Month: January 2021

By Bloomberg commentator Jan-Patrick Barnert

The year that everyone is pinning their hopes on is finally here. After a late 2020 rally, however, market signals are mixed about the potential for stocks to climb the next leg higher. Here’s a quick look at where we are and what to watch for in the coming weeks.

Europe’s stocks ended 2020 with a year-end rally as the Brexit trade deal finally made it across the finish line. It wasn’t enough for the Stoxx 600 to erase its annual losses, however, and the momentum has cooled down considerably. Many argue that a lot of good news is now priced in, at least in the short term.

Looking at Euro Stoxx 50 futures, the picture is rather neutral. While the latest support held and there are no clear sell signals yet, there are also no convincing signs pointing to another leg higher.

The first quarter isn’t short of risk events that could determine the initial market direction. This week’s U.S. Senate run-off election is the first stop, with Jefferies strategists calling it “the obvious risk.”

Later this month, the ECB and the Federal Reserve hold meetings, with fourth-quarter GDP figures following in February. Over in Asia, the China National People’s Congress will start in early March.

Volatility has stayed elevated, indicating some caution still lingers. The VIX Index, while at lower levels than during the sharp selloff in early 2020, has stayed above the 20-point mark for 218 days now. That’s only the fourth time since 1990 that the gauge has remained above that threshold for more than 200 days. The VStoxx Index of euro-area volatility has also held above 20 since late February.

The November rotation that sparked optimism about a long-awaited revival in the value trade got a reality check just a month later as growth stocks took over again. While a sustained switch may be key for Europe to outperform, a key value sector — banks — face hurdles ahead. The fine print of the Brexit may affect London’s financial industry, while the dividend debate is far from over.

Sentiment wise, there’s room for a catch up as markets have rallied harder than a euro-area measure of confidence. Other indicators like the CNN Fear & Greed index have recently retreated from very bullish levels, indicating that while stocks are higher, there may not be too much exuberance in the wider market.

Additionally, the high level of cash still on the sidelines might limit the downside in any short-term setbacks.

Things look smooth on the data front so far, although stricter lockdowns toward the end of the year in some countries may mar the short-term picture. With the consensus treating 2021 as the year of economic recovery, macro data will need to deliver on high expectations.

Exaggerated by equity weakness, oil prices have plunged from hope-filled overnight exuberance as OPEC+ meets (virtually) and Russia proposes a 500k b/d output hike for February.

WTI tested up near $50 overnight before plunging back below $47.50 on the Russia headlines…

Bloomberg reports that the opening remarks from Prince Abdulaziz Bin Salman suggest very strongly that Saudi Arabia will oppose any increase in production in February. That could make for another very fraught meeting, if Alexander Novak decides to dig his heels in over the Russian proposal for an increase.

However, as OilPrice’s Irina Slav notes, OPEC has signaled it is concerned about oil demand despite its production control efforts as Covid-19 cases continue to surge in key markets, and the global total is still on the rise.

It seems vaccine optimism has begun to wear off, too, as it has become clear mass vaccinations will take months rather than weeks, so demand will be subdued for longer than some optimists in the trading community may have hoped.

“The outlook for the first half of 2021 is very mixed,” OPEC Secretary-General Mohammad Barkindo said on Sunday, ahead of an OPEC+ meeting later today. “There are still many downside risks to juggle,” Bloomberg quoted the official as saying.

In December, the extended cartel agreed to Russia’s proposal to start adding 500,000 bpd to their daily total from January based on the improved demand outlook and some members’ unwillingness to continue cutting deep. Yet this may change at today’s meeting. Russian Deputy Prime Minister and OPEC coordinator Alexander Novak suggested at the end of last year that the new deal could be tweaked if demand were to recover faster than previously expected.

While this looks unlikely at the moment, prices have improved, which would lend weight to Russia’s support for another 500,000 bpd increase in production in February. It was in its original proposal, which covered the period from January to April, but OPEC+ also agreed in December to meet every month to keep its hand on the pulse of the oil market, which basically means surprises are always possible whatever the original plans were.

According to the Bloomberg report from the preliminary meeting of OPEC yesterday, oil consumption was about to “shift from reverse to forward gear,” soon, thanks to vaccines, Barkindo said.

There has been some confusion about the catalyst behind this morning’s sudden market selloff which followed promptly after the S&P hit a fresh all time high.

While there has been no single, definitive news catalyst, the answer for the risk weakness is to be found in Georgia, which goes to the polls in special run-off elections for its U.S. Senate seats. As a reminder, if Democrats win both, then the Senate will be split 50-50, and they will control it thanks to the vice president’s casting vote.

So why is Georgia suddenly a concern?

As Bloomberg’s John Authers explains overnight, while there have been few polls over the last two months, and with so much depending on getting people out to vote in the middle of winter during a pandemic, much must be left to conjecture, “but the prices on the Predictit prediction market show it is close.”

First, this is the race between the Democrats’ Raphael Warnock and Republican Kelly Loeffler:

The same trend is at work in the contest between the Democrats’ Jon Ossoff and Republican David Perdue, who is still hanging on to a lead:

Strikingly, while online betting markets priced in a relatively modest 25-30% probability of a blue sweep (i.e., Demorats winning both GA runoffs tomorrow), the Predictit odds for a “blue wave” have soared in the past few days, surging just shy of 50%.

As a further reminder, should Democrats win in GA and regain control of the Senate agenda, that would be a huge deal as “obstructionist tactics would become almost impossible for the Republicans” while the chances of more fiscal spending to alleviate the coronavirus, or a bigger push on infrastructure, would look much stronger. This, needless to say, “would boost the reflation trade” while more aggressive fiscal policy would also mean higher interest rates, while reducing the pressure on the Federal Reserve to keep them low.

It’s also why 10 Year breakevens just hit 2.01% earlier today…

… the highest level since 2018.

This, as Authers concludes “is an outcome for which investors aren’t positioned, so it could cause a market mess.”

Morgan Stanley’s Michael Wilson agrees, and this morning repeats his recent recurring warning that a notable market correction is imminent, writing that “the “risk-reward” of the US equity market has deteriorated materially and the market is ripe for a drawdown” and he lists the Georgia Senate seat run-off election as a potential downside trigger.

To be sure, while one can’t find much fear about a spike in inflation in the otherwise somnolent 10Ys nominals, Wilson writes that “the big surprise of 2021 could be higher inflation than many, including the Fed, expect. Currently, the consensus is expecting a gradual and orderly increase in prices as the economy continues to recover. However, the move in asset prices like Bitcoin suggest markets are starting to think this adjustment may not be so gradual or orderly.

The Morgan Stanley strategist concurs and adds that “with global GDP output already back to pre-pandemic levels and the economy not yet even close to fully reopened, we think the risk for more acute price spikes is greater than appreciated. That risk is likely to be in areas of the economy where supply may have been destroyed and ill prepared for what could be a surge in demand later this year—e.g. restaurants, travel and other consumer/business related services.”

Finally, while the best inflation hedges are stocks and commodities in the intermediate term, “inflation can be kryptonite for longer duration bonds which would have a short term negative impact on valuations for all stocks should that adjustment happen abruptly.”

We may be seeing the start of that adjustment this morning.

South Korea has announced it is sending the military’s anti-piracy Cheonghae Unit to the Persian Gulf after Iran seized a South Korean-flagged tanker off the Islamic Republic’s southern coast Monday, according to Yonhap News.

“The foreign ministry and the South Korean embassy in Iran have found that the crews are safe, and are requesting the early release of the ship,” the foreign ministry said in a statement.

Iran announced earlier in the day that its IRGC Navy forces detained the MT Hankuk Chemi chemical tanker for what official statements called “oil pollution” – a common excuse Iranian officials often given when they take such action.

Iranian state media also indicated the crew had been placed under arrest, which according to Yonhap includes 20 total crew members – among them 5 Koreans, 11 Myanmarese, two Indonesians and two Vietnamese.

The report notes further that the newly deployed anti-piracy unit will likely liaison with forces of allied navies already in the area:

The defense ministry said that it will deal with the seizure in cooperation with the ministries of foreign affairs and fisheries, and a multinational naval force operating in nearby waters.

The Cheonghae unit has previously operated in an anti-piracy capacity in the Persian Gulf, as recently as a year ago in conjunction with international allies. The operator of the Korean tanker that was seized has maintained the vessel did nothing wrong, but was still ordered to receive Iranian inspections, at which point it was detained in Iranian waters.

First photos of the Fujairah-bound South Korean chemical tanker HANKUK CHEMI, which was seized today by IRGC Navy because of “chemical pollution” in Iran’s waters pic.twitter.com/1P8t1vxV8w

— Reza Khaasteh (@Khaaasteh) January 4, 2021

“Iran’s Islamic Revolution Guards Corps boarded the ship at around 4:30 p.m. (local time) and demanded the ship face examinations in Iranian waters,” an official from the tanker’s operator, DM Shipping, told South Korean media.

The tanker is still said to be in Iranian territorial waters at a moment tensions with the US and Israel are at boiling point. As we noted before, the seizure is apparently in retaliation for South Korea’s previous freezing of Iranian assets in South Korean banks based on US-led sanctions.These assets in South Korean banks are commonly estimated at up to $7 billion.

Authored by Charles Hugh Smith via OfTwoMinds blog,

One of the dishes at the banquet of consequences that will surprise a great many revelers is the systemic failure of the Federal Reserve’s one-size-fits-all “solution” to every spot of bother: print another trillion dollars and give it to rapacious financiers and corporations.

Though 2020 is widely perceived as “the worst year ever,” it was only a snack. The real banquet of consequences will be served in 2021. The reason 2020 was only a snack is that systems didn’t break down in 2020. The reason 2021 is the main course is that systems will break down, and once broken, they cannot be restored.

I made the chart below to explain how systems fail and why they cannot be restored. 

Systems have numerous sources of potential fragility:

1. Systems can be tightly bound to other fragile systems, setting up the potential for a domino-like cascading collapse that starts with one system failure that then brings down every connected, interdependent system.

2. Systems can be hollowed out by self-interested insiders who mistakenly believe the system can survive endless looting.

3. Systems can be weakened by perverse incentives that provide strong incentives to under-invest in core functions and divert revenues to profiteering and extraction (stock buybacks, bonuses to managers, etc.)

4. Systems can appear robust to casual observers because insiders cloak the decay of function, accountability and transparency.

5. The decline of functionality / results can be hidden by bureaucratic obscurity (accounting statements in which all the important information is buried in footnotes starting on page 217, etc.) and by complexity thickets that reduce accountability to near-zero: no one is responsible for the decay of function, accountability and transparency.

6. Process replaces results as the Prime Directive of the system. Devoting resources to following processes rather than to getting results generates an illusion of functionality even as the ability to evolve and adapt is lost.

7. Buffers that enabled effective responses to crisis are stripped to the bone as redundancy and resilience are discounted as “hurting profits” or “needless expenses.”

8. Insiders and the public / customers wrongly assume money can solve all of these systemic frailties. But money cannot buy trust, competence, institutional depth, productive incentives or anything else that is essential to robust, anti-fragile systems.

Americans are unprepared for the collapse of core systems. The secular faith holds that corporate ownership of core systems, centralized state control and the relentless pursuit of infinite greed will magically manifest the best of all possible worlds because self-enrichment by any means available is what perfects systems.

Unfortunately for America, this faith has it exactly backwards: self-enrichment by any means available is what hollows out and fatally weakens systems. The relentless pursuit of infinite greed (“investing” in stock buybacks, legalized looting, etc.) has destroyed the moral foundation of society and the economy: there is no civic virtue or public good left. These empty phrases cannot hide that America is a moral cesspool so corrupted by greed and self-interest that the nation can no longer even recognize its own moral dissolution.

The second graphic I prepared a decade ago depicts the lifecycle of bureaucracy which can be either private-sector or public: the initial purpose of the organization that inspired the innovators and initial managers is slowly replaced by self-interest, and those who were willing to sacrifice to serve this purpose quit in disgust or are marginalized as “threats” to self-serving insiders.

The competent leave or are forced out, leaving those of supreme incompetence in power, managers who’ve been selected for loyalty to the Prime Directive, protecting insider looting from outside interference via a mastery of public relations (“managing the narrative”) and obfuscation.

The core function of the organization becomes masking dysfunction, ossification, sclerosis and the looting of insiders. The loss of function, accountability and transparency are hidden from prying eyes, and whistleblowers–the most dangerous threats to self-serving insiders–are hunted down and destroyed.

It is not coincidence that America’s “growth sectors” are corruption and public relations (“managing the narrative”) because the best way to cloak corruption and systemic failure is to manage the narrative by suppressing dissent and eradicating whistleblowers.

Unbeknownst to most Americans, many core systems are already in the first stages of collapse. No corporate sector does a better job of masking dysfunction and profiteering than healthcare, and so the collapse of healthcare systems will surprise everyone who swallowed the sector’s glossy PR.

The entire financial system is hopelessly compromised, corrupt, self-serving and obsessed with maximizing personal gains by any means available. One of the dishes at the banquet of consequences that will surprise a great many revelers is the systemic failure of the Federal Reserve’s one-size-fits-all “solution” to every spot of bother: print another trillion dollars and give it to rapacious financiers and corporations.

I suggest dining lightly on the feast of consequences because the courses of systemic failure will continue being served the entire year. So save some appetite for the really big systemic collapses that are only now being slid into the oven.

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