Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

Shaky Overseas Markets Dampen US Speculator Fun

China and Japan were in focus in world markets this past week. They are both grappling with the possibility that monetary fixes are fading in terms of effectiveness. In short, inflationary policies in both countries are badly hurting trade. After having expanded domestic lending (at a four-year high) and its monetary base (up 13.3% year-over-year), China is now seeing its exports unexpectedly contracting (-18.0%) and import growth slowing (+10.0%). Together these results produced a near-record trade deficit of $22.98 billion at the end of February. The deficit, although par for the course on a seasonal basis, was more than double normalized levels seen over past decades. Incidentally, China’s bad debts have risen by 38.0% in the last two years, and are now the highest on record since ’08 – and they may accelerate, according to recent comments made by China Premier Li Keqiang.

MWM 14, 3-14 Box ScoresA similar situation has plagued Japan. Its record two-year $1.4 trillion bond buying program (to be increased by approximately $65.0 billion per year) set off a chain reaction that started with a collapse in the yen and ended with a crippling spike in import prices. Local manufacturers are absorbing this increase in the face of declining exports, thus lowering their profits. Japan has historically run trade surpluses, but since August 2011 has sported hefty deficits – ¥2.8 trillion in the latest quarter (a record). It may also be of some worth to mention that Japan’s Misery Index is closing in on a five-year high – endangering, from a PR perspective, the future of so-called “Abenomics.”

Taking all that into consideration, Asian authorities came up short of expected reforms and/or reassurances needed to maintain, much less boost investor confidence. As a result, stocks tumbled in Asia and then in Europe. Bond and currency markets held relatively steady, with the possible exception of the PIIGS sovereign debt, while the precious metals rallied nicely. It’s difficult to prove, but the debt markets of the PIIGS may have been soft in the last few weeks, perhaps sensing a retrenchment in the Japanese yen carry trade if adverse inflationary dynamics at work in Japan throw Abenomics into reverse.

If not for the unwitting contribution of dip buyers, US stocks would have fared much worse given the bludgeoning witnessed in overseas markets. The metals responded favorably to what little discounting did take place in US stocks. Gold is now pushing against resistance of $1,400, and may see $1,450 if market uncertainty gains steam.

Fed tapering may contribute to that end, proceeding under the see-no-evil notion that all is well. Fed Governor Fischer, after stating to reporters on Wednesday that an “expansive” monetary policy must continue, had to publicly retract his remarks the very next day – perhaps reflecting some internal conflict at the Fed. For some time now, we have questioned the sustainability of US economic conditions in the absence or tapering of QE. But it seems clear that the Fed still wants to play chicken with stocks in the near-term, for reasons submitted in last week’s recap.

Aside from that, corporate first-quarter pre-announcements of merit have been scarce, but our eyes and ears remain fixed on the subject moving forward. US retail sales for February did little to validate post-weather rebound theories. Sales rose 0.3%, while results for January were revised down (for the fourth month in a row) by 0.2% to negative 0.6%. Another round of lack-luster sales for March would demonstrate that bad weather was merely a damper on an already weak underlying retail environment. Needless to say, stocks are not prepared for this kind of news.

Best regards,

David Burgess
VP Investment Management