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The answer to "What's going to give the Fear Index a boost ?" was staring us in the face all along .... The threat of Thermonuclear War,...

August 11, 2017

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Not so much analysis, more stream of consciousness...

October 9, 2018

ref :- General

 

We've been "off air" for a bit, which is possibly a bit unfortunate as there's been plenty going on. So much so in fact that taking a brief tour around the markets to reacquaint yourself with things might just be enough to make you wonder whether something significant's afoot... whether we might just be entering a new phase.

 

Commentators are always ringing alarm bells, warning of potential disasters. Most of the time these portentious alerts come to very little, which of course gives rise to those accusations of "crying wolf". But those commentators would argue  --  and they'd have a very fair point  --  that all investors should be aware of the dangers that might pose a threat to their investments. All we can ask is that those highlighting the dangers do so with a true sense of perspective, and let us know whether they're talking "worst case scenarios" or if they genuinely believe something nasty is lurking around the corner.

 

With that in mind, we're making no claims that this is definitely a particularly seminal moment for investors. It's just that the way that a range of different markets have been behaving at the same time is enough to suggest that we might... just might... have moved into a new stage of the cycle.

 

Most obvious are the developments in bond markets. After several false alarms, US 10yr Treasury yields broke through the highs set in May at 3.12% and now trade at 3.25%. According to some, the way is now clear for higher yields in the future (much higher, some say). Technical traders are saying that last week's upward move in yields constitutes an upside break of the 30yr downtrending channel  --  in other words, an end to the 30yr bull market in bonds (prices and yields move in opposite directions, of course). From a fundamental point of view, given strong growth and tight labour markets perhaps the only surprise is that it's taken so long, especially when you throw in the growing supply of treasuries required to fund tax cuts and public spending and the gradual unwinding of the Fed's balance sheet.

 

At the short end, the gradual tightening of monetary policy by the Fed continues. Another hike in Fed Funds is very likely in December, and if some were wondering whether three rate hikes in 2019 was a bold call, it now seems that if the Fed were to err from their expected course it's more likely to be on the side of four rate rises rather than two. Some believe that the massive boost given to the economy by Mr Trump's tax cuts somewhere near the end of the cycle may prove akin to pouring petrol on the fire, but it's undeniable that the President has been hugely successful in ramping up corporate profits. The same can be said of share prices, which in his mind seems to be the true indicator of an economy in great shape. Even the lower than expected payrolls number on Friday has been swiftly dismissed as an abberation resulting from Hurricane Florence.

 

Now, by historical standards the higher rates both long and short that seem to be on the horizon are hardly eye-watering. In fact, there is nothing inherently frightening about the kind of levels we might expect... other than the fact that the world has got used to something much lower, which for emerging markets in particular is a very big deal. But higher rates and yields fundamentally affect all markets, and we are already seeing their influence on currency markets. Mr Trump may complain about China massaging the Yuan / Renmimbi lower to gain a trade advantage, but the truth is that China doesn't need to play dirty while Mr Trump's domestic policies fuel higher rates, which in turn boosts the value of the dollar. It reminds us of his whingeing about the Fed raising rates in the first place... you want to ask what he thought would happen to rates once he embarked on such high-growth policies.

 

We are also now getting close to levels where there must be some concern that a US Treasury bond yielding say 3.50% is looking pretty attractive compared to stocks that may be pretty tired as the S&P 500 approaches its longest bull run in history. The impetus from tax hikes must run out eventually... it's hard to imagine that it would still be boosting equity prices in a year or eighteen months time, say.

 

Timing as ever is everything and professional doomsayers have been proved wrong repeatedly, so for all the reasons to be wary it would be a brave call to say that we're about to see the end of things as we've known them for so long. But what does seem inevitable as rates and yields move higher is that volatility must increase... we are already seeing the VIX measure of volatility (aka the Fear Index, last at 17.26) heading back to more "normal" levels, historically speaking. Increased volatility has particular ramifications for those emerging markets already under pressure from high levels of dollar-denominated debt, but it affects all markets and investors. At the very least, there's a decent argument for suggesting that the world is going to become a more uncomfortable place, if not necessarily one beset by impending disasters.

 

All this, and we haven't even got to Italy, or Brazil, or Argentina, or Brexit. Or for that matter to Oil, another instance where you want to ask Mr Trump "if you take Iran's supply largely out of the equation, what did you think would happen to prices ?".  They'll have to wait for another time. As for why a fundamentally radical change in markets may not occur ? Inflation staying firmly under control, resulting in a very gentle and gradual tightening not just in the US but worldwide... and the changes we are witnessing in the dynamics that drive inflation mean that is very possible too.

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