Welcome to the inaugural public version of the Covenant Weekly Market Synopsis. We have used this weekly piece for about two years as a tool for keeping our financial advisors and colleagues abreast of recent market events with the occasional comedic relief. It is important to note that this weekly missive will not contain any specific trade recommendations. Investing is a personal matter based on one’s unique circumstances and Covenant does not subscribe to a one size-fits-all investment philosophy.
With that introduction for context, I hope you enjoy Covenant’s Weekly Synopsis. If you find it valuable, please tell a friend, colleague or loved one to give it a try. And should you find it to be rubbish, I humbly respect your opinion.
Justin Pawl, CFA, CAIA
Partner & Chief Investment Officer
Last week was an “exciting” one for financial markets, in what has already been an “interesting” month. Although most developed market indices posted modest gains on the week, they followed an extremely tortuous path and the gains did little to dent monthly losses which range from -5% to -8%. Most major equity indices are negative on a year-to-date (YTD) basis as are precious metals and energy-related commodities. Fixed income and the VIX Index are amongst the only “assets” with gains at this point of the year, highlighting investors’ pessimism.
Whatever the specific cause of this month’s equity market trouble (and there is a long list of potential catalysts), the Peoples Bank of China’s decision to devalue the yuan at the beginning of the month certainly touched an exposed nerve amongst investors. The currency devaluation of a few percent was relatively insignificant in the grand scheme of all things financial (e.g. China’s currency had appreciated by 50% against the currency of Japan, its largest trading partner), but it signaled the entrance of yet another player in the surreptitious currency war being waged between sovereign central bankers as deep-rooted consequences of the Financial Crisis continue to reverberate throughout the global economy.
A Rose By Another Name – Following the Financial Crisis the U.S. Federal Reserve embarked on an innovative and aggressive easy monetary policy that included reducing interest rates and massive balance sheet expansion (known as “Quantitative Easing”) with the stated intent of preventing a deflationary spiral. As a result of those actions, the U.S. dollar declined in value making U.S. exports cheaper and more attractive to international trading partners thus stimulating U.S. growth. Though the Fed was the first developed central bank to pursue this strategy, others have since copied the blueprint including the Bank of England, the Bank of Japan and most recently the European Central Bank. As a major economic power (the size of China’s economy is second only to that of the United States), it should not come as a surprise that China is taking actions similar to their developed market counterparts to stimulate growth in their flagging economy. While the long-term impact of unconventional stimulus on economic growth is unknown, the short-term benefits are tangible. And though a central banker will never utter the words “currency war” publicly, the competitive currency devaluation is merely a rose by another name.
Gordian Knot – Ultra-loose monetary policies complicate the actions of free markets and price discovery, leading to capital misallocation and asset bubbles. Following the Financial Crisis, markets have become increasingly reliant upon central banker largesse, and as a result monetary policy expectations have replaced economic fundamentals as the primary market driver increasing the market’s susceptibility to sudden bouts of volatility. Unfortunately, we do not see this era ending any time soon as central bankers have created a Godian Knot inextricably intertwining monetary policy and financial asset performance. In this era the prospect of reduced government stimulus creates market volatility, and market volatility induces central bankers to act (witness China’s massive stimulus actions earlier this month to stabilize their currency and equity markets).
Weekly Economic Data Summary – Second quarter estimated GDP growth was revised upward to 3.7% annualized (from 2.3%); on a year-over-year basis GDP growth was a more muted 2.66%, which is on pace with annualized growth rates for Q4 2014 and Q1 2015. The August reading of Consumer Confidence rose to 101.5, offsetting the decline in June to 90.9. Durable Goods Orders rose 2% m/m in July and were revised upwards to 4.1% m/m in June, signaling businesses have been increasing equipment purchases potentially in anticipation of increasing demand.