Markets, particularly equity markets, are always climbing that wall of worry. Or, to put it another way, sniffing out the ongoing risks and weighing up each and every second whether they tip the balance towards fear or greed. Markets that are deep, liquid, and used for both hedging and speculation can be prone to swift moves back and forth between the two (e.g. futures or FX), but in the world of equities, it’s the climbing that is the operative word. This is largely due to the ongoing long-bias in the equity world. There are simply too many people who actually have to just own this stuff, and as the pool of assets grows (either due to economic growth, demographics, or cheap money), that persistent bid will always be there. The difficulty of short-selling a stock means that this market is philosophically always at the margin tipped towards buyers. Or at least that’s how it looks to any macro trader (Blondemoney readers feel free to rant against this assertion, as you clever bunch always do). So the question becomes, how much bad news do we need in order to tip that balance back towards the sellers?
This year has kicked off with quite a wall of worry to climb. US stocks opened with the worst start to a year since 2008. At the time of writing, US stock index futures are down and European equity markets are scrabbling around flat. Should we be worried?
1. A bad start to the year might write off the whole year!!
OK so it looks bad if you consider just the most recent occasions of an early decline, but it’s not necessarily terminal. However we might want to consider what other factors contributed to positive returns in the 80s, but not in the 30s and 2000s….
2. Agh, what about the first US interest rate rise in 9 years??
We’ve been playing with this particular wall of worry for over 2 years. Usually, when you’re really worried about something for ages, when it arrives, it’s not as bad as you thought it would be. Having said that, what if those worst nightmares really did come true, and the US made a dreadful policy mistake? Charts such as the one below will keep the worries coming, until the Fed make it clear that rates are STILL stimulative, and monetary policy operates with a lag. So, essentially we’re not through this particular anxiety yet, as there are currently still unknowns. The first hike came and markets didn’t implode, but what about the next hike?
3. Some bad things have happened that remind me of other bad stuff!!
The ghost of Lehman past continues to loom large, and with good reason. You don’t have the worst financial crisis in a generation and then magically spring your step into the future, shedding all bad memories. Charts like this initially make you think, ooh last year was as bad as some bad times, like 2008 and 2001 (cf. the 1st chart). However you could look at it differently: that after the previous 3 occasions of an annual decline in total returns for High Yield, the following year has been a really good one…
Now, the decline in Chinese stock markets was related to a few China specific things, such as the imminent expiration on Jan 8th of a ban on the sale of large stock holdings that was put in place during the August rout for 6 months. As ever, those Communist Capitalists have responded to this by, er, intervening heavily in the stock market and delaying the expiration of the ban. Meanwhile the decline in US stock markets is partly put down to the year-end dash for tax effective pension allocations ahead of the Dec 31st deadline. So some of these moves are effectively give-backs due to timing.
Does that mean we shouldn’t be worried? No, even for an optimist, Blondemoney is always scanning the horizon for risks. It just means that it might be an even bigger wall of worry to climb in the year ahead – and so the reaction to those risks will be larger.