I am a big proponent of the saying, “when everyone knows something, no one knows anything.” I am always asking myself what has the market fully priced in and where might the surprise come from?
During the past six months the market has become convinced that inflation is the least of their worries. Break even inflation rates have plummeted.
This is a natural response to the monster wave of selling that has hit the commodity markets.
The global economy is suffering from a massive lack of demand, which is dragging down economic growth.
Now these revelations are far from enlightening. Even my wife’s Grandmother says that the recent global slowdown is the talk of her nursing home. I am more interested in watching for clues for when this might change.
Recently there has been a slight shift in tone amongst the global leaders when it comes to the global economy. I am noticing some real concern that this mini deflationary wave might morph into something more sinister.
US Treasury Jack Lew recently gave a speech where he warned that Europe risks slipping into a “lost decade.”
From the Wall Street Journal:
The global economy is at a cross roads, Mr. Lew said. “It is time for the G–20 to act once again with a sense of urgency,” he said.
Then the UK Prime Minister followed right behind with the same message:
“Six years on from the financial crash that brought the world to its knees, red warning lights are once again flashing on the dashboard of the global economy,” Mr. Cameron wrote in an op-ed Monday in The Guardian. He reiterated the ominous theme in speech to parliament later Monday.
The world’s woes “were plain to see” at the leaders’ summit of the Group of 20 largest economies over the weekend, Mr. Cameron warned.
Today the markets are feeling no pain due to the Japanese induced QE stimulus. Everyone is all bulled up and not really listening to the warnings from these government officials. It hasn’t seemed to matter that the fundamentals are heading in the absolute opposite direction of the market. As long as Japan keeps the liquidity flowing, we can keep partying and sending markets perpetually higher.
I am not so sure that the current divergence between the real economy and the markets can continue forever.
Whereas the ZeroHedge types will all tell why this global economic slowdown means that stocks are eventually going to plunge into another 2008 style collapse, I am more open to different outcomes.
Given these recent warnings from both the US and the UK, I wonder if there is something big planned to boost the global economy. I know they both want Europe to engage in more expansionary monetary policy, but I have a feeling there might be more of a coordinated effort coming.
Also, why haven’t the other countries been more critical of the Japanese stealth devaluation? I can only surmise it is because they are actually supportive of the move.
The world is massively over indebted and cannot sustain even a little deflation. It would quickly snowball into a deflationary vicious circle. All world governments need more inflation to keep the real cost of their debt low.
My suspicion is that we are about to get more aggressive monetary and fiscal expansionary policies from a wide array of different governments.
Back to my original point. The markets are convinced that inflation will never be a problem. They are priced for commodities to go down forever. They are assuming that interest rates will stay low for even longer.
The surprise that will catch the most market participants flat footed is if there is a renewed expansionary government push that turns around the global deflationary mini-wave. Maybe China spearheads the move. They are most able to influence the short term economic climate. Or maybe there is the introduction of some sort of QE through IMF via special drawing rights. Whatever the method, I think something big is in the works.
I am dipping my toe into reflationary trades ever so lightly.
I know this is an out of consensus view. I know, I know – there is no inflation anywhere to be seen for miles and miles. But remember, when everyone knows something, no one knows anything…
Buying EuroStoxx / Shorting S&P 500
Not only do I think that there is something big in the works on a global level, but I feel that the pessimism regarding Mario Draghi’s ability to expand the ECB’s balance sheet is over done. Yes, I know he has over promised and under delivered. But I think that just as the world has hit a point where they must act, the ECB has also reached a similar point.
I will take the over on Draghi’s ability to expand the balance sheet in the coming months. The market’s negativity makes the trade too tempting.
I am buying EuroStoxx futures and shorting an equivalent amount of S&P 500. Europe is dirt cheap compared to the US. If we get an expansionary tail wind from the ECB’s balance sheet as compared to the neutral Fed policy, it should be easy for the Eurostoxx to out perform the S&P 500.