Friday 28 June 2013

"We're doomed, well that's a relief!" - What happened to behaving rationally?

                      

                           It’s been just over a week since my last post, and it’s been quite a week. As mentioned in last week’s blog the market decided that the potential end of the Fed stimulus was enough to reach for the sell button on almost all assets globally. In the days following the announcement, the major global equity indices dropped as much as 7%. Bond Yields rose as investors predicted rising interest rates of the back of reduced stimulus, and Gold dropped (and continues to drop) to levels not seen in years. The overnight Shibor rate (That’s the interest rate that banks lend the Chinese Yuan to each other at for overnight lending) spiked whilst predictions for Chinese growth were cut to be close to the 7% level further worrying investors in the west that growth in the developed world would be worse off as a result. All this while the markets continued to stomach the fact that the Fed might reduce stimulus should the economy improve. In the words of Dad’s Army’s Private Fraser, you could imagine traders running around the floor screaming "We're Doomed”!!! Then at the weekend the Bank of International Settlements (effectively the central bank’s central bank, although it has slightly darker past in history) released its annual report proclaiming that central banks around the world had done their bit in using effective monetary policy (zero bound interest rates and QE) and it was now up to governments to work harder to save the economy. The markets digested this in addition to everything else as a sign that all central banks were going to begin to reduce their stimulus further.

                            As has been the habit over the last 4 years, just when the markets were going round screaming “We’re Doomed”, the central bankers (or guardians of the financial world as I referred to them in my first blog), went on the defensive to rescue the situation. Mario Draghi of the ECB reassured the world that their monetary policy would "remain accommodative for the foreseeable future" with any exit in the "distant future", while soon to step down Bank of England Governor made similar noises clarifying that from the BoE's perspective that while eventually QE will need to end, and interest rates return to normality, "that point was not today". This along with several Fed board members coming out and clarifying that stimulus would only be reduced should things actually improve served to calm the markets and set equity markets back on an upward trajectory again. This was all simply clarifying and reassuring investors on something which I picked up on quite clearly from Bernanke's original comments last week.

                      If the initial comments all seemed so clear to me originally, why does it seem that professional investors (effectively the majority of the market), react in such a panic and so negatively, only to come to their senses after several guardians have explained it to them in plain English? Several commentators in the US have referred to the fear of the "punch bowl being taken away" from the markets. As we spoke about in the first blog, the fear that what is currently driving the markets is the alcohol being fueled through by the Feds QE. If they take away the alcohol, they may not be able to enjoy themselves quite as much and a sense of reality might settle in and things won't seem as rosy as we've made them seem. The problem with that is, continued over consumption on the alcohol will only lead to alcoholism and we won't be able to stop wanting to drink.

                   The market as such is in danger of being severe alcoholics, addicted to the stimulus as a way to turn away from reality. By continuing to want to receive the stimulus, even when things appear to be recovering, they are ignoring the signs that they might not need it any more. This was no better clarified when all US markets rose steadily on Wednesday off the back of US GDP growth for the first quarter only growing at 1.8% instead of the originally reported 2.4%. An ecstatic, almost celebratory, response to the fact that things aren't so great after all, and it might be a while longer before the punch bowl is taken away! "Phew! Well that's a relief! e're still in a bad place." And here was I thinking that bad news was the real reason to panic! As a result of this most markets have now rebounded significantly since last weeks falls to sit, as of last night, only 2-3% off where they were before the Fed announcement. Yet to get there you were looking at absolute movements of between 7-10%.

                     When I was first starting out, it was always intriguing walking down to the trading floor on the days when something truly worrying had happened and markets around the world started tumbling by 1.5-2%. You'd see panic and fury all around and would do well to avoid being hit by whatever object was being thrown in despair. But at least it was clear as to why markets were reacting the way they were (and you knew which traders to avoid.) Nowadays we're in an environment where bad news is good, and good news is......well it depends how the market feels on the day. It feels as though if chicken licken were to wander round and tell them the "sky was falling in" it would be welcomed with a great cheer!

                    It's like the child who doesn't want his parent to leave him behind because of work and is happy when some disaster occurs to keep the parent at home, even though actually the child would rather strive to have that independence to do what they wanted. From that perspective it's time to grow up and strive to get that independence back. Let's assist the the central bankers in weaning ourselves off the alcohol and look to what can be done, and what we know, instead of aimlessly speculating about impending doom before changing our minds every few weeks.

So what do we know for now?
             The US economy is growing - it has grown every quarter now since Q4 2010. It's not out the woods yet and is in a delicate situation, but the signs are there that the recovery is moving along. The Fed,as clarified by several members this week, that should it continue to improve then it doesn't need additional support and we can begin a long road to return to normality, but is there to help to try to keep it going should it stutter.

                     The UK and the Eurozone on the other hand are more of a concern. The eurozone is still in a recession with 6 consecutive quarters of decline and unemployment at 12.1%. Meanwhile the UK has only very narrowly avoided entering into a "double dip" recession at the end of last year and has just announced further austerity measures to try and reduce the large debt being accumulated. For these 2 there is no doubt there is a long slow road ahead with potential bumps along the way. But then we knew that was going to be the case for some time, which is why the ECB and the BOE have given no indication of any impending stepping off the QE gas.

                     It's time for the market to get back to looking at the fundamentals and behaving accordingly, instead of wild speculation. Efficient markets should price assets based on all publicly known information. If that were the case then we shouldn't see the extreme panic and sudden recovery evident in the past week, something repeated several times over the past 4 years. Let's not celebrate when things look shaky in the hope that we continue to get free booze, and let's react positively (within reason) and rationally to the good news again.

                    There's still cracks in certain parts of the sky, but then that's because it almost fell down a few years ago. The plaster put up to keep it from falling in is still in the process of drying.....but no one is talking about tearing it down, just about leaving it alone to dry in the parts that don't show the cracks any more.

                         Could Private Frazer and Chicken Licken be right? Not from where I'm standing, but we just might need to be a little more patient in waiting for the plaster to dry. If we remember the basics and judge things on what we know, then we might look at things with a much more rational perspective.


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