From yesterday’s open, the first since the tragic terrorist attacks in Paris on Friday night, France’s stock market, the CAC 40 Index is up about 3.25% from its short lived lows, and global stocks have been up sharply in sympathy. The financial media has used terms like resiliency, complacency and patriotism to describe the counter-intuitive stock market strength, but history shows that one-off unexpected negative geo-political events don’t have a lasting effect on financial markets (save 9/11).
One fairly simple explanation for the stock market strength is that the timing of the attacks, and fear of similar attacks across Europe, corresponds with a tricky time in the global economic recovery, as the US dollar index (DXY) challenges 52 week highs , commodities in terms of the CRB Index challenge 10 year plus year lows, global growth is teetering and the U.S. is readying a liftoff on interest rate increases that could exacerbate all of the above. So the expectation that the events of Friday could cause further economic weakness in an already struggling Eurozone economy speaks to more Quantitative Easing that ECB chief Mario Draghi already hinted to late last month.
I guess the trillion question is whether or not the current geo-political uncertainty gives the US Fed enough cover to push out a rate increase at their December 16th meeting, in which they increasingly feels as though they have painted themselves into a corner. Bloomberg’s World Interest Rate Probability (WIRP, which was brought to the attention of this long time Bloomberg user from a Business Insider article last week here), suggests that the events of the last couple days have done little to sway market participants of a rate increase next month, now at an implied percent probability of 66:
It been my view for the better part of 2015, that at this stage of the bull market, one that has been intact since early 2009, that buying stocks on the hope of a continuation of ZIRP in the US, and/or further QE abroad is not likely to yield the same results as it did in recent years past. It is also my belief that the selling across risk assets, across the globe after the FOMC’s dovish statement from their Sept 17th meeting, is likely just a precursor to what would occur if the FOMC were to once again balk at their first rate increase in 9 years if they were to again point to the risks to global growth. In the near term it’s my view that the FOMC is damned if they do, damned if they don’t given the uncertainty outside the U.S. And for those of you who point to The Home Depot’s beat and raise this morning as a sign that the U.S. economy is doing just fine, I think its important to note that HD is one of those special outliers, like Apple, Amazon, Facebook, Nike and Starbucks, and that the concentration of sales and profits into an increasingly narrow group of companies while multiples of their competitors fall by the wayside is not exactly bullish.
For those that think the bull market in U.S. stocks is still intact, remember that nearly 11 months into 2015, the largest stock market in the world, the S&P 500 (SPX) is flat on the year. It has seen little benefit from what was meant to be a massive tax break for American consumers and U.S. corporations in lower commodity prices, because along with that, dollar strength is strangling profitability of U.S. multi-nationals.
I remain in the camp that the current environment is less than attractive to commit new capital to equities. The risk reward feels like a one step forward two steps back at best.
In the next few weeks we have a few events that will make or break the year (which likely means up or down a few % from current levels), the ECB’s rate decision on Dec 3rd, the November non-farm payrolls on December 4th, and then of course the FOMC rate decision on Dec 16th. The SPY at the money Dec 4th straddle is offered at about $5.50 vs the etf at $206, implying about 2.7% move in either direction, which includes 2 fairly important catalysts, while the Dec 18th at the money straddle is offered at about $8, or nearly 4%. This expected movement over the next month is far greater than the norm, which would be about 2.5% in the last few year’s volatility regime, signalling the heightened fears.