October 13, 2014 Playa del Carmen
These are definitely confusing times for the world of economy and finance. Six years have passed since the US financial crisis blew up in investors’ faces and Lehman Brothers failed, and the world’s economies have yet to gather enough strength to really take off on a new expansion cycle.
But it’s no wonder. Since that fateful event, it has become almost normal for the markets to have to deal with an unusually large number of events and information at any one time. Even worse, they’re events and information that often point in different directions.
The last few weeks are no exception, and market participants find their plate full:
The US and UK economies doing more or less all right and, even though growth is still too low for comfort, the Fed and the BOE, the central banks, are getting ready to raise interest rates.
The Chinese economy, the second largest, is growing much too slowly and authorities seem inclined to privilege reforms over growth, so stimulus from the central bank is uncertain.
Japan, at this point, is a big question mark, more than anything else. The success of PM Abe’s reform plan is up in the air, judging by the terrible effect of the first increase in taxes on consumption. The Bank of Japan keeps injecting enormous amounts of yen into the economy and inflation is up, but exports and investment have not responded.
In Europe, most economies are still weak and fragile, and now Germany seems to be slowing down quite rapidly, which has the overall Euro Zone’s economy flirting with recession. Inflation is a problem because it is too low and threatens to become deflation, so the central bank, the ECB, is finally embarking on more meaningful stimulus measures. Now we have to wait and see if they work, or if the bank is forced to use its biggest ace – QE or the printing of euros to buy sovereign bonds in the marketplace.
The geopolitical landscape is also more complicated than usual. What with the West confronting Russia over Ukraine, and the imposition of back-and-forth economic sanctions, the Islamic State (ISIS) posing the biggest terrorist threat ever for the whole world, and Iraq, Kurdistan, Syria and Turkey at immediate risk from ISIS, the growing student protest movement in Hong Kong demanding full democracy, which puts China in a very, very tough spot, and the seeds of fear that may be planted by the very small, but growing, number of patients infected with the ebola virus outside Africa, so far in the US, Spain and Italy, all front-burners of the stove are overflowing. However, this does not mean, in any way, that other very serious problems that have necessarily been pushed to the back, like the Middle East conflicts involving Israel and its neighbors, nuclear Iran or North Korea, or even the US mid-term elections in November, can’t suddenly explode onto the stage.
Investors’ perceptions are built on actual events and people’s interpretations of these events, especially their implications for the near future. And perceptions are what drive the markets.
Most of the things happening today have been in the making for some time, but it is only now that they’re being seen together, and are being perceived as a potentially explosive and dangerous combination of factors. The markets are responding to the very real possibility of a new period of very low or even stagnant global economic growth, with a very complex geopolitical background, that can only act as a headwind.
So, the dollar has staged a tremendous rally against most, if not all, currencies, because the US is seen as the safest and strongest country, and its economy is putting in the best performance. Treasury bond yields had started to move up, but are now back down, again below 2.30% for the 10-year treasury note, on refuge demand. Commodity prices are now falling even more steeply because they’ve been hit by the dollar’s strength and the perception of economic weakness, especially in China, all at the same time. And the stock markets, which have shown an unbreakable spirit and weathered just about everything since 2009, are now starting to look shaky.
Regarding the Mexican financial markets, they are probable among the most defensive at the moment. Mexico is again a darling of emerging markets for the long-term, thanks to the structural reforms that have been approved by Congress, and the economic stability displayed since the US crisis. So, even though the peso and Mexican stocks will weaken along with international markets, and yields will tend to rise, we expect the magnitude of these movements to be relatively moderate and temporary.
Overall, it looks to us as if things might get worse before they get better. Market sentiment is cautious for now, but caution can easily turn to fear, especially when we enter turbulent times.