Markets are not hermaphrodite, they are female. They are not about abstract intelligence, but more of the emotional intelligence type. So they move along in fits and starts, even though they do value objective data in the (very) long run. Women are very pragmatic and business minded, and markets also end up being rational. But in the short run, they are prone to effervescence. And, to be sure, waiting for rational conduct by the market can give you a hard time. Ask John Hussman.
When moving markets, greed, fear, hope, or denial, come first. Lately, Central Bank intervention has crept up to a consolidated second place in importance. Two decades ago, they weren’t even trading the global market.
There were no POMO desks, and the emblematic NY Fed desk ignored the underlying size of an “E-mini” contract. They only traded treasuries and USD crosses. Now they have incorporated the contract size in their spreadsheet macros. They even get a special discounted brokerage fee for their trading.
Prolific and highly inconsistent Bullard now affirms that they shouldn’t be intervening all the time. He must now think that verbal jawboning can do the job. Maybe, from now on, POMOs can permanently take monday to friday off. ¿Or should we just give each POMO desk member a pink slip?
In today’s market pricing process, fundamentals are a very distant last. They have always been last. The oddity is that they lost the second place to central banks, and are now well behind the first two factors. Decidedly, the keynesian proverb about the capacity of the market to remain irrational, for longer than you can stay solvent, has gone hyperbolic. Keynes would be pleased to know. It vexes most first class financial analysts. Benjamin Graham delineated the issue more precisely:
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”
You probably don’t understand why the market is selling off, on what should be considered good news. At least for main street. ¿Why on earth are deflation and cheaper energy a problem for equities, weak currencies, or interest rate spreads?
There is a simple answer to that one. Markets are very upset, because everybody hates it when somebody changes the rules of the game without notice. Young and old were assuming that the main four factors sustaining their happy financial life were still there. They had been told that:
1.- Printing would continue, somewhere and somehow, in the intermediate future. Surprisingly, super Mario is finding more problems than thought when garnering support for his announced QE, and even France (Benoît Cœuré) voted against him.
Surprisingly as well, the last liquidity injections by the PBOC, have ended up financing margin buying in the Shanghai stock market. Instead of falling, interest rates are up across the curve. They are not pleased, and it does show that printing increasingly does not guarantee that fresh money will be used adequately. They must solve that dilemma, because there is no future for the actual “status quo” without printing.
2.- “NIRP”, or at least “ZIRP”, were here to stay, at least in most countries. Some vocal members and ex members of the FOMC are now voicing that interest rates should go up sooner than later, and suggest they could climb aggressively. I don’t think so, but market players are concerned. More on this later.
3.- Central Banks were supposedly in control of markets. Their “put” underwriting promise to investors, was alive and well. They ran the show. Yesterday night, in a Bloomberg channel debate, one of the anchors questioned. ¿Are they still in control? When volatility spikes, it goes against the perception that everything is perfectly tied up, and no disruptions will be allowed. In spite of volatility, I think they are still more or less in control, but players are not as confident as they were.
4.- No matter what the actual figures and common sense said, debt was sustainable by its own nature, and global balance sheets were thought safe and sound. No suspicious assets, eg. unpayable debt, were at risk of being marked down. ¿What’s all this talk about a Greek hair cut? Why has the spread on energy related HY bonds gone above 1000 bps?
So here come Greece, the PBOC, Russia, the FED, and Crude Oil to state otherwise. Investors feel betrayed. Market players ask themselves how can Central Banks allow this to happen. Some central bank should be buying crude, and stabilizing the market, they think! ¿Don’t they see that some countries are going to go under? Central Bank puts should cover everything, not just equities or treasuries. And Syriza should be outlawed. ¡Oh my God, don’t we hate all that volatility! ¿What the hell is going on?
Let’s analyze one thing at a time, because as a standard male, I run a low MHZ speed, single core, mono-processor kinda brain.
Crude Oil is the headline, and the latest black swan.
Fifty percent down in price, in six months, is the sort of calamity that shouldn’t take place in Central Bank controlled markets. And it wouldn’t … in times of economic peace. But wars are spreading, from currency parities, to crude oil markets. Iron ore, Shipping costs, or Copper are not particularly stable either. ¿What’s next, British or Swiss sponsored immigration wars? A ban on islamic inmigration in Germany?
Let’s not criticize the Saudis. Some prices went cheaper than oil in the not so distant past. What price did Microsoft charge you for the Internet Explorer, back when Netscape was the market leader? What about Google’s amorous tactics with on line travel? The nature of the capitalist system is that market leaders try to protect profits, and when not possible, market share. And if they feel that their competitor is vulnerable, they will go for his jugular. No remorse.
¿Can you see the growth in supply? If something, the Saudis are late when attempting to protect their franchise. I wonder why it took them so long to understand what’s at stake in the energy market. New oil producers and renewable energy were the elephant in the room threatening their golden quasi-monopoly. You can’t honestly blame them for their tactics.
Economic wars of all kinds also generate casualties. Oil will go back to equilibrium levels (just above the marginal market cost of production that ensures demanded amounts per day). In the interim, the shale oil industry can go belly-up, taking Venezuela with them (maybe even Russia). And putting a couple of additional countries on their knees. Arrogance does not go well with the inevitable ups and downs in life. Putin and Cheney are living examples. We should always remember to remain humble.
Fundamentally speaking, I am not sure of the actual marginal costs of extracting oil with the different techniques, in the different wells. I have read different views and copied different charts on the issue. See the one on the left by Reuters. Others point to lower marginal costs. But I am confident that it cannot be below 50$ per barrel for a productive grid of at least 70-80% of global output (I do not think we can do with less).
That means I have faith in actual levels (56$ as I write) being a long term buy. Energy is useful and necessary for the new society we must build, and renewable energies are still a long way off when we talk about relevant percentages of global energy demand.
I did say though, that fundamentals can take years to come these days. We also know that a 36 bp yield for a JGB is a rational short, and trader widows are in the thousands, and counting. We know two year rates cannot reasonably be negative in France, but that’s where they are. We know the US equity market is nearly twice its “sane” prices. Crude oil could well hit the forty’s and remain there for a long period of time. So I would stick to the wise advice on not trying to catch falling knives. But there is long term value at current prices.
As always, we end up talking about zero. People tend to forget that when crude oil’s price comes up or down, it is a zero sum game. In the world’s consolidated P&L statement, it is a non event. Bernanke would say (as he did with debt levels) that it doesn’t matter, because the profit for some is balanced with the loss for others. That is what mainstream macroeconomics is about. That is what the Princeton and DSGE models are about, and that is why they got it all wrong.
I dogmatically insist that zero matters. Zero rates not only transfer wealth from savers to debtors. Non linear economic relationships imply that you cannot net out debt, like Bernanke did years ago, or energy pricing consequences today. There will be winners and losers in this crude oil driven, zero sum, economic dislocation. Some countries will be winners, and others will be losers (Gundlach´s chart makes it clear on a per country basis). Life goes on.
But crude oil disruptions are not only about wealth redistribution. Consequences go deeper into social and economic live tissue. ¿Why? When you don’t know the answer for something, just think, and voilà, debt is the key. We live a time of debt serfdom.
It’s finally about debt, yet again.
We have lots of it. Pity we cant use it to generate energy. They are actually using old yuan notes to generate 850 kilowatts in China (I hope it is not just the beginning of a Weimarization). If we could use debt notes, Crude oil and Solar panel producers would be out of business.
Debt makes good things bad, and bad things excellent. All of a sudden, it is not good to have stable prices and low energy costs. It is all about the lesser evil. In fact, it ends up to being Main street’s interests against Wall street’s capital (interest, they are willing to forget about right now). For Wall Street, bankruptcies of TBTF’s (be it countries, multinationals or banks) are taboo. And a huge dislocation in oil prices is going to generate some uncomfortable realignments. Bad for the common knowledge game, even if it’s good for Main street. Nobody cares if it costs us more or less to fill our gas tank. The overwhelming burden is maintaining faith in the common knowledge game at all costs. Or the Ponzi scheme will end, and some will never recover their capital.
Markets look further than Russia. They are concerned about global defaults. Of two kinds. Junk bonds (now euphemistically called High Yield bonds), and specifically those issued by the fracking industry, and country bankruptcies
Some players even smell some problems for US growth. Bernanke is desperate to keep this a secret, but he can’t anymore. If we can know how they tortured Al Qaeda members, we are bound to know the rest. The energy sector has been key in the economic revival of America. QE has been a farce. It only stimulated the economy buying financial bubbles and low forex rates for the USD. But Bernanke is desperate to keep the QE success story alive. It is now a craze in Europe, we never seem to get enough of it.
And most market players are not concerned about defaults per se. They are worried because they intuitively understand that “defaulting” could become so widespread, that it will put basketball or soccer popularity to shame.
Ken Follett doesn’t know, but the value of actual world debt is one of the pillars of the earth. Debt has to be worth its book value, or else everything we see in financial pricing is fictitious. Defaulting is to finance what Ebola to health. It kills. If it becomes pandemic, we all go.
Elections can be an additional problem.
Sometimes a new political party comes up, and addresses the situation candidly. Take Syriza as a good example. They look at debt (170% of GDP in Greece and mostly held by foreigners) and decide to go against debt serfdom. It makes political and economic sense. As a political principle, it makes ends meet.
But then things, all of a sudden, become more complex (or putrid), and they end up repeating the same mistakes of the previous establishment, only with a left wing bias. Debt haircuts end up being the headline that never materialized. They just spend and print more than the previous government. Even if they default, they get into debt again.
I think populace fear, or Syriza conversion to the keynesian-princeton sect, will probably ensure that nothing really serious happens in Greece. Remember Scotland, a majority voted no, out of just fear. Fear runs the world. People would rather endure debt serfdom than try to fight for survival alone. It was the same thing with landlords and peasants. Freedom does not come cheap, people have to dispose of the welfare and protective state addiction in order to opt for it without being blackmailed.
Until, at some point, people decide they have nothing to lose. I don’t know if we are close to that point or not, in Greece. Until proved otherwise, the establishment (the world elite) has the upper hand. Things will keep deteriorating, but it doesn’t have to be Greece that will remind the world that debt is a phony asset in our balance sheets. If it isn’t Greece, some other country will come up next. Somebody will begin the default chain sometime, but hopefully not today. Specially just before Christmas. No hurry to default, provided everybody agrees to extend and pretend.
The FED is not helping this time around.
All those coincident comments (over the last few weeks), on the viability of a fast pick up in rates, make you feel uneasy. All Fed remarks are second and third thoughts. They are not verbally incontinent. There is always a strategy there. They make you think. ¿Now why would they voice that? Were they concerned about froth in financial markets? Twenty or more days above the five day moving average for stocks was eerily uncomfortable. Maybe they felt guilty they overdid things in October? Easy, they just had to ask Bullard to come with some comments on tightening. All the usual suspects in fact did. Richard and vice-chair Fisher, Plosser, and Dudley. Even Kocherlakota went on tape showing some hawkish feathers.
And then, almost simultaneously, it’s interesting they decided to test the RRP (reverse repo program) in size, just after QE ended. In addition to the standard term deposit facility. The result is that they have crowded out the market for government bonds and ensured that recent primary placements of 300 billion by the US treasury forced short term interest rates up, just as the long end was coming down. Flattening trades made a killing.
The combination of Fed speak and high short term rates has been a warning shot to market participants. All of a sudden it is like ZIRP is going down the same way QE did. I don’t think so. I think the Fed is, once again, playing games with markets. They prevented the october plunge from consolidating, and causing further trouble, and were recently trying to downtune november exuberance. See left what their stealth move on bank reserves is doing to both bank reserves, and the money base.
They are going to have to hire the Trade Tower tightrope walker. It is a very delicate balancing act for Janet and Stanley. No wonder the other Fisher (Richard), Kocherlakota and Plosser want to leave. Circus experience is going to be required to balance what’s left of free markets. They need them not too hot, not too cold.
An impossible task in the long run. But that is exactly what they plan to do. Read what NY’s Dudley had to say about pairing tightening with financial markets. Hat tip Tim Duy.
“First, when lift-off occurs, the pace of monetary policy normalization will depend, in part, on how financial market conditions react to the initial and subsequent tightening moves.
If the reaction is relatively large—think of the response of financial market conditions during the so-called “taper tantrum” during the spring and summer of 2013—then this would likely prompt a slower and more cautious approach.
In contrast, if the reaction were relatively small or even in the wrong direction, with financial market conditions easing—think of the response of long-term bond yields and the equity market as the asset purchase program was gradually phased out over the past year—then this would imply a more aggressive approach.
The key point is this: We will pursue the monetary policy stance that best generates the set of financial market conditions most consistent with achievement of the FOMC’s dual mandate objectives. This depends both on how financial market conditions respond to the Fed’s policy actions and on how …”
Energy price downfall should be less deflationary than expected.-
This piece is getting too long. But I have to say that there is a very positive side to the latest events.
1.- Lower energy will, as a rule, significantly improve our living standards (not applicable to Putin and friends, and similar suspects).
2.- Deflation is not bad, save for HY debt holders (and emerging market bond funds), equity margin buyers, and indebted actors in the global village. The rest will profit from it. And it will help clean up the mess.
The impact of lower energy prices will not be as deflationary as it seems. Global aggregate demand is the constraining factor for growth and development. If we can free some of it, we will improve the demand of other products with some producer pricing power. And we will free some of it, because the losers in this dislocation are the mega rich that have a low consumption rate.
3.- It will dent Inequality. Those who benefit from cheaper energy will improve their standards of living, against mega yacht owners and corrupt OPEC politicians. That is good news for global stability in the long run. Large yachts will be smaller, some will fell the heat of bankruptcies, but the rest will be able to dine out one more day per month.
4.- Finally, risk premiums will again be an obvious deliberation to market players. CB’s had convinced everybody that risk was something of the past. A repricing of risk would be welcome.
On the negative side, crude’s collapse, together with USD strength, might end up hurting liquidity levels significantly. We shall see.
In the end, after all this literature, we all want to know what to do.
And you expect me to tell you? I’m not playing this crazy game. My money is waiting patiently with as little risk (and zero associated reward) as possible today. Small equity short, small dollar long, strong short of euros, no yen, and ultra long the swissie, are my basic bets. And I’m way out of the money in my EURSEK. For some reason I fail to understand, EURSEK is following EURNOK prices north.
I loved this paragraph by Jason Haver -at pretzel charts.com- suggesting bears shouldn’t salivate too much. There is no way to know if CB’s will recover full control or not. He wrote.
“…let’s face it, bears have been here a few times before. It goes like this:
1. Support levels begin failing, VIX spikes.
2. The pattern starts to look exceedingly bearish.
3. CNBC trots out several analysts who all share the nickname “Dr. Doom,” and they each talk about how the fundamentals are garbage and the market is clearly headed to zero or below.
4. Bears see a bunch of green in their accounts and start to feel excited…
5. One of the major central banks announces some radical new program, such as that it will be providing free, unregulated personal printing presses for each and every banker who’d like one.
6. SPX gaps up 257 points, and shorts are left running for cover as the market rallies relentlessly.”
We just don´t know if it is going to be “wash, rinse, repeat” once again. What we do know is, that they will lose control at some stage. But nothing says they will not win this next battle, pushing the E-mini up 257 points straightaway.
Their end is a given, and it is probably near enough. Central Bankers are begging to be disposed of. They did a lousy job. Keep your money safe, and wait. Sometimes it’s best to do nothing but enjoy world peace while it lasts.