As we outlined in the Markets section, the August 2015 selloff presented investors with their best chance of outperforming the S&P 500 in that year. For those who kept their US equity allocation unchanged in 2015, the S&P returned just 1.4% – the worst annual performance since the Financial Crisis. Conversely, investors who added to their equity positions during the late August volatility saw better results; the S&P rose by 3.6% from August 31st to the end of the year.
Since the catalyst of a US-China trade war is different from the 2015 setup, we cannot just push rewind and see what sorts of market signals made the those August lows investable – we need to look in different places this time. Also important: a market bottom after outsized volatility is a process rather than an event. Still, the possibility of finding an entry point remains a worthwhile exercise.
Here is our list of 4 market data points to watch for signs of a low in US/global equities:
#1: A CBOE VIX Index closing over 30 (today’s last print was 24.6).
- The Christmas Eve 2018 US stock selloff saw a VIX close of 36, bracketed by 30-handle observations on either side. December 24th was also the low for the S&P 500.
- If the VIX cresting 30 was enough to push Fed Chair Jay Powell to quickly about-face on rates in early 2019, perhaps it will also be enough to soften White House trade policy. A big “If”, we know, but a logical starting point nonetheless.
#2: Fed Funds Futures putting +50% odds of a 50 basis point rate cut at the September 2019 meeting (currently 24%).
- Markets were clearly frustrated with Chair Powell’s communication skills at last week’s press conference, but further market volatility will cut through the clutter and make Fed policy predictable again via the well-worn theory of a “Fed put”.
- Equity investors have grown to trust Fed Funds Futures’ ability to call central bank moves better than human economists. If Futures definitively point to a 50 basis point move next month, markets will begin to believe it is inevitable.
#3: Stability in both the offshore Chinese yuan and Hong Kong dollar (currently 7.14/$ and 7.845/$).
- China’s decision last night to devalue the yuan to decade-low levels was a sign they are very worried about the effects of US tariffs on the country’s economy. If there were any other policy move that could have addressed the problem as well, they would have used it. Markets smell that desperation and worry it presages a full-blown Chinese economic slowdown.
- Lost in the shuffle today but equally important is the Hong Kong dollar, hit both by trade wars and local unrest. The currency is inching ever closer to the upper limit of 7.85, after which the government will have to step in to defend it. That would be bad news indeed.
- Bottom line: we don’t know where China intends to stop the current yuan devaluation and history says they move over multiple days. Also in the mix (but more headlines than anything else just now): the US’ decision late today to label the country a currency manipulator and seek remedies in conjunction with the IMF.
#4: Bitcoin starts going down (currently $11,750, +24% on the week).
- The downside of Chinese currency devaluation is capital flight out of the country. The government has become much stricter on this in recent years, but where there’s a will (and a lot of wealth) there is always a way.
- Bitcoin is traditionally one method high net worth Chinese have moved money out of the country. That bitcoin has rallied 24% in the past week and 7% in just the last 24 hours seems to signal that crypto traders are trying to front run Chinese demand.
- If bitcoin were to falter, it would be one non-correlated markets sign that Chinese policymakers intend the recent devaluation to be temporary and expect trade negotiations to resume. If there is one reliable closed-loop information system, it is that which exists between wealthy citizens (of any country) and government.
Summing up: the 4 ideas here are listed in order of our confidence that they provide an investable signal. Our biggest caveat: most rely on feedback loops between markets and policymakers. Put another way: if they DON’T work, we may have larger problems.