The Fed, China and Equity Market Risks

The Fed, China and Equity Market Risks

On Wednesday, the Fed raised interest rates by 25 basis points and announced plans to begin unwinding its balance sheet later this year. The Fed also indicated another rate hike is likely this year and possibly three more in 2018.

The Fed’s message was hawkish, more so than the market expected. Economic and inflation data have been weaker than expected but the Fed still subscribes to the Philips Curve view of the world, in which low unemployment will lead to inflation, thus the need to raise interest rates now. The problem seems to be that unemployment, at least measured by traditional metrics is already at unusually low levels and inflation remains stubbornly low.

An interesting thing happened on Wednesday morning before the Fed announcement. Retail sales in May were weaker than expected and consumer inflation fell, taking year-over-year CPI down to 1.9%. The bond market’s reaction was telling, long-term bond yields fell sharply, presumably because it meant the Fed might not raise interest rates after all.

I have different interpretation. The bond market, through the flattening yield curve has been signaling rising economic risk and the market perceives the Fed is at risk of a significant policy error if they continue down the path they are on. The Fed raised interest rates, articulated a more hawkish position than expected and the long end of the yield curve still rallied (lower yields)!

This defies the conventional wisdom that the economy is fine and leads me to this interesting chart.

iShares 20+ Year Treasury Bond ETF (TLT) – Weekly Chart

The TLT is on the cusp of a “golden cross”. A golden cross is defined by the 50-day moving average crossing above the 200-day moving average. TLT looks technically strong, implying additional appreciation (lower yields) is likely.

If bonds rally from here, I believe it signals a weaker global economy than is currently priced into the equity market and puts equities at risk of a correction.

Equity Market Valuations

By most common valuation metrics, the market is somewhere between fairly valued to expensive. I thought the graphic below was interesting, which shows the direct relationship between the stock market and global central bank balance sheets since 2009.

What makes this interesting to me, is this week’s announcement from the Fed to not only raise interest rates but to also begin shrinking its balance sheet. This action from the Fed, combined with existing tightening policies in China (PBOC) and expectations that the European Central Bank (ECB) is nearing an end to their quantitative easing program, potentially put global equity market valuations at risk.

China Concerns

One emerging risk story that seems to be getting little attention is China’s tightening monetary conditions, as the government tries to deleverage the economy.

One interesting consequence of this tightening policy is the impact it has had on the yield curve in China.

The Chinese yield curve has now inverted.

If this were to occur in the U.S. or most developed markets it would signal a recession is likely around the corner. When these types of things occur, there are always explanations from market pundits or government officials on “unusual circumstances” or other “factors” at work, causing a distortion in the market. In my experience, these explanations usually give way to economic reality.

This is the first major crack to form in the global synchronized recovery story and is a shot across the bow for equity investors.

This is a developing situation that needs to be closely monitored. If China’s GDP slows to even 4-5%, this would “feel” like a recession. China is the world’s second largest economy and the negative reverberations would be felt around the world.

Additional Equity Market Risk from Risk Parity Allocators

Risk parity is an asset allocation concept that involves allotting to various asset classes that are not highly correlated with each other, such as equities, bonds, commodities, currencies, etc., so that they have the same level of “risk” in the portfolio. Risk is usually defined by volatility and as equity volatility has been persistently low, more dollars are allocated to equities, relative to other asset classes. The most well know advocate of this strategy is Bridgewater Associates, run by Ray Dalio. For those unaware, Bridgewater is known as the world’s largest macro hedge fund.

The graphic below shows the allocation to equities in risk parity portfolios is at a record high. This is one more risk factor the market faces when these trades unwind. The abrupt allocation changes are easy to see in the chart. The last peak in this indicator was in early 2011, preceding the last 20% market correction by a few months.

Source: @WSJ; Read Full WSJ Article


The easy money policies from the global central banks that have propelled the equity markets higher since the global financial crisis are reversing.

China appears to be further along in this tightening process than widely recognized and the Fed appears determined to “normalize” monetary policy even in the face of weakening economic and inflation data.

The buy-the-dip strategy that has worked so well for years has caused complacency to set in among many investors. While the market remains in a clear uptrend, the risks are rising.

John Derrick

John is founder of The Derrick Letter, LLC and my passion is the U.S. equity market and my style of investing has bits of a classic growth strategy combined with momentum ... Click for full bio

Rosie the Robot, Amazon, and the Future of RAAI

Rosie the Robot, Amazon, and the Future of RAAI

Written by: Travis Briggs, CEO at ROBO Global US

It’s tough to find a kid out there who hasn’t dreamed about robots. Long before artificial intelligence existed in the real world, the idea of a non-human entity that could act and think like a human has been rooted in our imaginations. According to Greek legends, Cadmus turned dragon teeth into soldiers, Hephaestus fabricated tables that could “walk” on their own three legs, and Talos, perhaps the original “Tin Man,” defended Crete. Of course, in our own times, modern storytellers have added hundreds of new examples to the mix. Many of us grew up watching Rosie the Robot on The Jetsons. As we got older, the stories got more sophisticated. “Hal” in 2001: A Space Odyssey was soon followed by R2-D2 and C-3PO in the original Star Wars trilogy. RoboCop, Interstellar, and Ex Machina are just a few of the recent additions to the list.

Maybe it’s because these stories are such a part of our culture that few people realize just how far robotics has advanced today—and that artificial intelligence is anything but a futuristic fantasy. Ask anyone outside the industry how modern-day robots and artificial intelligence (AI) are used in the real world, and the answers are usually pretty generic. Surgical robots. Self-driving cars. Amazon’s Alexa. What remains a mystery to most is the immense and fast-growing role the combination of robotics automation and artificial intelligence, or RAAI (pronounced “ray”), plays in nearly every aspect of our everyday lives.

Today, shopping online is something most of us take for granted, and yet eCommerce is still in its relative infancy. Despite double-digit growth in the past four years, only 8% of total retail spending is currently done online. That number is growing every day. Business headlines in July announced that Amazon was on a hiring spree to add another 50K fulfillment employees to its already massive workforce. While that certainly reflects the shift from brick-and-mortar to web-based retail, it doesn’t even begin to tell the story of what this growth means for the technology and application firms that deliver the RAAI tools required to support the momentum of eCommerce. In 2017, only 5% of the warehouses that fuel eCommerce are even partially automated. This means that to keep up with demand, the application of RAAI will have to accelerate—and fast. In fact, RAAI is a key driver of success for top e-retailers like Amazon, Apple, and Wal-Mart as they strive to meet the explosion in online sales.

From an investor’s perspective, this fast-growing demand for robotics, automation and artificial intelligence is a promising opportunity—especially in logistics automation that includes the tools and technologies that drive efficiencies across complex retail supply chains. Considering the fact that four of the top ten supply chain automation players were acquired in the past three years, it’s clear that the industry is transforming rapidly. Amazon’s introduction of Prime delivery (which itself requires incredibly sophisticated logistics operations) was only made possible by its 2012 acquisition of Kiva Systems, the pioneer of autonomous mobile robots for warehouses and supply chains. Amazon recently upped the ante yet again with its recent acquisition of Whole Foods Market, which not only adds 450 warehouses to its immense logistics network, but is also expected to be a game-changer for the online grocery retail industry.

Clearly Amazon isn’t the only major driver of innovation in logistics automation. It’s just the largest, at least for the moment. It’s no wonder that many RAAI companies have outperformed the S&P500 in the past three years. And while some investors have worried that the RAAI movement is at risk of creating its own tech bubble, the growth of eCommerce is showing no signs of reaching a peak. In fact, if the online retail industry comes even close to achieving the growth predicted—of doubling to an amazing $4 trillion by 2020—it’s likely that logistics automation is still in the early stages of adoption. For best-of-breed players in every area of logistics automation, from equipment, software, and services to supply chain automation technology providers, the potential for growth is tremendous.

How can investors take advantage of the growth in robotics, automation, and artificial intelligence?

One simple way to track the performance of these markets is through the ROBO Global Robotics & Automation Index. The logistics subsector currently accounts for around 9% of the index and is the best performing subsector since its inception. The index includes leading players in every area of RAAI, including material handling systems, automated storage and retrieval systems, enterprise asset intelligence, and supply chain management software across a wide range of geographies and market capitalizations. Our index is research based and we apply quality filters to identify the best high growth companies that enable this infrastructure and technology that is driving the revolution in the retail and distribution world.

When I was a kid, I may have dreamed of having a Rosie the Robot of my own to help do my chores, but I certainly had no idea how her 21st century successors would revolutionize how we shop, where we shop, and even how we receive what we buy - often via delivery to our doorstep on the very same day. Of course, the use of RAAI is by no means limited to eCommerce. It’s driving transformative change in nearly every industry. But when it comes to enabling the logistics automation required to support a level of growth rarely seen in any industry, RAAI has a lot of legs to stand on—even if those “legs” are anything but human.

To learn more, download A Look Into Logistics Automation, our July 2017 whitepaper on the evolution and opportunity of logistics automation.

The ROBO Global® Robotics and Automation Index and the ROBO Global® Robotics and Automation UCITS Index (the “Indices”) are the property of ROBO who have contracted with Solactive AG to calculate and maintain the Indices. Past performance of an index is not a guarantee of future results. It is not intended that anything stated above should be construed as an offer or invitation to buy or sell any investment in any Investment Fund or other investment vehicle referred to in this website, or for potential investors to engage in any investment activity.
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ROBO Global LLC is the creator of the ROBO Global® Robotics and Automation Index series, which provides comprehensive, transparent and diversified benchmarks representing the ... Click for full bio