Mid-year review: the more things stay the same, the more they change

Brandon Snow's picture

While we have had fairly consistent drivers for the markets over the last few years, we have also had some very interesting things bubbling under the surface this year. If you just tuned in for the first time, you wouldn’t notice much action across markets over the past seven months:

Source: Bloomberg

These results mask some amazing trends beneath the surface. In April, we saw the most bizarre action in the bond market when European government bond yields went drastically negative (as we discussed in a former blog). At one point the only place you could get a yield above 1% was Greece! From the lowest yield on the 10 year bund of 0.06%, the yield increased an incredible 1100% over the course of 16 trading days. This speculative action in the bond market was an unbelievable occurrence, something history would tell us is impossible (for more discussion on this topic, read Jamie Dimon’s letter to shareholders this year).

The second area of discussion comes from the Chinese stock market. The market skyrocketed over 150% year-over-year and 64% YTD to June 9, 2015 as individuals ramped up speculation with the help of margin debt. Near the peak, an astonishing 67% of new accounts were being opened by individuals with less than a high school education.  For some highlights from the assent please read a recent blog here.

When momentum had finally slowed, the market fell 34% between June 10 and July 7, a number that would have been worse if it wasn’t for significant intervention: massive stock halts (see chart below), large shareholders banned from selling shares for six months, IPOs banned, and most recently, speculation that China’s central bank is injecting nearly $500 billion into China Securities Finance Corp. to make loans to brokers, to buy stocks and to buy funds.

Source: Wall Street Journal

While over half a trillion dollars pledged helped the market rebound for some time, last night we saw the worse single day decline in the Shanghai index since 2008. 57.6% of the market closed limit down and an additional 13.8% remained suspended leaving an amazing 71% of the market either untradeable or limit down. It’s a tough start for a country trying to legitimize its markets for foreign investment.

Later in the equity cycle as growth becomes scarce and visibility declines speculation tends to take over as investment time horizons shorten and capital gains (rather than earnings growth or yield) become the focus for returns. These are two significant examples of speculation in just the first half of this year. It hasn’t seemed to have caused a larger problem yet (although China is still a big question mark) but we are definitely on watch for any knock-on effects.

We can’t predict the future when investing (no one can), but our job is to watch and listen to the market to see how risk is being priced. Right now we feel that there is too much risk being taken on for the return potential available. There are few absolutely cheap markets or asset classes, other than commodities, so to find opportunities you have to be active.  We will continue to be patient with investing our clients’ money, waiting for the right opportunities and not getting caught up in the speculation.

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