The recent events in Libya apart from being gory and repulsive have provided American equities with an excuse to sell off. The past couple of days have witnessed a much needed sell off, and just as one was beginning to question the sanity behind the more or less straight line rally over the past two months (barring slight hiccups during the Egypt crisis), the fates have once again conspired to provide markets with a pseudo legitimate reason to sell off. There are a few people who dare to short the American equity markets these days. The VIX volatility index is finally up more than 20% after having flat-lined for the past few months at low levels indicating extreme confidence in the bull run. This is of course a healthy sign for equities which will eventually make their way higher. But what is amusing to me is that it took the beginnings of a revolt in the largest African oil producing nation to get investors to take their bear claws out.
Analysts are panicking about oil prices being too high to sustain the global recovery. This is comical to me, because a few months back, almost everybody was confident of a ramp up in oil prices, and WTI crude touched $92, without producing any overt discomfort amongst equity investors. Now that WTI is catching up with Brent, people are churning out articles about how harmful it is for equities and economies in general that oil prices are so high. Where was this concern two months ago? $100 which is seen as the inflection point for WTI crude oil is within gunning distance as I type this. There is no way of course that the global economic recovery is going to go anywhere with oil prices at such levels. I feel that there is going to be a significant amount of options volatility at these levels, and it is going to be interesting to see when the Libya situation diffuses, what keeps prices so high. With another spate Chinese monetary tightening last week, all indicators point towards a slight cooling off in Chinese demand for commodities like oil, which may lead to more sustainable prices by May. If not, the developing/emerging world is going to suffer more than anyone else.
I cannot begin to count how many times something like this has happened to the markets. They are certainly not efficient, but as soon as there is a hint of a guiding light, they do follow in the direction the charts indicate they are supposed to go. What is interesting to me is that while monitoring simultaneous market movements I find that equity indices and currencies reach extremely stubborn market levels together, and move in unison from those key levels. It almost seems like somebody is orchestrating perfect harmonious movements, because it really gets to the point where it seems too obvious to be true. I start questioning my own analysis at such points because things seem perfectly synchronised. I am sure the fact that 95% of futures are traded on computer screens, and the whole trading community has access to pretty much the same charts and key levels has something to do with this.
It certainly cannot be termed as destined market movements, since nothing is certain but the likelihood of the uncertain. However, in terms of raw probabilities, more often than not, the prevailing investor sentiment has much more to do with where the markets are, than any piece or data released at any point. A few weeks back when the unemployment data for the US came out, I was amazed that the market rallied on bad headline numbers. People found all sorts of justification for the rally, including the fact that America much like Europe saw a harsh winter, so people did not turn up to claim benefits etc. Another argument propagated by market pundits right after the rally was that the unemployment rate had fallen to 9%, and this was reason to rejoice. The irony of all this analysis that was churned out to justify the rally was the fact that within a week from the time of the rally, economists started talking about the natural rate of unemployment having gone up in the US. All that really mattered to the markets was that the bad headline numbers were not a good enough reason for a correction when the prevailing investor sentiment was overly bullish even in the overbought conditions.
Of course most analysts believe that the markets are always right, so it is better to give investors a bit of ‘forgetting the actual market reaction’ time before publishing the truth. Historically speaking, American unemployment has been at a structural rate around five and a half percent. Lately, economists have been stating that this might have gone up to seven percent, and in my opinion this is true. Just in order to sustain population growth, America needs to create 125,000-150,000 jobs every month, which it has consistently been falling short of. It is not true however that the fall in unemployment rate that has been occurring since December has only to do with the weather. It is more related to people dropping out of the search for jobs, and running out of benefits to claim. Last year, the Nobel prize for economics was given to a couple of gentlemen who have done extensive research on search frictions, and it is ironic that search frictions are not understood at all by analysts who make tall claims about the recovery in the American jobs sector. This is definitely a jobless recovery and this is the ‘new normal’.
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