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Smooth Sailing

January 19, 2014


2014 has started with record low volatility and slumbering financial markets.  Commodities and bonds are trading in a sideways to down-trending theme while global stock markets are in the continuous process of climbing the well-known wall of worries. Who can blame investors of being scared to join the equity rallies? 50 million Americans depend on food stamps to put dinner on the table, 60% of young people in Southern Europe are hopelessly unemployed, daily demonstrations and riots are to be found in Ukraine, Thailand, Brazil and virtually everywhere in the Middle East as the economic back drop overall appears desperate for so many. Yet, take a look at the “fear index” or VIX below and you will find a record low and ever descending graph:


Is this the calm before the storm or are the markets “wrong”.? Well, it all depends on your time frame but as of now, the markets are correct as they trade in ample liquidity at current prices. The trend is the clear market opinion comprised of millions of market participants who currently state that all is well. At some point down the road this will change of course but right now, there are no signs of pending financial stress. Once the trend changes it will be worth following the “changing winds” similar to the ship on top. However, keep in mind that the market is never efficient in the long run and the equilibrium state that economists like to refer to is a nice theoretical construct that simply does not reflect reality. Markets are not perfect and the world constantly changes. Economists that claim perfect market efficiency run the risk of not picking up a $20 bill on the street when they see one because they conclude rationally that in an efficient environment it would be impossible to find a $20 bill on the street, thus it can’t be there.

The Taper

Next month, the Federal Reserve will change leader ship and it will be very interesting to see how Janet Yellen continues or changes current policy. As an excellent scholar in monetary history, Mrs. Yellen is surely aware that Mr. Greenspan presided over the 1987 crash in his first year in office and Mr. Bernanke took over the Fed right before the financial crisis. It will be up to Mrs. Yellen to convince the global markets that she can and will continue on a path of liquidity injections in order to keep the markets in the current slumber that they are. As for the feared “taper”, let us not forget the Fed has already fully “tapered” several times in recent years as previous monetary injections were temporarily suspended and led to a decline equities. That in turn convinced the Fed to print ever more money. The current taper from $85 billion a month to $75 a month of money printing is a drop in the bucket and still amounts to gigantic monetary stimulus. The charts below explain the cause and effect behind the history of QE.

QE End of QE

While I don’t know Mrs. Yellen’s thoughts, I highly doubt that she is in favor of causing a global crash by reversing QE and raising interest rates. It will be a dangerous balancing act of hers to take over the hopelessly inflated Fed balance sheet and try to painlessly unwind it. By the way, the same issue haunts all major central banks around the world as you can see below. Good luck Mrs. Yellen!


The Markets

The chart below is evidence to all of us that global central banks have taken over the financial markets in an attempt to restore calm and economic prosperity after the financial crisis from 2008. They have clearly succeeded in restoring confidence in the markets yet not so much in the economy at large. In the long run it remains to be seen whether the QE’s in America, Abenomics in Japan and LTRO’s in Europe will bring economic prosperity or just another historic asset bubble but that will not unwind tomorrow or next month. At least, that is what the market is telling me. Check out the most important benchmarks below. S&P

First, the S&P500, the American stock market index is in the healthiest chart pattern I have ever seen. If I were to write a book about technical analysis this chart would surely be a candidate to describe a healthy up-trending market with no parabolic rise which usually precedes a top of enthusiasm. Unless I see a meaningful deterioration or an exponential rise in this chart there is no reason to fight the tape no matter what you think of monetary policy or the economy. In fact, I would like to point out that 60% of profits in the S&P500 are earned overseas and to that extent the S&P500 is really a global equity index. Given that fact, the European and Emerging Market Indices appear poised to go higher and follow “Papa Dow”.

EuroStoxx 50

Emerging Markets

Bonds and Oil

As I have written before, the main risks to the current financial recovery lie in the absurdly low-interest rates reversing to the upside and in “out of control” inflation. So far, we have neither seen the bond markets spiral down nor my favorite measure of inflation, energy, spike to new highs. While I would not recommend buying long-term bonds at record low yields and fully expect increased inflation over the coming years, we do not observe imminent out of control markets at this stage. Take a look at the bond and oil markets below and you will find a slowly declining bond market and a sideways energy market, very much helped by the “energy revolution” in America. US Long Term Bond Crude oil


While there are countless socioeconomic problems in the world today, the financial markets are protected by global monetary policy. For now, the central bankers have convinced the capital markets that all is under control. While it may be interesting to discuss all these issues from a critical angle, financially speaking you should always remember to never fight the trend. I remain highly skeptical of the eventual outcome of all the money printing in the world but as of today, the effects are clearly found in the prevailing trends. Once they change, it will be time to adapt, for now stay disciplined and open-minded. Finally, a great quote from a great man:



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