Weekend Reading: Risk

December 11, 2015

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Courtesy of Lance Roberts at Real Investment Advice

While the world patiently waits for Janet Yellen to raise interest rates this month, the markets have been unable to decide as of yet whether such an event is good or bad thing.

As I discussed earlier this week, there is an ongoing belief that despite the rest of the world struggling with deflationary pressures and weak economic growth pushing Central Bankers globally toward further negative interest rate environments and more liquidity, the U.S. can remain an “island of economic prosperity.”

“International And Emerging Market Divergence. As I stated above, there is currently a belief that the U.S. can remain isolated from the rest of the world. Given the global interconnectedness of the world today, there is little ability for the U.S. to permanently diverge from the rest of the world. As shown below, historically when international and emerging markets have declined, the U.S. has been soon to follow.”

The reality is that such divergences have rarely lasted for very long and the ultimate reversion to reality have been brutally painful to investors.

This week’s reading list is a compilation of articles and research notes dedicated to understanding more clearly the “risks” that are currently building within the financial markets and economic environment. What you choose to do with that information is entirely up to you, however, ignoring it has generally never worked out well.

1) Give Me Only The Good News by Jeremy Grantham via GMO

“This is more or less the best I can do to prove the point. We in the U.S. have a broad and heavy bias away from unpleasant data. We are ready to be manipulated by vested interests in finance, economics, and climate change, whose interests might be better served by our believing optimistic stuff ‘that just ain’t so.’

We are dealing today with important issues, one so important that it may affect the long-term viability of our global society and perhaps our species. It may well be necessary to our survival that we become more realistic, more willing to process the unpleasant, and, above all, less easily manipulated through our need for good news.”

But Also Read: Voters Know The American Dream Is Over by Charles Hugh-Smith via OfTwoMinds

2) Reasons “Not To Hike” Pile Up by Caroline Baum via MarketWatch

“What do Larry Summers, market monetarists, gold bugs and other hard-money types have in common?

No, it’s not a trick question, but it yields a surprising answer. Three different economic philosophies are aligned in challenging the wisdom of the Federal Reserve’s stated intention to raise interest rates next week.

The better question is why the Fed is determined to raise rates now. The world’s major economies are diverging, with Europe, Japan and China requiring additional stimulus from their central banks. The dollar is likely to strength further, crimping U.S. exports and restraining import prices. A renewed decline in oil prices is going to prevent inflation from moving up to the Fed’s 2% target, a premise for any Fed action.

The 5% unemployment rate remains the only reason for starting to normalize rates, and that’s based on the Fed’s flawed Phillips-Curve thinking. A sustained increase in wages is more hope than reality at this point. And since wages lag prices, not the other way around, forecasts of higher compensation may have to wait.”

But Also Read: OK Jobs Report Paves Way For $6.8B Fed Giveaway by Louis Woodhill via Real Clear Markets

3) Rare Data Point Sighting Sends Warning by Tim Mullaney via CNBC

“The S&P 500 has a big performance issue that should be a focus for investors: Too much of the index return is coming from too few of its stocks.

The 10 most valuable companies in the market are up roughly 21.4 percent as a group this year, versus a loss of 2.6 percent for the rest of the stock market.

That 24 percentage-point spread between the biggest stocks and the index as a whole is the widest since 1999, heading into the dot-com bust.”

But Also Read: A 20-Year-Old Perversion In The Stock Market Is Ending by Sam Ro via Business Insider

Contra-Take: Is It Time To Go Full Zero Hedge? by Cam Hui via Humble Student Of The Markets

4) The Junk Bond Market’s Early Warning Signals by Ben Wright via The Telegraph

“The relatively high global equity prices point to expectations of strong economic growth; the historically very high bond prices point to expectations of weak economic growth. How does one reconcile these two wildly inconsistent worldviews? The short answer is quantitative easing, which has pumped up asset values far beyond what the fundamentals would justify. Any bad news that comes along – and there has been a fair bit of that in recent months – merely serves to highlight that growing disconnect.

With the paths of the US Federal Reserve, the Bank of England and the European Central Bank starting to diverge as we enter the new year, it is clear that, at the very least, investors are in for a bumpy ride in 2016.”

But Also Read: Corporate Loan Charge-Offs & Delinquencies Surge by Pater Tenebrarum via Acting-Man Blog

And Also Read: This Time Is Not Different For Credit by David Keohane via FTAlphaville

5) When Forward Guidance Leads To Misdirection by Joe Calhoun via Alhambra Partners

“As we approach the Fed meeting expect markets to get more volatile. While the odds favor a move, it isn’t a sure thing until it is actually done. We found out last week what happens when forward guidance turns out to be forward misdirection. All those traders who thought they had a sure thing, who assumed that Draghi wouldn’t dare disappoint the market, got whipped. Whipped good.”

But Also Read: Fed’s Decisions Really Come Down To Guessing by Alex Pollock via AEI

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