With risk levels rising across all asset classes, as well as a public holiday in Japan for Health and Sports Day, and with bond markets closed in the US for Columbus Day, Europe had a great reason to sit out Monday with its hands in its lap – and that is just what it did. I encountered more than one player who wondered why he or she had even bothered to come in. When I chose to slip out early at four o’clock, the rush hour out of Canary Wharf was already clearly in full swing.
Equity and credit had begun the day on a decidedly weak note but it felt as though nobody was prepared to be a proper seller without the full support of the Yanks. However, in no need of active bond markets in order to sell stocks, they hit the sell button yet again and the Dow shed another 223 points and that on decent volume. We have not seen five consecutive days of volumes over 100 million shares traded since early February, but three of the last four trading days have been in that range – although they were part of a buying spree, and not a sell-off.
Thus, the “risk-off” move we are part of would appear to have some depth. There are certainly no technicals behind it; there is no less technically driven a period in the calendar that two weeks into a new month and a new quarter so it would be fatuous not to take the direction, to some extent at least, seriously.
Strategist Suki Mann of UBS, part of the credit market furniture and all-round good egg, nailed it in his European Credit Daily yesterday when he summed up the global environment as follows:
“The lack of a durable, or otherwise, economic recovery is all the rage again. The eurozone, US and Chinese growth outlooks are uncertain at best – racing lower, questionably on the up, and potentially unsustainable, respectively. There’s threat from Draghi on QE; Germany needs to loosen its purse strings; France is feeling the heat more and more on the lack of reform, while the IMF is throwing out warnings about the potential for the ‘global crisis’ becoming systemic again. When it rains, it pours….”
He goes on to assume – I think “conclude” would be too strong a word – that therefore global rates are going nowhere in a hurry, and that investors will subsequently continue to reach for yield in peripheral assets, be that peripheral in the geographic or rating sense is not clear and I suspect, knowing Suki, that he means either or both.
What he does not do, and this is just an observation, is help us find out when the time might be when declining economic prospects is supposed to call for an unloading of risky assets. We have been stuck in the loop of “economy bad, rates stay low, buy risk; economy good, buy risk” more or less since the Fall of the House of Lehman. Any investor who has not felt comfortable with risk pricing and has prophylactically de-risked has repeatedly had his butt handed to him on a plate.
Oily spreads
Meanwhile, oil markets continue to amaze, not least of all when it comes to the spread between the price of West Texas Intermediate and that of Brent Blend, the two key futures contracts. At the end of November 2013 – that’s just under a year ago – Brent was around US$112/pbb and WTI was priced at US$92/pbb. The high and the low never quite coincided so the widest recorded differential was just over US$19.00 which was explained with the boom in US domestic hydrocarbon production. That spread is now back at $3.09, having hit a tight of $2.41 on October 2nd.
It would certainly not be wrong to think along the lines that the economic slowdown in Europe is taking pressure off the European benchmark for oil and that, coupled with rising production in the US, there is good reason for the two to be closing in on each other. However, at 3.33 standard deviations from the mean, the temptation to sell Brent against WTI must be quite strong.
Yet, if one were to follow logic, then the deteriorating economic outlook should have risk assets falling out of bed. That said and as noted, risk seems to thrive even in the most hostile of environments and it is hard to apply rational thinking to markets.
As John Maynard Keynes reminded the unwary… markets can remain irrational for longer than you can remain solvent.
Can that mean buy Brent to trade through WTI?
My thinking, your money.
