The amusing thing about this ongoing market volatility is watching the mainstream media’s reaction to it. One day it’s all doom and gloom. The next it’s blue skies.
After the recent sell-off I read an article talking about the psychology of investing and dealing with losses. After a one-day rally I saw another article highlighting a bunch of ‘bargain’ stocks to buy.
The problem with reading the business media on a daily basis is that it doesn’t provide a consistent narrative. And that’s ok. It’s not meant to. But it’s important that you understand one thing.
That is, understand that 95% of what you read in the business pages is a reflection of what you, or the market, already knows. Holding a paper in front of you (or the electronic equivalent) is like holding a mirror up to your face.
It simply tells you what you already think or feel, whether you acknowledge it or not. It doesn’t give you insights. If it’s in the news, it’s in the share price.
The task of The Daily Reckoning, on the other hand, is to try and provide you with a daily insight. We won’t always be successful, or you may not agree. But the idea is to cut through the news and tell you what we think is really going on.
Whether you choose to follow our individual narratives or not is up to you. But if you’re at least thinking about it, then you’re on the right track.
Today you get a bonus…two insights! At least I think they are. You can decide for yourself at the end.
Firstly, this day to day market volatility you’re seeing is nothing new. It might feel extreme, but it’s just how markets work. What is new is the reason why markets are acting the way they are.
That is, the big picture narrative here is that the world is preparing for the first US interest rate rise in nearly a decade. This situation means that the easy flow of capital that has defined global markets for so long is now in reverse mode.
Emerging markets are at the centre of these global capital cross-currents. And China, being the king of emerging markets, is the focal point. Markets are nervous about how the world will adjust to rising interest rates. It looks to China for clues on how the adjustment is going.
Right now you wouldn’t say it’s going swimmingly for the Middle Kingdom. The ultra-low interest rates that propelled global capital flows over the past decade have been kind to China. Now that they’re reversing, China is struggling to cope.
Still, China’s rulers have a number of policy options. The pulling of these levers helps to create the daily fluctuations you’re seeing. On Tuesday for example, China announced more fiscal stimulus, an announcement desperately needed by fragile market.
This is what the official news agency Xinhua had to say about it:
‘Although growth uncertainties abound home and abroad, China has plenty of policy options especially on the fiscal front to put the economy on track to deliver the around 7 percent annual target.
‘In its latest effort, the Ministry of Finance on Tuesday put forward multiple fiscal policies aimed at stabilizing growth, such as coordinating funds to accelerate project construction, activating idle money and widening tax breaks.
‘Other measures include guidance funds for small and emerging businesses, and promoting public-private-partnerships (PPP).’
China stimulus to the rescue!
Well, it helped for a few days at least. But after starting positively last night, US markets finished heavily in the red again. Nervousness is back. Expect this trend to continue.
I have no idea whether this expected interest rate rise will cause a crash or a GCF Mark II. Right now my guess is that it won’t. There are few signs of systemic stress in the markets. There is volatility, sure, but this is just how markets work.
The simplest explanation is that markets are adjusting their expectations and risk tolerance after years of easy money. As a result, you’re seeing a correction take place. Whether we’re close to the bottom now or whether we will continue into a deeper bear market is anyone’s guess at this point.
The takeaway is that this is normal, even though it feels anything but. This is how markets work. They go up and they go down. It’s infuriatingly simple. We just do our best to make it complex.
Today’s bonus insight concerns the Woodside [ASX:WPL] takeover offer for Oil Search [ASX:OSH]. This announcement fired the Aussie market up this week. Many people see it as a sign of a bottom in oil stocks.
I don’t though. Before I explain why, I will declare an interest. A few weeks ago I recommended that Crisis & Opportunity subscribers short sell both Santos [ASX:STO] and WPL. I consider these two stocks the most vulnerable of the large energy stocks.
WPL’s play for OSH confirms this view. I see this as a desperate play from WPL. With the oil price at these low levels, WPL has little to no growth options. It had plenty when the oil price was higher though. Its massive LNG projects require a higher oil price to make them viable. But I see them as unlikely developments in this price environment.
WPL’s bid for OSH is therefore an acknowledgment that the oil price will probably be lower for longer. That’s why WPL needs to buy growth. Hence it’s play for OSH.
But OSH won’t sell based on the current offer. It’s too low. If WPL really wants it, it will have to pay more. It will end up paying too much (OSH already trades on 22 times 2016 forecast earnings) to the detriment of its shareholders.
In short, it’s a debacle for WPL. All of Australia’s big energy companies are hugely exposed to LNG. And with LPG shaping up to be the new iron ore market for Australia (excess supply, falling returns) I wouldn’t want to have any exposure to the sector right now.
Editor, The Daily Reckoning
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