starts to turn lower again that the losses are close to being over.

So where do we stand currently? From the charts below we can see that bucket 1 (the dark blue line) is starting to turn lower while bucket 2 (the red line) is turning higher. In other words, more and more stocks are moving into a corrective phase. The corrective phase has taken root primarily in Europe and least so in Asia. North America is somewhere in the middle. In Europe, the percent of stocks that are either in a correction or a bear market (buckets 2-4) represent 68% of the total, so we know that the selloff in Europe has been widespread. In North America and Asia the percent of stocks in a correction or a bear market is only 35%.

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Pinpointing The Weakest Industries In Europe

As we have highlighted recently (see Europe: Short-term Oversold, Detailing The European Correction and Down Days On the Rise In MSCI Europe) stocks in Europe have been under pressure.  We count four industry groups that have tipped into correction territory: transportation, automobiles, food & staples retail and retailing.

Performance
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The three retail sub-industries that have fared the worst are: 1) apparel, accessories and luxury goods, 2) home improvement retail and 3) internet retail.  Over half of the companies that comprise these sub-industries are down over 10% (chart below).

Performance
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We do find these moves to be fundamentally based.  From a bottoms-up perspective, all these retailers (with the exception of Pandora) have seen earnings estimates for the current fiscal year fall over the last six months. Some, such as Adidas or Asos, have seen estimates drop by a third (table below)

Change in FY1 Earnings Estimates
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From the top-down, the consumer discretionary sector in Europe has seen relative earnings and price momentum plunge relative to the MSCI World Index lately.  In the chart below we show the mean earnings estimate for European consumer discretionary sector for the next twelve months overlayed on the price of the country-sector relative to the MSCI World Index.

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The industrial sector is another place we see broad-based weakness also.  We noted above the transportation industry was down 10% YTD, but the capital goods industry isn't far behind, down 8.89% YTD.  There are four sub-industries to focus on here: 1) air freight and logistics, 2) airlines, 3) construction machinery and 4) heavy electrical equipment.  The companies within these sub-industries have experienced a pretty time lately.

Performance
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Here again, from both the bottom-up and the top-down, earnings estimates have been a problem.  Half of these companies have seen their earnings estimates slashed by over 10% over the last six months.

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And, the industrial sector more broadly has been its forward 12 month estimates relative to the MSCI World Index come off by about 7% since April, with relative prices having fallen about 13% over the same period.

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The last group of note is food and staples retailing.  While the broader consumer staples sector has held in relative well, the food retailers have gotten hammered (Russian food import sanctions?).  Below are the members of the European food retail sub-industry, with all having fallen over the last 50 days by a meaningful amount.

Performance
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For all these reasons (and a few more) this is why current year earnings estimates have taken a dive compared to the other MSCI regions over the last three months.  This also goes a long way to explaining why Europe has been the weakest MSCI region lately.

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Thursday, August 7, 2014

Treasury Bond Yields Making New 1-Year Lows in Line with Slowing Fed Asset Purchases

Barely a week after 2Q GDP and a slue of revisions indicated that the economy has performed better initially indicated in the first half of 2014, bond yields are again making new 1-year lows. Thus the initial bond selloff following the better than expected GDP stats has been completely reversed and the downtrend in yields has been reasserted (charts 1 & 2). This also means our model of how bonds are likely to react given slowing Fed asset purchases remains intact (charts 3 & 4).

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Down Days on the Rise in MSCI Europe

While the number of days where MSCI Europe declines by 1% or more remains low by historic standards, that number is rising-- especially since June.  In the past, increases above 15-20 have been consistent with an acceleration in losses:

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In general, up days represent an increasingly smaller proportion of market moves over any given time period.  More defensive sectors such as Consumer Staples and Utilities have seen particularly large declines:

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Has the market reached extreme enough conditions to warrant a bounce?  For more on European weakness, see here and here and here.

Wednesday, August 6, 2014

Update on VIX Curve Inversion

A few weeks ago, we noted the relationship between an inverted VIX curve and declines in the S&P500 (see here).  Taking a longer-term view, we see that the last few years have been relatively quiet--characterized by few, intermittent inversions and minor pullbacks in the index.  A larger spike than we saw last week and/or a sustained inversion between prices of the VIX and the 3-month VIX would be symptomatic of a more meaningful correction:

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Detailing The European Correction

Over the last 50 days European equity markets have taken a beating.  The average stock in Europe is down 6%, and both Portugal and Austria are down more than 10%--putting them in correction territory.  Down almost 9%, Germany isn't far behind.

Performance
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The cyclical sectors in Europe have taken it the hardest, with the energy, consumer discretionary and industrial sectors leading the decline.

Performance
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In fact, the cyclical sectors in Europe are on the edge of breaking down, failing support from 2012 and 2013.  The plunge in German bunds has been a good leading indicator for the recent sell-off.

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As we highlighted Monday (http://gavekal.blogspot.com/2014/08/europe-short-term-oversold.html) eight out of ten sectors had fallen into an oversold position.

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Almost 40% of European stocks are making new 50-day lows, a reading last seen in May 2012.

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Only 18% of European companies have outperformed the MSCI World index over the last 50-days, a reading we haven't seen since 2010.

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More than 50% of European stocks are down more than 10% form 1 year highs, with 41% of the companies down 10-20%, 14% down 20-30% and 6% down more than 30%.  The majority of European stocks are in correction territory, down more than 10%.

Distance From 1 Year Highs
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As we detailed in our recent quarterly video (https://www.youtube.com/watch?v=4fJh87McWa4), if an investor has to be allocated to Europe, he should focus on the counter-cyclical groups.  The move in German rates suggests continued outperformance of European counter-cyclicals vs. cyclicals.

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Tuesday, August 5, 2014

US PMIs Highest Since 2005

The ISM Non-Manufacturing index came in much higher than expected for July at 58.7 vs consensus of 56.5. Consequently, it helped boost our "GDP weighted" PMI to it's highest level since December 2005. The new orders index also reached it's highest level since August 2005.  Overall, it was a very solid ISM Non-Manufacturing report for the US today.

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Monday, August 4, 2014

Europe: Short-Term Oversold

One of the ways we track movements in the equity markets is by considering the number of stocks in a sector trading above a moving average.  For a shorter term view, we use 20 days (trading days, not calendar days).  We calculate this breadth stat daily for all the regions and sectors in the MSCI World index.  A reading of 20% or lower--meaning less than 20% of companies in a given region or industry are above their 20-day moving average-- constitutes an oversold condition.

The MSCI World index isn't quite registering an oversold condition, helped a recently resilient Asia-Pacific. Europe is the one region where we observe a shorter term oversold condition, with only 12% of stocks in the region above their 20-day moving average.

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The only two sectors not in oversold territory by this measure are information technology and health care. Everything else is in oversold territory, with fewer than 20% of the names in each sector above their 20-day moving average.  Charts of the oversold European sectors are below.

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And The Best Performing Sector Year-To-Date Is...

Emerging Markets Telecom! Probably not what one would have guessed, right?

The Emerging Markets Telecom sector has outperformed the 2nd best sector by over 6% so far this year. Overall, the Emerging Markets have easily outpaced the Developed Markets year-to-date. In fact, the average stock in the Emerging Markets has outperformed the best performing sector in the Developed Markets by 19 basis points.

So far in the third quarter, the Emerging Markets are are still in positive territory (+1.29%), while July and the first trading day of August were rough for Developed Markets (-2.30% QTD).  The Developed Markets Energy sector has taken a particularly rough beating in the 3rd quarter. After being the high flyer of the first half of the year and especially in the 2nd quarter, the Developed Markets Energy sector is down over 6% so far in the 3rd quarter. Also, the Emerging Markets Energy sector is actually the worst performing sector in the MSCI All-Country World Index. Finally, the Developed Markets Consumer Discretionary sector continues to pull up the rear in the Developed World.

Emerging Markets
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Developed Markets
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