I spent quite some time thinking up the title for this post, 'coz the points I'm about to cover in this post are neither bullish nor bearish...and it all rolls-up so differently for different countries, despite being ever more interconnected with each other. Its' like playing a game of chess, but with 10 boards kept beside each other, with the possibility of moving pieces of one board to the other...imagine the possibilities...the inter-connections...the complexity of the game...
Something similar is at play here, and like I've said in my earlier posts as well, the players are central bankers and governments more than the usual market players...who'll decide which way the game goes.
Inflation - A Global worry?
Inflation - A Global worry?
Inflation is troubling almost every country on earth right now, though for some its the lack of it while for some its excesses. Countries like China, India, and even UK, are looking at uncomfortably high levels of inflation despite taking several measure to contain liquidity. Others, like US are reeling with such low levels of inflation, that some circles have been worrying about deflation in US (deflation is a scenario in which prices of goods reduces over a period of time...I know it sounds like god-send right now, but its worse than inflation, 'coz people don't spend at all, hoping to buy some non-essential items after some time when the prices reduce, thereby completely clamping down the demand and rendering running large manufacturing units unsustainable...leading to loss of jobs and GDP contraction). US is printing money hoping that it'll spur some inflation in the system.
Expect further tightening from China and India, especially on the real estate sectors, and overall as well through increases in interest rates...these are going to be bad for the markets...and there will be some coming in within the next 1 month.
Slowdown in Emerging Markets?
Inflation, and the response of central bankers thereof, especially from the emerging markets, is keeping investors on tenterhooks. If not played correctly, it can result in a hard landing for the emerging economies...imagine China growing at 5% next year versus the projected 8.9% or so...all commodities, most industries, will get hammered by the markets in anticipation of a sudden clamp-down on demand side of the equation. The crash, in this scenario, would be so severe, that it would possible break all previous 1-day fall records. So while inflation has to be managed, growth too has to be managed carefully...and these are in the able hands of our central bankers.
Bonds - End-game?
Bond market collapse is increasingly been seen as a game changer...and its not just about sovereign bonds (issued by countries), but even at local levels in US by way of Municipal Bonds (known as Munis). Just saw an article by Mish covering various Munis in trouble: Mish says -
Here are several examples of rising default risk:
The point here is, several states are in trouble, state governments (like Detroit) are cutting back police patrols, garbage pick-ups and such. Fed printing money and lending to these states (via bond purchases of these states) will only worsen the situation for everyone. In anticipation of this, Munis are already in a sell-off mode, people are pulling out their money from these bonds, any additional bonds will have to be sold at much higher interest rates to compensate for the risk of default....and these near bankrupt states will have to then service those interest payments...how's that going to happen is beyond most of the people.
Besides, Fed's statement like the latest one, "Retain $600 bn bond-buying plan to boost economy", adds further to the woes of bond markets. Bonds declined further after this statement was made.
John Mauldin also notes in his blog that 10 year yields for most of the bonds are increasing. (bond prices are going down)..in fact, in Europe, some corporate bonds are doing better than the sovereign bonds ! Recent talks about extension of tax-cuts has only accelerated the fears of inflation, reducing bond prices further.
Now, bonds are a major part of any large portfolio. Also, most big funds will have limits on exposure to bonds of any one country and also in proportion to other countries. So if a major sell-off of bonds has to be done for 1 country, the others also have to be re-balanced....thereby bringing a sell-off in those as well. Banks also have these bonds as a major part of their treasury portfolio, and unlike large funds, cannot keep taking large M2M losses as this is one of their biggest income sources. So they will also sell bonds to contain their losses to a minimum, further bringing down the prices.
One relevant question to ask now is - what happens to bond markets now? But, to me, the bigger question is - where is all this money coming out of bond markets, going to go.? Some simple answers could be, Gold, Silver, oil, currencies, interest rate swaps, emerging markets. These are some places where massive funds coming from the bond markets will be placed, raising the prices of at least some of these. But most emerging markets are fighting inflation (remember) and raising interest rates to contain liquidity...(although as per this news which is just in, China is trying to resist harsh tightening of interest rates by increasing the inflation target for the next year)
So where does that leave us...the only clear answer is - Uncertain. And that's the new trend...
Its not that the markets will not continue to move up from here, or move down and continue so...what's more important is that its difficult to determine how these factors will play out. And a very timely release by Hussman says "...Its an Awful time to invest"....So its important to keep hedges in place...If you're long only Equity markets, (either directly or via MFs), diversify into Gold / Silver...if you're heavy in debt markets, diversify into equity / gold. The run can continue for some time....but its time to be cautious...and to bear in mind what someone famously said..."...trend is your friend...till it isn't".
Here are several examples of rising default risk:
- Detroit Mayor Plans to Halt Garbage Pickup, Police Patrols in 20% of City; Expect Bankruptcy, Massive Municipal Bond Turmoil in 2011
- Miami Commissioner Says Bankruptcy is City's Best Hope; Chris Christie Says New Jersey Careens Towards Becoming Greece
- Oakland California Bankrupt - Councilwoman Pat Kernighan Calls Rest of Council "Crazy and Irresponsible"
- L.A. Controller Says City Could Run Out of Cash by May 5
- Chicago's Mayor Daley Discusses Bankruptcy For City Pensions
The point here is, several states are in trouble, state governments (like Detroit) are cutting back police patrols, garbage pick-ups and such. Fed printing money and lending to these states (via bond purchases of these states) will only worsen the situation for everyone. In anticipation of this, Munis are already in a sell-off mode, people are pulling out their money from these bonds, any additional bonds will have to be sold at much higher interest rates to compensate for the risk of default....and these near bankrupt states will have to then service those interest payments...how's that going to happen is beyond most of the people.
Besides, Fed's statement like the latest one, "Retain $600 bn bond-buying plan to boost economy", adds further to the woes of bond markets. Bonds declined further after this statement was made.
John Mauldin also notes in his blog that 10 year yields for most of the bonds are increasing. (bond prices are going down)..in fact, in Europe, some corporate bonds are doing better than the sovereign bonds ! Recent talks about extension of tax-cuts has only accelerated the fears of inflation, reducing bond prices further.
Now, bonds are a major part of any large portfolio. Also, most big funds will have limits on exposure to bonds of any one country and also in proportion to other countries. So if a major sell-off of bonds has to be done for 1 country, the others also have to be re-balanced....thereby bringing a sell-off in those as well. Banks also have these bonds as a major part of their treasury portfolio, and unlike large funds, cannot keep taking large M2M losses as this is one of their biggest income sources. So they will also sell bonds to contain their losses to a minimum, further bringing down the prices.
One relevant question to ask now is - what happens to bond markets now? But, to me, the bigger question is - where is all this money coming out of bond markets, going to go.? Some simple answers could be, Gold, Silver, oil, currencies, interest rate swaps, emerging markets. These are some places where massive funds coming from the bond markets will be placed, raising the prices of at least some of these. But most emerging markets are fighting inflation (remember) and raising interest rates to contain liquidity...(although as per this news which is just in, China is trying to resist harsh tightening of interest rates by increasing the inflation target for the next year)
So where does that leave us...the only clear answer is - Uncertain. And that's the new trend...
Its not that the markets will not continue to move up from here, or move down and continue so...what's more important is that its difficult to determine how these factors will play out. And a very timely release by Hussman says "...Its an Awful time to invest"....So its important to keep hedges in place...If you're long only Equity markets, (either directly or via MFs), diversify into Gold / Silver...if you're heavy in debt markets, diversify into equity / gold. The run can continue for some time....but its time to be cautious...and to bear in mind what someone famously said..."...trend is your friend...till it isn't".
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