To say that central banks around the world have managed to box themselves and the world's economies into a corner would be an understatement in the extreme. From the ECB's adoption of negative real interest rates in 2014 to Japan's BOJ shift to the same this year. From China's unsustainable draw down on foreign currency reserves in part due as a result of the PBOC's move to devalue the yuan to the Federal Reserve's move to raise rates in the face of global deflation. The lack of monetary coordination by the world's central banks, in a world economy increasingly framed by uncertainty, has left both debt and equity markets in a state of extreme dysfunction and volatility. However, it would be simplistic to place all the blame for our current state of affairs on central bankers. There are limits to what monetary policy can achieve. Fiscal policy, bloated debt loads (personal and as per GDP), anemic demand and many other factors all play a role.
Look no further than the banking sector in select markets around the world. For example, since the BOJ move to negative rates two weeks ago, the financial sector of Japan's economy has dropped by 20%, as measured by equity prices. Here in the United States, the financial sector as measured by the S&P financial sector ETF, (N:XLF), has dropped 15.85% this year. Financials have borne an uneven weight of selling pressure but they are hardly alone. The broader market as measured by the major US equity indices paints a painful picture for investors as well. The S&P 500 is off 13% from its 52-week high and lower by 10.23% thus far in 2016. The NASDAQ Composite is 18% below its 52-week high and 14.65% thus far in 2016. The best performing of the three is the Dow. The Dow Jones Industrials are 13% below their 52-week high and 7.86% lower on the year. My point simply put is that markets have rotated towards a level of volatility and uncertainty that we have not seen since the financial crisis. Conventional analytics during a period of such remarkable global dysfunction rarely makes much sense.
If you take into consideration that crude oil has fallen over 70% from its all-time high, that OPEC has dissolved as a pricing/production cartel into an irrelevant organization, that the United States is exporting crude for the first time in over forty years and that Cushing Oklahoma has literally run out of storage capacity, matters become increasingly challenging. Uncertainty is being priced into markets from equities to commodities, from debt instruments to currencies. This chapter of upheaval will not come to a tidy and neat conclusion any time soon. As if to undermine how challenging equity market conditions have become, Bloomberg News posted an article last night entitled; "Goldman Sachs Abandons Five of Six Top Trade Calls for 2016." That is a first in my 35 year career.
The cautious outlook with which I framed my 2016 outlook remains unchanged. I continue to find meaningful value in volatility protection and gold as a counter measure to weakness in equity pricing. That said, it hardly takes a genius to point out that we are likely very close to a bottom in crude. We will not bounce off the bottom we reach. Crude prices will remain constrained for an extended period of time - likely until the fourth quarter. By that time, the damage done will be irreversible for the economies reliant on the energy sector.
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