Category Archives: Macro Markets

5 Possible Natural Black Swan Events To Monitor In 2015

As we constantly try and avoid the “unpredictable,” I thought I would throw out a few ideas and thoughts I’ve been hearing talked about in my travels. Obviously I have no idea if anything will come from the events, but they are certainly worth thinking about. As you know, I constantly talk about the “what ifs” pertaining to geopolitical risk, but these trends are more concerning in regard to weather and natural events.

  • El Niño – I can’t stress enough how much “weather” is impacted by El Niño patterns. As of this writing there’s still a 45% to 65% chance that a full-blown El Nino weather pattern will appear in 2015. To put it simply, this warm band of water in Pacific ocean could help push the global thermometer up further in many locations. The effects could mean many different things, most of which are highly unpredictable. The biggest fear would be a massive drought in Asia couple with intense rainfall and flooding in South America.
  • Blocking Deserts in China – I don’t know if you’ve seen this yet, but workers in China are busy planting the “Great Green Wall,” a massive belt of man-made forest that eventually will stretch nearly 2,800 miles across China, in an effort to block the growth of the Gobi and Taklamakan deserts and stem the massive dust storms they create. If the trees survive and do the job as envisioned, a similar green belt might be planted in Africa. How this so called “changing of the landscape” effects longer-term weather is still up to debate. Just understand there are some dramatic man-made changes to the landscape taking place. This sounds great in theory, but generally never works out so well in practical application.
  • Ocean Acidification – The oceans are absorbing carbon dioxide and it’s causing the pH levels to change. In a just published study by British Canadian and Swedish researchers they conclude that shrimp aren’t going to taste so good to humans in the near future. There’s also been recent evidence that mussel shells are becoming more brittle because of rising acidity. There is no question that our oceans are changing. The more important question is how close are we to the “tipping point”?
  • Water Shortages – We have discussed water shortages for the past several years and this year is no different. Expected water scarcity and problems with allocation will pose significant challenges to governments in the Middle East, Sub-Saharan Africa, South Asia and northern China. I continue to believe we will see increased civil and political tensions in regions where water supplies are limited.
  • Earthquakes – To start with, lets make certain everyone understands I am a huge proponent of “fracking” and the benefits associated with US energy production and self-reliance. But at the same time we have to acknowledge some additional risk-factors that are being talked about in associat​ion. Study after study is showing an increasing risk of earthquakes along various fault lines. It’s not necessarily the fracking itself causing the concern, but rather the disposal of the millions of gallons of waste water being pumped into injection wells or disposal wells. The oil and gas industry has been grappling with the disposal piece of the puzzle for years. Several states are now starting to jump on the bandwagon and propose legislation that bans fracking in certain areas because of what they are seeing as increase earthquake risk. Regardless of if you agree or disagree this could eventually turn into more substantial headwinds for the energy industry.

Oil prices drop to their lowest since October 2011

Oil seems to​ be​ all the talk inside the trade as it​’​s down almost 30% since early-summer: AAA is saying this is leaving US consumers with an extra $250 million a day in their pocket when compared to mid-June price levels. The question is how long can oil producers afford to hang on? Keep in mind, several nations and private oil explorations companies are already being forced to digest prices below their cost of production. Below is a great map from Reuters and Deutsche Bank that has been floating around the trade. As you can see, oil prices below $80 could spell disaster for countries like Iran, Nigeria, Russia, and Venezuela… maybe there’s a “bigger picture” item being put into play by some of the global powers? I’ve already heard rumblings from inside Russia that they may soon need to make massive government spending cuts. With Russia already being considered a “high risk” creditor it might be next to impossible for them to borrow money. W​e’l​l see how popular Putin is inside Russia once their government is forced to make massive cuts in public spending? Let’s also not forget that a nuclear Iran is a huge thorn in the side for Saudi Arabia. Bottom-line, the North American shale boom has flattened the supply curve and OPEC is no longer the only price determining player in the game. Maybe the Saudis realize this and are trying to run some of the other players out of the game? Maybe there is more global political jockeying here than we care to realize? In any regard it appears the Saudis are serious about shaking up the world of energy production as we know it. I’m afraid this is just the beginning of a long process with many uncertainties associated. Be careful swimming out too far into the “energy” space…

Why Some Are Spooked About A Possible “Reversal”

There was a lot of talk circulating in the market this week about a possible “reversal.” Not just in stocks but perhaps commodities as well. For some odd and strange reason, blame it on the stars, the moon or ocean tides the period of time surrounding Sept 22nd makes many traders a bit nervous. Back in 2009 Barron’s editor Randall Forsyth, who cites work by Paul Macrae Montgomery, wrote a bit about this phenomena and the propensity for this period of time to be tied to major market moving shifts or “reversals.” Below is his note on the subject (Source: Business Insider)

Montgomery recalls living through the October “massacres” of 1978 and 1979, the crash of 1987, the mini-crash of 1989, the 1997 Asian collapse and the Long-Term Capital Markets plunges, which started to cascade downward in late September. And while gold bullion topped in January 1980, gold stocks made their highs on Sept. 22 of that year, he adds. That date also saw the peak in many oil stocks.

Looking back farther, on Sept. 22, 1929, the Dow Jones Utility Index became the final major average to make its high before the Great Crash. And in 1873, a panic forced the New York Stock Exchange to shut down, Montgomery further details.

And who can forget 2008, when markets went into free fall in the days following the collapse of Lehman Brothers? What’s remembered less well now is the market chaos in the subsequent days after the House of Representatives initially rejected legislation that created the Trouble Asset Relief Program.

Currencies have seen historic changes around this date as well, he adds. The British pound was taken off the gold standard and was devalued a huge 28% on September 21, 1931. Exactly 54 years later, the Group of Five produced the Plaza Accord, which brought a sharp decline in the dollar and expansion of global liquidity. Black Wednesday, when Britain was forced to withdraw from the European Exchange Rate Mechanism, came a few days early on Sept. 16, 1992.

I also recollect that Treasury note and bond yields made their historic highs in late September, 1981, with shorter maturities hitting 17% and long bonds reaching 15%. That marked the end of a 35-year bear bond market from the end of World War II.

What Does A Strong US Dollar Mean For Markets?

Traditionally a strong dollar has been bullish for the stock market. Since the late 1970s, the stock market has actually performed twice as well during dollar bull markets than during dollar bear markets. I should however point out there are some additional questions being raised this time around in regard to the US dollar possibly losing its reserve currency status? I’m not particularly in this camp (at least not any time soon), but we need to recognize the powers that be in other areas of the world are desperately trying to debunk the US dollar as the world’s global currency. Remember, back at the end of August, Gazprom (who is the Russian equivalent of ExxonMobil), announced it would be accepting payment for its oil in Rubles & Yuan…NOT US dollars! Obviously the US dollar will not fall from the leader board overnight, but there are certainly those in the trade who are becoming much more concerned about a longer-term transition from power. For now the US dollar remains in the midst of a major bull run and I suspect it will continue. Below are some reasons why and what the rally may mean for your investments:

  • Several Reasons Why US Dollar Is Strengthening… Improving US economy; Fed moving toward monetary normalization (no more QE) while other global central banks—notably the European Central Bank (ECB), the Bank of Japan (BoJ) and now China are aggressively easing policy; Thoughts of increasing US interest rates attracting more investment dollars; US energy renaissance means improving US trade and account deficits.
  • Benefits of a Stronger US Dollar: Lower import prices (cheaper oil, autos, etc…) equating to more discretionary spending power; Foreign travel and land purchases become cheaper for Americans.
  • Negatives of a Stronger US Dollar: This is a tough environment for US farmers because it lowers commodity prices (particularly those priced in dollars). As the dollar appreciates, commodities become more expensive for overseas buyers since they have to convert their weaker currencies into dollars, which basically works to curb or slows global demand. As you can see this makes US exports more expensive and less competitive in foreign markets. Short-term, there is some concern that third and fourth quarter corporate earnings could be hurt a bit by the dollar’s recent surge.

CALPERS Parting Ways With Hedge Funds

CALPERS (California Public Employees’ Retirement System) has decided to completely pull out of hedge funds, announcing they’ll be divesting all $4 billion they have invested because they are too complicated and their fees are too high. A few months ago, they cut hedge fund investments by 40% for the same reasons and saying they were looking to get back to basics. That was in July, so this decision to cut the other 60% of their hedge fund program so soon afterward is kind of unexpected. CALPERS is the largest pension fund in the US and the fifth largest in the WORLD with nearly $300 billion in assets. They currently have investments in 24 different hedge funds and six fund-of-funds, in which they earned returns of 7.1% in their fiscal year that ended on June 30. In turn, they paid a total of $135 million in fees to those funds. CALPERS aims to average a fiscal return of 7.5% and says that for hedge fund investments to have a material impact, they would have to increase fund holdings to at least 10% of their portfolio, which they say isn’t possible when considering their complexity and cost. CALPERS certainly isn’t the first to express concern over how high hedge fund fees are, which usually operate on a “2 and 20” model, meaning they charge 2% of of total assets and 20% of profits. These fees seem even more unreasonable in light of recent hedge fund performance, which returned on average just 9.1% in 2013, compared to the S&P 500 which increased 32.4%. CALPERS originally turned to hedge funds back in 2002 after the global financial crisis erased more than one third of their value. Returns at the time helped them meet the costs of retiree benefits. Over the last ten years though, their annual hedge fund investments have only returned an average of 4.8%. The hedge fund industry has already started weighing in to defend itself, putting the blame squarely on the shoulder of CALPERS, saying they just didn’t pick good funds. One hedge fund manager told Business Insider, “They got what they paid for since they only invested in managers who would cut fees. So the best funds wouldn’t do that, so they had a mediocre portfolio.” Some managers also argue that those who are critical of hedge fund performance aren’t taking into account their ability to manage assets during down market cycles. While CALPERS $4 billion withdrawal is just a drop in a bucket to the total $2.8 trillion in assets that hedge funds currently have under management, the bigger worry is that other pension funds might follow. Considering CALPERS sheer size, it is only natural that other pension funds look to them for direction, which could be a very bad thing for hedge funds in this case.

Why The Landscape Is Different and What It Means For Commodities

The ECB rate cut is significant because it signals to the trade that European Central Bankers and the US Fed are clearly moving in different directions. Rember, since the crash back in 2008, every move the ECB made to lower the value of the euro was trumped by a US Fed move to lower the value of the US dollar.  There is no debating the fact the lower US dollar helped fuel the commodity supper-cycle.  Now all of a sudden the ECB and the Fed are headed in opposite directions and the US dollar is surging higher.  Many analyst believe this environment will make it extremely difficult if not impossible for commodities (as a whole) to attract NEW big money investors! Make certain you understand how the landscape is changing and what this might mean for your business and your investments.

What Is A Negative Interest Rate?

As anticipated, the ECB cut its already historically low interest rates yesterday, which now puts the benchmark rate paid on overnight reserves at 0.1% BELOW ZERO. That means that banks will essentially be charged for parking their extra cash with the ECB, which officials hope will spur lending, in turn providing a kickstart to economic activity and pulling the zone out of its deflationary woes. If you recall, this idea gained a lot of attention late last year and had investors in a bit of a panic, as no one is really sure what the end result might be. Denmark is the only other country that’s ever gone to such extremes and it had little effect. It wasn’t a disaster, but Denmark is one country. The EU is comprised of 18! This is a huge experiment that has no comparable history for economists or investors to look at, which makes it borderline terrifying. Apparently less terrifying than deflation though!  Needless to say, investors will be keeping a very, very close eye on how this affects the EU economy.

Why You Do NOT Want To Short The Bond Market

Every trader I know has tried their hand at shorting the bond market on thoughts that yields are eventually moving higher…only to donate to the bulls.  There is some thought out there amongst the bigger money players that as the US stock market continues to surge higher and the largest Pension Funds try and keep their 60/40 “stock-to-bond” ratio, they are constantly being forced to liquidate stocks and buy more bonds.  In other words as the price of stocks keep moving higher it pushes them more towards a 70/30 “stock-to-bond” ratio. In order to get it back in sink and closer to their traditional 60/40 ratio they simply scale back the stock side a bit and add a few more bonds. Hence, it’s going to be tough to win the short battle in bonds as long as the stock market is making fresh NEW highs. 

“Dark Markets” More Damaging Than High-Frequency Trading?

High-frequency trading is generating a lot of attention since Michael Lewis’ book “Flash Boys” was drawn into the spotlight. Along with it, some in the financial world are trying to turn some of that attention to what they say could be an even bigger problem – “dark markets”. This refers to trading activity that happens outside official exchanges and some claim that so much of it is happening now that official exchange quotes may be meaningless. A broker can fill a customer order via their own collection of customer orders, called “internalizing”, or send them onto another dealer that has a “dark pool”. These orders are matched up outside the public exchanges, never seen by the broader market. This can allow for someone to secretly offload a large number of shares without anyone publicly knowing that unusual trading activity is happening until after the fact. For all the orders taken out of the public exchanges, large or small, this takes away from market liquidity, price transparency, and in some cases momentum. It’s estimated that 40% of US stock trades happen via these “dark pools” and brokers use public exchanges only as a last resort. There are 13 public US exchanges, compared to around 45 dark pools and 200 internalizers. When trades happen outside the public exchange, it is not a matter of record. The fact that there is a buy or sell order does not show up. The trade is only recorded after it’s been executed. That was sort of the point of the dark pools to begin with – being able to trade a large block of stock without upsetting the market. For example, if someone put in a massive million lot order, traders on the sell side could run the price up. While that makes sense, the majority of trade activity going through the dark market are 200 shares or less. The CFA Institute did some research that shows once a given securities trade volume reaches less than half on public exchanges, the price starts to become skewed as the price discovery process is eroded. So far, financial regulators in Canada, Australia, Hong Kong and Europe are looking at ways to cut back on the dark market growth. Whether outrage over high-frequency trading here in the US will eventually bleed over into this practice will be interesting to watch.

What Is Driving The Stock Market Sell-Off?

The downward momentum from the NASDAQ has managed to pull the Dow and S&P down with it, but as for one big explanation for why this is happening, there is no blatantly obvious culprit. Keep in mind we’ve not had a 10% correction in two years now, so in that sense we’re overdue. Also, as I’ve been pointing out a lot lately, many LARGE investors are shifting allocations into more defensive “value” type plays such as bonds, dividend paying securities and even commodities. Below are few of the more obvious reasons for this change of momentum: 

  • Fears of Rising Interest Rates and or Higher Inflation: Even though it doesn’t look like the Fed will raise its benchmark rate until the last half of 2015 or early-2016, bond yields are already moving higher. Traders are starting to re-position to accommodate for the changes that could ensue.
  • Slowdown In China: It’s not NEW news that China’s economy is struggling to meet their growth targets. The popular thinking has been that the government would step in with a stimulus package to pump some life back into it. Yesterday however, after releasing another round of poor import and export numbers, they pledged NOT to resort to any type of short-term stimulus measures. The government has been implementing tiny bits of stimulus for a while and still has room to do more, but the trade is looking for something BIG to turn everything around and that’s just not happening. With the news they aren’t going to get that and in anticipation of China’s first quarter GDP results due out next Wednesday, which are expected to be shockingly poor – big bets on China are being pulled back off the table.
  • Geopolitical Risks: The situation in Ukraine has turned into a much bigger monster than most have been willing to admit. We are now looking at Russia once again being an “enemy” of the West, which has undoubtedly started to bring back fears of the Cold-War and the harsh economic times that were associated. Russia is also using their relations with Iran to derail nuclear negotiations and their influence over Syria to stall peace talks as well as the chemical weapons deal. By using those two countries as pawns in their power play, hopes for bringing stability to the Middle East is also quickly fading. The Russian move is also starting to bring more attention to the ongoing debt crisis in Europe and bringing back headlines about just how fragile their economies really are.
  • Distrust Of The Markets: The last few years has generated a never ending series of regulatory investigations into financial companies and banking practices. For a while, most were related to the financial crisis, but as regulators dig deeper, they keep finding more and more questionable activity. From interest rate and currency scandals to the manipulation of commodities, and now the newest revelation – that High Frequency Trading (HFT) has created a “rigged” market. Some investors might be to a point where they feel like they’re being taken advantage of and just don’t want to participate anymore. *Remember, the market might only be down -3%, but that’s not the case when you are leveraged to the max! Which might be the case for the big players.