The devil is in the detail

That was the quarter that was

As we approach the end of the first quarter of 2016 it seems appropriate to look back at the events that shaped the trading landscape during this time, to see if we can learn anything that can inform our thinking in Q2.

2016 started with a bang rather than a whimper the S&P 500 gapped lower on the 4th of January, traded at a high of 2038.2 and sold off. It would post a low of 1812.29 on the 20th of January. The index would ultimately print at 1810.10 in early February,before rallying strongly,as investor sentiment moved from away from fear and back towards greed. The selloff was triggered by concerns over the global recovery, a plunging oil price and the Fed's decision in December to raise US interest rates.

A similar cocktail of concerns caused the market to gyrate wildly over the summer of 2015. But the issues behind those gyrations were swept under the carpet, as they so often are. The rally came into effect as the market saw scope for further stimulus from China,additional QE from the ECB and the both the ECB and Bank of Japan's move to negative interest rates. The lack of further US rate rises also boosted the recovery in share prices. As I write the S&P is up by 0.3% year to date and January looks increasingly like a bad dream (though some might consider it a taster of the nightmare to come).

Currencies did their own thing

The Dollar weakened and both the Yen and the Euro strengthened in Q1, as monetary policy divergence become more entrenched. This was the polar opposite of what textbooks tell us should have happened. Which is that money should flow into the currency with the highest interest rates,both current and future and out of those currencies with lower, or in this case negative interest rates.

We touched on the reasons behind Yen strength in our article the perpertual learning curve published on the 12th of January. What is interesting to note though is that this strength has persisted and indeed has been mirrored by strength in the Euro,despite the wider market moving firmly back into the risk on camp,as we can see in the chart below.

The Vix and its 60 day EMA a risk off risk on barometer

Readers may recall that we proposed that risk off was signified when the CBOE Vix index was 10% or more above its 60 day EMA line. As we can clearly see above the volatility index is substantially below that moving average at the current time.

Improving economic data

The economic background for both the Eurozone and the USA has been improving over the opening months of 2016 and as we discussed last week, there are signs that inflation is returning to both economies. Though I guess we should expect some return on the €80 billion that the ECB is now pumping into the Eurozone each month.

If we look at the Citigroup economic surprise index,which can been seen in the chart below and that measures the under or out performance of economic data releases, versus consensus forecasts for those releases. We can see that the US (dark blue line) and Eurozone (yellow line) have picked up considerably over the last month,so there may well be some genuine cause for optimism,however the devil is in the detail.

Citi economic suprise index

Non-Farms kick off Q2

We will get another opportunity to assess the health of the US economy on Friday the 1st of April (let's hope that date is not a bad omen) as we get the March Non-Farm Payrolls. We saw another convincing beat in the February release at 242k vs forecast of 190k,though there were concerns about the hours worked and average weekly earnings components of the data. Consensus forecasts for March Non-Farms are for 210K new jobs.

The employment situation is not the only data that is scheduled to be released on Friday in the USA. We will also hear from the Institute of Supply Management or ISM which publishes its manufacturing survey for March then. The ISM PMI or Purchasing Managers Index,a measure of US industrial activity,moved into contraction territory in December 2015 and has remained below 50 (the boundary for growth) since then.

As we have mentioned before critics argue that this indicator is not as important as it once was in today's modern service led US economy,they may have a point. However investment bank Credit Suisse published a strategy note recently,in which it noted that there was only one occasion in the last 66 years (1955) where an industrial recession was not the precursor to a wider economic downturn in the USA.

Credit Suisse's benchmark for this assertion was Industrial Production data,rather than the ISM numbers per sae. But the ISM PMI could certainly be seen as being indicative of the ebb and flow in the wider Industrial Production number. The US Industrial Production data for February were released on the 16th of March and showed a fall of -0.5% in addition to a fall of -1% on a year over year basis,from February 2015. This was the 4th negative number, month on month,out of the last 5 releases.

Industrial Production and US recessions (source Credit Suisse research)

Credit Suisse also flagged that

"When ISM new orders fall below 50 (as we saw in November and December 2015),it has tended to signal that a formal recession has either begun, or will follow. On those occasions when recession has been avoided, it has tended to be a function of the Federal Reserve responding with monetary easing, something which appears highly unlikely on this occasion."

Ironically then any further tightening in US interest rates, at a time when ISM Manufacturing and Industrial Production data are declining,could actually be sowing the seeds of the next downturn. So whilst the Non-Farm Payrolls release will as ever grab all the headlines,the data rich ISM release may ultimately have a bigger impact on what happens next in the US economic cycle.

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