MorningWord 6/24/16: “This is not a moment, it’s the movement”

by Dan June 24, 2016 9:33 am • Commentary

Ummm, I suck. Yesterday I started my morning post (Cause I Don’t Want to Be… Anarchy) with a confession, and an apology:

Confession: Not for a moment in the last couple months have I seriously considered that UK citizens would vote in favor of a Leave vote from the European Union.


Apology: I never got caught up in the Brexit hype I’ve probably offered fairly apathetic commentary

Plain and simple, I trusted betting and financial markets (the “Smart money”) and didn’t trust the polls (which were essentially too close to call) and miscalculated the potential for yesterday’s Brexit referendum to pass. As such my reasoning for fading this recent rally (and particularly targeting banks) didn’t account for the sort of overnight havoc we are seeing in global financial markets.  While I was little to no help to readers of RiskReversal and viewers on CNBC over the last week on this topic, I will stand by one important point from yesterday’s post, also important to keep in mind as we trade markets during what’s next for the EU:

Playing for anarchy in financial markets is a tough bet.

It usually takes deep pockets and a high risk tolerance that most individual investors just don’t have.

In my nearly 20 year career I have seen the build up to many impending financial dooms, Asia & Russian currency crisis, Long Term Capital, Y2K, implosion in the late 1990s, and the sub prime debt crisis, European Sovereign debt crisis, Debt Ceiling over the last decade (I’m sure I am missing a couple).  The main point here is that is hard enough to trade these sorts of known events, and nearly impossible to be ready for surprises like 9-11 (and the terrorism we have seen since) or natural events like the Japanese earthquake, tsunami, and nuclear leak.

So now that the overnight event is out of the way, what investors have to do right now is create a broader thesis.  Is the news of the last 12 hours a one off, or has it set a course in motion like the aftermath of the dotcom bust in 2000 or the start of the subprime crisis here in the U.S. in 2007?

This morning, S&P 500 futures are indicated down more than 70 points. But that’s not a lot more than the move higher we’ve seen in the past week. And it’s nothing compared to the more than 200 point rally we’ve seen since the February lows. So the move so far is exciting, but in the larger scheme of things, it’s nothing. So will it become something?

It’s been my view for some time that overly accomodative monetary policy the world over, some 8 years after the start of the subprime debt crisis, is evidence that the world is in the midst of a rolling credit crisis that started here, never concluded in Europe in 2011/12 and is in the process of enveloping Asia and emerging markets.  The crisis monetary policy used to avoid a depression in the U.S. has become the playbook for global central banks to keep their economies afloat. There is little evidence of organic growth anywhere in the world, and at this stage of the game its just downright scary. The Brexit vote, and the rise of presidential candidates like Donald Trump here in the U.S. demonstrate an anger that in some ways is a result of some of the  unintended consequences of these central bank policies.

So the biggest risk from last night’s news is that the hand-off from monetary stimulus to a new wave of fiscal stimulus (that many have been calling for) could be off of the table because of political chaos. This further weakens growth prospects and dramatically increasing the odds of a global recession as central banks are forced to push forward with unconventional monetary policy (NIRP- negative interest rates). For now that probably means a reverse effect for most risk assets. In the last year since we have seen a more than ten fold increase in negative yielding sovereign debt from $1 trillion to over $11 trillion, most of it in Japan and Europe. And during that time we have seen their equity markets get clobbered, with the Nikkei down nearly 30% from its year ago levels (including last night’s 8% decline) and the Euro Stoxx 50 (SX5E) down about 25% during the same time period.

So what to do? My view has been that U.S. stocks have topped. I suspect the S&P 500 (SPX) will remain an out-performer as foreign investors flock to it as a sort of safe-haven trade, but ultimately it will re-test the February lows at some point in 2016. And who knows what lies beneath?

I’ll leave you with this. It’s a point that I have made on more than one occasion this year. At some point very soon, an increasingly Dovish U.S. Fed, and crashing U.S. Treasury yields will not be bullish for U.S. stocks (yeah yeah T.I.N.A). If you need evidence, see Europe & Japan.

8yr chart of 10 yr U.S. Treasury Yield from Bloomberg
8yr chart of 10 yr U.S. Treasury Yield from Bloomberg

So again, my apologies for missing Brexit specifically. But I’ll reiterate that my cautious thesis for risk assets in this environment remains intact and had little to do with last night’s referendum. So in many ways it reinforces my views and just speeds up the process of what I thought would happen anyway.

What worries me the most, to quote Lin-Manuel Miranda, the dude who wrote and plays Hamilton in the Broadway musical:

“This is not a moment, it’s the movement”

And if that is the case, then this could spread globally. Say hello to Donald Trump as the leader of the free world? That still seems unlikely but so did a Brexit a few months ago. A retreat to isolationism and nationalism would mean more financial anarchy.  If that is the case then we are likely headed for a post dotcom or post subprime crisis period as opposed to a sort of V reversal that we have become accustomed to in recent years. So keep an eye on news from other EU members for signs that the UK was just the first domino. If that’s the case, this volatility is just beginning.