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Overpriced Stocks, Low Bond Yields Leave Market Vulnerable to Shocks

Overpriced Stocks, Low Bond Yields Leave Market Vulnerable to Shocks
(Dollar Photo Club)

By    |   Monday, 13 March 2017 07:43 AM

Money Blog – Hans Parisis – Monday – March 13 – 2017.

This week is packed full of momentous events. None of which should, in theory of course, make any difference to financial markets.

Financial markets are supposed to be efficient and therefore to price in all available information at any moment in time.

Now, a quick visit to a trading floor could easily make anybody doubt about the accuracy of that assessment. If it is that is what the efficient market hypothesis (EMH) suggests then it should not come as a surprise that it is mainly surprises that really move financial markets and cut them loose from herd mentality/actions.

That said, this week will have undoubtfully momentous events, but the big question is, “Will we have surprises?”

On Tuesday, the UK government is likely to be able to trigger the article 50 mechanism of the EU Lisbon Treaty, which should begin the long separation process of the UK from the European Union (EU), which is not a surprise because the whole separation process since the UK decided by referendum on June 23, 2016, to leave the EU has been evolving at the slowest speed of slow-motions.

However, take care, there may be some potential for surprise in the very nature of the European Union reaction, though even this is dubious.

The EU is apparently ready to respond almost immediately as European Council President Donald Tusk said last week that it will take the EU just 48 hours to issue its first plan for Brexit negotiations after Britain formally triggers under article 50 its departure.

Nevertheless, for long-term investors it could be not such a bad idea keeping in mind what the great basketball player Paul Pierce always said: “The game isn’t over until the clock says zero.” Brexit’s game over “zero” time should be somewhere around the end of March of 2019.

Of course, there is a lot what can happen between now and then in the EU as well as in the UK.

Then on Wednesday, we have the Federal Open Market Committee’s (FOMC) decision on interest rates and other policies, which is expected to produce a rate increase of 25 basis points (bp).

By the way, Goldman Sachs wrote after Friday’s good jobs data it now expects 3 Fed rate hikes this year that should happen in March, June and September against March, June and December before.

This again, is anticipated by the financial markets.

Members of the Fed have reiterated that they do not wish to surprise financial markets. Investors have priced in a rate increase and members of the Fed have done nothing to dissuade financial markets from that view. It seems almost inconceivable now that the Fed could surprise on this specific policy stance.

However, there is a possibility of nuances in the language of the FOMC accompanying statement or other signals of future Fed policy positioning.

There is that vexed question, in particular, about the process of quantitative policy tightening at some point.

Finally, on Wednesday or better said on Thursday morning in the US, we’ll get the results of the Dutch general election that will have taken place among 28 parties. An event that won’t in a direct sense at least, change the Dutch government at all.

The current Dutch government will continue in office until a new government coalition can be formed, which could easily take weeks if not months.

The only thing that is known with much certainty about is that the new coalition will almost certainly not include the Freedom Party of Wilders, which is far-rightist and that wants a ban on Muslim immigrants, the closure of mosques in the Netherlands and a ban on Koran sales and, last but not least, the exit from the EU.

It should be not surprising that the main parties have already said they will not cooperate with Wilders’ Freedom Party.

The potential for surprise comes in the relative strength of the different party groupings in the Dutch parliament.

There is a sense that because of the extraordinary rise of populism among voters, investors now tend to draw a straight line from the UK referendum through the US election and the Italian referendum and extend that line to ever more improbable future political scenarios.

Whether the Dutch election validates that extrapolation or repudiates it will potentially matter to markets.

Investors should remember that equity prices are overpriced and bond yields are too low, which makes this an ongoing situation vulnerable to surprises.

Etienne "Hans" Parisis is a bank economist who has advised global billionaires and governments on the financial markets and international investments.

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Investors should remember that equity prices are overpriced and bond yields are too low, which makes this an ongoing situation vulnerable to surprises.
investors, equity, bonds, price
Monday, 13 March 2017 07:43 AM
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