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Dog days of summer

July 12, 2014

dogdays 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: Vix 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.

Japan CPI

Source

 

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.

Death cross

Source

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!

 

 

 

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