This quote from the Financial Times says it all, but needs some interpretation:
‘US stocks briefly turned positive for the year in a sharp reversal of the unbridled selling that kicked off 2016.
‘Recent evidence the world’s most important economy is in better shape than thought, an injection of fresh monetary stimulus by central banks in Europe and Japan, a stabilisation in oil prices and Wednesday’s dovish Fed statement has given financial markets a fresh jolt of optimism.’
Make no mistake, this ‘fresh jolt of optimism’ is all about coordinated central bank action. This is the investment world you live in. You need to analyse it correctly so you’re not completely whipsawed and confused about what’s going on…or by what will happen in the future.
That’s the task of today’s Markets and Money. To make sense of this volatile market and explain why it has quickly morphed from sustained pessimism at the start of the year to a ‘fresh jolt of optimism’ today.
Cast your mind back to early January if you can. A month earlier, the Fed raised its official rate in the most telegraphed interest rate move in history. Even so, the move unsettled markets.
Raising interest rates, while your major trading partners (Europe, China and Japan) are doing the opposite, has major ramifications in the world of foreign exchange markets. As a result, the strength of the US dollar put major stresses on the global economy.
As I’ve pointed out before, when the world’s reserve currency (the US dollar) is strong relative to other currencies and assets, it is deflationary. That is, when the US dollar goes up, commodities, emerging markets and many other assets go down.
In early January, this effect was in full force. China was suffering. Because of the yuan’s peg to the greenback, dollar strength was hurting China’s economy. That’s why China’s central bank wanted to try to devalue the yuan in baby steps. This attracted global hedge funds. They wanted to exploit the currency weakness immediately. But China couldn’t risk a large fall.
Then, at the end of January, the Bank of Japan pulled out the negative rate card, which turned out to be a disastrous move. It focused the markets’ attention on the risks to the banking sector. That is, how profitable would they be in a negative interest rate world?
Soon after, a number of large European banks reported big losses. With Europe playing the negative interest rate game too, the market started to panic about the European banking system. Credit spreads began to widen materially, which means the market began to see the banks as increasingly risky.
In short, by early February, things were not looking good at all. Markets were becoming increasingly chaotic.
Clearly, the powers that be needed to ‘do something’.
Here’s what they did…
China used its National People’s Congress to communicate that growth (economic, monetary and credit) would take precedence over reform. Around this time, they also committed to maintaining stability of the yuan.
The European Central Bank (ECB) then announced its latest monetary experiment. The big news was an expansion of the Quantitative Easing program. This included the ECB potentially buying corporate bonds.
Et Voilà, European Bank spreads (which measure risk) went back to normal. No crisis here!
Next up, Japan. Remembering the poor response to their January negative rate announcement, they realised the best option for them would be to do nothing. Which is pretty much what they did.
Then, finally, came the star of the central banking show, the US Federal Reserve. They announced yesterday they would take their sweet time raising rates. They also mentioned they were concerned about international developments, which put the market even more at ease.
So…China, Europe, Japan and the US all announce soothing and market friendly policies within a few weeks of each other, at a time when global markets were becoming increasingly chaotic…and rogues look like they could inhabit the White House.
Clearly, this was predetermined and deliberately coordinated. And the actions are having their desired effect.
Don’t be fooled by the words from the likes of the Financial Times though. Markets are not more optimistic. They are just conforming to the wishes of the world’s elite policymakers, who evidently still have the power to turn sentiment around in the short term.
And why not? As long as the majority of players believe the policies will work in the short term, there’s money to be made.
But this policy coordination has been done before. After a time, it generally succumbs to chaos again. That’s because the underlying structure of the global economy is unsound. There is too much debt, and not enough demand.
How long then will this charade last before chaos (reality) returns?
Obviously, I haven’t got a clue. But I have an idea.
You know the saying, ‘Sell in May and go away’? I would adjust that slightly to ‘sell in March, April, and May and go away’. Check out the chart of the ASX 200, below. I have circled the times over the past five years where these months have been a sell zone. Only 2014 didn’t work out.
That’s uncanny, no?
If it works in 2016, this period will again represent a good sell zone. Let’s keep an eye on it.
Has this change got anything to do with seasonal changes? Sunday marks the autumnal equinox, or the vernal equinox in the northern hemisphere. This is when the Sun sits directly over the equator.
For those of us in Australia, that means the days will quickly get shorter and colder. It might just mean some chill winds for the market too.
For Markets and Money