For the Yinzer Analyst, Yogi Berra’s greatest line of all time has to be “It’s déjà vu all over again” and while we may not be watching the greats like Mantle and Maris, the expression holds just as true in the equity markets. Last Friday reminded me of the quote when it seemed like we were stuck in a time warp back to 2011. With one central bank contemplating how it wants to tell the markets that rate hikes are coming possibly sooner than expected, others around the world are literally throwing the kitchen sink at the dual problems of weak confidence and low aggregate demand. While there are still a few more weeks in 2014; I’m starting to get really excited about what changes could be coming down the reallocation pipeline for 2015.
We’ve talked extensively in the last few weeks about Europe and Mario Draghi did not disappoint on Friday. Not to be outdone by the PBOC’s first rate cut since 2012, he indicated that inflation in the Eurozone needs to return to the 2% mark “without delay” and from there, it was off to the races. Now I know we’ve heard a lot of talk from the ECB and yours truly has been among the first to label most of Mr. Draghi’s statements as “pillow talk” but now I’m beginning to wonder if a major change is afoot for investors.
Let’s start with a daily chart of the iShares MSCI EMU Index (EZU) and picking up where we left off last Monday, you can see that the ETF was indeed range bound between prior support and the downtrend line so score 1 for the Yinzer Analyst. Honestly I can’t say I am disappointed by the outcome, I would have been far more disappointed if it weakened and fell back below the downtrend line that has held it in bondage for most of the fall. But with Draghi’s commitment to creating inflation (something the Fed hasn’t been able to accomplish) and by inference expanding their balance sheet, EZU was off to the races on Friday and recent laggards like Italy, Spain and event France outperformed Germany and EZU.
What makes it more important is that unlike domestic equities, EZU traded in a fairly narrow band for the day with the close almost at the midpoint between the high and low of the day which was at the prior support/resistance band around $37.80. SPY on the hand closed significantly closer to the low of the day and even then was only saved by the afternoon ETF buying. For small and mid-caps the situation was far worse with IWM giving up nearly all of Friday’s gains to close only slightly above that of Thursday’s.
Now before you think I’ve fallen completely in love with my investments, you should know that while the Yinzer Analyst is a lover and not a fighter, he always keeps a wary eye where money is concerned. While the recent performance is a great start, it’s only that…a start. You can see on the following charts that EZU has a long way to go before it can crack the relative momentum downtrend line that formed early in 2014. Until then, I’m treating last week’s outperformance as an interesting early sign and part of several trends, all as yet still in their infancy, which could spell a major shift in the market dynamics. Let’s start by looking at a few of the other throwbacks from 2011.
Let’s begin with the big shiny yellow rock that most investors have come to hate, gold or in this case the gold miners. After a painful fall (no pun intended), GDX has finally cracked that downtrend line that held back its progress although it seems to be losing steam as it approaches the simple 50 day moving average. If it can clear that, there are legs to the downtrend line between $21 and $22 but then nothing but sweet air until the 200 day moving average at $24.01 and then prior support at almost $26.
The first big central bank announcement on Friday where the PBOC announced its first interest rate cut since 2012. While the hikes of the last two years were attributed to the need to cool off rampant speculation in the housing market, I subscribe to the school of thought that says the true purpose was to prevent and then slow a capital outflow that has seen large amounts of investable funds transferred to overseas markets by Chinese nationals. Normally I’d say the proof is the Vancouver, New York or Boston housing markets, but I’d encourage you to check out Michael Pettis’ blog for more (here.)
Look at the Shanghai Exchange, were the multi-year underperformance relative to the S&P 500 ended this summer after the market finally reached rock bottom in March on concerns over the health of the Chinese banking sector and the various off-balance-sheet financing vehicles. While still in its infancy, this recent trend has still pushed Shanghai above the S&P 500 in 2014 and not too surprising considering that 100% of 2014’s returns have come from earnings growth rather than multiple expansion. It’s entirely possible that as the Federal Reserve begins to seriously consider rate increases to cool the economy and with valuations as stretched as they are already, investors may have to shift their focus overseas if they’re seeking larger equity returns.
2014 S&P 500 Return Attribution: Source: Yahoo Finance, Standard&Poors, The Yinzer Analyst
Brazil and Mexico: “So far from God and so Close to the United States”
And while China may have been the only emerging market on anyone’s mind last Friday, the real action was south of the border where investors found a whole bunch of new reasons to love Brazil again. In many ways, the story of Brazil and Mexico closely resembles the European model; in Brazil the story or rising rates, weak growth and political uncertainty surrounding the re-election of Dilma Rousseff contrasts sharply with Mexico where a stronger economy with its deep ties to the U.S., combined with the election of Enrique Peña Nieto and promises for major reforms to the state-dominated energy sector has helped make the country a darling for international investors. Before Friday’s rally the iShares MSCI Mexico Capped ETF (EWW) was up .68% in 2014 compared to a negative 3.41% for the iShares MSCI Brazil Capped ETF (EWZ) while over the last three years EWZ has an annualized return of-5.97% to EWW’s 10.41%.
What prompted this stunning reversal of relative momentum? On the surface, EWW enjoyed a solid 1.44% advance on Friday as investors digested lower economic growth forecasts for 2014 and 2015 while EWZ rallied sharply, up 6.83% and with the Real gaining ground against the dollar for the first time in almost a month on news that President Rousseff may be close to a new economically savvy finance minister. But on deeper inspection, the real story may be the shift in political instability from Brazil to Mexico. President Peña Nieto continues to deal with the fallout from allegations of crony capitalism as well as the murder of 43 student teachers while the instability surrounding the recent elections in Brazil as well as alleged corruption at Petrobas begins to fade. Given the weight of Brazil in the largest Latin American tracking ETF, the iShares Latin America 40 ETF (ILF), at 45% compared to Mexico’s 31.7% and the relative underperformance of EZW to EWW over the last three years could signal a change in relative momentum could help lift ILF from its multiyear momentum lows versus the S&P 500.
While the recent outperformance of Brazil among Latin American markets may yet prove to be short-lived, it does raise the question of whether Mexico can expect to trade-in line with its peers to the south or its larger trading partner to the north. Given the highly integrated nature of our two economies, Mexican stocks could find themselves being left behind by other international markets if U.S. equities do begin to lag as investors seek out markets with more liberal monetary policies. Porfirio Diaz may have it right after all.