The US Federal Reserve under its Chairman Janet yellen is "data dependent" though conscious of exogenous linkages - oil, China and emerging markets - in a fragile, hyper-volatile world where panic, as well as greed, is transmitted at the speed of light.
Free-flowing cash transformed investment paradigm. Now what? Matein Khalid analyses.
By Matein Khalid/Wall Street
Published: Mon 21 Dec 2015, 10:45 PM
In retrospect, the last six years were a unique period in global central banking, an epic monetary experiment that averted a Great Depression after Lehman's failure and interbank/credit contagion plunged the world into recession in 2008-09. Yet the Fed (and later the Bank of Japan, the ECB and even the PBOC) quantitative easing also led to asset bubbles, credit market excesses, currency wars and the mispricing of risk as volatility plummeted across asset classes. Ben Bernanke, Mario Draghi and Haruhiko Kuroda reflated the world's three mission-critical economies with an easy money tsunami that transformed the investment paradigm. Now what?
The Yellen Fed is "data dependent" though conscious of exogenous linkages (oil, China, emerging markets) in a fragile, hyper-volatile world where panic, as well as greed, is transmitted at the speed of light. A 150 basis point rise in the Fed overnight borrowing rate is entirely possible in 2016.
After all, the Bernanke Fed raised the Fed Funds rate by 425 basis points in 2004-06 as the credit bubble raged across the world. The FOMC projects a 3.4 per cent Fed Funds rate sometime in the next three years. The end of cheap money is a game changer event in world finance and thus my investment strategy.
Higher bank funding cost, a squeeze in liquidity, a rise in corporate and sovereign risk premiums, an aversion to leveraged balance sheets and poor corporate governance will reshape equity markets worldwide, even right here in the UAE. Bond proxies and go go momentum stocks are leprosy in the post December FOMC investing zeitgeist. I expect merger mania to accelerate as lack of pricing power in a slow growth world resurrects the Darwinian/Schumpeterian demons of capitalism.
I have consistently argued since early 2014 that the King Dollar theme argued for a sell off in commodities, de facto monetary tightening in Wall Street, a plunge in crude oil, GCC equities and an Asian flu/Mexican peso run scale disaster in emerging markets. This was the macro rationale behind my most successful macro trades in 2013-15 - short oil services index at 50, long US dollar/Canada at 1.06, short euro at 1.3650, short Turkish banks, short Gazprom/VTB in Russia and long Wall Street financials since 2013. Citigroup at 25, Lazards at 27. Of course I got some companies wrong, I was wrong on ICICI. India faces credit disaster. I cannot fathom the logic of Amazon.com trading above 900 PE, well beyond the lifetime of Jeff Bezos and every human on earth. I thought Emaar was a compelling buy at Dh6 but did not grasp that the post-Vienna meltdown in crude would affect all Gulf equities, blue chip or potato chip.
The Fed rate hike celebrates the rock-and-roll US economy, with its five per cent unemployment rate, 19 million unit car sales, accelerating bank loans, consumer spending goosed by the plunge in gasoline prices. As Gulf sovereign wealth funds recycle $500 billion less petrodollars and China links its yuan to a currency basket, I expect the 10-year US Treasury bond yield to rise to 2.80 per cent next year.
The highest duration equities markets - Russia, Turkey Brazil, Indonesia, Malaysia, Thailand, even India and Egypt - are most at risk when Uncle Sam's IOU yield rises and the Fed monetary pump sputters amid FOMC rate hikes. The strategy implications for 2016 are crystal clear to me.
Embrace Taiwan, shun commodities exporters in Southeast Asia. Embrace financials and shun utilities. Leveraged property speculation? The kiss of death, exactly as it was in 2009. Skippy the Bush Kangaroo, a favourite show of my boyhood, will be an apt metaphor for the scenario I expect in Gulf without a bankruptcy code. Skippynomics!
Profit growth will be pressured by higher US rates in 2016. So dividend risk has never been higher. Default risks will rise beyond energy. Liquidity shocks will emerge like malign demons, as the Third Avenue junk bond fund just did, as Orange County, the Granite hedge fund and Metallgesellschaft did in the Greenspan Fed rate hikes of 1994. When the planet's cost of money rises, bad things happen in the money bazaar, as they will in 2016. Oil prices trade at $35 West Texas, a post-2008 low. A wet barrel oil trader friend tells me Basra Heavy (Iraq) and Mexican crudes trades at $25-$28 a barrel. West Canada Select sells for a meagre $22. The Opec's game of output chicken continues even as the oil glut overtakes global storage capacity with 90 per cent capacity in Amsterdam/Rotterdam/Antwerp/Galveston tanks. Iran will soon sell 500,000 MBS from floating storage. Index funds selling is frenzied as oil ETF investors panic.
Winter product demand in North America is awful. Russia now battles Saudi Arabia in its core Baltic markets.
The endgame? Brent falls to $30 by April 2016.
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