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The World Is Awash in Oil, False Assurances, Magical Thinking and Complacency as Global Demand Careens Toward a Cliff
The World Is Awash in Oil, False Assurances, Magical Thinking and Complacency as Global Demand Careens Toward a Cliff
This collapse of price will manifest in all sorts of markets that are based on debt-funded purchases of desires rather than a warily prudent priority on needs.
Since markets are supposed to discover the price of excesses and scarcities, it’s a mystery why everything that is in oversupply is still grossly overpriced as global demand slides off a cliff: oil, semiconductors, Uber rides, AirBNB listings and many other risk-on / global growth stories are still priced as if pre-Covid-19 demand was still guaranteed.
Punters are still buying semiconductor stocks based on out-of-touch projections that are the equivalent to counting the number of fairies on the head of a pin, ignoring the fundamental reality that very few people actually need a new mobile phone, vehicle, laptop, refrigerator, etc.
It boils down to confidence and certainty. People pursue what they desire but don’t need when they’re brimming with confidence in the future, bolstered by an animal-spirits euphoria that their income and wealth will continue rising–a sense of certainty anchored by a belief that their economic world is essentially without risk.
When confidence dissipates and is replaced by fear and uncertainty, desires lose their luster and needs take precedence. When you’re afraid of getting a deadly virus or losing your livelihood, status symbols and frivolous spending no longer top the agenda.
Yet the entire risk-on / global growth story is based entirely on desires not needs. The vast majority of demand isn’t for a pressing need, it’s for euphoric aspirational consumption, spending intended to make the buyer larger than they really are, in their own self-image and in the image they present to the world in the brands they display, the cafes they dine in, etc. etc.
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Risk On/Risk Off: What Schizophrenic Markets Are Telling Us
Risk On/Risk Off: What Schizophrenic Markets Are Telling Us
These trends cannot be reversed with yet another rate cut or another “whatever it takes” announcement.
In the conventional investment perspective, risk-on assets (i.e. investments with higher risks and higher potential returns) such as stocks are on a see-saw with risk-off assets (investments with lower returns and lower risk, such as Treasury bonds). When risk appetites are high, institutional managers and speculators move money into stocks and high-yield junk bonds, and move money out of safe-haven assets such as gold and U.S. Treasuries.
But recently, markets are no longer following this convention. Safe haven assets such as precious metals and Treasuries are soaring at the same time that stock markets bounced strongly off the post-Brexit lows.
Risk-on assets (stocks) rising at the same time as safe-haven assets is akin to dogs marrying cats and living happily ever after.
What the heck is going on?
Why are markets acting so schizophrenic? What’s changed?
Before we cover the dynamics that are in play, let’s review the market gyrations so far in 2016.
The Market Gyrations Of 2016
Risk-off / safe havens
Gold: from $1,060/oz in January to $1,360/oz (as of July 5)
Silver: from $13.90/oz to $20/oz
U.S. dollar: from 99 in January to 92 in May to a current level around 96. (The DXY dollar index was 80 in mid-2014 and topped 100 in March 2015.)
U.S. 30-year Treasury bond yield: from 3.00% in January to 2.14% in early July.
TLT (20 year bond ETF): from 120 in early January to 142 in early July.
Risk-on
S&P 500: from around 2,035 in early January to 1,820 in February, topping 2,100 in April, then a decline below 2,000 in June and back to 2,100 by July 1 – and a new all-time high just today. (SPX was above 2,100 in mid-2015, then it plummeted to 1,825 before bouncing back to 2,100 in late 2015.)
JNK (high-yield bond ETF): from 36.5 in May 2015 to 32.5 in early January to 30.5 in February to 35.5 on July 1.
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Dollar Demand = Global Economy Has Skidded Over the Cliff (March 18, 2015)
Dollar Demand = Global Economy Has Skidded Over the Cliff
Borrowing in USD was risk-on; buying USD is risk-off.
There is a lively debate about the global demand for U.S. dollars:
Global finance faces $9 trillion stress test as dollar soars (Telegraph.co.uk)
Is There a US$ Shortage? Will it Sink the Global Economy? Again? (Mish)
The Dollar Squeeze – How Problematic Is It? (Acting Man)
The Global Dollar Funding Shortage Is Back With A Vengeance And “This Time It’s Different”(Zero Hedge), which references a Bank for International Settlements (BIS) paper: Global dollar credit: links to US monetary policy and leverage.
“Unless you enjoy multivariate regression analysis I suggest skimming the BIS working paper. Major points I got were:Correspondent Mark G. went through the BIS report and offered these insightful comments:
1. Almost all of the dollar denominated debt and bond growth since 2009 was generated by the global shadow banking system. Banks per se were smaller players in issuing this debt, and US-based banks (i.e. the ones in reach of Federal Reserve life preservers) were minor. Sovereign wealth funds are large players in this. When we think of huge sovereign wealth funds held by major hydrocarbon exporters then the pucker factor rises.
One implied result of the BIS paper is that it will be extremely difficult or impossible for Federal Reserve emergency liquidity operations to stem a panic, even if the Fed is inclined to do so. AEP in the Telegraph article stated this more directly. The real problem is that modern bailout operations have large fiscal components as well as monetary components. Looking at the Bundestag’s chronic heartburn with Greece and the EFSF is educational. Alternatively, consider how well proposals for a larger TARP type program aimed primarily at foreign entities would be received by the US Congress. And especially in 2016.
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