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When sideways is good

Brouwer & JanachowskiFebruary 12, 2016

You know how it is when you take a reflex test? A doctor thwacks you on the knee and 400 milliseconds later you involuntarily react. You can try it here. Markets are on the same track these days and, as we wrote back in January, news comes in and there’s a spontaneous reaction.  Here’s what we saw in a week where the market was little changed:

  1. World of Negative Rates: QE, gave way to ZIRP and now NIRP. Strange things happen when rates go negative. In fact, we’re somewhat used to them. Your bank pays 0% on your checking account. Every ATM transaction fee, transfer, debit card or monthly fee extracts a charge. So what do you do? Hoard cash, move your accounts, sign up for Venmo. Anything but allow the bank to keep nicking your money.

Economics rarely dealt with negative rates because, well, they just shouldn't happen. And even if they did, the idea was that people would move to cash and start spending. Which leads to demand. And (good) inflation. But in the post Great Recession, things don't work in standard ways. This week the Swedish Riksbank announced negative rates joining Switzerland, Denmark, Japan and EU. What should not happen is this:1

Less than two weeks after the Bank of Japan cut rates, the Yen strengthened and the stock market fell. One reason, we suspect, is that the Yen was bought by Chinese investors anxious to exit out of their own currency. But it was also an indication that, in a deflationary world, the Yen still provides a positive real rate of return.

via GIPHY

  1. Treasuries again: we saw Treasuries touch a low of 1.52% as equities and energy rattled investors. Chairperson Yellen’s testimony acknowledged weakness and even the possibility of negative rates. The Fed is a proponent of the much-discredited Phillips curve. So they are all about employment (which is ok) and wages (mostly bad despite a recent uptick). We’ll allow that some of the Treasury action was as a place to go to rather than a full-bore commitment. But for now, they are one of the better investments around.
  1. Banks: were among the weaker sectors, here and in Europe. Some loans, especially energy, are going bad but the biggest problem is that with near zero rates, banks cannot make their net interest margin and in a slow economy, there is not much loan demand. So, not a great business and not much of it. We think investors are just waking up to this.
  1. High Yield: we haven’t heard much about this recently except that the rating agencies continue to quietly downgrade commodity related companies. It’s helpful to remember how the High Yield cycle works. Here it is:2

So it probably ain’t over.

Bottom Line: There’s an element of fatigue in the market. Hence the sideways moves. There is no policy response in the cards although we might see something at the G20 meeting two weeks from now. Meanwhile, we’re keeping a close eye on earnings and for any deterioration from what we know is a weak reporting season.

Other:

Not all ETFs are created equally and now the SEC thinks so too.

Saudi Arabia says boom times over, time to reform. Trouble is, that was in 1998.

You have been warned. Amazon has a walking dead clause at 57.10 in its service terms.

Nice to see perfectionists at work.

 

--Christian Thwaites, Brouwer & Janachowski, LLC

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