Comstock Partners, Inc.February 05, 2015
A Race to the Bottom
As our viewers know, we have been sounding the alarm about the deflationary process that is playing out in the world’s equity, bond and currency markets for quite some time. Because of the activity by central banks in major and more recently in developing countries we have described what is going on as “The Central Bank Bubble”.
It is truly an irony that in their efforts to fight the forces of a crushing deflationary environment, central banks have been the direct cause of one of largest inflations of financial assets in history. This asset inflation even extends to collectibles such as art. As we write, equities in several major markets around the world are trading at or near all-time highs while growth in those economies remains anemic. In others, such as Japan, equities are trading near the highs of recent years with the same anemic growth. On the fixed income front, sovereign yields in the US, Japan, and most countries in the Eurozone are trading at all-time lows. In the latter case there is an unprecedented negative yield curve out 3-6 years for the very best credits (France and Germany). All of this, as many currencies are falling rapidly relative to the dollar. To paraphrase the character Marcellus from Hamlet; something is clearly rotten in the state of the currency markets!
We strongly believe that the Currency Wars, (described in our Cycle of Deflation as “competitive devaluation”) have begun. Many countries have now joined “the race to the bottom”. Since the beginning of 2015 no fewer than 8 countries have unexpectedly cut interest rates in an effort to stimulate their economies. In our view, they clearly took these actions in a desperate attempt to export the deflationary forces that are plaguing them. For its part, Switzerland would have no part of defending the value of the Euro versus the Franc and decided to get “out of the way” and remove the cap that had existed since 2011. The reaction in the Swiss export dependent equity market was an immediate 15% correction. Imagine for a moment what the Swiss must expect to happen to the Euro once the ECB starts their “Quantitative Easing” program of about $1 tn. in March. They had to be frightened about the Euro declining sharply to be willing to take a valuation loss of that magnitude to their equity market in one day!
We continue to reiterate that all of this will not be good for US equities. The decline of oil, copper, iron ore, the Baltic Dry Index, and many other commodities, is starting to have a telling impact. In the past few days Chevron has suspended its $5 Billion (2014) share buyback and cut its 2015 capital spending budget by 13%. Exxon, for its part, while refusing to give a cap-ex budget, reduced its share repurchase by 75%. We fully expect a cascading effect as companies down the chain feel the pinch. Included will be commensurate effects on wages and employment which we strongly believe are not the improving picture the government has painted.
Lastly, volatility has ramped higher in response to all of this. The VIX Index and futures on VIX, while not on their recent highs, are well off of their lows. More volatility is coming and we expect the US equity market to begin a large corrective phase shortly as most of our trading partners will do whatever they can to “win the race to the bottom” with their currencies. This process will continue to drive the U.S. dollar up. We can’t win this race since we have virtually run out of ammunition after the most outrageous monetary easing ever over the past 7 years.