Emerging Markets - Stocks Fall Back On Wednesday

Emerging markets - Wednesday reversed the gains from Tuesday as the S&P 500 was down 0.76%, the Nasdaq was down 1.23%, and the Russell 2000 was down 1.29%. The VIX was up 9.99% to 14.64. The good news is the CNN Fear and Greed index fell to 47 out of 100, which is neutral.

That was a sharp decline from 58 on Tuesday, signaling the correction could be mostly over. In a previous article, I wondered when the dollar’s rally would begin to hurt equities. The answer was given quickly as the market reached a tipping point on Wednesday.

The dollar index was only up 1 cent on Wednesday to $96.67, but the fact that it is at this level is enough to push commodities and stocks lower.

Emerging Markets - Strong Dollar Hurts Emerging Markets & Commodities

As you can see from the chart below, the rise of the dollar has caused the emerging markets currency index to crater. Emerging market stocks have cratered as well as the Vanguard emerging markets index was down 2.93%.

It’s at its lowest level since July 2017. The dollar is beginning to have a widespread impact on the areas you’d expect. Gold was down 1.47% on Wednesday and is now down 10.99% year to date. It’s at an 18 month low. Copper was down 3.5% on Wednesday and is down 22.49% year to date.

It’s fair to say the global economic weakness and the strong dollar are equally problematic for doctor copper. The Bloomberg commodity index was down 1.83%. If this decline continues, headline inflation is going to fall sharply in the fall.

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Emerging Markets - Oil Crashes

As expected, the biggest losers on Wednesday were materials and energy stocks which were down 1.55% and 3.51% respectively. Real estate was the best performer as it was up 0.84%. Energy stocks were down because oil prices cratered 3% to $65.01 which is the lowest price since June 6th.

It hit an 8 week intra-day low of $64.51 and it is about to extend its weekly losing streak to 7 weeks. Oil was down sharply because commercial crude inventories rose by 6.8 million barrels when they were expected to fall by 2.5 million barrels.

The stock market and oil have been highly correlated in the past few years, so you can say it’s bad news that oil is falling. Cheaper oil is good for the consumer, but it signals global growth is weakening.

Emerging Markets - Treasury Yields Fall

The 10-year bond yield fell on the ‘risk off’ trade. There were a few major economic reports that I will get to in this article and in subsequent articles which were mostly positive. This makes the decline in yields surprising as the market followed the fear in emerging markets and ignored the good American economic reports.

The 2-year bond yield fell 3 basis points to 2.61% as the chances of rate hikes fell slightly. The chance of 2 hikes by the end of 2018 is now 68.6%. The yield curve flattened again as the difference between the 10-year yield and the 2-year yield is 25 basis points.

The Fed hasn’t made any remarks about the strengthening dollar and weakening emerging markets that make me think it will suddenly become more dovish.

I’m wondering if the decline in inflation, which will likely come in the fall, will be enough to prevent the 4th hike of the year in December.

As you can see from the chart below, the Fed is using the words ‘projections’ and ‘models’ less in its statements. This could imply the Fed is becoming less data dependent. It could also imply that it is trying to protect the economy from the anticipated rise in inflation, which I think won’t occur.

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Emerging Markets - Strong Empire Fed Reading

As I mentioned previously, there were strong reports on Wednesday which could have caused the 10-year yield to increase if the bond market didn’t focus so much on the emerging market weakness. The July manufacturing ISM report showed deceleration as was anticipated by the average of the regional Fed manufacturing reports.

The August Empire Fed report was very strong, potentially signaling a rebound in manufacturing in August. The headline reading was 25.6 which was above last month’s report of 22.6 and above the consensus estimate of 20. The highest estimate was 22, which the August report also beat by a wide margin.

The new orders index actually fell 1.1 points to 17.1. The shipments index was up 11.1 points to 25.7. However, it still looks like there is a bottleneck in the supply chain because the unfilled orders index went from 1 to 11.1 and the delivery times index increased 4.4 points to 10.4.

The good news is the inventories index increased 4.3 points to 0. The rate inflation is increasing it seems to have been stable as the prices received index was down 2.2 points to 20 and the prices paid index was up 2.5 points to 45.2.

6-month expectations for general business conditions index increased 3.7 points to 34.8, but the new orders expectations index fell 1.2 points. Businesses expect the supply chain problems to end because the shipments index increased 4.2 points to 37.7, the unfilled orders index fell 9.7 points to -3.7, and the delivery time index fell 6.9 points to -5.2.

The inflation expectations were like the current indexes as the prices received index fell 1.5 points to 26.7 and the prices paid index increased 4.6 points to 53.3.

Emerging Markets - Conclusion

The S&P 500 outperformance over the MSCI emerging markets index (ex-dividends) is now the longest ever. The S&P 500 is also at a record length of outperformance over the MSCI all-world index. This is about to be the longest bull market ever and next year it will be the longest expansion since the mid-1800s.

It’s interesting that I’m proposing the possibility of emerging markets bring America down rather than America falling and emerging markets rising. Brazil is facing political issues which could roil the economy if the right people don’t win in the October elections.

The Chinese economy is in free fall, which doesn’t inspire confidence that investors should go long it and short the S&P 500.