December 17, 2014

Market Facts

Volatility derivatives expire today as the Federal Reserve gives monetary guidance. How would you like to be in those shoes? Oh but if you’ve chosen investor-relations as your profession, you’re in them.

Management wants to know why holders are selling when oil – or pick your reason – has no bearing on your shares. Institutional money managers are wary about risking clients’ money in turbulently sliding markets, which condition will subside when institutional investors risk clients’ money. This fulcrum is an inescapable IR fact.

We warned clients Nov 3 that markets had statistically topped and a retreat likely would follow between one and 30 days out. Stocks closed yesterday well off early-Nov levels and the S&P 500 is down 100 points from post-Thanksgiving all-time highs.

The point isn’t being right but how money behaves today. Take oil. The energy boom in the USA has fostered jobs and opportunity, contributing to some capacity in the American economy to separate from sluggish counterparts in Asia and Europe. Yet with oil prices imploding on a sharply higher dollar (bucks price oil, not vice versa), a boon for consumers at the pump becomes a bust for capital investment, and the latter is a key driver in parts of the US that have led job-creation.

Back to the Fed, the US central bank by both its own admission and data compiled at the Mortgage Bankers Association (see this MBA white paper if you’re interested) has consumed most new mortgages coming on the market in recent years, buying them from Fannie Mae and Freddie Mac and primary dealers.

Why? Consumption drives US Gross Domestic Product (GDP), and vital to recovery in still-anemic discretionary spending is stronger home prices, which boost personal balance sheets, instilling confidence and fueling borrowing and spending.

Imagine the consternation behind the big stone walls on Maiden Lane in New York. The Fed has now stopped minting money to buy mortgages (it’ll churn some of the $1.7 trillion of mortgage-backed securities it owns, and hold some). With global asset markets of all kinds in turmoil, especially stocks and commodities, other investors may be reluctant successors to Fed demand. Should mortgages and home-values falter in step with stocks, mortgage rates could spike.

What a conundrum. If the Fed fails to offer 2015 guidance on interest rates and mortgage costs jump, markets will conclude the Fed has lost control. Yet if a fearful Fed meets snowballing pressure on equities and commodities by prolonging low rates, real estate could stall, collapsing the very market supporting better discretionary spending.

Now look around the globe at crashing equity prices, soaring bonds, imploding commodities, vast currency volatility (all of it reminiscent of latter 2008), and guess what?  Derivatives expire Dec 17-19, concluding with quad-witching. Derivatives notional-value in the hundreds of trillions outstrips all else, and nervous counterparties and their twitchy investors will be hoping to find footing.

If you’ve ever seen the movie Princess Bride (not our first Market Structure Map nod to it), what you’re reading seems like a game of wits with a Sicilian – which is on par with the futility of a land war in Asia. Yet, all these things matter to you there in the IR chair, because you must know your audience.  It’s comprised of investors with responsibility to safeguard clients’ assets.

You can talk yourself blue about why your shares deserve to be carved out as prime turf apart from this seismic turbulence. Until risk and currency-instability clarify, investors won’t listen. Your effort will be better spent setting realistic expectations for management. The problem is intertwined global currencies, where a move here has an equal and opposite reaction there (witness dollars and rubles).

Markets could soar this week, depending on what the Fed does. As in October when markets abruptly stabilized at options-expirations, we’ve come again to the cliff. Do we stop, or go over (our data signal more risk yet)?

The answer lies beyond business fundamentals. That’s just a fact.

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