Emotion Takes Over?

There are two major areas where emotion has heated up to the point of driving events. Domestically, race is getting more attention. Globally, financial markets are giving the impression of more than just an orderly retreat, meaning there are whiffs of panic in the ranks in some places as regrouping is full-throatedly underway, also infecting SA markets. By Cees Bruggemans

Race is the ultimate cleavage in this country and revisiting this, sharpening the verbal interventions, invites recasting many understandings. Who knows where this will lead next, though no shortage of opinion. Something to watch. If race is a long fuse (it has been burning for centuries), financial markets are notorious for their short-fuse mood swings.

The one moment markets can be happy and in full bloom (for instance major mining companies paying top dollar for energy assets as recently as 2011), the next all morose as “something” keeps selling out, taking prices down and this increasingly getting a life of its own, eventually to the point of undershooting long-term fundamentals (these same energy assets now written down by half).

That is not quite how the rational investor, seeing himself as stone-cold sober, would describe the situation, finding many stories in the fundamentals that underwrite his moroseness, warranting his sell mode. And infecting some more people with his morose selling, all exploring downside.

Not a panic, mind you. As one observer on the New York stock exchange floor exclaimed happily on Friday, no headless chickens to be seen around here. This is an orderly selloff, no panic.

But as others observed, thereafter a long weekend to lick ever bigger wounds, and new opportunities to sell some more next week? All gut. Ever more distrust about numbers. Anxiety building, fear seeping in? Not a rout, by all means, but a withdrawal that is becoming tense and not at all feeling strategic.

Brent oil is down to $29, with commentary giving the impression there is no limit to downside. That’s hard to believe, even if the physical reality globally is tepid demand, serious oversupply, no appetite to cut back, driving prices south.

As with other commodity stories, this one will break/end, except that the same global fundamentals have created enormous currency disruptions among free-floaters, in the process shielding suppliers, this aside of too many governments on the supply side refusing to give up.

The nice thing about $29 oil? It is only 29 to go to zero, and not 115 like 19 months ago. Theatre of the absurd. You may think this makes forecasting easier, but it doesn’t. More like a massive crash filmed in excruciating slow-motion, taking forever to reach the wall, then the metal starting to buckle. The end result will be perfect scrap, but we aren’t quite there yet. And so in gas, coal, iron ore, copper, you get it.

Standing back from commodities (an ultimate play), one wants to visit higher up the feeding chain (where the proximate causes originate). Here is the old circular reasoning. Bad West innovated and overextended a little too richly financially, crashed, was prevented from entering depression but still turned into a smoking, drifting hulk. Greatly reduced export potential for China, which started to turn inwards, towards own consumers. Exit commodities.

But the other leg of this drama is only now playing out more fully. For China, like Japan before her, for long believed in undervalued managed currency boosting export market share. Americans believe in fair play, attacked this with gusto, and the Chinese ultimately played ball, allowing the Yuan to appreciate against the Dollar. And keeping this up, strangely, long after events had changed their basic model. The water broke last August (just like Saudi’s next door in the oil market six weeks earlier).

The Yuan had to decouple from the Dollar which was heading north, boosted by Fed policy normalisation underway, even as China was heading south, needing a weaker currency (especially considering the massive currency depreciations being absorbed by many smaller countries – and Japan….- potentially competing with China’s trade).

Complicating the whole exercise has been the Chinese decision to reduce such future distortions by liberalizing, handing over to markets the job of pricing capital flows and currency. Just like we do, and also do in the oil product market, instead of bureaucrats setting prices and getting progressively away from reality.

So China wanting to liberalize its currency market is a force for the long-term good. It just happens to come at an awkward moment, markets having to take over pricing, shocked, having to find their bearings, unclear about many things (not least too little info or too much misinformation) and thus setting in motion shocked Yuan depreciation, a bit much for the Chinese (it is difficult to give up interfering), generally mismanaging the process, the world paying for its school fees as they stumble through this.

In other words, nothing sinister, no crisis, in fact constituting welcome reform, if hamfistedly executed (like a few other things they are engaged in?).

But if Fed liftoff was a serious nuclear trigger for global capital reallocation as risk/reward shifted, a Chinese Dollar decoupling was like a thermonuclear trigger (a good deal more potent for upsetting global calculations). We saw what followed in the wake of the ‘minor’ Yuan devaluation last August. That was only the beginning, now also seeing huge capital flight leaving China in addition to its growth & trade problems.

More was coming. More came in recent weeks, and again more now projected for the year ahead, but in the process feeding growing anxieties as these shifts have unexpected consequences.

Not only the Shanghai stock market still on skids (novice overgeared underwater Chinese investors in stages allowed by regulators to sell, prolonging the pain as they adjust to their own adjusting economy, in the process setting in motion major stresses in global commodity, currency & equity markets).

Safe havens back in vogue, as the US 10yr Treasury bond yield broke below 2%, mainly an indication of total investor disbelieve that in an imploding world inflation will be going up, and blatantly calling into question Fed proclaimed intentions of growth & inflation prospects warranting four rate hikes this year, same next year, more in 2018. Bollocks. Not real, say the markets, somewhat shrilly, indicating the emotion of too many being found out on the wrong side of the street and belatedly en masse starting to shift.

So Dow Jones and S & P500 may not be headless chickens yet, but their shrieking certainly is drawing attention and more and more sounding like real anxiety.

Economists, particularly devoid of emotion, and not inclined to allow for non-normal behaviour (clearly their babies are all planned affairs), are doing a lot of head scratching. For none of this is warranted (famous observation as people start hyperventilating).

The Chinese economy at worst will be doing 6% growth, the American economy is now very steadily creating jobs (last few months averaging near 300 000) and there is nothing on the horizon suggesting derailment in either, despite endless “stories” to the contrary.

It doesn’t pay to be the only rational voice in a panic. If a crowd wants to panic, report the event, for it is newsworthy.

Meanwhile, will the Fed and PboC be swayed? The Chinese are running down their forex holdings impressively, now down $700bn from a $4 trill standing start six months ago, defending the Yuan by letting flight capital go, allowing the Yuan to go lower, a desired outcome in its own right (though the emotional harvest it is reaping which is also counterproductive for the Chinese). That process could go on for longer, but indefinitely would be a long time.

The Fed meanwhile is spooked, frankly. A few too many governors were iffy to begin with about liftoff. The growth and job lift is real, but the global turmoil and stronger Dollar are major mill stones grinding down US industrial growth, while imploding energy is lowering inflation expectations.

Cease and desist? Not four Fed hikes this year, as advertised, but three – these became two – I am offered one – and might as well leapfrog – none. Market is down to saying the next Fed hike is in September. It is a moving feast, though. How about a rate cut?

That’s a problem. There is no ammunition. They can cut only once, and to restart bond-buying (QE5) with the 10yr bond already below 2% and falling (indeed doing all the heavy lifting by itself) questions what comes next.

Not everyone is this far down the road. Fed standing pat, steady hand to the tiller. But American markets notoriously emotional when they want to be, and such disorder a threat to economic outlook. At what point would the Fed shift? But we aren’t there yet. This is the noisiest moment, as cooler minds may prevail (in markets doing buying and at the Fed not being diverted by the baying crowd).

The rest of the world is watching all this with open mouths. Their commodity exports devastated, capital being sucked out, currencies being sunk, in currency wars that make you dizzy as the world keeps adjusting, rationally to real economic changes coming from America and China, and increasingly emotionally (as only humans can) to financial events accompanying such shifts.

Feel adrift, do you? Welcome to a growing global crowd. It will blow over, it always does, but you might not quite recognise the landscape as we hit bottom and exit. Hopefully soon, still this year.