New year market rally looks under threat F

Investors left with little appetite to double down on bets made in January

ebruary is shaping up to be a lot less friendly than January, as the cheer that drove last month’s global equity rally — the biggest in more than seven years — dissipates under a cloud of negative developments.

The most obvious trigger for the slide in stocks on Thursday and yesterday was newfound doubts on prospects for the US and China to avoid an escalation in tariffs on March 1, just three weeks away. President Donald Trump’s comment that he’s not likely to meet with President Xi Jinping calls into question the conventional wisdom that a deal was in sight, or at least that talks would keep going without further damage to trade flows.

But a panoply of other concerns is also starting to take hold, leaving investors with little appetite to double down on bets made in January, from rallies in developed-world equities to an appreciation in China’s yuan. The tumble of as much as 2.2 per cent in the Hang Seng China Enterprises Index yesterday boded ill for the domestic Chinese market’s Monday reopening after a week off, though the gauge pared losses later in the day. The broader MSCI Asia Pacific Index saw the biggest loss in a month.

“Share markets have had a great rebound from oversold conditions in December and are now up against technical resistance and getting overbought,” Shane Oliver, head of investment strategy at AMP Capital Investors, said. “Meanwhile a bunch of balls remain up in the air regarding the trade war, the US shutdown and slowing global growth. So there is a high risk of a pull back.”

When the risk rally began in early January, Treasury yields climbed along with stocks. But that’s changed. True, cheaper borrowing costs should be helpful to the growth outlook and theoretically mean a lower discount rate to apply to corporate earnings streams. But falling yields could also suggest that bond investors are seeing greater dangers than equity investors have in recent weeks.

Not only have Treasury yields come down, but the universe of negative-yielding debt has expanded again. Japan’s 10-year government bond yields fell to minus 0.035 per cent yesterday.

This season is a whole lot less robust than past quarters when it comes to corporate results. With 73 per cent of the US S&P500 Index members having reported, Bank of America Merrill Lynch analysts estimate that the proportion of “beats” relative to expectations is the weakest in four years.

Cheaper valuations after the historic slide in equities at the end of 2018 were one big reason to dive in at the start of 2019. But to some analysts they’re now looking less compelling.

ron ore futures surged more than 5 per cent to hit the highest level since 2014 on concern that the increasingly severe crisis at top producer Vale SA will curtail global supplies, tightening the seaborne market and offsetting the impact of a slowdown in China, the largest importer.

Vale invoked force majeure last week after a judge forced it to suspend some operations at its Brucutu mine in Brazil — a move that it said would result in an annual production loss of 30 million tonnes. That’s on top an earlier reduction of 40 million tonnes following a deadly dam burst. In addition, Vale’s licence to operate a dam at Brucutu was revoked by a state regulator.

Iron ore has been supercharged since late January after the dam burst in Brazil, which killed at least 150 people and rattled the mining industry. The exact extent of the lost production isn’t clear as Vale has said it’ll be able to offset some of the impact by boosting supply from other sites. As the crisis has intensified, banks have raised their price forecasts, with Citigroup Inc. boosting its 2019 estimate 40 per cent to $88 a tonne and raising the possibility that the disruption to Vale’s operations may yet worsen and could last for years.

Major risk

A major risk is that the Brucutu operation may be “the first of many of Vale’s mines to see its production halted,” and there’s also the prospect that tighter regulations may affect supplies from other miners, Citi said in a note, outlining its bull case, which carried a 30 per cent probability. Vale’s production will slump 40 million tonnes this year, the bank estimates.

Futures advanced as much as 5.8 per cent to $94 a tonne in Singapore, the highest since August 2014, and traded at $92 at 2:55pm. Prices were 8.9 per cent higher last week after surging 14 per cent the previous week.

Last week’s drama played out as the most important iron ore user has been offline, with Chinese markets closed for Lunar New Year. When the country’s exchanges resume on Monday, it should help set iron ore’s direction more decisively after an initial period of yuanbased prices catching up.

“Steel mills in China need security of supplies 24/7, and it’s hard to tell how long this situation will go on,” said Philip Kirchlechner, director at Iron Ore Research Pty. “We’re in an unusual situation where it’s in the middle of Chinese New Year.”

Goldman’s View

Goldman Sachs Group Inc. warned that there would be “significant disruption” to Brazilian supplies in the near term, and prices are expected to be elevated and volatile as production elsewhere cannot be adjusted quickly enough to offset shortages, according to a report from the bank.

Still, Goldman said that further out, prices of about $90 would not be sustainable as miners outside Brazil, especially in China, are expected to ramp up output. It sees the price back down at $60 in 2021.

Shares in Australian miners Rio Tinto Group, BHP Group and Fortescue Metals Group Ltd. fell yesterday even as iron ore surged above $90 a tonne. Over the full week, the trio remain higher, with Rio posting the fourth weekly gain in five.