Tuesday, February 16, 2016

Central Bank Failures And Realities Are Weighing On The Market...........

Central Bank Failures And Realities Are Weighing On The Market

Has the "Yellen put" finally expired?

Financial markets are in the grips of a global rush to safety. Central banks, whose flood of liquidity have been given much of the credit for the sharp post 
crisis rise in stocks and other asset prices, seem unable to stem the tide.

"This week may go down in financial history as the week when central bank planning died—the 2016 version of the fall of the Berlin Wall. It sounds worse than it is, as this was always coming," said Steen Jakobsen, chief economist at Saxo Bank.

The ability of central banks to steer the market—or vice versa—was first dubbed the "Greenspan put," then renamed the "Bernanke put," and, finally, the "Yellen put." A put option gives an investor the right to sell the underlying security at a preset strike price. In other words, bullish stock investors could count on central bankers to keep a floor under the market. That's what some think is finally coming to an end.

"We have relied on central bankers to fix the world's economic woes, when all they could really do was to get the global financial system back on an even keel," said Kit Juckes, global macro strategist at Société Générale, in a note. "Keeping policy too easy, for too long and boosting asset markets in the vain hope that this would deliver a sustainable pickup in demand has meant that even a timid attempt at normalizing Fed policy has caused two months of mayhem."

Now, amid a growing realization that central banks' powers are on the wane, investors are rushing for safe havens. The increasing number of central banks adopting [negative interest rate policies] is weighing on the profit outlook for financial companies that now must pay to hold some of their reserves at the central bank and hurting the performance of the global financial sector.

A main worry is that banks might have to push up lending rates to cover the cost of holding some reserves at the central bank. As a result, it's the financial sector, not falling oil, that has been the leading driver of the fall in global stocks in 2016.

A growing chorus of economists and analysts are suggesting that policymakers, who really want to get on with the process of bringing interest rates back to a normal level, just won't be able to do the deed. We see the Fed as trying to manage a retreat in an orderly fashion, while hoping for the best, the economists wrote. We do not think the best will materialize. Everything from deeper pain in emerging markets to further easing from other major global central banks is conspiring against the Fed

Go long on cash, gold, and volatility and avoid risky assets at all cost until China, commodities, credit and consumer spending improve.

That's the recommendation of Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch, who says the massive injection of funds undertaken by central banks around the world since the 2008 financial crisis has failed.

Hartnett, in a report titled, "The Fall of the QE Wall," counted "637 rate cuts since Bear Stearns, $12.3 trillion of asset purchases by global central banks in the past 8 years, $8.3 trillion of government debt currently yielding 0% or less and 489 million people currently living in countries with official negative rates policies."

Three landmark financial events — policy failures of the U.S. in 1937, Japan in the 1990s, and the Asian financial crisis in 1998 — are important case studies for today, Hartnett wrote.

"History is no foolproof guide to the future," he said, but insisted that in a "dystopian" financial landscape dominated by bear markets, a deflationary recovery, quantitative failure and economic nationalism, they offer valuable insight for investors.

In late 1936, Harnett wrote, the Federal Reserve raised banks' reserve requirements on concerns over inflationary pressure stemming from swelling gold reserves. That triggered a plunge in the Dow Jones Industrial Average and by late 1937, the U.S. had entered into a recession.

Stocks rebounded and interest rates fell after the Fed reduced reserve requirements.

There are even more striking lessons from Japan. The country, then the world's second-largest economy after the U.S., suffered prolonged deflation and stagnation through out the 1990s, an era that came to be known as the "Lost Decade." Among key takeaways: bonds are accurate barometers of deflation or inflation; rate-sensitive stocks such as banks become insensitive; and "best of breed" stocks outperform.

"The business cycle does not die and the inventory cycle in particular drives equity market inflection points within the big, fat trading range," he said.

At the moment, Europe is inadvertently emulating Japan, as seen by the decline in European bank stocks and bond yields.

Hartnett believes 2016 looks a lot like 1998.

"Back then, as is the case today, a bull market and a U.S.-led economic recovery was interrupted by a crisis in Asia/emerging markets," he wrote. "Other parallels to 1998 include high yield spread widening, collapsing oil prices, peak profits, high corporate leverage and widespread financial engineering."

The key difference is that the Fed-funds rate is currently at 0.25%. It was 5.5% 18 years ago.

In Hartnett's opinion, the stock market is so bruised that it is ripe for a bear-market rally even though a near-term sustainable 
rebound is not likely without more pain.

"We think panic and a big policy move may be needed first," he said.

The S&P 500  will likely have to sink below 1,800 or the 10-year Treasury yield will have to hit 1.5% for the Fed to retreat from its tightening cycle, according to Hartnett. If the S&P 500 crumbles below 1,600 and the 10-year yield plunges to 1%, coordinated global action—including a potential Shanghai Accord where central banks jointly move to bolster the Chinese yuan—cannot be ruled out, said Hartnett.


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