Every day, before jumping into the fray, the big and small players in the financial markets examine two things. On the one hand they look at the reality of the world, made up for them above all of macro data and estimates on listed companies. On the other hand, they carefully evaluate any word that comes out of the mouths of central bankers and governments. The objective world, therefore, and the political will.
There are times when everything seems clear, in a good or bad way. Clear doesn't necessarily mean true. In fact, sometimes the market tells itself fairy tales and adopts them as truth. This isn't pretty, but it still gives a feeling of control over events.
However, there are other moments, such as the one we are experiencing, in which signals become contradictory and the perspective changes continuously. It will be said that even in recent years the data has been mixed, some good and some less good. Precisely this continuous alternation has created that temperate atmosphere, neither too hot nor too cold, which the markets like so much.
Why then is the current moment so scary? We said it is a matter of perspective. When you walk along a valley in the mountains, you move between two slopes and are not afraid of falling. However, if you walk along a ridge you always move between two slopes, but you risk falling on one side and also on the other. Goldilocks without inflation is as refreshingly safe as walking along the river that carved out the valley. On the other hand, having half the world that is growing rapidly and perhaps needs to be slowed down and the other half that seems to be sinking hopelessly into the quicksand of deflation gives a feeling of vertigo.
There are other factors that further complicate the picture.
The first is that macro data is not easy to read. US wage inflation, the most important element in the Fed's rate decisions, is extraordinarily mild in some statistics (those from the Labor Department) and is instead lively and growing in others, such as those collected by ADP. The former have the weight of being official, but are old and outdated in design. The second ones, those of Adp, are qualitatively better, but have a smaller following. The Fed relies on the former, which support the political choice to keep rates at zero, but it knows that there may be some truth to the latter as well.
Another data that is difficult to read is that on the heavy fall in German industrial production. It has always been known that not much can be expected from Italy and France, it has long been understood that the story of European recovery is a lot of optimism of the will and little effective reality. However, no one had so far questioned Germany's stability and its ability to deal with the reduction of the Russian market produced by the sanctions.
If Germany falls, the markets said, Europe falls and if Europe falls, accompanied by China, Japan, Brazil and Russia who are not doing so well, America also risks weakening. Goodbye share price hike.
Stop, however, says Greg Fuzesi of JP Morgan. German auto production is exceptionally volatile this year. A very heavy month can be followed by a month of strong recovery. Let's wait a moment before making definitive judgments on Germany (which is in any case in a bit of trouble on many fronts) and on the world.
Another element that is difficult to interpret is the attitude of central banks towards the financial markets. Yellen had already tried to draw up a small list of overvalued assets (some high-yield bonds, some biotechnology and social networks). The reaction had been brief. The feeling was that the Fed, by choosing some highly symbolic sectors, simply wanted to communicate that it was keeping an eye on the markets, not that it wanted them to go down.
Now, however, the Monetary Fund is speaking of swollen stock markets, making no subtle distinctions and fearing sharp falls next year. It is more than just a call for moderation. Why does it? Why do you notice a growing gap between increasingly self-confident stock exchanges and a more fragile global economy than previously thought and do you really fear crashes that could further weaken it? Or because he wants everyone to continue to keep interest rates at zero without feeling hampered by stock market bubbles which at these levels are more annoying than anything else? The first interpretation is very negative for the stock exchanges, the second is actually very positive, because it corresponds to a buy on weakness with permanent validity.
Another complication is Ebola. In certain moments, seeing the approximation of the response of the authorities and of human beings in general, one really gets worried. The Spanish animal rights activists who opposed the suppression of a possibly infected dog are so reminiscent of Brad Pitt of the Twelve Monkeys (which in the film causes the near extinction of mankind). In other moments you see things in their current limited proportions and you calm down. However, it is clear that Ebola is, for the markets, a totally uncontrollable variable.
Trying to summarize, the current framework appears very open. A recovery of German industrial production is enough (quite possible, as we have seen), a European Qe made up of Abs (potentially 1.2 trillion, says Constancio, equal to a trillion and a half dollars, much more than the American Qe3 which is about to end) and an Ebola that makes less talk about itself to give good space to new stock market highs in the next period. A Europe that is quarreling, an ECB with the handbrake on, a German industry that does not recover and an Ebola that does not stop can instead tip the balance to the opposite side, even heavily.
We are quite confident about Europe. Fiscal policies are once again slightly expansionary (thanks to the French rebellion) and Germany will gladly allow itself to be placed in a minority in the ECB, accepting a QE that is less theologically impure than the American one. Of course, we know nothing about Ebola.
In practice, we maintain the profile favorable to the dollar and to equity, but with the idea of lightening the equity (not the dollar) in moments in which high volatility brings it back close to the maximum. Ebola aside, a market that rises and which falls and hangs a little less on the lips and political will of central banks is nothing else, as Richard Pzena notes, than a market that is becoming more normal.
