Great Expectations

Fear is building on Wall Street (alt): “The CBOE Vix index of implied US share price volatility — known as the ‘Wall Street fear gauge’ — jumped to 24.6 late on Monday, the highest since June 2012, when investors feared the eurozone was close to breaking up.”  “This is all Ebola right now,” says one market strategist on Yahoo! Finance.  “We’ve had growth concerns.  We had Russia.  We had Ukraine.  We had the Mideast.  We had everything.  And [yesterday] what kicked us off was more Ebola headlines when the market was trying to rally back.”  Sure it was.  For a much more thorough diagnosis of what’s ailing the market right now, I recommend this list from S&P Indexology.

 

You may remember how about a month ago all anyone could talk about was diverging economies, diverging monetary policy, diverging currency etc. etc…Well, all of that established some pretty high expectations for the United States; e.g. “Despite the recent global growth scare, a relatively strong U.S. economy continues to suggest that the [Fed] will tighten monetary policy sometime in the first half of 2015.  This is creating an ironic twist to the selling: soft growth globally, but a U.S. economy strong enough to induce some normalization in monetary policy.”  But then we got another twist: ”spot prices for oil have dropped 20 percent in the last three months, from $110 to $90 a barrel.  If they remain at these levels, inflation in the United States will slow quite a bit, and quickly at that…At a time when we are supposed to be a couple months away from a rate hike, this could complicate the exit plan.”  You see, even the slightest hiccup on the runway can turn into a psychologically disastrous catastrophe when the takeoff is priced for perfection.  In other words, “we have an economy here that is obviously doing better than the rest of the world, but we also know that the Fed has basically taken the training wheels off.  So, we have a market for the first time in many years that doesn’t have that implicit put from the Fed.”  Similarly, “‘investors around the world are shocked, shocked that the monetary wizards may have run out of magic tricks to revive global economic growth…Even the wizards are admitting that their powers to do so are limited.”

 

Meanwhile, rumors abound that Saudi Arabia, OPEC’s largest producer, won’t cut supply to drive oil prices back up, “betting that a period of lower prices…will be necessary to pave the way for higher revenue in the medium term, by curbing new investment and further increases in supply from places like the U.S.”  Indeed, a US shale consultancy company “estimates the majority of US shale production will break even at $75 (alt)…If the funds for drilling dry up, then production will fall quickly and the US oil boom will go bust.”  Then again, “the risk for the Saudis is that they overdo it (too much production is knocked out and demand continues to grow), and end up with $150 oil on the other side.”  But in the meantime, “to be able to continue drilling, US shale companies will have to be able to convince investors that it is worth committing more debt and equity capital to the industry.”

 

Meanwhile, “investors are now conditioned to expect binary outcomes in the markets.  It’s either a top and we’re heading for a crash or it’s a bottom and markets are going straight up.  Either of these scenarios is always a possibility, but rarely are the markets at an inflection point.  There’s usually more of an ebb and flow than most investors realize.”