ETF Pricing Problems Cause Continued Wide Market Swings

October 27, 2015


By Louis Navellier

All content in this Introduction to Marketmail represents the opinion of Louis Navellier of Navellier & Associates, Inc.

ETF Pricing Problems Cause Continued Wide Market Swings

We remain in a “washing machine” market with wild daily price swings, but through last Friday we’ve seen an 8% gain in the S&P 500 during October. We are now in the heart of earnings announcement season; but the short sellers are out in full force, doing their best to scare investors, sometimes targeting specific stocks. Short sellers like to slam leading stocks and then use sector ETFs to ruin the entire neighborhood. Due to the overall nervous nature of the market, one more retest of the August 24th lows is still possible.
Speaking of the August 24 lows, in a public statement released by the SEC on October 15, 2015, recently retired SEC Commissioner Luis Aguilar said it may be time to “reexamine the entire ETF ecosystem,” specifically how market structure rules are applied to the products following the wild price swings several ETFs experienced on August 24th. Aguilar added, “Why ETFs proved so fragile that morning raises many questions.” However, I suspect that any ETF policy reforms will be presented in 2016 at the earliest as SEC proposals are typically subject to industry and public comments.
In the meantime, ETF pricing will likely remain the “Wild West” of Wall Street, since the premiums and discounts relative to the underlying securities in ETFs remains abnormally high in the wake of the market volatility during the third quarter. Complicating matters further, ETFs are clearly responsible for much of the recent day-to-day volatility, since they accounted for 42% of overall daily trading volume on August 24th.
In This Issue
Crude oil has failed to rally, despite escalations of the hot war in the Middle East. In Income Mail, Ivan Martchev will handicap the chances for a continued decline in crude oil. Gary Alexander’s Growth Mail will examine the case for owning both stocks and gold, while Jason Bodner’s sector spotlight will psychoanalyze the bipolar nature of the S&P sectors. My “Stat of the Week” column this week will focus on international trends, particularly the evidence of deflation in Europe and Asia during China’s slowdown.
Income Mail: A Crude About-Face
The U.S. Dollar Awakens
by Ivan Martchev
Growth Mail: The Case for Owning Both Gold and Stocks
Five Reasons to Consider Gold Now
by Gary Alexander
This Week in Market History: The Bright Side of Late October
Major Market Moves in Late October
by Gary Alexander
Sector Spotlight: Bipolar Disorders in the S&P Sectors
The Last Shall be First
by Jason Bodner
Stat of the Week: China Cuts Rates to Revive Economy
European Deflation Deepens
by Louis Navellier
High Yields in Both Stocks and Bonds
Income Mail
All content in “Income Mail” represents the opinion of Ivan Martchev.

A Crude About-Face

By Ivan Martchev
The fact that crude oil is refusing to rise due to the escalating geopolitical situation in Syria is rather telling. The Russian Air Force just got authorization to hit ISIS convoys coming from Syria into Iraqi territory – which is a rather nebulous concept, since an ISIS convoy is an ISIS convoy, so who really cares where it is coming from? The Russians are also opening another coordination center with Amman and will fly joint operations with the Jordanian Air Force. It seems the Jordanians have determined that ISIS is a big enough threat to their country that fighting ISIS is more important to them than pleasing some world powers who might be unhappy about their cooperation with the Russians.
In other words, the heat on ISIS and any (oxymoronic-sounding) “moderate rebels” in Syria just got turned up, way up. Yet, oil is falling.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
December 2015 WTI futures (pictured above), which managed to close above $50 two weeks ago, closed below $45 on Friday. This does not look good for the oil bulls, whose only hope was for the geopolitical tensions to cause a super spike as combat operations get closer to major oil producing regions of Iraq.
Crude oil is seasonally weak in the fall and winter months. There are more people in the Northern (than Southern) hemisphere and these people tend to drive less when it’s cold. But there is another major cyclical factor and that is China. China is decelerating, so its demand for oil is not growing as fast as planned, while the supply is increasing. These seasonal and cyclical factors are reinforcing each other and are putting pressure on the oil price. The geopolitical situation is the only hope for the oil bulls in the intermediate term. The oil price can still spiral out of control if there is damage to major oil infrastructure, but so far that has not happened. And there is Iran, which is desperate to come back to the oil markets.
Over the past week the U.S. and the EU have pressed ahead with implementation of the Iran nuclear deal, which is rapidly clearing the way for the Islamic Republic – eerily resembling the more nefarious Islamic State that it is fighting – to come back to the oil markets, which should happen before the end of 2015.
After the 2012 sanctions, Iranian exports averaged 1.4 million barrels a day in 2014, down from 2.6 million at the end of 2011 (see July 14, 2015 Wall Street Journal article entitled, “Iran Deal Raises Prospect of a Fresh Oil Glut”). Since the Iranians have been prepping for this moment for a while and they need the money badly, it would seem a safe bet that they would want to come to the oil markets as soon as possible. This is unlikely to be bullish for the price of oil if there is no damage to the energy infrastructure in the intensifying aerial bombardment in rebel-controlled territories in Syria and Iraq.
I have often written that if it was left only to the forces of supply and demand – without the Russian-inspired blitzkrieg on ISIS – crude oil could fall below $20/bbl. Commodity prices on average this year fell nearly down to the level they reached in the Asian Crisis in 1998, when oil went down to $10/bbl.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
In the two months since the late August short squeeze, the December 2015 crude oil futures have been trading in a range of $44 to $51. If they fall out of that range in the coming week, that means a likely retest of the August lows in oil and major commodities, notwithstanding the Syrian situation.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Such moves in commodities are relevant to the bond market as the shale boom was financed via junk bonds which have been under serious pressure as the price of crude oil has gone down. Cheaper oil means less cash flows to service that mountain of junk debt, higher credit spreads, and more bankruptcies when shale producers get out of the absurd situation that requires them to increase production as the price of oil is falling in order to service their debts. Sooner rather than later that absurd dynamic will end, but we many need a more catastrophic decline in the price of crude oil than we have already seen. This dynamic in oil futures raises interesting questions about the major short covering rally in commodity and oil-related names that has been leading the market in October.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
All in all, earnings for energy and commodity producers are shrinking faster than George Costanza’s self-esteem when coming out of a cold swimming pool (in an infamous Seinfeld episode). This dynamic in oil futures seems to also be divorced from the short-covering moves in the Energy SPDR (XLE) and the smaller, more leveraged sub sector, the Market Vectors Oil Services ETF (OIH), both of which are substantially above their August lows. If oil is about to challenge those summer lows, one would think that XLE and OIH would do the same. (Please Note: Ivan Martchev does not own positions in XLE and OIH. Navellier & Associates, Inc. does not currently hold positions in XLE and OIH in client portfolios. However, XLE and OIH have been held in Navellier & Associates, Inc. clients’ portfolios in the past).
The U.S. Dollar Awakens
It has often been contended in these pages that the U.S. dollar rally is not over. As to how high it is going to go I cannot be sure, other than to say that it is not only Fed policy that pushed the dollar but also ECB policy and the policies of all other central banks combined.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
If we only look at the squiggly lines and the technical mumbo jumbo to help us see how the fundamental picture develops in the price discovery process, the U.S. Dollar Index has (almost) completed a six-month consolidation and is about to deliver a second leg higher in the rally that started in mid-2014.
The ECB accelerating QE would certainly be a catalyst for such a dollar move, which appears to have started. I think it is only a matter of time before the euro reaches parity to the dollar with the present ECB policy path, and I don’t think it will stay at parity.
The ECB sounded remarkably dovish from sunny Malta last week, which caused quite the sell-off in the largest component of the U.S. Dollar index (DXY) – the euro at 57% – and quite the two-day surge in the DXY itself (see October 22, 2015 Reuters articl entitled, “Euro continues fall on ECB president’s dovish tone”). There is talk of the ECB diving deeper into negative interest rate territory with their short-term policy rates, which caused German 10-year bond yields to sink into record negative territory.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
It is reassuring to see that commodity-leveraged currencies like the Australian and Canadian dollars, the Russian ruble, and the Brazilian real have been acting remarkably well, given the action in oil in the past two weeks; but I don’t think that would be the case should oil begin to flirt with its August lows. I think the Russians, or anyone interested in the oil price, know exactly where they need to land a stray bomb or a missile for us to have a major spike in crude oil futures, despite the bearish fundamentals. I don’t think that a major oil producer should think that way but you never know when billions of dollars are at stake. That is the only thing stopping me from calling for new crude oil lows by the end of 2015, which may come anyway without such a geopolitical “accident.”
Growth Mail
All content in “Growth Mail” represents the opinion of Gary Alexander.

The Case for Owning BOTH Stocks and Gold

By Gary Alexander
“I like gold. I believe it’s under-owned. It should be a part of every investment portfolio, maybe five to 10 percent.” 
– Billionaire hedge fund manager Paul Singer, speaking in Tel-Aviv (Bloomberg, October 14).
Bad news sells, and there’s something in the human psyche that seems attracted to Armageddon – or a train crash, a hurricane in Mexico, a flood in Texas, a flash crash on Wall Street, or a political dog fight.
As you read this, I’m heading to the 41st annual New Orleans Investment Conference, where I’ve been MC and/or panel moderator for the last 33 editions. It’s no secret that the crowd is generally pro-gold and many speakers are negative on the stock market. I once believed in that bipolar worldview, but since 1990, I’ve been a fan of both gold and stocks. Yes, it’s possible to like both gold and stocks. Why not?
The answer is a matter of faith. The most dedicated gold bugs believe in the yellow metal as an article of faith, in particular as a defense against the devil of “fiat” (unbacked) paper money. They have a point, but investments in well-run companies can also represent a free-market response to government power.
There have been two long and depressing stock market crashes in the new century, but stocks have rewarded investors well in the long run – and so has gold. The short-term, however, is anyone’s guess.
After sentiment indicators for stocks and gold seemed to be the lowest in years – see my Growth Mail column to that effect on September 29, when the S&P 500 was retesting its August lows – both stocks and gold have rallied strongly. In the dreaded month of October, stocks surprised the bears by rallying!
Here’s the tale of the tape, in brief: Following an intra-day low of 1871.91 on September 29, the S&P 500 closed last Friday at 2075.15, up 10.9%. The gold market rose in tandem with stocks. The London pm gold fix on September 30 was $1114. It then dipped to $1106 on the morning fix of Friday, October 2. In the following two weeks, gold rose $78 (+7%) to peak at $1184 on the London pm fix as of October 15.
My case for gold is based on asset allocation, with stocks making up the lion’s share of a growth portfolio with gold in a small minority position (maybe 5% to 10%) as a portfolio balancer. In the 44 years since gold started trading freely, there have been long stretches of time when gold “zigs” while stocks “zag.” For instance, gold rose from $255 to $1920 (2001 to 2011), partly offsetting the decline of stocks from 2000 to 2009. A similar divergence happened in the 1970s, when gold soared while most stocks lagged.
In a mirror image, gold trended downward from 1980 to 1999 while stocks soared. The same situation (favoring stocks over gold) has been in force since 2011. In the last four years, stocks outperformed gold.
For over 35 years (in New Orleans and elsewhere), I have moderated debates between gold bugs and stock market bulls, but I say, “Make profits, not war.” Own them both! I am happy to report that Louis Navellier is one of the very few market analysts (in my experience) to favor BOTH stocks and gold.
Five Reasons to Consider Gold Now
#1: The Federal Reserve May Not Raise Rates – and if they do, it may be “one and done.” Gold has suffered in recent years based on the assumption that the Fed will raise rates – but they haven’t. Gold offers no interest income, so near-zero rates put gold on an “even playing field” with cash. However, if rates rise, that puts gold at a disadvantage. Gold has been trending downward based on this (so far) failed assumption. The Federal Open Market Committee (FOMC) meets again this week. If they postpone any interest rate decision again, gold may rally. Longer-term, near-zero inflation (or deflation), plus low wage growth and fear of global economic slowdown will probably convince the FOMC to keep rates near zero.
#2: The U.S. Dollar Has been Flat-lining. The U.S. Dollar Index rose rapidly (+25%), from 80 to 100, from mid-2014 to March 2015, but the Dollar Index has been flat to down over the last six months. As Ivan describes, above, the Index has risen in the last two days to 97, but it is still below the March peak. Since most commodities are priced internationally in terms of U.S. dollars, the price of gold has been gently rising in recent months. Earlier this year, when the dollar was soaring, gold soared in euro terms. One way or another – weak dollar or strong dollar – gold will likely be rising in euros or dollars or both.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
#3: Autumn is Gold’s Best Historical Season. Jewelry is still the largest single source of gold demand, and two large nations (India and China) account for about half of global gold demand. From the Indian holiday and wedding season in the fall to the Chinese New Year, gold jewelry sales tend to rise in those two economies. We could also see rising jewelry demand in the U.S. for Christmas and Valentine’s Day (note the jewelry ads on TV lately?). Jewelry fabricators must stockpile raw gold in September for the holiday season, so September is gold’s best month historically – and November is the second best month.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
#4: Central Banks are Stockpiling Gold: European and American central bankers own plenty of gold in their foreign exchange coffers – as a relic from the old gold standard years – but the developing world is catching up fast. Russia’s central bank added 31 metric tons of gold in August – its highest monthly total since March, and Reuters reported on October 16 that China increased its gold holdings by over 3% in the third quarter, buying over 50 metric tons, lifting their total holdings to 1,708.5 metric tons as of September 30. To stem its financial crisis, China has been selling dollars, but China still has the largest foreign exchange horde in the world. Its gold holdings (fifth among nations, behind only the U.S., Germany, Italy, and France) represent only 1.7% of their total foreign exchange kitty so China has plenty of opportunity to buy more.
#5: “Paper gold” Traders are looking at Gold Again. Gold-backed exchange traded funds (ETFs) have increased their gold position in recent months. The leading gold ETF, SPDR Gold Shares (GLD) must buy gold to back up net new purchases and GLD has attracted net inflows of $950 million since August 1. The same trend is evident in the commodity market. Data from the CFTC (Commodity Futures Trading Commission) shows that speculators’ net-long position is now the highest it has been since mid-May.
In addition, third-quarter demand for Gold American Eagles at the U.S. Mint rose 181% over the second quarter. According to the Mint’s official Website statistics, the U.S. Mint sold 397,000 ounces, or 45% more than the 273,000 ounces they sold in the first half.
None of this means gold will soar anytime soon, but the stars may be lining up for a positive finish to the year in both stocks and gold. Why not be the first investor on your block to own BOTH stocks and gold?
This Week in Market History
All content in “Market History” represents the opinion of Gary Alexander.

The Bright Side of Late October

By Gary Alexander
October is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August & February.”
— from “The Tragedy of Pudd’n’head Wilson” (1984) by Mark Twain
You hear a lot about “Black” days this time of year – such as “Black Thursday” (October 24, 1929) and the “Black Tuesday” that followed (October 29) – but if you put 1929 aside, late October has often been a great time to invest. Several major bull markets have begun in October. Here are a few examples:
Deeper into history, J.P. Morgan bailed out Wall Street on October 25, 1907, ending the Panic of 1907. The previous evening, he called all the major bankers to his office. Within five minutes, he raised $27 million. Then, he said that any bears would be “dealt with.” Overnight, he called every important banker in the city to his private library on East 36th Street. After hours of indecision, the bankers raised $84 million. It was Morgan’s shining and defining moment. His partners compared it to great generalship in a war. President Theodore Roosevelt, who railed against “malefactors of great wealth,” said that these “substantial businessmen acted with wisdom and public spirit.” But Morgan was 70. He didn’t want to go through a night like that ever again, so he and others urged Congress to establish a “Federal Reserve.”
On October 27, 1492, Christopher Columbus first sighted Cuba. Eventually, gold from the New World transformed the Spanish economy and the balance of power in Europe. But 470 years later, to the day, on Saturday, October 27, 1962, Soviet premier Nikita Khrushchev reneged on his promise to remove Soviet missile bases from Cuba. Under pressure by Soviet hard-liners, he publicly called for the dismantling of U.S. missile bases in Turkey in return for the removal of Soviet missiles in Cuba. While Kennedy and his advisors debated this dangerous U-turn in negotiations, a U.S. U-2 spy plane strayed into Soviet airspace, and narrowly escaped Soviet MiG fighters. Hours later, a U-2 reconnaissance plane was shot down over Cuba and its pilot, Rudolf Anderson, was killed. At the brink of disaster, and to the dismay of the hard-liners, Kennedy vetoed a military retaliation against Cuba. Instead, he agreed to dismantle Jupiter missile sites in Turkey in exchange for removal of Soviet missiles in Cuba. We narrowly avoided Armageddon. (P.S. Ironically, the U.S. stock market was fairly flat during the entirety of the Cuban Missile Crisis.)
Other Major Market Moves in Late October
On Friday, October 27, 1978: President Carter signed the Humphrey-Hawkins full employment bill, which mandated reducing unemployment to 4% and inflation to 3%, giving the Federal Reserve its “dual mandate.” Alas, both rates were to reach double digits within the next three years.   Meanwhile, 1978 was another one of those nasty Octobers, with the Dow falling 12% in 20 days (from 901 to 792, October 11 to 31). On Halloween day, the dollar set a new record low. The dollar fell by 34% in the 1970s.
On Thursday, October 28, 1982, the DJIA closed at 991, down from 1,006 the previous two days.   The DJIA closed over 1,000 10 times in October, but couldn’t break permanently above 1,000. This four-digit phobia began in 1966, when the DJIA first hit 995 and then crashed. Again in 1968, the DJIA hit 985 and crashed. The 1000 barrier was pierced in 1972, but then crashed to 577 by late 1974. The four-digit Dow barrier was pierced again in 1976, and in 1981, only to crash into the 700’s both times. Would history repeat itself in 1982? It seemed so, but the DJIA closed below 1000 for the last time December 16, 1982.
On Monday, October 26, 1987, a week after Black Monday, the DJIA fell 156.83 points (-8%), closing at 1793.93 in the second greatest daily percentage drop since 1932 – second only to the previous Monday’s 22.6% loss. The Hong Kong market, after being closed all the previous week, fell over 25% this day. The NASDAQ was down 9% on this day, and 7% the next, the #3 and #5 worst daily losses to that date. But on Thursday, October 29, 1987, the DJIA gained 91.51 points (+5%), the fourth largest point gain to date.
Monday, October 27, 1997 was the worst one-day point drop in market history, to that date, down 554 points (-7.2%), from 7715 to 7161, spurred by the Asian currency crisis. On a percentage basis, it was the third worst daily decline since the 1930s, trailing only two Mondays in late October, 1987. But the next day, the Dow rose 337 points, the biggest one-day point rise, to that date, coming a day after the worst point loss to date. For the haunted week of October 27-31, 1997, the Dow fell 272.61 points (-3.5%).
Tuesday, October 28, 2008 was the second-best DJIA point gain in history, up 889.35 points (+10.9%). The DJIA gained 14% that week, but the worst was not over for the stock market until March of 2009.
Cheer up! October is nearly over. Next week (November) begins the market’s best historical season.
Sector Spotlight
All content of “Sector Spotlight” represents the opinion of Jason Bodner.

Bipolar Disorders in the S&P Sectors

By Jason Bodner
The sun has magnetic poles just like earth. In 2024, over the period of a few months, the poles of the sun will flip with the north becoming south and the south becoming north. Given the sun’s power and size, it sounds as if this event could be cataclysmic, wreaking havoc here on earth and in the rest of the solar system. The thought of such seismic change conjures up images of unusual occurrences in our atmosphere causing our communications systems to fail and leading to panic and disorder.

But before you begin making survival plans for Armageddon, you’ll want to know that solar pole flipping is quite a regular affair. In fact, the last time this happened was 2013, and we felt little if any effect on earth. This is a very normal process, as part of its 11-year solar cycle, which coincides with the sunspot activity which runs on an 11-year cycle as well. The possible consequences to earth are some weather and communications disruption, but the overall effect tends to be pretty benign and potentially constructive. As the magnetic fields of the sun change, they undulate an invisible magnetic surface reaching out to the edge of our solar system. This undulation can help increase earth’s protection from radiation from the sun.
The equity markets seemingly flip poles a lot more often than the sun does. This market volatility rattles nerves, causing motion sickness. It’s been a tumultuous few months with wicked gyrations in the broad-based index averages, and wild undulations within the 10 S&P sector groups. It’s almost spooky to watch, like Halloween every day. Just this past week witnessed mammoth moves in some stocks, largely due to news events. On the negative side, scathing reports, missed earnings, and regular news events have been causing outsized moves on individual stocks. These moves can begin a ripple effect which spills over into related areas. ETFs holding the stocks are sold, causing downward pressure on stocks that are held alongside the offender within the ETF. This propagates more selling by short sellers and eventually leads to retail selling. The witching we are seeing in stocks is wild to watch. Then, all of a sudden, positive catalysts come along and vault the market higher. If I had told you in late August that the NASDAQ composite would be less than 1.5% away from its all-time high in 7 weeks, would you have believed me?
What we witnessed this past week in sector rotations has been more of the same story. When looking at an index, what seems like an orderly recovery grinding higher belies what is really going on under the hood. Healthcare continues to see a major exodus of money. Retail stocks have also been getting sold with abandon. The rotation has been into Financials and this week notably into large-cap tech stocks. As bellwethers and lesser-known players have come out with solid earnings “beats” in these sectors, it seems as though there may be the potential for a new uptrend to form in these groups.
The Last Shall be First
Last week, I talked about how the rally that has led us out of the depths of August’s discontent has been largely led by the losers of last year, namely energy and industrials. It is interesting to see some glimmers of hope as new leadership wants to emerge out of this past week’s earnings reports.
Let’s look at how the sectors performed this past week…
Big earnings beats attracted lots of capital as the NASDAQ approached new highs. The clear winner of this week’s sector showdown was undoubtedly Information Technology, which notched a sizeable 4.61% gain. Looking at the 1-year chart of the sector index, we can see a clear breakout to 1-year highs. The space saw a lot of accumulation in the semiconductor group, helped by M&A activity. The fact that we saw significant inflows into the info-tech space this week is encouraging as this would mark acquisition of strong stocks with notable earnings and revenue growth, bucking the recent trend of lower quality stocks leading the market higher.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Financials saw some significant life this week as well. In the past couple of weeks, we have seen accumulation of stocks in both REITs and regional banks. Last week strengthened this trend. REITs are again attracting capital as they offer attractive yields in the face of what now seems like a more uncertain environment in regards to the Fed’s view towards rates. Utilities have also staged an impressive rally since August for similar reasons as investors seek yield.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
Despite the recent increase in energy as a sector, it remains by far the weakest sector index out of the 10 majors. For 12 months, the S&P 500 Energy sector index has a return of around -25%. Looking at the 6-month chart, even with the past few weeks of relief rally, we see the index trying to stabilize near lows:
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
When the sun flips its magnetic poles, it carries out this volatile process for a few months, and then sets about a new cycle for the next 11 years. When markets correct and shift, oftentimes old leaders will not provide the new leadership out of a correction period. Healthcare has shined for years, and is now facing serious pressure. Is this the beginning of a new bullish cycle for U.S. stocks? Will financials and tech lead the way for the foreseeable future? It may be too soon to say, but with the market showing new 52-week highs outstripping new 52-week lows for a few weeks, this very well could be the start of a bull run.
We will keep an eye on regional banks, REITs, and large cap tech to see if their leadership continues. The U.S. is still “best in class” and the equity markets still look to be the place for strong potential returns. If the past few months seem like the sun reversing its poles, this could be an interesting pivot point for the market. Once the volatility and dust settle, what will lead us higher? Time will tell, but this week’s wild action could be an early signal that the poles of the equity market are close to concluding their shift.
Stat of the Week
All content in this “Stat of the Week” section of Market Mail represents the opinion of Louis Navellier of Navellier & Associates, Inc.

China Cuts Rates to Revive Economy

By Louis Navellier
The big news on Friday was that the People’s Bank of China cut its one-year deposit rate 0.25% to 1.5%. This is the sixth rate cut this year and China is now approaching the ultralow interest rates that have come to characterize the West. The Chinese central bank also cut bank’s reserve requirement by 0.5%.
There was a sigh of relief that China did not devalue the yuan, like it did recently. Overall, this latest rate cut was well received by financial markets, since it could help China’s economic growth firm up.
China announced that its official GDP “slowed” to a 6.9% annual pace in the third quarter, slightly below Beijing’s official 7% target, but above private economists’ consensus estimate of a 6.8% annual pace. However, since (1) China’s exports and imports declined in the third quarter, (2) industrial production was weaker than expected, and (3) factories have faced 43 months of falling prices due to widespread deflation, some economists were skeptical about China’s GDP report. (On October 19, the Wall Street Journal reported that economists “believe actual growth is one or two percentage points below the official figure.”) The bright spots in China were growing retail sales, an improving service sector, and improving lending data.
Deflation is now clearly a worldwide problem, complicated by (1) a strong U.S. dollar pushing down commodity prices, (2) concerns over China’s slumping demand, and (3) seasonal weakness in crude oil.
Speaking of energy prices, crude oil prices fell nearly 6% last week after the U.S. Energy Information Administration announced on Wednesday that crude oil inventories rose by 8 million barrels in the latest week, which was substantially higher than analyst consensus estimate of a 2.7 million barrel increase.
OPEC met in Vienna with non-OPEC members Mexico and Russia last week to discuss ways to shore up falling crude oil prices, but since many OPEC members do not like each other and are bitter rivals (e.g., Iran and Saudi Arabia), no significant solution was accomplished. However, another special meeting was proposed in November before OPEC is officially scheduled to meet again on December 4th.
The truth of the matter is that as more countries slip into recession and crude oil demand falls further, exasperating the current supply glut, crude oil prices are expected to remain low until overall economic growth perks up and demand rises in the spring – partly due to normal seasonal demand.
European Deflation Deepens
On Tuesday, Germany announced that its producer prices declined by 0.4% in September, the biggest monthly drop since February. Prices are now down 2.1% in the past 12 months. Germany’s energy prices declined 1.1% in September and fell 6.1% in the past 12 months. Excluding energy prices, producer prices fell 0.1% in September and 0.6% in the past 12 months, so deflationary forces dominate Germany.
On Thursday, European Central Bank (ECB) President Mario Draghi signaled that the ECB is prepared to expand its quantitative easing. Specifically, Draghi talked about “downside risks” related to the slowing growth in China. Translated from central banker language, the ECB may be gearing up to boost its bond buying and quantitative easing to combat deflation by pumping more money into its banking system. (The anticipation of seeing more money in the banking system sparked a big rally in European stocks.)
Due to the anticipation of more quantitative easing from the ECB, interest rates are now plummeting in the euro-zone. In most euro-zone countries, government bond yields are now back to where they were in April. In mighty Germany, two-year government notes now yield -0.32%, which is truly shocking.
On Friday, October 23, Markit reported that the euro-zone composite Purchasing Managers Index (PMI), which measures both the manufacturing and services sectors, rose to 54 in October, up from 53.6 in September. This was a big surprise, since economists were estimating that the composite PMI would decline to 53.3. According to Markit, new orders are now at a six-month high and businesses are lowering their prices due to lower commodity prices. Since any reading over 50 signals expansion, business is booming in the euro-zone.


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