ref :- " Markets appear calm but are behaving abnormally" , Opinion by GILLIAN TETT, The Financial Times
"Not again !" , we hear you cry . It's true .... we have fairly regularly pointed you towards articles commenting on the remarkable buoyancy of a whole range of asset classes in the face of factors that in the past would have had investors reconsidering their position(s). The implication is always that markets have become complacent, overly confident that the support offered by the hugely accommodating monetary policies of central banks (amongst other things) will continue to support valuations.
And guess what ? On balance and despite some recent wobbles, those investors have largely been proved correct and the would-be canaries-in-the-coalmine have been a bit premature in raising alarm bells. The MSCI world equity index is still up 10% from one year ago, and the upside break of 3.00% for the yield on 10yr US Treasuries -- supposed to finally herald the end of the great bull market in bonds -- has so far failed to follow through (last at 2.90%).
But that doesn't mean that anyone should stop sounding warnings if they genuinely believe them to be appropriate, even if some might accuse them of crying wolf. After all, the point of that particular tale was that the wolf did eventually make an appearance with some pretty devastating results. It becomes a question of whether the arguments put forward still retain their credibility. So hands up, then ..... who believes that the world is still in an investment-friendly sweet spot ?
Not for the first time, it seems like a fair question to ask. The trade spat is now within a whisker of becoming a full-blown global trade war, and the geopolitical picture is truly extraordinary : The US president suggests inviting Russia back into a G8 while the group are still applying sanctions on that nation ; he then picks a fight with his allies before cosying up to dictator Kim Jong-un in a deal that analysts believe can only favour N. Korea. Rather than being in a sweet spot, the commercial, economic and diplomatic implications of these developments point to the world being in decidedly precarious position.
On top of all that, the US Federal Reserve is leading the world's other major central banks in a move towards the normalisation of monetary policy -- desperately slow though the process may be in some cases. The dynamics that drive markets may have changed a bit in recent years (the relationship between employment levels and inflation, for example), but it seems perfectly legitimate to question once again whether market valuations can continue to ignore some pretty basic fundamentals.
Ms Tett is not a harbinger of doom, but she does point out how truly bizarre the current situation is, and that spells danger. It's one thing for US equity indices to retain their froth , buoyed by tax cuts, higher earnings and the technology sector. But what about credit markets ?
How often have you heard commentators warning of soaring corporate debt ? A Bank of America Merrill Lynch survey suggests that 42% of asset managers think that companies in the developed world (never mind emerging markets) have borrowed too much money -- the previous peak in 2008 (of course) was 32%. Amid a welter of leveraged buyouts and mergers, nearly half of all US corporate bonds issued this year carry a rating of triple B plus, triple B of triple B minus -- in others words : RISKY. You'd think that would seriously concern investors. On the contrary, the demand for risky debt is so strong that the spread between the yields of SAFE corporate debt (triple A) and RISKY corporate debt (triple B) has narrowed from 200 basis points in 2012 to just 50bp. Odd, isn't it ?
Here's another one .... "Term premium", which essentially is the Fed's calculation of the extra yield required by investors to put their money into longer bonds rather than rolling over a series of shorter-term ones. Right now, at a time of rising interest rates and inflation and the prospect heavy bond issuance to fund Mr Trump's tax cuts, we could expect the US term premium to be distinctly positive. It's flat .... and what's more JP Morgan reckons that the global yield curve has inverted for the first time since 2007.
Another puzzler is the lack of correlation between currency moves and interest rate differentials -- that most basic staple of FX trading. In the US, rates have been on a steady climb for some time and show every sign of continuing on that path. Elsewhere, despite good intentions about policy normalisation, central banks are having to take things at a glacially slow pace and interest rate differentials are expected to widen further in favour of the dollar. Now, it's true that the dollar has strengthened 5% lately (on a trade-weighted basis) but it is still 4% weaker since the beginning of the year.
Ms Tett cites other phenomena such as the fall in the reading of the VIX , which measures expected volatility in US equity markets. February's bout of market turmoil saw the VIX spike above 37, the move exaggerated by those short volatility (i.e. who had bet against it rising) scrambling to get out of their positions. The VIX is back down to about 13, and when people look for possible evidence of complacency, that's the kind of thing they're looking for.
Who knows, all these oddities may (yet again) amount to nothing at all but the point of the article is that just because things appear calm in terms of price movements that doesn't mean that they're normal .... and if they're not normal, it would be foolish to ignore the possibility of impending danger. People may look back from some point in the future and wonder how it was even possible to be complacent in a world so geopolitically scrambled as the one we're facing now.