It may be an idea to keep your smartphone charged and within reach, if you are planning a trip to the beach this month. Certainly market behaviour since June has been more and more skittish. The experts, after all, were telling us that central banks were certain to do more major stimulus efforts to boost stock and commodity prices: they were also sure that the US economy was poised to do well.
Instead, we have had minimal stimulus from the European Central Bank (ECB) and Bank of Japan (BoJ), whilst the US Federal Reserve was clearly taken by surprise with Friday’s weak GDP news for Q2.
Now investors are beginning to worry that the central banks are out of stimulus ammunition, and have very little further room for manoeuvre. Japan has suddenly become the “weak link” in the chain:
Its interest rates have risen sharply since Friday when the BoJ disappointed markets with only minor policy moves
The benchmark 10-year bond is almost yielding a positive amount, after offering only negative yields since March
Some traders now even worry that the BoJ may have to raise interest rates to protect the banking sector
There was a similar state of confusion at the ECB last month, when markets were told to wait until after the holidays for any further stimulus.
So traders have gone on holiday leaving a vacuum behind them. And as we all know, “nature abhors a vacuum”. Oil prices are thus becoming a key indicator for the financial sector:
They are now down $11/bbl since their early June peak, a 21% fall
Their attempts to rally are being beaten back by news of ever-higher supply gluts in oil and products
And even though the US$ has weakened sharply over the past week, the hedge funds are not moving back into the market, as has always happened in recent years, when they believed that “weak dollar = higher oil prices”
So we could now be watching the second stage of the Great Unwinding in action. The first stage began nearly 2 years ago, when the dollar began to rise and oil prices to collapse. Now we may be seeing markets start to ignore the actions of central banks, and instead focus for the first time since 2008 on the fundamentals of supply and demand. If they do this, they may not like what they see:
Oil markets have record levels of inventory all around the world
Traders have become nervous about buying shares with borrowed money in the New York stock market
Developments in the European debt and refugee crises are also not encouraging
Plus there is increasing nervousness around the world over the outlook for the US Presidential election
As always, the IeC Boom/Gloom Index is highlighting the potential turning point. Although the S&P 500 has recently made a new all-time high, the Index did not confirm the higher numbers. Instead, it has retreated to just above the 4.0 level which has signalled pullbacks in the past.
If this proves accurate, and oil prices keep tumbling, then we may have a busy month ahead.