1Q16: Fear and Greed
As far as the markets were concerned, 2016 got off to a very bad start with most falling sharply for the first three weeks of the year: Asia ex Japan -13%, Emerging Markets -14% and Global Equities -10%. Markets then bounced along the bottom until the end of February when they rallied hard. Sentiment was aided greatly by very dovish statements from Chair Yellen and the Fed. Come the end of March (and thanks to Chair Yellen) the MSCI World was at -0.35%, MSCI Asia ex Japan was +0.54% and the wider MSCI Emerging Markets was +5.71%. In short, we saw a swing to extreme fear and back to greed in a few short weeks; this mirrored earlier episodes, most recently last summer when markets fell to similar levels as lately seen only to rally in a similar manner to the March rally.
The transition from greed (market highs) to fear (market lows) and back to greed is highlighted effectively in the excellent CNN Fear & Greed Index which tracks an equally weighted composite of seven key indicators: stock price momentum, strength and breadth, put/call options ratio, junk bond demand, market volatility (VIX) and safe haven demand. The below chart details the swings between Greed and Fear; we have highlighted the two most recent highs and lows that broadly coincide with the ‘low-high-low-high’ ranges of the wider equity markets.
In the below chart we can see the current index reading, which is at the upper end of “Greed” having very recently eased back from “Extreme Greed” as markets softened in the last day or two of March. The logical question is what comes next. Will the ‘high-low-high’ cycle repeat for a third time or, if markets haven’t gone too far too soon, can they go on to new highs? If so what will be the drivers behind this? In truth, nobody knows and that includes Chair Yellen and the other FOMC committee members.
Readers of our blogs might have read our recent and evolving views on the FOMC (Floundering Open Market Committee), which we summarise below:
The Fed has deviated from its long standing and well understood dual-mandate of ”maximizing employment, stabilizing prices, and moderating long-term interest rates”. Or more plainly: keeping as many folk in work as possible without allowing inflation to get out of hand (unofficially at or around 2 percent). So it’s “goodbye dual mandate” and “hello de facto tri-mandate”, with the ‘new’ third leg emphasising soft global growth and mushy US earnings expectations. Since when does the Fed base policy on Chinese equity markets? Well, since last summer, that’s when and Chair Yellen reaffirmed this at her most recent presentation.
The truth is that labour conditions in the US are tightening, the unemployment rate is fast approaching the Fed’s target levels, and at the same time inflation (the Fed’s preferred measure) is heading towards their unofficial target. Under the trusty old dual-mandate this would mean that the Fed would likely raise rates. However, Chair Yellen and the wider FOMC are going to some lengths to say just how dovish (unlikely to raise rates) they are (despite the dual-mandate looking ‘met’) and that they are rather worried about events unfolding beyond the US geographic border. This worry might answer the earlier question posed: “What comes next? Will the ‘high-low-high’ cycle repeat for a third time or, if markets haven’t gone too far too soon, can they go on to new highs? If so, what will be the drivers behind this?”. Other than continued loose monetary policy it is hard to see what will push developed markets higher. Will politicians finally move away from fiscal prudence and resort to some good old Keynesian fiscal spending? This would be logical as conventional monetary policy seems at its limits.
That is all for this quarter. As always, you are most welcome to contact us should you have any questions relating to your portfolio, discretionary mandate or the markets.
PCL: April 2016
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