Perspective: Morning Commentary, 01/08/2016

Friday, January 08, 2016

January 8 – China removed the circuit breakers for its stock market overnight, after seeing them bring a halt to trade in two of the first four trading sessions of the new calendar year. The circuit breakers were believed to be set too tight – U.S. circuit breakers kick in at 20% versus China’s 7% - creating fear among investors each time the market turned lower. Chinese markets tumbled early, down more than 2%, before firming late to settle 2% higher. Support came from apparent buying of stocks by state-controlled funds, with additional help from a higher reference rate for the yuan from the central bank; neither of which is likely sustainable long-term. Nonetheless, the markets firmed going into the weekend to ease fears for now. Retail investors remain quite fearful though, leaving risk in the market. Data showing declining German industrial output in November reminded traders that the global economy has plenty to worry about outside of China as well.

This morning’s jobs report showed that the economy created 292,000 jobs in December, beating Wall Street expectations of 200,000. Furthermore, the previous two months were revised upward roughly 50,000 combined. About a half-million people returned to the workforce, leaving the unemployment rate at 5.0% as expected. The jobs participation rate inched higher to 62.6%, but remains near its lowest level of the past four decades. The primary disappointment was that hourly wages were flat in December, falling short of analyst expectations of 0.2% growth, which was what we saw the previous month. Even so, the data supports another 25-basis point rise in the Fed’s key interest rate ahead of April. That’s bullish the dollar, which in turn creates additional headwinds for the broader commodity sector. An improving global economy is needed to boost demand for commodities, while a stronger dollar continues to make it difficult for U.S. commodities to compete amid ample supplies.

There is still nothing bullish about market sentiment toward the commodities this morning! Commodity prices are firm this morning, led by crude oil, but traders remain quite bearish. I get nervous when everyone leans in one direction. That’s a recipe for the market tipping over. Fundamentally, the Ag markets need a weather story and no significant story exists. Recent rains should soften the impact of previous dryness concerns in Brazil, giving it a good crop. South Africa will likely need to import corn this year, but there are currently no signs that alternative supplies won’t be adequate and its infrastructure would make distributing large imports difficult. India, and perhaps the Former Soviet Union, will likely see a shorter wheat crop due to adverse weather this year, but global supplies are abundant.
Yet, I get nervous when I see the market leaning hard in one direction. To be sure, some of the global economic risks are currently similar to or higher than they were in 2008. As such, the threat of a deeper deflationary cycle in the commodities must be respected. It would likely take a significant weather event to pull us out of the bearish fog at this point in the cycle. However, speculative hedge fund managers hold record to near-record short positions in the grain complex.

That alone leaves us vulnerable to a sharp short-covering rally as we head into Tuesday’s USDA January crop report known for its surprises, which is partially responsible for the overnight bounce. Chatter is also increasing about increased weather risks for the Midwest this summer. The transition from a strong El Nino to a La Nina has produced both favorable and unfavorable growing seasons in the past. The risk of adverse weather is higher than normal, but probably still below 50% based on a study of the analog years that I have looked at. Even so, market emotions can be very fickle when the trade is leaning hard in one direction. I remain bearish the commodities, but caution is advised as long as the above factors are at play.

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