Posts tagged ‘black swans’
We noted last time that some of the popular analysis of market jitters doesn’t really stand up to scrutiny. So far this month those jitters have eased. But one of their possible sources has persisted.
The punishing winter weather in the US has been devastatingly persistent. Record low temperatures have seen a long series of severe snowstorms and associated transport disruption and this pattern is expected to continue.
As well as flight cancellations there have been some sharp effects on energy markets. The shale revolution has transformed the domestic American supply picture for gas and oil, but the harsh winter has blown it back for now. Natural gas prices have spiked back to levels not seen since early 2010 and the nation soon expected to be the world’s largest oil producer has been reduced to importing heating fuel from Europe.
Inevitably, the wider economy has not gone unscathed. Most obviously, consumer activity has felt the chill, with retail sales data disappointing and fears that the inflationary effect of heating costs will see this persist into the spring. Employment numbers have been more mixed but there seems to have been a temporary effect on hiring too.
It used to be said that when the Fed sneezes, the world catches cold. Fears over tapering remain, but it is yesterday’s news. In this case it is the US which has been caught out by a nasty cold snap. Activity has suffered, the shale phenomenon behind much of America’s economic optimism has had its limits tested – and even Wall Street titans can’t like trudging under damp grey skies through sleet.
A white winter doesn’t make a proper black swan. But it has had an effect. The US recovery has been a self-conscious beacon over recent quarters; Wall Street dominates cross border capital flows in emerging markets; and Americans have even been calling time on the Great Rotation.
With the UK suffering terribly in some places from flooding and tidal surges we know that brutal weather should not be dismissed as a storm in a teacup. But we also know that in time, even the worst storms do blow over.
With 25 December only days away now we might have expected a calm period for markets. The Chinese sometimes enjoy doing things like taking monetary policy decisions on Christmas Day, but whether they are celebrating Christmas, Yuletide or the Holiday Season, western markets and policymakers generally prefer to make a quieter time of it. So it was interesting to see the Fed choose this Wednesday to vote to start tapering off its most recent asset purchase programme.
Fears over tapering reinforced several major market behaviour patterns in 2013, making it one of the year’s key investment themes. Readers may remember the panic which ensued when it was first floated, despite the fact that the Fed’s own research (and calm, thoughtful analysis) suggested that the actual effects of QE3 on the US economy have been negligible. Now tapering is actually to begin, however – from January – market reaction has been quite controlled: the ten year Treasury yield is higher, but only by about 7bp; the trade weighted dollar was stronger by Thursday evening, but by less than 1%; gold fell, but to a price only a little over $10 under its previous low for the year; and the S&P 500 rallied all of 29.65 points on Wednesday before closing yesterday flat.
Speculation, however idle, as to the globally deleterious impact of tapering will certainly continue into the New Year. Perhaps it will continue to have some power as a market theme in 2014. But we have surely reached the point where we can say it is old news. So what other themes may emerge next year?
Growth will be one. This blog has highlighted the importance of a return to growth in Europe, including the UK, in particular. 2013 has already seen the first consecutive quarters of growth across all the major developed economies since 2010. Within the eurozone especially it remains patchy and sclerotic – but better than the alternative, nonetheless. A gathering of momentum in 2014 should see gloom continue to recede from markets which have had to trudge through a bruising and tedious few years. As one rightly respected fund manager put it in his most recent report, when it comes to the rally in developed-world markets, returns “have come from a rerating … But to prosper from here we need growth.”
One other theme which we have followed has been inflation. This has gone right out of fashion as prices have generally been behaving themselves lately. There is nothing to suggest an immediate change here. But a year is plenty of time for labour markets to pick up slack, the more so if the recovery gets a little more earnest – and that alone should begin to see expectations for monetary policy change, whatever happens to other moving parts such as commodity prices. This is a wild card, and like tapering a potentially hazardous one.
A couple of weeks ago we had a look at the impact of higher growth on the UK’s sovereign debt position. There are still countries with serious problems in this area (we might think of Greece in particular), and as a result we cannot discount the possibility of further shocks. But with a more deeply entrenched recovery underway, Britain’s happy story will find other tellers. More and more governments should find themselves closer to balancing, if not actually balancing their books in 2014.
In some cases this will come in the nick of time. Even if inflation expectations do not develop as one of next year’s themes, the burden of debt at the shorter (and cheaper) end of yield curves make higher rates here a potential worry for many borrowers into 2015 and beyond. On the other hand, it is possible that other more problematic sovereigns will join Ireland in revisiting bond markets, putting another stake through the heart of the debt crisis.
Turning to the negative: there were no black swans in 2013. Compared to preceding years this was highly unusual. In 2010 we had the eurozone / sovereign debt crisis, in 2011 the Japanese earthquake and US GDP shock and then in 2012 the Greek elections. These are not things we can plan for. However, with events in the Middle East having moved in favour of Iran this year, and an escalation in tension between China and Japan, it is not obvious that the world has become a materially safer place. In the event that major government bond yields continue to rise a prudent investor (who has been well positioned to date) might look for opportunities to begin diversifying back into these and related assets over the course of next year.
As crystal balls go this one has been kept deliberately opaque. Depending how they play out, these themes could each have very different consequences for market behaviour and the pricing of risk. As a closing observation: even though it has been relatively benign compared to its immediate predecessors, 2013 has still been a nervous year. It still feels as if a large number of market participants and observers are more at home with setbacks than advances.
Should this change convincingly next year it would be something of a theme in itself. In any event, based on vigilant analysis of the fundamentals and a reasoned understanding of price, it should still be possible to make investment sense of 2014, as it has been for the past few years, in spite of everything.
As readers know, markets enjoyed a period of relative stability across the summer of 2012. Despite the mild nerves shown over the last week or two, that stability has largely continued. But one of the events which has emerged to threaten it of late should serve as a reminder that this should not make us complacent.
Barcelona has voted for independence from Spain. A short year ago this would have seemed unthinkable – not to mention rather ridiculous. It is a classic “black swan” event. Everyone has been worrying about the breakup of the eurozone; no one has worried about the breakup of a European country since the dissolution of Yugoslavia. And as for the breakup of Spain in particular, who would ever have thought of betting on the Catalans over the Basques?
Of course, local politics is still politics. The region of Catalonia has been begging for a central government loan for some time. (It is surely a tribute to humanity’s persistency of spirit that so many of us believe in borrowing our way out of a debt crisis.) Perhaps their threatened secession is no more than a bargaining chip.
From the market reaction so far the threat does not seem too powerful, but it is instructive. This year might have been quiet – so far – but remember what happened in 2011: the Arab spring, the Japanese earthquake and tsunami, the referendum gambit in Greece and subsequent fall of the government … All these things were unpredicted and unforeseen.
Over the next few months, who is to say what might not happen? We wait anxiously for military action against Iran while there is civil war in Syria. Anti-Japanese sentiment in China has had real social and commercial effects. Then there is the enigma of North Korea. The dominant military power in the Pacific is the United States. Could it be possible that, one day, America will have to learn the lesson it taught Britain over Suez: that an indebted nation can only fight with the permission of its creditors?
It doesn’t pay to be too terrified, however. There is more to markets, and economics, than political events and natural disasters. A year after Suez, and Harold Macmillan was telling people they had never had it so good; according to the Barclays Equity Gilt Study, British stocks during the period 1956-1960 delivered a compound annual return of over 13% in real terms.
As we have all been reminded in recent times, volatility can be painful. But left field events cannot be planned for. Difficult as it can sometimes seem, the safest option is to back the fundamentals.