Tuesday, 27 October 2015
The markets are pricing the medicine, not a cure.
Since the Fed no hike decision and the ECB 'likely cut' press conference, it is looking as though markets are pricing interest rates rather than growth. The low rates lever has been pushed down almost to the floor and expectations are now taking it into nutty negative territory. With EUR and JPY real rates at -40bps, there’s not much more they can do and my concern is that a further depo cut by the ECB will ultimately prove to be contractionary and/or neutral at best because of the bizarre nature of negative rates (I stand by my suggestion of a QE credit card to get the money directly to where it belongs).
The commodity sector is not playing ball as one would expect it to if we were looking through CB policy to the end game of that policy which is growth. Oil and commodities are not the only disconnect with equities. High Yield is too, with credit guys skittish and issuance starting to ramp up again leaving the credit markets nowhere near as bullish growth as the equity markets. Something is fishy.
US equities are effectively back in their pre August dump range and European equities are around their early 2015 ECB QE expectation hype levels. But the background situation is worse than it was either in January or August. Earnings growth is still weak/negative everywhere and I have a hard time seeing equities make new highs in that context alone.
As a background indicator I am wondering if the proliferation of stories about companies cooking their sales books to disguise falling performance is a sign that leverage can-kicking in the balance sheets is hitting a brick wall. Growth realities are poluting the growth dreams that many of these companies need to sell in order to survive. A company that borrows to fund a dream and then uses that borrowing to pay itself and the interest on its borrowing without earning anything will go pop. Unless it can resell the dream to the next punter willing to lend to it and repeat the process.
But it is oil that is my barometer. Oil is looking horrendously sick again and it is beginning to look as though the broader swing in oil is a leading indicator for how other markets will behave. A fall, a rally and then a fall. Oil is down 2.5% as I type and it is now really hard to see what is going to give it a lift if CB uber-dovishness doesn’t instil expectations of growth, Russia in the middle east doesn’t upset expectation of supply and the last bulls (including me) are throwing in the towel as the last rally fades. What is more we haven’t even had the press signalling a bottom by calling for sub £1.00 petrol imminently - it normally works a treat as a base caller.
I just can’t get away from believing that oil prices are the key to everything at the moment. Oil is the centre of one of those overlapping Venn diagrams we all learnt about at school, but have never really used since, other than as allegorical references such as this.
Oil is shaping Russian policy, it's reshaping US policy (or lack of it) towards the Middle East, it's driving CB policy as referenced by Draghi at the last ECB press conference, it's shaping financial stresses through high yield as well as long term mega-investment plans and it is reshaping political alliances in the Far East. It is now even being used to fund the US budget deficit with the sale of their strategic reserves (rearrange the following words - Brown, Gold, Gordon).
One of my embryonic pet themes is the relationship between Russia and Saudi Arabia. All roads, whether financial, economic, political or military seem to end with that interface as key. If the West is drawing battle lines supporting Saudi interests, to support their own, as Russia builds ties with the crescent of Syria and Iran then the easiest place to anticipate the make or break of the region is Saudi Arabia. Russia jabbing the Saudis is as good as jabbing the West, whilst also applying pressure indirectly by coercive pressure on Saudi to reduce supply or by wrecking the region making sure that supply diminishes. Europe’s increasing deals to procure Saudi oil as a means of energy diversification away from Russia is understandable but Saudi offering discounted oil to Poland is as good as Walter White selling meth in Los Pollos Hermanos. Gustavo ain’t going to be happy.
In summary, the oil and the equity rebound together with the positional/leverage reasoning mentioned yesterday has lead me to believe we are better set up now for a sharp fall in markets than we were in August. Oil remains the leader and it is telling me that equities are about to have a another big wobble. The markets are pricing the medicine, not a cure.
In the meantime I will nurture my Russia/Saudi theories.