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Weekly Market Recap for December 31, 2015

As 2015 comes to a close I want to share some interesting statistics from this
year and compare them to 2014:
During 2015, the USD is up 9% following a 10.8% appreciation in 2014.
Commodities are down 16% in 2015, following an 11% drop in 2014.
Emerging Market currencies and US High Yield were the main side-effects
of a strong USD and lower commodities. EMFX (Emerging Market
currencies index) is down 15% in 2015, following a 12% decline in 2014.
High yield is down 13% in 2015, following a 4.3% decline in 2014. The SPX
is closing the year virtually flat, following a 13% rise in 2014.
One concern into 2016 I will be watching is contagion from high yield
spread widening into investment grade and USD denominated Emerging
Market corporate bonds. The US corporate debt market is down 5% in 2015,
against a gain of 4.2% in 2014.
In all, the US economy will close 2015 with GDP growth at 2.5%, which is
well below consensus, which stood at 3.2% in January. Nevertheless, the US
is growing more quickly than all main economies in the Americas and more
rapidly than any single G10 economy.
In RBC's latest round of forecasts for 2017, they predict USD/CNY at 7.50
by the end of 2017. That is a 15% depreciation in the Chinese currency from
today's level.
US dollar strength and its effects (see here) have been major themes in my
weekly newsletters this year. Specifically, the weakness in emerging markets
and commodities were in focus. In 2016 I believe the focus will centre on the
US dollar against the Chinese Yuan as China has effectively broken their peg
and attempts to devalue their currency.

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This isnt anything new, as we saw in August of this year, however the effects
of a Chinese devaluation will be significant. The USDCNY chart below is the
most important chart for 2016. The chart shows the amount of Yuan $1 US
dollar buys and when it increases the US dollar is strengthening against the
Chinese currency.

As can be seen in the chart, the Yuan is depreciating on a steep trajectory

(remember the line increasing means the Yuan is losing value against the US)
and Chinese policymakers seem to be letting it go. If RBCs forecast of a 15%
depreciation by the end of 2017 proves true, parts of the Chinese economy will
benefit but there will also be plenty of pain for commodities and foreign
corporations who borrowed in USD.
Wishing all of our readers a gracious thanks for your support this year and
wishing you much peace and prosperity for 2016. Happy New Year from
OtterWood Capital!!

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Weekly Market RunDown

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Reads of the Week

Hayman's Bass sees energy as investment opportunity as glut ends
China fires a warning shot at Yuan speculators with bank bans
Its Amazon and everyone else in retailers race for online sales

This Weeks Macro Thoughts

The BOJ could run out of bonds to buy
The Bank of Japan has been one of the most aggressive central banks in the
world with its current easing program adding roughly $660 billion in
government bonds to its balance sheet annually. This is almost as much as the
Federal Reserve was buying at its peak but in a country a quarter of the size of
the US! With the Bank of Japans bond purchases already double the
governments net bond issuance many are beginning to wonder what happens
when there are no more bonds to buy?
Currently the extra supply of bonds is coming from large bondholders such as
banks, insurance companies and pension funds which are being pushed into
riskier assets (i.e. equities). However, these bondholders have minimum holding
requirements and will eventually be unwilling to sell more bonds and once this
happens the Bank of Japan will have to resort to other policy measures.
The IMF estimates the Bank of Japan may have to reduce its purchasing
program by 2017 or 2018 due to the lack of bonds which explains why the Bank
added ETFs to its easing program in December. This move buys some extra time
but if Japan doesnt begin to see growth and inflation the Bank of Japan may
have to resort to other policies such as negative interest rates.
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New Tech has been a standout in current recovery

RBC Capital Markets has an interesting chart on the differences within the
technology sector. In aggregate technology has outperformed the S&P500,
however when we split the sector into New, Transitional and Old technology its
clear New Tech has done all of the heavy lifting.
New tech is defined as companies with innovative growth models (Apple,
Google, Facebook), Old Tech consists of commoditized traditional technologies
which are facing competitive threats (Intel, Cisco, HP), and Transitional Tech is
companies navigating from Old to New by sacrificing legacy businesses for
higher margin businesses (Microsoft, IBM).
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Since the 2009 lows the New Tech group has outperformed the broader
technology sector by over 350%!

For the full list of New, Transitional and Old Tech see the chart on the next
page:

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Phone: 416-479-0645

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Phone: 416-479-0645

Market breadth concerning heading into 2016

After a frustrating and volatile year, the S&P500 managed to finish 2015
virtually flat. The flat finish covers the wide divergence between market leaders
and laggards, a point I have been making for a while now (see here and here and
here).
The market capitalization weighted S&P500 does better when the bigg est
companies gain and this is the main index everyone watches. When you look at
an equally weighted S&P500 you can see that on an even basis the market is
down year to date. As you can see in the chart below the two indices have
veered apart significantly since the August lows.

The narrowness and breadth of the market rally worries me because it signals
only a portion of stocks are participating in the rally. This trend appeared before
both the 2001 and 2008 market tops and it is something everyone should b e
following closely.

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