How to describe this market?
Vin Diesel in the new “Fast Five” trailer has as good a line as any:
“Chances are, sooner or later, we’re going to wind up behind bars or buried in a ditch somewhere. But not today…”
On Wednesday the bottom dropped out of the dollar. The VIX (as tracked by VXX) tumbled to brand new lows. “Risk on” surged with a euphoric vengeance, gold cracked $1500, and the spot price of Brent surged (recently above $124 a barrel).
As others have variously noted, crude oil has become “financialized.”
But what happens to real world end users of crude (like China) if or when Brent hits $150 per barrel… $175… $200?
Inflationary pressures in the Middle Kingdom are already reaching extremes. Trucker strikes are being suppressed with violence. The vast majority of Chinese are dirt poor (via George Friedman, “sub-saharan Africa” poor), and spend the lion’s share of their income on food.
Yet the prospect of a dollar meltdown and subsequent food and energy melt-up is of no concern here?
Or how about the euro, now pushing $1.46 as Greece pays loan shark interest rates and Finland threatens to derail the Portugal bailout (and subsequent bailouts to follow). Or the Aussie dollar at a cool $1.07: Can the Australian economy survive “Dutch Disease” — the term that describes severe economic distortion as a result of resource boom?
Or consider all those E.M. economies faced with the prospect of hiking interest rates… letting the value of their currencies rise significantly… enduring a potentially painful drop in exports to the West… or all of the above. Beyond a certain stress threshold, a diving dollar magnifies the headaches of every mercantilist-minded central banker on the planet.
To wit, how can we expect the $USD to fall ever further — as the financialized price of oil climbs higher in counterpoint — with no serious consequences?
Those who gleefully predict the $USD will plummet to the center of the earth forget that the greenback is still the world’s reserve currency, and thus still a fulcrum of sorts for the global economy. The dollar cannot free-fall without feeding major tectonic pressures, of the sort that eventually shatter the status quo.
For instance: Can you imagine a world where European exporters (PIIGS in particular) are shouldering the weight of a $2 euro… even as China’s inflation rate has gone from “white hot” to “supernova” on the back of $200 Brent… with America facing up to $150 West Texas Intermediate and $6 per gallon gasoline… and the pollyannas yet still rejoicing in the endless bid of a paper asset bull market?
If the answer is “no”, then how much lower, pray tell, do we think the $USD can go before something important snaps? And this is to say nothing of U.S. domestic concerns…
The wonder drug of dollar decline and QE asset pump is simultaneously a suicide pill, yet investors seem not to care. As we recently wrote in our “Big Short” review, Mr. Market is a cross between Gordon Gekko and Forrest Gump — and now with a touch of Vin Diesel thrown in.
For those who want the party to continue on indefinitely, there are plenty of questions to answer, as noted last week in Sizing Up the Bull. But to get a handle on the sentiment currently driving things, our mental rolodex keeps pulling up the year 2000.
An excerpt from a May 22nd, 2000 Wall Street Journal article, How the Soros Funds Lost Game of Chicken Against Tech Stocks, sets the stage:
NEW YORK — For months, through late 1999 and early 2000, the Monday afternoon research meetings at George Soros’s hedge-fund firm centered on a single theme: how to prepare for the inevitable sell-off of technology stocks.
Stanley Druckenmiller, in charge of the celebrated funds, sat at the head of a long table in a room overlooking Central Park. Almost as if reading from a script, he would begin the weekly meetings with a warning that the sell-off could be near and could be brutal. For the next hour, the group would debate what signs to look for, what stocks to sell, how fast to sell them.
“I don’t like this market. I think we should probably lighten up. I don’t want to go out like Steinhardt,” Mr. Druckenmiller said in early March as the market soared, according to people present at the time. He was referring to Michael Steinhardt, who ended an illustrious hedge-fund career in 1995, a year after suffering big losses.
Mr. Soros himself, often traveling abroad, would regularly phone his top lieutenants, warning that tech stocks were a bubble set to burst.
For all this, when the sell-off finally did begin in mid-March, Soros Fund Management wasn’t ready for it. Still loaded with high-tech and biotechnology stocks and still betting against the so-called Old Economy, Soros traders watched in horror when the tech-heavy Nasdaq Composite Index plunged 124 points on March 15 while the once-quiescent Dow Jones Industrial Average leapt 320 points. In just five subsequent days, the Soros firm’s flagship Quantum Fund saw what had been a 2% year-to-date gain turn into an 11% loss.
“Can you believe this? This is what we talked about!” cried a senior trader amid the carnage. Others on the firm’s gloomy trading floor busied themselves calculating how much they had lost by aping Soros investments in their own accounts.
Aside from an April 28 news conference about the firm’s agonies and brief interviews afterward, the secretive Mr. Soros and Mr. Druckenmiller, long his No. 2, have said little about the period leading up to the humbling disclosure of the problems. An account pieced together from interviews with a dozen Soros insiders and managers of other hedge funds — private pools of investment capital — shows two longtime friends and colleagues increasingly at odds until it all became too much.
As the losses piled up, tension inside the firm grew, with Mr. Soros second guessing the traders who had made him billions of dollars in the past decade. Soros executives say they overheard heated arguments, as Mr. Soros pressed Mr. Druckenmiller to bail out of some swooning Internet stocks before they sank even further, while Mr. Druckenmiller insisted that the funds hold on.
During the worst of this period, it happened that the Soros offices were consumed by a powerful burning smell as electrical work on the floor above kept starting small fires and setting off deafening alarms. The smoke and racket and the dizzy headaches they caused seemed “like a divine message,” recalls one Soros executive of the bizarre office scene. “We almost wished it would burn down.”
By the end of April, the Quantum Fund was down 22% since the start of the year, and the smaller Quota Fund was down 32%. Mr. Soros had stated in a 1995 autobiography that he was “up there” with the world’s greatest money managers, but added, “How long I will stay there is another question.” Now came an answer. Both Mr. Druckenmiller and Quota Fund chief Nicholas Roditi resigned. Mr. Soros unveiled a new, lower-risk investing style — completely out of character for him — and conceded that even he found it hard to navigate today’s murky markets.
“Maybe I don’t understand the market,” a reflective Mr. Soros said at the April 28 news conference. “Maybe the music has stopped, but people are still dancing.”
An ironic quote, given the Chuck Prince echo seven years later.
The lesson that we draw from history — particularly the more recent history of the years 2000 and 2007 — is that sometimes Mr. Market acts irrationally in the face of deadly serious risks. When sentiment and status quo have built up enough self-reinforcing power, the “conundrum” of reckless behavior that follows is no conundrum at all.
To close with a favorite from Walter Bagehot, 19th century editor of The Economist:
“At particular times a great deal of stupid people have a great deal of stupid money… At intervals, from causes which are not to be the present purpose, the money of these people — the blind capital, as we call it, of the country — is particularly large and craving; it seeks for someone to devour it, and there is a ‘plethora’; it finds someone and there is ‘speculation’; it is devoured and there is ‘panic’.”
Let the good times roll,