Tags: Ukraine | Russia | Japan | euro

Markets Can Remain Irrational for Incredibly Long Periods of Time, But Not Forever

Tuesday, 11 March 2014 09:36 AM Current | Bio | Archive

On Monday, weak data from China and Japan, not geopolitical risk, caused a sharp sell-off in Asian stock markets and the biggest one-day crash in iron ore prices since the Lehman Brothers crisis.

As an investor, I certainly would take notice that it is becoming clearer by the day China is really slowing down with negative mindboggling events surely to come, while Japan is in the doldrums.

In Japan, I can't see how Akira Amari, Japan's Minister in Charge of Economic Revitalization, is telling everybody who wants to listen 1) please "don't panic" despite the downside revision of fourth-quarter GDP to 0.2 percent quarter over quarter and 2) prosperity will be created by "Abenomics."

Regarding Ukraine, it's really interesting to see how the markets show apparent indifference to the clear risks posed by the crisis developing over there. Of course, only time will tell if markets are right not taking this situation seriously. Please keep in mind that everything could change extremely quickly.

As of Monday evening, we saw the ambassadors at the intergovernmental military alliance of the North Atlantic Treaty Organization (NATO) in Brussels, Belgium agreeing to start Airborne Warning and Control System (AWACS) reconnaissance flights over Poland and Romania, which are two NATO member countries bordering the Ukraine.

Also on Monday, we saw the "super power" diplomacy actions between the United States and Russia faltering on the highest level when, among other things, in a "staged" appearance on Russian television President Putin and his Foreign Minister Sergei Lavrov said the current U.S. diplomatic proposal was unacceptable.

The U.S. proposal asked Moscow to 1) start immediately taking the necessary steps for halting the planned referendum vote on a Crimea secession from the Ukraine and joining the Russian Federation and 2) demobilize the Russian troops and pro-Russian paramilitaries that are on the peninsula, which in fact comes down to completely renouncing the annexing of Crimea to Russia.

In the meantime, all diplomatic efforts of the West trying to move Russia and Ukraine to talk "to" each other instead of talking "at" each other have also completely failed, so far.

Until now, Russia hasn't shown any real move for de-escalating the crisis.

No, the whole situation doesn't look well at all. It makes me think of that famous aphorism of the Prussian (German) General and military theorist Carl von Clausewitz (1780-1831), "War is the continuation of politics (policies) by other means." Let's hope it isn't the case this time around.

I still don't think we are headed for a second edition of a Cold War between East and West let alone a military confrontation. Nevertheless, the situation is serious enough to keep it on your "watch-and-what-to-do list" in case we should face some kind of a totally unexpected turn for the worse. No, in my opinion at least, this is not a situation that permits investors to continue their actual overly strong inclination for complacency.

And if all this weren't enough, Crimean Tatar leader and member of the Ukrainian parliament Mustafa Jemilev warned in a Financial Times interview on Sunday of Tatar Jihadi reprisals against Russia in Crimea in case the Ukrainian region decides to join Russia in the referendum planned for this Sunday. He stated: "We have Islamists, Wahhabis, Salafis, groups who have fought [with the opposition] in Syria. . . . An enemy has entered our land and we are ready. . . . We can't stop people who want to die with honor." We could say, we have been warned.

In the meantime, the world moves on and Tuesday we got the Organization for Economic Co-operation and Development's Interim Economic Assessment stating it expects global growth to remain "only" moderate in the near term, mainly because of continued subpar economic performance for several of the major emerging economies, which now account for more than half the world economy and continue to experience a marked loss of momentum while, in the major advanced economies we see further indications to continued underlying strengthening of the pace of growth notwithstanding the recoveries in the euro area as well as in Japan are less established and inflation in both remains below their 2 percent target.

One should take notice that neither the euro area nor Japan have so far been helped in their growth objectives by their respective too-strong currencies. The question is how long that can, or even will be allowed by the concerned economies to, go on.

Of course, markets can remain irrational for incredibly long periods of time, but certainly not forever. As an investor, I certainly wouldn't remain long the euro. From my side, I wouldn't be surprised to see a substantially lower euro, in a range from 5 to 10 percent, which would bring us back to more or less $1.25 per euro, before this year is done.

In this context, it is interesting to take notice that on Monday, Christian Noyer, current member of the European Central Bank (ECB)'s Governing Council and Governor of the French Central Bank (Banque de France) as well as current chairman of the Bank for International Settlements, voiced publically his concern regarding the appreciation of the euro.

In this context, I'd like just to mention a small event scheduled for Wednesday, March 12th, whereby Peter Praet, the ECB's chief economist (some categorize him a maverick), is scheduled to give a speech at the ECB's Watchers XV conference in Frankfurt, Germany. In November, he spoke publicly about deflation risk in the eurozone and what could be done about it, stating: "The balance-sheet capacity of the central bank can also be used. . . . This includes outright purchases any central bank can do." (Yes, that's quantitative easing!) That event then "coincided" with a "temporarily" weaker euro.

I'm not saying the euro is going to weaken tomorrow after Praet speaks.

But, also on Monday, International Monetary Fund Chief Economist Olivier Blanchard said he sees definite long-term deflation in the euro area, which would be a double-edged sword for countries like Spain and Italy stating: "On the one hand deflation would certainly improve their competitiveness and help exports, but on the other hand it would increase the real interest rate and the real value of debt and so reduce domestic demand."

Interestingly, Blanchard also called on central banks to combat financial market bubbles.

As a long-term investor, I'd try not to act like the vast majority is acting. In my opinion, among the majority of investors there is way too much unjustified optimism and too widespread "myopism" that completely negate reality.

Yes, actual widespread complacency that considers most of the ongoing situations as "glasses half full" stories could easily turn out as very costly wrong perceptions in the not so far future. At least, that's how I think about it, but I really hope I'm wrong.

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Actual widespread complacency that considers most of the ongoing situations as "glasses half full" stories could easily turn out as very costly wrong perceptions in the not so far future. At least, that's how I think about it, but I really hope I'm wrong.
Tuesday, 11 March 2014 09:36 AM
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