On Monday it seems we all thought
That crises were sold and not bought
On Tuesday we learned
Those sellers got burned
Chair Powell; just look what you’ve wrought!
hu·bris | \’hyü-brƏs \
Definition of hubris : exaggerated pride or self-confidence
Example of hubris in a sentence
//It takes remarkable hubris to survey the ongoing situation regarding the 2019-nCoV virus and decide that Monday’s 1.5% decline in the S&P 500 was a buy signal.
I saw a note on Twitter this morning that really crystalized the current market condition. All prices are based on flow, not value. It is a fool’s errand to try to determine what the underlying value of any financial asset is these days, as it has no relevance regarding the price of that asset. This is most evident in the equity markets, but is equally true in the currency markets as well. So for all of us who are trying to determine what possible future paths are for market movements, the primary focus should be on how favored they are, for whatever reason, compared to the rest of the investment universe. In fact, this is the key outcome of the financialization of the global economy. And while this is just fine, maybe even great, when flows are driving equity prices, and other assets, higher, it will be orders of magnitude worse going the other way.
But the bigger issue is the financialization of the economy. Prior to the financial crisis and recession of 2008-2009, there seemed to be a reasonable balance between finance and production within the global economy. In other words, financial questions represented a minority of the impact on how companies were managed and on how much of anything was produced. This balance, which I would have put at 80% production / 20% finance, give or take a nickel, was what underpinned the entire economics profession. Finance was simply a relatively small part of every productive endeavor with the goal of insuring production could continue.
But in the wake of that recession, the fear of allowing massively overpriced markets to actually clear resulted in central banks stepping in and essentially taking over. The initial corporate reaction was to take advantage of the remarkably low interest rates and refinance their businesses completely. The problem was that since markets never cleared, there was still a dearth of demand on an overall basis. This is what led to a decade of subpar growth. Remember, the average annual GDP growth in the decade following the GFC was about 1.5%, well below the previous decade’s 3.0%. At the same time, the ongoing shortening of attention spans, especially for investors, forced corporate management to figure out how to make more money. Unfortunately, the fact that slow GDP growth prevented an actual increase in profits forced senior management to look elsewhere. And this is when it quickly became clear that levering up corporate balance sheets, while ZIRP and NIRP were official policy, made a great deal of sense. If a company couldn’t actually make more money, it sure could make it seem that way by issuing debt and buying back stock, thus reducing the denominator in the key metric, EPS.
And that is where we are today, in an economy that continues to grow at a much slower pace than prior to the financial crisis, but at the same time allows ongoing growth in a key metric, EPS, through financial engineering.
Which brings me back to the idea of flow. It is financial flows that determine the future paths of all assets, so the more money that is made available by the central banking community (currently about $100 billion per month of new cash), the higher the price assets will fetch. Let me say that they better not stop providing that new cash anytime soon.
With that as a (rather long) preamble, today’s market discussion is all about the Fed. This afternoon at 2:00 we will get the latest communique and then Chairman Powell will meet the press at 2:30. Current expectations are for no policy changes although there seems to be a growing view that the ongoing coronavirus situation, and its likely negative impact on Chinese/global GDP growth, will force a more dovish hue to both the statement and the press conference. Remember, the Fed is currently going through a major policy review, similar to that of the ECB, as they try to determine what tools are best to
manage the economy achieve their mandated goals going forward. Given that ongoing policy review, it would take a remarkable catalyst to drive a near-term policy change, and apparently a global pandemic doesn’t rise to that standard.
Oh yeah, what about that coronavirus? Well, the death toll is now above 130, and the number of cases is touching 10,000, far more than seen in the SARS outbreak of 2003. (And I ask, if so many are skeptical of Chinese economic data, why would we believe that this data is accurate, especially as it would not reflect China in a positive light?) At any rate, while the Hang Seng fell sharply last night, its first session back since last week, the rest of the global equity market seems pretty comfortable. And hey, Apple earnings beat big time (congrats), so all is right with the world!!
What will this do to flows in the FX market? Broadly speaking, the dollar continues to see small gains vs. its G10 brethren as US rates remain the highest around. Granted Canadian rates are in the same place, but with oil’s recent decline, and growing concern over the housing bubble in Canada’s main cities, it seems like the dollar is safer to earn those rates. At the same time, many emerging markets currently carry rates that are far higher than in the US, and what we saw yesterday was significant interest in owning those currencies, especially MXN, RUB, BRL and COP, all of which gained between 0.5% and 1.0% in yesterday’s session. While those currencies have edged lower this morning, the flow story remains the key driver, and if markets maintain their hubris, the carry trade will quickly return.
On the data front, yesterday’s US Consumer Confidence number was much better than expected at 131.6. This morning we saw slightly better than expected GfK Consumer Confidence in Germany (9.9 vs. 9.6 exp) and better than expected French Consumer Confidence (104 vs 102). That is certainly a positive, but it remains to be seen if the spread of the coronavirus ultimately has a negative impact here. Ahead of the Fed, there is no important US data, so we are really in thrall to the ongoing earnings parade until Chairman Powell steps up to the mic. As to the dollar, it continues to perform well, and until the Fed, that seems likely to continue.