Two investment issues have come up this week that could benefit from the wisdom and experience of the inimitable Charles Morris.
Charlie also responded to my query about an 18% one-day rise in ore prices alongside a 25% year-over-year decline in Chinese exports. That does not compute. I speculated it might be a case of losers winning, or the “momentum crash”.
So is this a momentum crash or not? Charlie responds:
Momentum crashes happen regularly. Big ones in developed markets are rare such as 1932 and 2009. Small tremors happen on a daily basis. This current one lies somewhere in between. They happen because the best stocks do too well, the worst ones too badly over a period of time. The gap between them, like a piece of elastic, becomes stretched. At that point their roles reverse and the winners fall while the losers rally. Despite the corrective or “mean reverting” behaviour, over long periods of time, the winners beat the market by 5% – a fact backed up by numerous academic studies. That perhaps explains why the winners are so popular with investors, and get heavily bid from time to time to lofty valuations.
The big momentum crashes have followed bear markets. The small ones can happen at any time. What we have seen in recent years are emerging markets, commodities and industrial stocks get hammered while the broader developed market has held up. Furthermore healthcare, biotech, the consumer and technology have been strong. The gap just became too wide. Too many investors were long the good stuff and short the bad stuff. The elastic didn’t snap as they hoped – it snapped back.
The question is whether the snap back is solely a quirk within financial markets or is justified by improvements in the real economy. A big moment crash can last for a year, with the first three months being the most powerful. This one is young, but if it continues for several more weeks it is likely to be real and better economic news will follow. If it fizzles out, I’d expect to see the bear market in equities continue.
Secondly, Charlie got back to me on whether the price action in Brazil made it a target for momentum investors. Specifically, I asked whether the 14% nominal yield in Brazilian government bonds made it an attractive target for momentum investors. Charlie says:
This momentum crash has bid up commodity prices and industrial stocks around the world. In turn, that has helped commodity exporting nations such as Brazil. The Brazilian stock market is the oil price in disguise as they two rise and fall in tandem. As the Brazilian real collapsed last year, along with oil, future inflation expectations rose to 9.5% – an old school number that stands out against the developed world.
Since oil has bounced, that number has fallen to 8%. It might not sound like much but it’s a way of expressing greater confidence in the future value of the currency. At 9.5%, the real will lose 60% of its purchasing power in a decade. At 8%, that drops to 54%. As inflation expectations fall further, that will attract investment as it’s a sign of stability.
Did you notice that in this case, rising oil leads to lower inflation in Brazil? In the developed world, it would be the other way around. Brazilian bonds are indeed cheap. If you are tempted, just make sure you’re an oil bull first.
Category: Market updates