This note is generally written on Thursday morning. The closing of Standard and Poor's the previous evening is therefore the point of reference for most of the considerations it seeks to develop. Well, four Wednesdays ago the index closed at 2433. Three Wednesdays ago it closed at 2437. Two Wednesdays ago it closed at 2435. One Wednesday ago it closed at 2440. Last night it closed at 2433. which can also address hypertensives and heart patients. The emotions it gives are comparable to those of a Christmas bingo, where you play more to be together than to win.
Three questions. Because that's how it is? How long can it last? What can you do to bring something home?
Flat markets are usually caused by the absence of significant news, possibly combined with neutral positioning of portfolios. The importance of the news may be objective, but it is the perceived importance that counts. Kim launching a missile in January 2016 paves the way for a sharp and insidious correction, which then picks up oil, low growth, China and so on along the way. Kim launching a much larger and more dangerous missile in July 2017 is met with a yawn, at least up to now, even in South Korea.
Simply put, stock exchanges have two factors to consider, expected earnings and the rate at which to discount them. 2017 began with a forecast of sharply rising US rates accompanied, however, by even sharper rises in profits. The bags then went up. Then we became convinced that the fear of interest rates was exaggerated and this more than compensated for the profit estimates, which in the meantime had become less rosy due to the fading of Trump's reforms. The stock market therefore continued to rise, albeit more slowly. Finally, for a month now, a tightening on rates has been noted in many central banks, but the markets have remained stationary because they thought that this tightening will be more in terms of tone than in deeds and because profit estimates have once again returned to go out. Hence the flat markets, in perfect balance.
We talked about profits and rates, but in reality, for some years now, a third element, liquidity, has overdetermined the long cycle of the markets. If we use the size of the balance sheet of the main central banks as an indicator of liquidity, we see a rather constant growth that starts from 4 trillion in 2009 and reaches 15.4 today, with an acceleration in the first five months of this year which, coincidentally, coincides with the strong stock market rise of the same period. Between now and the end of 2018, the overall size of central bank balance sheets will continue to grow, but increasingly slowly, and then begin to slowly decline until returning to its current size at the end of 2020.
If the market trend in the short term will be decided by the quarterly earnings that will start coming out in the next few days, in the medium term, looking at liquidity, it can be argued that we have entered the first phase of a very rounded secular top. In other words, the bulk of the rise is behind us and what is looming is a lateral phase, initially moderately positive and then, further on, moderately negative. Deciding how bad inflation will be.
The loss of speed of the markets, at this moment also desired by central banks, has led many (and many more will lead in the future) to look for easy ways (in addition to the difficult and demanding one of stock picking) to continue earning. We list them in increasing order of danger.
The first is that of rotations. The calmer the index finger, the more violent the rotations because everyone tries to ride them. This year all sectors, in turn, had their quarter of an hour of fame and their quarter of an hour of darkness and now, for some (such as energy and banks), the second round is perhaps starting . Playing rotations is a perfectly regular and orthodox practice, but in addition to the analytical skills necessary to understand what is expensive and what is relatively cheap, you need a keen sense of rhythm, or market timing. It's easy to get in late and it's even easier not to get out on time.
The second is the volatility game. There are two ways here. The first is selling calls and puts (with or without the underlying stock), the second is selling the Vix. The first path has noble enthusiasts, such as Buffett, who has been accompanying the rise for years by systematically selling puts on the index. However, anyone who wants to do like Buffett must be willing to buy if the put option is exercised and, above all, must have the money to do so.
Short selling of options becomes progressively less profitable in times of flat markets. To make up for it, many sell a higher amount of options. Recklessly, because not only can one do a lot of harm to oneself, but also to others. In fact, even a small surprise is enough to move the price suddenly, to exercise puts and to force exercisers, if they don't have Buffett's liquidity, to sell frantically, amplifying the decline and causing large and small crashes.
As for the sale of the Vix index (which corresponds to the bet that volatility will be even lower in the future than it is today), the utmost caution is advisable. In recent years many have made fortunes, but from now on the risks increase. Volatility is strongly inversely correlated to liquidity and growing liquidity, as we have seen, has its months numbered.
Another path taken in this period by the most daring is that of cryptocurrencies. Fortunes have been made and lost here as well. The allure of cryptocurrencies has at least three components. The first is monetary. Unlike traditional currencies, which can be printed at will, and even gold, which can always be extracted, cryptocurrencies have a predefined number of units and therefore appear to be real money. The second is blockchain technology, which makes transactions secure and certain. The third is anonymity.
There are some big problems though. Cryptocurrencies are a means of payment, like PayPal, but they are not a store of value except for those who believe in it. It will be said that this is also true for the banknotes we have in our pockets, but these, if nothing else, we can always return to the issuer when we pay him taxes. Bitcoins therefore appear as serious money due to their finite number but have no intrinsic value and cannot be redeemed at the issuer.
As for technology, the blockchain is secure, but up to now, it has been the world of intermediaries, frequently attacked by hackers, that hasn't been secure at all. Still in terms of operational risks, if you speculate on cryptocurrencies with contracts for difference, you are exposed to flash crashes and stop losses automatically applied by intermediaries.
As for anonymity, there is perhaps an explanation why legislators eager to regulate even the shape of cucumbers have remained passive in the face of a phenomenon such as cryptocurrencies. The explanation is that central banks consider them an interesting experiment in view of a possible future complete abolition of cash. If a recession similar to that of 2008 were to recur, this time rates would be driven to heavily negative levels. To avoid a race for banknotes, it would therefore be necessary to be able to abolish them and to have a replacement solution ready, such as a crypto-dollar or a crypto-euro, this time naturally not anonymous.
Cryptocurrencies, thanks to their anonymity, have a very large potential demand that will support their price and may even multiply it. But there will come a day when all of this will suddenly be outlawed or when transparency will be introduced about ownership and transactions.
The old and very ancient gold, although neglected today by the public and by managers, offers many more guarantees in terms of operational safety. We have always said that gold has its function in portfolios but should only be purchased on weakness. The prospect of less and less expansionary monetary policies is already weighing on its prices, but it should not be forgotten that gold is often inversely correlated to stock exchanges.
