Sentiment is an ephemeral beast and yesterday’s hopeful market bounce turned back into carnage overnight, not too strong a word, as markets decided that it is the looming global economic weakness that is the more important driver not the Fed’s friendly words.
At the close of play the FTSE’s 3% fall looks good compared to 5% falls in Europe and the 4.40% and 4.6% falls in the S&P 500 and the Dow. The SPI futures are telling us that our market is going to open around 2.4% lower this morning. The AUD sits at 1.0183 from a high around 1.0383 in our time zone yesterday.
I posted yesterday first on what the Fed was trying to achieve and then later after more reflection that I felt the Australian dollar bounce was a head fake because the overriding story out of the Fed was that their is likely to be a low growth future. this is not a good environment for the AUD or other risk assets.
The key reasons for last night’s moves in my view are three-fold. First, as Delusional Economics has led the world in arguing, the ECB purchase of Italian and Spanish bonds has triggered risk shifting to France because the EFSF bailout liabilities are now moving toward the core of Europe, contingent or not. I also think American traders and money managers are outraged that they got down graded but other countries did not and they are hunting those countries they perceive as weaker than them – last night it was France’s turn. Second I think having had 24 hours to assimilate what the Fed said they are focussed more on the 3 dissenters, most in around 20 years, and the inaction that is likely to engenders the Fed fights the same internal battles as the US Congress.
But the slide in ratings has been coming for decades, just look at how few AAA companies there are out there now compared to 20 years ago. When I was a fund manager I used to work with a bloke who I reckon is the best fund manager I have ever come across, let’s call him Greg 2.
Greg 2 taught me more about portfolio construction, the management of risk and how to make money in various stages of markets. Certainly our boss at the time feed my desire to trade my portfolio aggressively but it was Greg 2’s mentoring that taught me how to ensure that with all the trading I liked to do I didn’t blow up the fund.
But Greg 2 was more than that he was also very insightful and he said to me back in the 90’s that there was going to be an inextricable downgrading of credit ratings over the coming years and decades. I won’t go into the hows or whys but he was and remains spot on.
Last night’s carnage on markets is driven by exactly the drift that Greg 2 highlighted a decade and a half ago – more fears of downgrades. As I said above this time it was France in the headlights (it’s the blue line coming out of the pack and chasing Italy in the CDS chart above) and when the ratings agencies said it was not about to be downgraded the market went hunting for French Banks with Soc Gen down something in the order of 14% and its share price has now halved, yep halved, since the beginning of July and is down 44% from July 22nd.
US Banks also got smashed with Bank of America and Citibank in the frame and the former’s CDS price has moved sharply higher in the past few weeks as you can see from the yellow line above. The hope we might have had yesterday of the Fed injecting a little stability into the market has proved ephemeral and markets are well and truly in a funk.
The reason for this is that if the economy is weak all over the globe, as it is now looking, then the Fed will need more than words – so the market is moving first. Unfortunately, the market is also hunting countries and companies as the two CDS charts above show. CDS was a beautiful risk sharing and mitigation innovation, but it has gone beyond its initial design and is now used a predatory tool to destabilise institutions and countries. Regulators need to shut this market down.
But unless or until they do market sentiment is almost guaranteeing a global recession – we won’t escape here in Australia unfortunately.