Unfamiliar Risks
Financial markets are facing
unforeseen or less traditional sets of risks. Uncertainty is increasing
as witnessed by angry voters, unstable unions, the demise of less diversified
economies, and the desperate rise of nationalism. The disconnect
between the intellectual circles and the real economy are being revealed
viciously. In recent years, the disconnect between the Central banks and real
economies were ignored for a while as markets rose and assets were inflated. The
painful truth was deferred via a delicately crafted Central bank messaging,
despite the boiling anger and frustrations of failed policies.
Investors in financial markets
are not equipped to measure the various forms of risks. Dancing with the
uncomfortable is one issue, but markets have recognized that the old analytical
models are bitterly broken. Negative interest rates, lack of faith in
capitalism, increased aggression by ex-communist nations (China, Russia and
North Korea), and desires to break from the European Union are a brutal
reminders of a new unfathomable era that lies ahead.
The so called “Brexit,” Britain’s
potential breakaway from the Eurozone, is a risk where traditional banks are a
bit clueless. Granted, as seen in prior European drama, the posturing ends up
being more than the end result. Nonetheless, the political climate (some caused
by the refugee crisis) and accumulating angst send a strong warning sign. Plus,
France is on the radar as well with a new coined term “Frexit.” All these
developments are a bit unsettling as traditional models have reached their
limitations. The current, unfruitful results from globalization mixed
with the frustration with the European Union triggered resentment and a revival
of nostalgic nationalist sentiment. An unforeseeable era remains ahead,
as slow growth leads to bickering of all kinds.
In terms of the European economy
ultra-low rates, further stimulus, and revival from anemic recovery seem to be
overly familiar. From investors' points of view, the massive addition to low
rates resulting in higher share prices might actually be a positive twist. As
strange as that sounds, the real economy and political crisis has not marched
to same beat as financial markets—A theme that’s all too familiar even though
it is quite misleading.
Impact of Oil Demise
The ongoing damage from the
recent Crude demise is being realized by
energy companies and oil-related economies, but it is reflected most
importantly in banks' earnings. Amazingly, in stressful periods, true colors
are revealed from weak demand, to risky banks loans, to less effective
stimulus.
This is exhibited by Russia,
whose economy is in shambles. Putin has chosen to spark all Russian pride, as
seen by the conflicts in Ukraine and more recent involvement in Syria.
Otherwise, the Russian economy is bleeding from the massive crude oil price
adjustment. Saudi Arabia is equally feeling the pain, as it scrambles to tinker
with supply. Countries like Nigeria and Venezuela are in a fragile mode, as
their leadership's ego deflated along with economic sentiment:
“Moody's on Friday placed Russia and Saudi Arabia on review for
ratings downgrades, citing both countries' exposure to the struggling oil and
gas industry. The agency put Russia's Ba1 government bond and issuer ratings on review,
while it placed Saudi Arabia's Aa3 issuer rating on review. Moody's said it
expected to complete both reviews within two months.” (CNBC, March 4, 2016)
Desperately Synchronized
The correlation between Crude, US
stocks, and US treasury yields was vividly showcased during the last few weeks.
Since the February 11, 2016 lows, Crude rose more than 40% and the S&P 500
index rose 11%. At the same time, US 10 year Treasuries went from 1. 52% to
1.87%. Surely, this begs the questions, have the decline in crude prices
hurt the broader economy? Do OPEC, central banks, global banks, and investors
need to be on the same page to avert further pain? Ongoing reliance on
government entities or global organization is not an ideal way to run a free
market or to build business confidence. However, semi-crisis symptoms are seen
as the synchronization becomes pronounced.
Perhaps, any pending downside move will also be felt collectively across
markets.
Most importantly, central banks
will dictate the sentiment that’s already tricky with an audience that is growing
more skeptical. Pressure is
mounting. There is no question that
policy reforms (beyond interest rate “games”) are needed after the dust settles
in Crude prices and Chinese economy. Both are critical in this inter-connected
world, and the residue from the fallout is still being deciphered.
For now, traders, political
leaders, policymakers, and observers seem to live day to day, given the
multi-faceted layers of concerns. Being aware of all might be the ultimate path
for survival.
Article Quotes
“All but 2 of the top-10
trading partners of the UK belong to the European Union. The UK’s main
trading partner in 2014 was Germany, which accounted for 12.3% of all UK trade
in that year. In second position was the United States (9.5%), followed by the
Netherlands (7.5%), China (7.3%) and France (5.9%). Together, these 10
countries accounted for 61.4% of UK trade in 2014. The UK was a net importer
from 7 of its 10 main trading partners. The biggest bilateral imbalance
in 2014 was the 36.3 bn euro trade deficit recorded with Germany,
followed by the 26.2 bn trade deficit with China and the 12.3 bn deficit with
the Netherlands. The biggest surplus position (16.5 bn) was recorded with
Switzerland, followed by a 7.5 bn surplus with Ireland and a 5.1 bn surplus with
the US.” (Bruegel, March 3, 2016)
“The BIS’s verdict on negative
rates gives backing to the European Central Bank, the Bank of Japan and others
at a time when such unconventional methods are facing increasing criticism for
their potential impact on the financial industry and currency markets. A
sell-off in European bank stocks this year was partly driven by fears that
further rate cuts by the ECB would damage profitability in a sector still
recovering from the debt crisis…. Fears that interest rates below zero
would prompt banks or the public to withdraw and hoard cash rather than pay
penalties so far haven’t materialized in any jurisdiction, according to the
report. This is partly due to banks’ “reluctance to pass negative rates through
to retail depositors,” with the exception of Switzerland, where some lenders
actually increased mortgage rates to mitigate some of the costs incurred at the
central bank.” (Bloomberg, March 6, 2016)
Key Levels: (Prices as of Close:
March 4, 2016)
S&P 500 Index [1,999.99] – The lows of
February 11th to March 4th showcase an 11% rise. However,
taking a step back showcases a well-established, narrow trend around
1,900-2,100. Breaking out of this trend is the
next suspenseful move.
Crude (Spot) [$35.92] – A near 40%
rise since the lows on February 11th. Stabilization is forming after
massive sell-offs.
Gold [$1,231.15] – Sharp rise
since the start of the year. Bulls target $1,350 as the next critical level to
trigger further momentum.
DXY – US Dollar Index [97.34] – Since early
2015, the dollar index has stayed above 94. That has remained in place. At the same time, breaking above 100 has been
a major challenge. For now, the well-established dollar strength trend is in
full gear.
US 10 Year Treasury Yields
[1.87%] – In the last 6-7 months, yields have failed to hold above 2.00%. A
critical fundamental change is needed to drive yields much higher (i.e. rate
hike, better economic data, etc). Unless a major catalysts resurfaces, the low
yield trend seems set to hold.
Dear Readers:
The positions and strategies
discussed on MarketTakers are offered for entertainment purposes only, and they
are in no way intended to serve as personal investing advice. Readers should
not make any investment decisions without first conducting their own, thorough
due diligence. Readers should assume that the editor holds a position in any
securities discussed, recommended or panned. While the information provided is
obtained from sources believed to be reliable, its accuracy or completeness cannot
be guaranteed, nor can this publication be, in any Publish Post, considered
liable for the future investment performance of any securities or strategies
discussed.
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