“The secret of being tiresome is
in telling everything.” (Voltaire 1694-1778)
Crude Awakening
If there was any debate as to the
health of the economy, the global market has responded resoundingly. Weakness is highlighted on various fronts in
this inter-connected world. The US is
not isolated in this, despite a relative edge that has shined in recent
times. The collective sinking in asset
prices reawakens prior fears and signals the late inning of a prior bullish
run.
Clearly, the anemic demand for
Crude is not that difficult to spot while the supply is expanding. Thus, Crude
is struggling to justify a price movement above $30. Even OPEC bureaucracy
cannot hide the harsh reality. The decline in Crude prices negatively impacts
Russia and Saudi Arabia. Not only are oil investors comforting the pain,
but nations that are reliant on oil in their economies are concerned for their
survival. That’s as desperate as it gets for Putin and Saudi leaders,
but it also gets painful for energy companies, various banks, and investors, as
well. A cataclysmic collapse in Crude only highlights the ongoing slowdown of
the global slowdown led by China and Emerging Markets. Amazingly, the
age-old claim that lower oil is better for the economy is being severely
challenged. The collapse of
Crude actually hurts the real economy in the short-term more than the common
narrative would have one believe. This adjustment is hitting some by surprise
even months after the sharp declines.
Fed Up
The faith in risky assets is
collapsing given the demise not only in energy, but in other sectors, too. From
retail to tech to banks, the sour results are being discovered. Within that,
there is a backdrop of negative yields, which were thought to be strange, but
are now becoming more normal than before, especially in Europe, which
highlights a desperate time. The Gold price stabilization (or mild revival)
recently highlights that even the most out of favor commodity is in some
demand, since the faith in Central Banks is crumbling quickly. The biggest theme of all is the lack of trust
in Central Banks, which the Fed is struggling to cope with in public messaging.
The stimulus efforts of government-led agencies (i.e. Fed) have failed
miserably to produce broader growth; and, there is no hiding from that reality
either.
The gold bugs were wrong for
several years as Gold prices corrected and a bottoming action in prices were
nowhere to be seen. Now, desperation is so high that investors are
willing to seek shelter in Gold and willing to chase negative earning yields in
search of safer assets. The
ultimate desperation is here, even if the most optimistic participants want to
look beyond the watershed events that are mounting.
Fatigued by Calming Words
To calm the sensational market
responses and reactions is a difficult task:
- The
Chinese regulators attempted to calm markets several times, and this
action failed to slowdown the sell-offs.
- OPEC
nations saw the demise of Crude prices and now struggle to tinker with production
cuts in search of stabilization.
- European
banks are in such a vicarious shape that bank executives had to assure
stability. The bleeding continues.
- Central
banks are ferociously feeling the skepticism and are forced to counter
with calming words of confidence.
In all these cases, delaying the
reality or “spinning” the painful occurrence is not receiving a warm welcome by
fatigued investors. Basically, calming words have no value when reality sinks
in quickly. Investors are fatigued
since the reality has been long disconnected with the Central bank narratives.
Hence the outrage, which drives up volatility and makes 2016 a brutal year to
manage for risk-managers.
Fragility of Banks
Banks are facing the pressure
from all angles. First, the commodity decline is creating pressure on banks as
exposure to oil related areas:
“John Shrewsberry, chief
financial officer, Wells Fargo & Co.‘At the end of the year, we had $42
billion of total exposure to oil and gas, including loan commitments and unutilized
commitments, down 5 percent from a year ago. Loans outstanding were $17.4
billion, down 6 percent from a year ago and less than 2 percent of our total
loans outstanding.’ Shrewsberry
said that if oil
prices remain in the $20s or low $30-range for the next six months, banks are
likely to reduce the amount of credit available to energy companies.” (Bloomberg,
February 9, 2016)
Second, the negative rates are
changing the traditional business models and creating further concern. In many ways, this is unprecedented and
navigating through this will be filled with surprises, which scares the
rational observer. The fear alone can create more worries than imagined. (More
on this below.)
Finally, the regulatory pressures
since 2008 are mounting, which is well known. The banks seem more like a
government agency rather than a service for wealth creating enterprises.
Increased regulation, discovery of further liquid assets, and less willingness
to take risk for future growth all make for a difficult period for banking.
Interestingly, the ongoing
challenges facing banks is a further reflection of the broader market issues.
Article Quotes
“So what is the impact on banks
of a negative refinancing rate? Clearly, since policy rates are
benchmarks for bank lending rates, it forces down the price of new lending.
Currently, banks like HSBC have resisted the temptation to cut deposit rates
below zero in response to the ECB's negative deposit rate, because they have
been able to maintain their net interest margins by keeping lending rates up.
But downwards pressure on benchmark lending rates would squeeze their margins.
So HSBC is giving notice that if the ECB pushes the MRO ["main refinancing
operations"] rate below zero, the cost to them of reducing the price of
new lending in Euros may be passed on to businesses in the form of a negative
interest rate on Euro deposits. But hang on. HSBC is a British bank, and the
letter has been sent to UK business customers, most of whom have sterling
accounts. And these days, foreign currency payments can be made directly to
sterling accounts with the bank managing the currency exchange. So who would
this affect? It would affect any
business which is doing sufficient business with the Eurozone to justify having
a Euro account. Particularly, businesses which are both exporting to
and importing from the Eurozone, perhaps importing raw materials and parts and
exporting finished goods. A negative MRO rate would, in effect, be a tax on UK
businesses doing business with the Eurozone.” (Coppola
Comment, February 5, 2016)
“Commodity exporters like Russia
and Saudi Arabia, which ran large current-account surpluses when oil prices
were high, are the main exception to this pattern of diverging foreign-asset
positions. With the precipitous decline in world oil prices since June 2014,
their fortunes have reversed. Their export earnings have plummeted – falling by
half in many cases – forcing them to run deficits and draw on the large
sovereign-wealth funds they accumulated during the global commodity boom. A
radical reduction in expenditure has now become unavoidable. The industrialized economies face
very different challenges. Their problem – in a sense, a luxury problem –
is to ensure that their consumers spend the windfall from lower import prices.
But in the creditor countries, negative rates do not seem to advance this goal;
indeed, some external surpluses are even increasing.” (Project
Syndicate February 9, 2016)
Key Levels: (Prices as of Close:
February 12, 2016)
S&P 500 Index [1,864.78]
– The 1,850 level is becoming
critical again. That’s where buyer’s conviction is being tested. The next few
days will tell the story of that conviction.
Crude (Spot) [$29.44] – Attempts to
hold above $30 and confronts a fragile territory. February 11th lows of $26.05 mark the ultimate bottom in
the current sell-off. Desperate stabilization is needed.
Gold [$1,239.75] – A sharp spike
recently as most asset classes shift away from risk-taking. The March 2014 high of $1,350 is the next
critical point. Interestingly, the $1,200 level has been targeted as a possible
bottoming level as buyers and sellers wrestle around that range.
DXY – US Dollar Index [95.94] – The strength weakened a bit, especially in
February. Early hints of peak at 100 appeared on December 2, 2015, since then a
downtrend has been well established.
US 10 Year Treasury Yields
[1.74%] – The scramble for safe assets remains in place, driving yields lower.
Plus, the bond markets are not convinced of a growing economy. This is
highlighted by the rapid drop in yields from 2.20% to below 1.80%.
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