Another challenging October seems to have gripped the global equity markets. Some market participants claim there will be hyperinflation, some argue we are in a deflationary death spiral. Interestingly, both arguments, although extremely overstated have some merit to them.
It is true that the global central banks have created tens of trillions of national currency units and have tried to put them into circulation. However, the money has not entered the real economy as recipients of these funds(banks) have been largely unwilling to take risks in lending to the private sector. As a result, we now face 500 year lows in European interest rates which supposedly should act as a stimulant to the economy.
The problem is, zero interest rates only apply to capital depositors, not borrowers. In a truly bizarre announcement, former Fed Chairman Ben Bernanke recently stated that he has been rejected to refinance his home. As strange as that may seem, ask yourself who is credit worthy these days if Mr. Bernanke isn’t? Only eight years ago, in America, practically anyone was able to get a mortgage, interest rate free and above 100% equity with no documentation or job. Today, hardly anyone can obtain credit, be it middle class folks or start-up companies. As a result, we cannot grow as an economy, certainly not as fast as we otherwise would. Risk/Investment is choked off, savings are not creating yields and investors turn increasingly risk averse which slows down progress.
Financial markets have become interesting reflections of these conditions. Blue chip equities appear to be safer than government bonds, thus they rally. Losing nothing or merely the loss of purchasing power beats gains, thus we see higher rated sovereign bonds rally along with the money created. The dollar despite all its flaws is once again in a bull market as the US is still viewed as the safest place to park money.
I am not sure what it will take to change this global stagflationary situation that we are all in. My best recommendation would be to make sure that some of the printed money does indeed find its way into the real economy. At the end of the day, global central banks can print as much money as they want but they won’t be able to print jobs and assets. Good luck, Mr. Bernanke!
As loyal readers of this blog may know I am focused on trading FX although my general interest includes all financial markets. For this post, I choose to point to an article that a talented, young journalist conducted with me a few weeks ago.
The article was just published at Profit & Loss Magazine and reveals good insights to the markets that I operate in. Thank you Galen for a great conversation. May there be many to follow!
In February of 2013, I had dedicated an article to coffee, Hot Coffee. In it I discussed its price, production and possible future development. Back then I wrote :
“…a pound of coffee cost 50 cents in the 1970s’ and currently goes for 141 cents. If you can find one staple commodity that costs less than triple the price from 40 years ago, please email me and let me know.Let’s take the analysis a step further. In commodities, high prices are the cure for high prices and vice versa, low prices the cure for low prices. Why? Quite simply, as a commodity becomes pricey, it is more profitable to grow/mine the commodity and thus, supply expands as demand drops. In the case of low prices, the opposite happens. When a commodity nears the price of production, supply falls off sharply as the production of the commodity yields little to nothing. That supply shock plus higher demand at lower prices lead to a general reversal in price… Therefore, as long as a commodity does not disappear altogether, the bottom price is naturally around the cost of production. Coffee costs about $1 to $1.2 per pound to produce at the moment depending on coffee bean and Location……. Evidently, coffee grows around the equator and as such, you need to add approximately 10 cents a pound in transportation cost to the colder climates north. Given total cost of $1.1-$1.3 per pound of coffee and a current price of $1.41, this may be a perfect time to buy coffee. This does not mean that coffee cannot fall to the cost of production but your down side is probably limited to 10-15% while the upside is a multiple of that. Besides, if your purchase of coffee turns out a loser your Sunday morning cup of coffee should be that much cheaper as well. Another way to look at this would be to say you can buy your coffee consumption for the next 1,5,10,20 years today at close to 2013 production cost. Makes sense to me…”
Now, what has happened to the price of coffee since I wrote that article 18 months ago? As so often, the down trend to below production cost continued as speculative and leveraged positions were forced to liquidate. However, once the “hot money” was out of the market, the Price of coffee had nowhere to go but up as coffee producers would not be able to grow at Prices below production.
So far this year, coffee is the only commodity breaking out on the upside despite subdued inflationary pressures in the global economy. For all the short-term reasons, please read the following Reuters article “Why Coffee Prices are piping hot“.
Fundamentally, it is back to basics, supply and demand. As demand for coffee is constant and growing, the price for coffee is largely determined by supply which in turn is price sensitive. If you choose to get involved in the commodities markets, use common sense and avoid leverage. And as always, caveat emptor!
Yesterday, I was interviewed by an Austrian newspaper regarding the direction of the EUR/USD Exchange rate. As always in this blog, the content is not investment advice but must be regarded as personal opinion. Caveat emptor!
In November of 2013 I wrote an article titled “Surfing the Elliot Wave” . In it I opined “One of the most respected long-term technical methodology to identify and chart financial market movement is called the Elliot Wave(on top). So far, the pattern displayed in US equity prices since 2009 follows the Elliot Wave model very accurately(for further analysis and explanation please click here). We are currently in the beginning of the final wave (4-5, look at top image) of the up move and the model suggests a peak of around 2000 in the S&P500 and 20,000 in the Dow, most likely within 12-18 months. I think this prediction is well in line with the typical psychological pattern of market cycles depicted below”.
So, here we are 10 months later and the perfect top of the final technical wave has been reached in the SPX(albeit not in the Dow). The coming year will be very interesting for those market observers who lean towards technical or fundamental models as one approach will be proven wrong. Fundamentally, capital flows and credit creation are solid, monetary policy is loose and inflationary pressures subdued, all fuel for continued rising equity markets. Technically, we should see this point in time as close to the top of the market cycle according to the Elliot Wave theory. Good luck!
Today I would like to share an article that was written in an Austrian newspaper about the author of this blog. Unfortunately for non-German speakers, the article is in German and may require a good sense of humor when utilizing an online translator.
It appears that markets have followed most of Europe on summer vacation displaying very little movement. The calm can be perfectly put into historical context in the long term volatility chart below: Source
Given the wide spread challenges in the global economy one can’t help but wonder whether the calm is justified or if this phase is merely the “dog days of summer” in the financial cycle that we observe as regularly as we experience summer in the calendar year.
Beneath the surface, many severe problems are brewing. For example, a year ago, I explicitly warned about Japan”s economic policy, named “Abenomics”, referring to the current Japanese prime minister. It now appears that the Japanese policy of flooding the market with printed yen has caused inflation to increase to 3.7% while the 10 year Japanese government bond yields 0.53%. Why would anyone in their right mind hang on to yen or Japanese government bonds? Abenomics is clearly unsustainable and all I can do is shake my head and wonder when this problem rises to the global financial surface.
Finally, I would like to show the chart below which shows a falling global GDP while global equity prices are rising. Considering that companies’ earnings are derived from GDP and equities’ reflect future profits, it is quite illogical to assume this dichotomy to continue indefinitely. Either GDP needs to move up or equities need to come down.
In conclusion I would like to once again remind readers that while complacency has entered the financial markets, do not expect this era of slow motion to last. Considering the action behind the curtain it is truly stunning to see the VIX at record lows. Caveat emptor!
Very often it pays to listen rather than speak. The presentation below is one where I would urge anyone with an interest in the financial markets and economics to spend some time soaking in the best analysis I have seen so far this year.
When global central banks reduced short term interest rates to rounding errors in 2008, the mission was clear: prevent financial disaster and arrest a world wide liquidity crunch. Mission accomplished. Yet today, six years later, we still find zero interest rates and money printing on an epic scale. In the article “Central Banks shift into shares as low rates hit revenues”, The Financial Times reported this week that global central banks have accumulated $29.1 trillion of assets including equities pushing up prices in anything that can be exchanged for the promise of purchasing power of cash. For those of you that are having trouble with such large numbers, total annual global GDP is about $77 trillion. In essence, central banks have created nearly 40% of global real GDP through “unreal” activities.
Rather than discuss the sense or nonsense of this global quasi-nationalization policy, I would like to point out to the reader that if history is our guide:
a) artificial price setting is always temporary in nature as price levels find their true levels in the long run
b) the longer price levels are kept away from their natural equilibrium, the bigger the resulting potential diversions and thus, the larger and more rapid the eventual price adjustment.
While the financial market skies are relatively blue at the moment, math and history both point to extreme conditions in the coming years. Enjoy the warm summer days for as long as they last. Winter is not too far away(first snow falling in September 2015 in my opinion).
In recent years, the computerization of the financial markets has been stunning. 10 years ago, orders were placed side by side humans in order to exchange financial products. Today, over 90% of all trade decisions are made and executed by computers without human input. Adding computers to human intelligence has allowed the financial markets to become more efficient, faster and liquid, all positive attributes. However, there is a segment of trading that relies on HFT(High Frequency Trading) where it is legitimate to question the purpose of market participation.
Take a look at the explanation below given by the New York Times.
As you can see, the example above leads to worse execution for the customer who enters the market while the HFT computers “front run” the order in order to capture a tiny gain on large quantities. Is it legal, is it ethical, is it efficient? I leave all these questions for the reader to be answered. Personally, at my firm, we also exclusively trade through our computers but I find much more satisfaction in trying to get the market right rather than front run customer orders.
Finally, take a look at a video a precious friend of mine has shown me in this regard. It’s a human hand playing “rock-paper-scissors” against a robot who wins every time due to faster signal recognition. Similar to HFT, decide for yourself, is the robot cheating or outright winning and does it matter or not?