Saturday, January 17, 2015

Further thoughts on financial markets after yesterday's dislocation

While each of these speculative thoughts are ultimately related, they are random in that they will not tie together into a neat commentary.  They are separately discussed:

---For several years most commentators on the stock market, from professional pundits to serious economists to top ranked securities analysts, have always mentioned the huge amount of "money on the sidelines".  The supposition has been that when more of this money begins to come back into the equity market there will be an eventual resurgence in values.  By most accounts the money on the sidelines remained huge throughout the 2014 melt up.  Looking at that sideline money (a large portion of which is apparently settling for almost zero return and the rest seeking out high risk alternatives) has been reassuring here as well and has been mentioned many times.

Now the thought arises that the "money on the sidelines" will stay there indefinitely.  It is not coming back.  The retail investor did venture back into the market marginally more in 2014 and institutions that are compelled to stay mostly in equities may have increased their exposure somewhat, but there is no information here that it was any kind of seismic move.  The urge to protect assets that are already in place and keep a large portion of money off the table may be long term, even if it means lower returns.  Prices are not set by volumes in the long term, but valuation can lag reality for a long time.

---The decline in oil prices has been almost unprecedented in such a short time frame.  Most commentators seem to putting their hands up in the air in befuddlement at the negative impact this is having on the stock market.  The oil price declines should be, must be, a boon for consumers.  Hey, I just filled up my car for $40 when not too many months ago it was $55.  The problem is that the rapid oil price decline could be viewed by some of the lead steers as a precursor to deflation, and a commodity price turn downward that is getting out of control.

When looking at the challenges in Libya, Iraq, Nigeria, Venezuela, and other oil producing nations one can see an almost inevitable decline in production, despite Saudi Arabia's intransigence.  The Saudi's may need to change their tune as well, as budget challenges could emerge if this decline is magnified.

While there is much effort, investment, and research into non-fossil fuel substitutes for oil and coal, that is a long term effort.  Solar is expensive and with a long term payback, wind is not pervasive at all except in a few wealthy European countries, and other promising technologies are exciting, but how many Tesla's are there on the road.  Ever seen one?

One could think that this oil price decline is reaching bottom, I do, but markets have a habit of over correcting in either direction.

---Speaking of deflation, along with their misguided surprise elimination of their currency peg against the Euro, the Swiss National Bank reduced deposit rates to minus 0.75% from an already penalizing minus 0.25%. You pay me to hold your money.  It seems that their view was that this would mute the reaction to removal of their support for the Swiss Franc.  Ooops.  I don't think that the Japanese have ever done anything this drastic.  It is not reassuring, and it obviously had zero impact,maybe even a negative impact, on foreign exchange market reaction.

---Finally, to get to an easy target, on CNBC yesterday Jim Kramer called large bank earnings this season "horrendous" in the emphatic way that only he seems to have license to do.  Bank earnings in general were not strong, but from what was seen here most banks missed securities analyst's estimates by just a few pennies, one major one by just one penny.  The biggest culprit was fixed income trading.  Traditionally, when banks have strong fixed income trading they are discounted or almost ignored by bank analysts and some investors because they are called "unrepeatable, or not core, or too volatile".  As usual though, when banks have weak fixed income trading it is treated as a major setback by those same analysts.

To professional investors who follow markets more closely than is possible here, the lack of good volumes in fixed income markets, and thus revenues for the banks, was absolutely no surprise.  The lower revenues were not the result of bad trades, just less opportunity.  The other more modestly weaker area at the banks was in the credit card and mortgage businesses as that activity slowed in the market in general.  Does Kramer want banks to act like they did from 2003 to 2007 and be out chasing business at any cost, any risk.  It seems that banks should not be trying to take more business than a rational market has to give, as was the case this past quarter even if it meant slightly lower revenues from those areas.

True, the bank stocks have been performing poorly in the last two weeks and whether it is due to ingrained but flawed perceptions, or that deflation worry, or systemic financial system concerns, or the realization that regulatory assaults and huge penalties on the banks are never ending under the reign of Obama, it is unclear. What is clear is that the minute to minute all-knowing Kramer's comment on bank earnings was an overstatement in fact and in his delivery.  What's new?

I must eat dinner, and remain observant and reserved.

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