There have been a number of critical developments in the first 5 weeks of 2015. I thought I would take this opportunity to take a step back and give a 30,000 foot overview of where the global markets find themselves today.
In order to accurately paint the picture of the current state of the markets, I’m going to use economic data as well as anecdotes and I’m going to cover everything from the China to a hedge fund manager that lost 99.9% of his clients' money in just 3 weeks.
So, lets’ get started…
Everybody Cut Loose
There are 3 indisputable facts that came out of the Financial Crisis and the 6 years that have followed.
One: No economy has ever stayed at 0% interest rates for this period of time and as such, we have historical guide for what might occur if and when that experiment ends.
Two: When the US went to 0% interest rates, it was a coordinated effort amongst all of the major central banks, namely the ECB and the Bank of Japan.
Three: While the major central banks coordinated the beginning of massive stimulus, each is coming off the juice in an uncoordinated manner, beginning with the US.
This last fact has become more glaring in the first 5 weeks of 2015. Fighting deflation fears and global growth slowing, central bankers from around the world have been busy putting all forms of monetary easing to work.
So far, 16 central banks have eased this year including: Singapore, the European Central Bank, Switzerland, Denmark, Canada, India, Turkey, Egypt, Romania, Peru, Albania, Uzbekistan, Pakistan and Russia.
Last eek alone we added Australia and China to the ranks of those banks hoping to fight deflation, increase liquidity and boost their respective economies. The Reserve Bank of Australia cut rates by 25 basis points.
The rate cut itself was not a huge surprise but the timing caught some off guard. Many believe that is just the first cut and that another cut could come in Q2.
In China, not only did the PBOC cut the reserve replacement ratio by 50 basis points but it also cut the amount of cash lenders need as reserves in order to add liquidity to the economy. Keep in mind that the latest GDP number out of China showed the slowest growth since the first quarter of 2009, just after the Crisis.
The PBOC also moved its reference rate for the Yuan outside the daily trading band for the first time in 21 months, forcing the currency to strengthen. The PBOC is hurting the currency on one hand with rate cuts and trying to prop it up on the other hand by manipulating it directly.
The PBOC doesn’t implement these types of policies unless it sees significant trouble coming for its economy. But don’t worry, the "People's Bank of China will continue to implement a prudent monetary policy, maintain an appropriate degree, guiding monetary credit and social financing scale steady moderate growth, and promote the smooth operation of economic health."
We've seen significant evidence that the rest of the world is continuing with the easy money policy that began in 2009. However, in the US, we're attempting to beat to our own drum.
US yields have been getting drilled since New Year’s Eve 2013 and have yet to show any real signs of life.
This fact has lead a number of prominent investors, gurus and pundits to believe that the Fed will not raise rates at mid-year, like they have communicated. Labor market data and last week’s price action that followed may have indicated a shift in that sentiment.
Last Friday’s non-farm payroll release showed that the US created 257k jobs in January, handily beating expectations, and in a month that has historically disappointed the consensus.
Not only that, but the jobs numbers from both November and December were revised higher, making the last three months, the strongest for job gains since 2008. US yields had the strongest one day rally in months and the US Dollar showed impressive strength as well.
The labor market data also seems to have pushed the pendulum of expectations back to the likelihood of a rate hike occurring in June, rather than in September. This observation is backed up by both the implied rate of the Fed funds and Eurodollar futures, which both show that a mid-year hike is the most likely scenario.
Act Like You’ve Been There Before
So far in 2015, we have confirmed that the US seems firmly on its path to tightening while the rest of the globe is fighting deflation and slowing growth by any easing policy necessary. This policy approach in turn is torching currencies around the world and making sure that King Dollar keeps its throne.
How this will play out is anyone’s guess but there are already examples all around us, even if the mainstream media doesn’t want to acknowledge them.
Several weeks ago, the Swiss National Bank (SNB) decided to remove its peg to the Euro. I didn’t take time to discuss it here because the move simply exacerbated themes and trends we had already discussed. However, the move did two things.
First, it removed one of the largest buyers of the Euro because the Swiss realized that the ECB is going to continue to do QE in perhaps a very big way and the Swiss could not continue to buy unlimited quantities of Euros, in the event that the ECB continues to print unlimited quantities of Euros.
The second thing that the SNB’s action did was show what happens when the “never has happened before” actually happens.
Everest Capital is a hedge fund that has been around almost 20 years and manages over $2B. When the Swiss unexpectedly made their move, Everest Capital lost $830MM, almost the assets of its largest hedge fund, in one day.
The head manager was no dope, he had profited from 5 previous emerging market crisis and is considered one of the best in the business. Imagine how many more funds have blown up?
The central banking policies over the last 6 years have allowed money managers to develop some very bad habits that certainly cause extensive damage for most and opportunities for the rest of us.
One of those bad habits is believing that US equity markets can’t go down and that every pullback should be bought. One hedge fund manager was underperforming heading into December.
In an effort, to tack on some year end performance - in his own words - he got “overzealous” and made some bad bets on the US equity markets rallying into the end of the year. The markets did not rally.
This manager lost 99.9% of his $200MM fund in just 3 weeks. The only thing is clients received was an apology letter and their cut of the remaining $200,000.
But it's not just people who are unsure how to behave in this environment, it's assets themselves.
Just last week, Nestle, the chocolate maker, saw its 2016 Euro denominated bonds trade with a negative yield. This marks the first time EVER that a corporate bond maturing in more than a year traded with a negative yield.
Ever, as they say, is a very long time. And this isn’t the good kind of “first time ever.”
In another edition of the bad kind of “first time ever,” 10-year German Bunds traded below 10-year Japanese bonds for the first time ever last week. Really?
Whose economy and ability to repay debt in 10 years do you trust more, Germany or Japan?
We're seeing unprecedented events on a weekly basis now. Couple that fact with the reality that currencies are crashing, most equity markets are positive year-to-date and volatility has been declining all year.
Despite the fact that the whole world allocated capital for one based on a single US labor market data point, I still contend that the US will not and cannot support global growth on its own.
That said, the US certainly can sustain being the prettiest belle at the ball; but that’s only because its competition looks like homemade sin.