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Search for Yield Has Misguided Many Investors

Search for Yield Has Misguided Many Investors
(Dollar Photo Club)

By    |   Wednesday, 17 February 2016 07:25 AM

The financial markets are still not generally reflecting fundamentals.

An agreement between Saudi Arabia and Russia to freeze oil production has not provoked much reaction in the oil markets. In reality, not very surprising, at least to me, knowing the consistent oversupply situation that can’t go away anytime soon.

There is also the fact that Iran has repeatedly stated it will come back to its “pre-sanction” oil production levels, which were roughly about 1 million barrels per day above Iran’s actual production levels.

Anyway, the Iranian Oil Minister Bijan Zanganeh has already made it clear Tehran would not agree to “freezing” its output at January levels.

And then, a minor move by China on their currency fixing operations whereby today the renminbi (yuan) was allowed to weaken by 107 basis points to 6.5237 CNY per U.S. dollar provoked a somewhat strong reaction in Asian markets and the bounce in sentiment we have seen earlier in the week showed once again signs of fading into memory.

This is not the right balance of risks and the efficient market hypothesis is certainly taking something of a beating in the current climate.

Maybe not a bad idea to remember the general weakening of the Chinese currency is most emphatically not a competitive devaluation. Competitive devaluations require weaker export prices and an attempt to increase market export share, that is sort of the defining characteristic of a competitive devaluation and China is obviously doing neither of those things with its currency moves to date.

That said, in the U.S. today we get industrial production. This is a relatively minor part of the economy, but it is a more significant part of the equity market. The industrial sector is roughly three times as important to equities than it is to the economy.

It may be interesting trying to get a sense of what the energy sector in the U.S. is up to in terms of production, not because it has a bearing on the U.S. economy in a very significant way, but because the idea of an increase in the oil price over the course of this year would be, at least partly, contingent on reduced supply from the United States. Production was close to full last quarter and there is the theory promulgated by the IMF in particular, that the U.S. and its shale oil (unconventional oil) will make it likely to be the swing producer in the oil markets in the coming years.

Investors could do well not overlooking the fact that according to the International Energy Agency (IEA) the U.S. was in 2015 the world’s biggest oil producer and ahead of Saudi Arabia and Russia.

So, we’ll see what comes out…

The Fed’s Rosengren recently spoke on putting the Fed’s monetary policy in the context of the inflation figures quite specifically suggesting that economic date need to improve to signal a return to 2 percent inflation, which then could signal higher interest rates.

There is a logic to this and it is important to know Rosengren was not suggesting inflation needs to be 2 percent before the Fed acts.

However, there is a risk that beneath the surface of a placid headline CPI there are inflation pressures building. The steady rise in U.S. core CPI over the last year is palling not because of the increase over the last year per se but because of the relentless nature of that increase.

Perhaps this is comparable to 2004 and 2005 when the Fed was in a serious tightening cycle.

Finally, for investors that have interests related to Puerto Rico bonds that are held by about half of open-end muni funds, finally we got a draft of a long-delayed fiscal year 2014 financial data report that states “... The Commonwealth’s management believes that there is substantial doubt as to the ability of the Primary Government … to continue as a going concern…” The report also says Puerto Rico faced a net deficit position of $49.2 billion as of June 30, 2014.

I’m afraid, but nothing good should be expected from Puerto Rico bonds.

Unfortunately, the search for yield has misguided many people.

In fact, Fed Chair Ben Bernanke touched the subject in his May 10, 2013, speech saying:

“… In light of the current low interest rate environment, we are watching particularly closely for instances of “reaching for yield” and other forms of excessive risk-taking, which may affect asset prices and their relationships with fundamentals…” 

As we all know, many didn’t get the message.

Etienne "Hans" Parisis is a bank economist who has advised global billionaires and governments on the financial markets and international investments. To read more of his articles, GO HERE NOW.

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Unfortunately, the search for yield has misguided many people.
stocks, economy, investors, fed
Wednesday, 17 February 2016 07:25 AM
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