SPX Capital January 2016 Letter: China’s hard landing; lower oil prices

SPX Capital letter for the month of January 2016 titled, “We increasingly depend on ourselves. And we continue to face major challenges…”

Dear Investor,

Global markets again had a volatile month in January. Stock indexes fell sharply in response to doubts about world growth. Oil prices remained under downside pressure, reaching their lowest level seen since 2003. Central banks were evidently worried by these new tensions. In Europe, the ECB signaled at its last meeting that it intended to review its monetary policy stance in March, when it will probably ease further via an additional rate cut. In Japan, the BoJ surprised the markets by introducing negative interest rates for the first time. In the United States, the Fed left rates unchanged but signaled concern about recent developments in financial markets, fueling doubts about the timing of the next hike. In Brazil, despite a lull in political battles while Congress was in recess, prices of financial assets were also volatile and in the equity market the Bovespa Index fell about 7%.

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SPX Capital – China’s hard landing; lower oil prices

The world’s problems continue to accumulate. Alarm is growing as to the prospect of a hard landing in China. The perception that the Chinese authorities are making sequential mistakes in response to recent market volatility has fueled fears that Beijing may after all, lack the skill and instruments to handle a more serious crisis.

The fresh drop in oil prices, whose steady fall appeared until recently to be net positive for the global economy, has also weighed on the markets. Companies in the commodity sector have seen credit risk premiums and interest rates rise significantly, and this trend has started to spread to other sectors, leading to a generalized credit squeeze. Perceptions of higher corporate risk in turn have fueled concern about the banking system, especially in Europe – where financial institutions expected profits are being squeezed by tight capital regulation and the specter of negative interest rates.

In Brazil, we continue to observe very weak economic activity data compatible with our forecast of an economic contraction in the range of -3.5% for this year, following a contraction of -3,8% in 2015. The difficulty of balancing the budget during a recession, not only for the federal government but also for states and cities, has led growing numbers of economic agents to conclude that a short term fiscal adjustment is not on the cards. This evidently results in deteriorating expectations, affecting investment and consumption decisions, worsening the recession.

In monetary policy, the Central Bank of Brazil left its benchmark interest rate (Selic) on hold and was accused of being politically influenced in making this decision. In our view the decision itself was not wrong but it was badly communicated. The depth of the recession is sufficient justification for not raising rates right now. However, doubts about the real intentions of the Monetary Policy Committee (Copom) were fueled by the way the process was conducted. In any event, rates were left on hold and are expected to remain so for a long period.

In the political arena, normal business resumes in Congress when it returns from recess in mid-February and only then will it be possible to say the political year has truly begun. Important pieces of draft legislation will be debated, each with a material impact on the markets. The main bills relate to pensions and social security reform, and reinstatement of the CPMF tax on banking transactions. Both require a three-fifths majority. Assuring passage of these bills will be far from easy for the government. Elsewhere, the Federal Police continues to investigate corruption in Petrobras (Operation Car Wash), as always with unpredictable fallout, and now the investigations appear to be closing in on former president Lula. In Congress we have the bid to strip Speaker Eduardo Cunha of his seat and political rights, while Cunha drives forward the impeachment proceedings against President Dilma Rousseff. In other words, stormy weather lies ahead and will make the markets highly volatile.

The external outlook is extremely uncertain and on the home front the outlook also remains full of uncertainty because of the political situation. The Brazilian economy will continue to contract, the unemployment rate will continue to rise, and inflation will remain high. All this points to a low probability of a stock market rally or indeed any substantial improvement in prices of financial assets.

SPX Capital – Portfolio allocations

Our main allocations are described below.


We remained long the USD, partly against the BRL and partly against a basket of currencies.


In international markets we reduced our short position in US equities, and started a long position in some sectors that are benefiting from cheaper oil. We maintained a short position in Asian banks that are taking losses due to slower Chinese growth and capital control by China. In emerging markets, we reduced our long exposure to Chile and maintained our long exposure to Argentina. We started a long position in Mexican telecommunications. In directional terms we remained neutral.

In Brazilian equities we remained moderately short overall, while remaining long in financial services and utilities, and short in consumer goods and companies linked to metal commodities.

Interest Rates

After signaling in recent guidance its intent to begin raising rates soon with the aim of getting inflation down to the midpoint of the target range (4.5%) in 2017, the Central Bank of Brazil surprised the markets by leaving rates on hold. In light of this, we opted not to hold any positions in Brazilian rates.

International rates have suffered from diverging monetary policies in the developed economies. On the one hand, in the US the Fed has begun raising rates; on the other, central banks in Europe and Japan are still committed to monetary easing. In this context we have avoided taking significant directional positions.


We continued to hold short positions in copper, aluminum and soybeans. In the oil market, we closed out a short position after confirmation of the end of sanctions against Iran but restarted it late in the month. Production data from OPEC, Russia and the US came in strong in January, suggesting that the process of rebalancing supply and demand remains very slow.

In precious metals, we closed out a short position in gold after the Fed’s January post-meeting statement signaled that a rate hike is not likely at the March meeting.