Tags: euro | US | bubble | burst

The Time Window to Cash in on Equities Is Closing

Tuesday, 10 June 2014 12:49 PM Current | Bio | Archive

St. Louis Federal Reserve Bank President James Bullard said Monday at the Tennessee Bankers Association's annual meeting in Palm Beach, Fla., that the Federal Open Market Committee (FOMC) now faces a classic challenge concerning the appropriate pace of monetary policy normalization given the improving macroeconomic conditions, although labor markets don't seem to be fully recovered, but unemployment rates keep falling, and inflation has been low, but rates are slowly rising.

Remember that in March this year the average FOMC participant's long-run Fed Funds rate, which is beyond 2016, was 4 percent.

In clear English, that means the "long" way to "normalization" of Fed policy rates could and probably will start, if nothing really disturbing happens, sometime in 2015.

About inflation I'd like to add, the Dallas Fed's one-month trimmed mean personal consumption expenditures (PCE) inflation rate, which is an alternative measure of core inflation, came in at 2.5 percent in April, up from 1.9 percent in March and 1.1 percent at the beginning of the year. The 12-month PCE inflation measure for April came in at 1.6 percent, up from 1.3 percent where it has been since the beginning of the year. It will be interesting to see how the index evolves when the next data are released later this month.

It becomes clearer by the day that, for now at least, the United States isn't facing a disinflation — let alone a deflation — threat. This can't be said of the euro area, which probably will have to face disinflation or very low inflation for a prolonged period of time.

In relation to last week's bold move by the European Central Bank (ECB), Benoit Coeure, ECB executive board member, said on French radio: "Clearly what we wanted to indicate on Thursday is the fact that monetary conditions will diverge between the eurozone on the one hand and the U.S. and the UK on the other for a long period of time, which will be several years. . . . We are going to keep rates close to zero for an extremely long period, whereas the U.S. and the UK will at some point return to a cycle of rising interest rates."

That said, one thing remains for sure: deflation is not (yet and hopefully never) an imminent threat to the core euro area nations, even though low growth, coupled to way too high unemployment rates, especially for the young people in the majority of the member states, remain one of the main concerns. There is no doubt the ECB will do all that it is allowed to do within its mandate, but the extraordinary measures taken by the ECB will also need direct support from the politicians.

On Monday, Jens Weidmann, president of the Bundesbank and also ECB governing council member, underlined this matter when he said the decisions taken by the ECB last Thursday were a "wake-up call" for governments that needed to continue with reforms. If that will be achievable is another question. It will be interesting to see Wednesday what happens when the negative deposit rate at the ECB is implemented.

There is no doubt whatsoever that the actual hype of unrealistic optimism about the euro area is not sustainable.

For example, annual inflation in the euro area is expected to come in at 0.5 percent for May, which would be down from 0.7 percent in April.

One thing is for sure, the underlying divergences in the real economies among the different euro area nations is not going away, and as long these divergences remain in place, investors should remain on alert for negative surprises.

The euro area bond prices bubbles (yes, plural!) we are witnessing today, with the Spanish 10-year at 2.57 percent yielding less than both the U.S. 10-year at 2.62 percent and the UK gilts at 2.70 percent, have no other outcome than to burst.

When that could happen, that's anybody's guess; however, I have no doubt the burst will hurt a lot in many portfolios.

For now: Do the markets care? Apparently not.

Also, first-quarter GDP in Italy, the third-largest economy of the euro area, contracted 0.5 percent year-over-year and 0.1 percent quarter-over-quarter.

On the other side of the globe, inflation data for China came in "mixed," which is of course no headline news. The consumer price index (CPI) came in at 2.5 percent year-over-year in May, up from 1.8 in April, but the producer price index fell 1.4 percent year-over-year in May and decreased 0.1 percent month-over-month, which kept the index in deflationary territory for the 27th consecutive month. If you ask me, I can't see any serious reason for getting optimistic on where China might move in the near future.

On equities, and U.S. equities in particular, a new research paper by Deutsche Bank signals the price-earnings ratio for the Standard & Poor’s 500 Index divided by the quarterly average for the Chicago Board Options Exchange Volatility Index, which is an equity market emotions measure, stood at 1.49 on June 5, which is on the border of entering what they call the "mania zone" that starts at 1.50.

To me, that's definitively a red light that has started blinking to all investors who try to remain with both feet on the ground. I think the time window is closing to cash in, in case you still have open positions in equities.

The larger the bubbles become, the bigger the bursts when they finally happen. No, there is no escape to that and this time won't be different.

The downward path once started should be a big one, but it won't be in a straight line down, that's for sure.

Of course, I could be wrong.

Nevertheless, as always, "Forewarned is forearmed."

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The larger the bubbles become, the bigger the bursts when they finally happen. No, there is no escape to that and this time won't be different.
euro, US, bubble, burst
Tuesday, 10 June 2014 12:49 PM
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