BLOG

The stock market experienced its worst quarter since 2011, and was highly volatile due to worries about a global recession, a slowdown in China leading to panic selling in Chinese shares, a severe commodities selloff, interest rate uncertainty, worsening geopolitics in the Middle East, and the refugee situation in Europe burgeoning out of control.
Chinese President and Communist Party Chief Xi Xinping reiterated in New York in September that Chinese GDP was still on target for 7% growth in 2015. Skepticism abounds over official Chinese economic figures, but the chilling fact is that Chinese electricity consumption growth was only 1.3% in the first half of this year, the worst figure in 30 years. The slowdown has impacted commodity and oil prices dramatically. Chinese cold rolled steel prices are down 40% this year, Copper is down 20%, (75% from its 2011 highs), similar to iron ore. Crude oil is down 23% this year, (60% from its highs in 2011), and lumber is down 34% year to date.
Commodities are priced in dollars worldwide, so weak commodity prices strengthen the dollar against other world currencies. Thus, the U.S. dollar index has appreciated by 6.1% in 2015.
45% of the revenues of S&P 500 companies are exports, which are impacted negatively by a strong dollar, reducing profitability in a market overvalued by the stimulative policies of the Fed since 2009. We have now seen two consecutive quarters of falling sales growth in the S&P 500.
While the Fed was widely expected to raise interest rates in September, Fed Chairman Janet Yellen argued the case for raising short term interest rates later this year, mentioning that any weakness in the economy has diminished to a point where inflation pressures should start to build in the coming years. The Fed is now in a corner. Raising rates will further strengthen the dollar, while holding rates at zero is an admission that the world economy is in recession. High U.S. stock valuations are being challenged by tighter financial conditions, led by a higher dollar and a sense that years of easy money has borrowed from future stock performance. The dollar risks strengthening much further if the European Central Bank accelerates its economic stimulation. In August the Chinese Central Bank devalued its currency by the largest amount (3%) in twenty years, in order to boost their export driven economy. This move roiled global stock markets, and led to capital flight out of China. Many investors believe that there will be more Chinese devaluations ahead.
Financial markets have been booming for the past six years while the U.S. recovery has been mediocre at best. Stock valuations rose to unsustainable levels based upon the narcotic of easy money. Now that this era is coming to an end, expect a continued readjustment involving lower prices, high volatility, price overshoots, contagion (meaning one market impacting another), unusual correlations, and violent rebounds, all of which will coincide with an uncomfortable period of withdrawal symptoms.
It should be mentioned that there are signs of credit stress in the energy sector. There has been a sharp rise of defaults among U.S. and Canadian oil and gas companies over the past quarter. The Energy Information Administration said Friday that 83% of the operating cash at U.S. companies with onshore activity was devoted to debt repayments over the last 12 months. Lower oil prices mean lower cash flows, but many of these companies have large fixed debt repayment schedules. The cost of credit in the energy industry has accordingly exploded, reflected by bond spreads in the sector.

The Economic Cycle Research Institute (ECRI) just published an article discussing the large decline in global trade growth, specifically mentioning that year-on-year world trade growth is nearing zero. After almost four years of falling export prices and major policy stimulus, export price deflation is almost at a point that compares to the financial crisis of 2008.
Japan began its own massive stimulus programs in April of 2013 and stunned the world market a year ago when it increased that program. Yet Japanese growth remains negative, and inflation is still at zero, far below the Bank of Japan target of 2% indicative of a healthier economy. European growth is not much better, at 0.4%, and the migrant crisis is causing strains within the E.U. and between Angela Merkel and her own party, which, when combined with the Volkswagen scandal, is dampening optimism on the Continent.
Brazil is in deep trouble, and its economy will contract this year by 2.5%. The country was downgraded to ‘junk’ status a month ago by Standard and Poor’s. The Prime Minister could face impeachment on corruption and bribery charges between herself and members of her party and Petrobras executives. The head of the Brazilian Congress has indicated that it is already too late for Brazil to avoid further downgrades of their credit rating in the near future, as the Brazilian currency hits new lows after having lost 38% against the USD this year. Petrobras, the Brazilian oil giant, is the most indebted company in the world, owing over $125 billion, $90 billion of which is denominated in dollars. If and when the U.S. raises interest rates, the Brazilian currency will weaken further raising the possibility that the company could face difficulties with repayment. The lower oil goes, the worse shape Brazil is in. Lower oil prices are likely to negatively impact any country too economically dependent upon oil, including Russia, Venezuela, Kazakhstan, Saudi Arabia, Iran, Nigeria, Norway, Ecuador, and Mexico. Countries highly dependent upon commodity exports, such as Australia and Canada, are also suffering.
Lastly, geopolitical factors are going from bad to worse as Russia bombards anti-Assad rebels in Syria. Close attention should be paid to Iranian military movements; according to Reuters, Iranian troops are already arriving in Syria. Iran aspires to replace Saudi Arabia as the regional superpower, while Russia aspires to continue, through its support of Assad, preventing any hope of an oil pipeline between Iraq and the Mediterranean. Investors should not expect Saudi Arabia, Israel, or the United States to remain passive much longer. The humanitarian loss will continue to be colossal.
The level of bearishness among investors is reaching extremes, which usually indicates a buying opportunity. However, with a growing risk of global recession in 2016, it seems imprudent and premature to begin buying until there is further clarity over the oil and commodity markets, and over the attitude of the Federal Reserve concerning interest rates. There may be unforeseen events unfolding in the Middle East which will set investors on edge in the near future as well, and the growing risk of sovereign credit events may prove unsettling.
Defensive stocks have become a crowded trade, and offer less refuge status than usual. Low-volatility stocks are trading at the highest premium to the broader market since 1984.

For the first nine months 2015, the Dow was down 8.63%, the S&P 500 was down 6.75%; and the Nasdaq was down 2.45%. .

Grant Rogers

Global Disclaimer
This report has been prepared by Metis Capital Management LLC. This report is for distribution only under such circumstances as may be permitted by applicable law. It has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient. It is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. No representation or warranty, either express or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein, nor is it intended to be a complete statement or summary of the securities, markets or developments referred to in the report. The report should not be regarded by recipients as a substitute for the exercise of their own judgment. Any opinions expressed in this report are subject to change without notice. The analysis contained herein is based on numerous assumptions. Different assumptions could result in materially different results. The analyst responsible for the preparation of this report may interact with trading desk personnel, sales personnel, other analysts, journalists, and other constituencies for the purpose of gathering, synthesizing and interpreting market information. Metis Capital Management LLC is under no obligation to update or keep current the information contained herein. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. Options, derivative products and futures are not suitable for all investors, and trading in these instruments is considered risky. Mortgage and asset-backed securities may involve a high degree of risk and may be highly volatile in response to fluctuations in interest rates and other market conditions. Past performance is not necessarily indicative of future results. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related instrument mentioned in this report. Metis Capital Management LLC accepts no liability for any loss or damage arising out of the use of all or any part of this report. Certain of the information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. Metis believes that such statements, information, and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.