If you are buying this morning to cover shorts or to chase a long you had your eye on, I get it, lately snap-back rallies seem like you’ll never get another chance. If you are buying because you’re sticking to the “don’t fight the Fed playbook”, I get that too, as the last few years have shown us that new highs are likely in store after dovish commentary. But let’s remember what the market is cheering this morning. Despite continuing strength in U.S. economic data… low inflation, slow wage growth and global growth fears are likely to keep the Fed from raising rates anytime soon. In plain speak, the U.S. recovery in global terms is an outlier and is skating on thin ice as there are no shortage of potential headwinds that could trip it up, none more possible than a self-inflicted wound by an overly hawkish Fed.
I would suggest that even-though the Fed is done with QE this is the exact sort of environment that could ultimately cause the inflation of risk asset bubbles that do not already exist. Monday in this space (MorningWord 01/06/15: Oil’s Cold War) I detailed my belief that while investors had been eyeing stocks and bonds as the obvious beneficiary of the Fed’s unprecedented ZIRP & QE, it was in fact industrial commodities that inflated to un-sustainable levels with the subsequent crash in Crude Oil:
The financial crisis required extraordinary measures that have since become extended economic policies in places like China. Headlines like China Fast-Tracks $1 Trillion in Projects to Spur Growth from Bloomberg this morning seem commonplace. This relentless stimulus has created a fairly unique bubble in industrial commodities, producing demand in a place where it otherwise should not have existed given the state of their economy and the realization of the end of a hyper growth phase.
To me it’s no coincidence that crude oil started it’s 50% decline in mid 2014 right as the Fed started tapering QE. The decline in crude and other industrial commodities could be the very asset bubble burst everyone was looking for after ZIRP & QE. Much like what we saw in tech stock’s in 2000-2002, and real estate in 2008/09.
I remain in the camp that the volatility that we have seen in the last six months, in currencies, treasuries, commodities, high yield and even equities will likely continue for some time in 2015 until we get a sense for the success of BOJ, BOC and ECB stimulus and QE. It is unlikely that the U.S. economy can go it alone as the strength in the dollar is likely to offset the positive impact of lower oil and while central bankers remained concerned about stoking inflation, they may quickly be battling deflation which in my mind would not be an attractive investment environment for U.S. equities, despite our relative economic out-performance.
I think it is important to remember that the S&P 500 has had ONE down year since 2002, and that was 2008, and the only reason that crash was so short was the trillions of dollars in global stimulus thrown at keeping the financial system afloat. Here were my thoughts from this space from late October (MorningWord 10/31/14: A Glitch in the Financial Matrix):
I find this artificial financial reality that we are currently in nauseating and as a rational actor I am not sure how it can end well. But in the meantime, if the BOJ and the ECB are going to keep the party going, then just keep raising your stops on your long stock positions and add a little protection along the way when things are starting to feel a bit overzealous.
The purpose of this post is not to get you all beared up, just to throw in a dose of caution as it seems whatever happens from central banks across the Atlantic, or others across the Pacific, that for now the Dollar is going UP and rates are going DOWN, which could cause risk asset volatility for a “considerable time”. So buckle up, as past performance is not always indicative of future results.