Bearish signals emerge, markets are holding on

THEY say when giants fight, the dwarfs get squeezed in the middle.

The current rumbling over North Korea is far from that kind of fight.

There is no giant-to-giant fight; it is more like a cat-and-mouse game.

The powerhouses of the United States, Japan and South Korea are going round and round after this small country called North Korea which is goading them with missile launches, one of which flew over Japan.

Adding to the tensions, South Korean and Japanese jets joined military exercises with two supersonic US B-1B bombers above and near the Korean peninsula.

After an initial reaction, markets shrugged off the geopolitical tensions as positive growth data emerged from the United States and China.

Yesterday, in its sixth and most powerful nuclear test, North Korea said it tested a hydrogen bomb that can be loaded onto an intercontinental ballistic missile.

Nevertheless, strategists see risks stacking up for markets that are attempting to stay afloat from these gnawing tensions, damage from Hurricane Harvey and other issues.

Citigroup Inc strategists including Jeremy Hale cite “worrying developments” that may signal the approach of a correction in stocks, while Commerzbank AG finds growing evidence of bearish sentiment in bond funds, said Bloomberg.

“The pairwise correlations between the S&P 500 and its industry sectors have fallen near levels that preceded the last two bear markets. The previous downturns in stocks started when correlations re-established themselves,” said Bloomberg, quoting the Citigroup strategists.

The ratio of outstanding puts to calls on the S&P 500 has risen to levels last seen in the late-2015 market sell-off, Richard Turnill, BlackRock Inc’s chief investment strategist, was quoted as saying.

The ratio for German stocks has also risen, noted Turnill, adding that this move to boost downside protection indicates investors’ nervousness. (Call options give the holder the right to buy, and put options to sell, an underlying asset at a specified price for a certain period of time.)

Fund flows in bonds show that bond investors are also shunning risk.

While high-yield funds suffer “considerable” redemptions, cash has flowed into those that invest in government debt, said Bloomberg, quoting Commerzbank strategists including Alexander Kramer and Ulrich Urbahn.

Despite the caution, markets are hanging on. “There is nothing new that drives the market upwards, but also no vivid reason to sell, so people are looking for a catalyst,” Katrina Lamb, head of investment strategy and research at Bethesda, Maryland-based MV Capital Management Inc, was quoted as saying. September is historically a rough month for US stocks, with equities on average losing about 1%, noted Bloomberg, quoting data compiled by S&P Global.

Growth data

While diplomatic efforts to contain North Korea’s nuclear programme are underway, the investment mood brightened as data showed that China’s official factory gauge had strengthened further in August.

The number came in above economists’ expectations. China’s manufacturing purchasing managers index increased to 51.7 in August, compared with an expectation for 51.3 in a Bloomberg survey of economists, and 51.4 in July.

Amid the bright outlook, the challenge ahead for Chinese policy makers is to balance preserving the pace of growth with slowing the pace of credit expansion, said Bloomberg.

Earlier, US data pointed to second-quarter growth reaching the fastest pace in two years with robust hiring in August.

The US economy grew at an upwardly revised 3% annualised pace in the second quarter, on robust consumer spending and strong business investment, said Reuters.

Consumer spending increased by less than estimated in July, though rising incomes and an upward revision to June purchases put the economy on a stable footing for the second half, said Bloomberg.

Funds from shadow banks

In just three years, Chinese conglomerate HNA has invested at least US$45 bil around the world; purchases included multi-billion dollar stakes in Deutsche Bank AG and Hilton Worldwide Holdings Inc.

From fund prospectuses and disclosures to China’s Administration for Industry and Commerce, Bloomberg news has discovered that HNA employed a network of trusts and asset management products, in addition to more conventional financing, to fund everything from takeovers to day-to-day expenses.

Units of the group have pledged more than US$10 bil of unlisted shares to non-bank lenders and, in some cases, have paid interest rates on shadow debt that far exceed China’s benchmark rates for bank loans and bond issuance, said Bloomberg.

HNA’s parent company said in a response to questions that financing from non-bank institutions makes up a “small portion” of the group’s overall funding and its debt-to-asset ratio has dropped for the past seven years.

The issue of shadow debt, that is incurred off the balance sheets of banks, is gaining new urgency as Beijing moves to curb debt-fuelled overseas investments while the heady growth of China’s vast shadow banking industry has begun to worry authorities.