There is no doubt about it; German August Industrial Production which reported yesterday was a severe shock. I think one would have needed to have either been on the moon or on one’s way there or back in order to have missed the horror. A reasonably weak release had been expected with consensus forecast on a MoM decline of 1.5% and a YoY decline of 0.5%, but when the actual figures popped up on the screens ahead of the open at -4.0% and -2.8% respectively, most of the market didn’t know where to put its hands – other than on the “Panic” button.
Over recent weeks we seem to have migrated from buy if the economic news is good and buy even more if it isn’t, to sell at any opportunity. This will embolden those with a morbid love of October 19th, the date of the ‘87 crash, to predict that risk markets are about to go to hell in a handcart and that we should once again be talking about return of capital rather than return on capital.
Investors’ love affair with risk could be deemed to be over if one were to take the Adidas deal in credit, and the Rocket Internet IPO in equities, as a measure of things. The shorter tranche of the former caught a nice bid yesterday, while the latter continued to drop. Rocket, originally priced at €42.50 closed last night at 32.62, a fall of 23.25%.
But back to German Industrial Production. The issues affecting exports to Russia had been kind of included in the estimates but it seems that the double whammy of eurozone torpor and economic sanctions on Russia were too much at once. Not only that but the manner in which manufacturing has been scaled back indicates that industry leaders do not see either as passing phenomena, and that they are battening down the hatches. In other words, it is in my view not the headline figure which is the horror but what is behind it.
The sell-down in risk which followed is intriguing, in as much as the Dax ended up as being one of the better performers on the day with a fall of “only” 1.34% as opposed to the CAC which lost 1.81%, the FTSE MIB 1.73% and the IBEX 2.02%. This was a classic case of a wholesale dump. Markets are, nevertheless, still at better levels than they were during the early August panic and until the DAX drops below 9,000 points, we’re just nervously trading around with the range. If 9,000 points breaks, things will technically look very different indeed. It is harder to nail a specific point where the iTraxx S21 Xover enters danger territory so I guess we might have to use equity markets to lead us.
VIXing questions
Mind you, there was a remarkable spike in the VIX yesterday. The Dow closed last night at 16,719 points, well above the 16,368 low of August 7th, but the VIX ended up at 17.20 which reflects higher volatility than that seen in August where it peaked at 17.03. Initially this should indicate that the Dow still has down-side risk built in, and believers in using option-implied volatility models to price credit should be good sellers here.
On the other hand, and this is what makes an investor’s life so difficult at the moment, the slowing in Germany must increase pressure on the ECB to step out of its comfort zone and to embark on some form of Quantitative Easing. I agree with those who argue that with Bunds trading at 0.9%, there is not much to be gained by pushing them lower, other than maybe to make owners a bit richer.
The Fed continues to wrestle with inflation, or the lack thereof, as I pointed out last week. I alluded to the strength of the dollar which brings with it imported disinflation and I warned of letting this cloud the judgement of what underlying domestic price pressures are building up, but I failed to take account of the impact of falling hydrocarbon energy prices. WTI closed last night at US$87.81, an 18-month low. If it drops through US$86.68, the next technical point is US$84.44 and again at US$77.69. Despite the shenanigans in Iraq and Libya, there is manifestly a global glut of oil – not that fuelling the car appears to be getting any cheaper (seeing as that I drive a piece of kit which can pass anything but a petrol station I know these things).
Putin, oil and fear
The impact on both input and output pricing should become progressively more evident. Peak to trough – June 20th to last night – WTI has fallen just over 18% but the player has been Brent which has fallen by very nearly 21%. If anything is going to bring the Russians to the negotiating table, it will be this. Germans should in a strange way be hoping for further drops in the oil price, but at the same time the ECB should not get too fearful about the lack of inflation as such a large part of it is to be found in the price of fuel. Russia’s ability to blackmail the West is diminishing by the day. Alas, it also leaves President Putin with a conundrum – and one which I still think risks undermining his grip on power. Think?… Fear. There a dark forces afoot in Russia I would prefer not to know more about. In this case I truly prefer the devil I know.
I grew up learning to fear of what impact rising oil prices might have on politics and the economy, Maybe I will now have to adapt to the risks inherent in them falling.
