The violence of the recent sell-off has left many an economist struggling for an explanation. The question is not so much whether oil prices will hit $20, and whether China will have a hard landing. It is why such prospects are having such a profoundly negative effect on developed markets. After all, every economic model says that DM is not particularly exposed to EM, and that lower commodity prices ought in principle to be a net positive for commodity-consuming countries, and at worst neutral for the world as a whole. Does the market know something the economists’ models don’t, or is this an exceptional buying opportunity?
Answering this question has proved hard, in large part because of the potential for circularity . Strategists are basing their market view on what economists tell them about the fundamental outlook. But economists are increasingly anxious that the fundamental outlook is susceptible to the moves in markets.
- Matt King
If the idea of circularity sounds familiar to you, as a reader of this blog, it should. We’ve discussed the concept of markets affecting the real world – and not vice versa – many times. Most recently, in Everyone is a Closet Technician: “price dictates what the news is, not the other way around.”
Yesterday morning Jeffrey Gundlach of DoubleLine Capital took the stage at Inside ETFs and pretty much blew the doors off the room with bearishness. Even people like me, who have seen him speak five or six years straight, were taken aback.
When Gundlach talks about price, he likes to refer to it as “the bloodless verdict of the market.” Jeff’s a technician in that he believes price tells the story of what’s going on across asset classes much better than people can tell it.
His take on what’s going on is that the Fed had no business raising rates in 2015, but that they’d promised to do it for so long, that in December they had to. This action, and their continued insistence that they could hike as many as eight times before the end of 2017, is playing havoc with international bond and stock markets, global currencies and commodities prices.
Gundlach notes that the Fed has raised rates 118 times since WWII and on 112 of those occasions, GDP growth was above 5.5%. He points out that they have never raised rates when GDP growth was sub-3%. He thinks the idea of promising rate hikes and then being forced to deliver regardless of economic conditions is outrageous. “What. The Heck. Are These People Doing?” he asks rhetorically.
Back to markets and prices – they are the real news, the real story. The most controversial thing Jeff tells the crowd is that oil is not the cause of economic weakness – “It is a symptom. Demand is not there.” For almost two years now, the price of oil has been crashing and we’ve been told that it is entirely a supply issue – everyone’s pumping too much. The idea that there is also a demand problem – mostly emanating from overseas economies like Europe and China – is starting to creep into the discussion as a maybe. Jeff’s saying “definitely.”
He’s also saying that not only is China not growing at 6 or 7%, he actually believes they could be shrinking. He’s calling EM stocks an obvious short and junk bonds a disaster in the making.
A lot of this is chicken-and-egg stuff. Markets drive economic weakness which drives markets. Matt King*, the Citi analyst above, calls this circularity. George Soros refers to it as reflexivity. Call it what you want, but everywhere you look, price is telling you that things are not okay. And depending on how much you believe in circularity, price may also be making them worse.
*hat tip Shane