2016 has already sent the analysts running back to the history books

Shake, rattle, and roll! Investors finally jumped off the three-week rollercoaster that just would not quit, breathing a collective sigh of relief after a mild recovery rally this past Friday. Buyers still seemed to be on holiday, oblivious to the latest volatility, but they returned in a flourish to the amazement of all. In the meantime, analysts and economists alike are betwixt and between, unable to fathom the reasons for the latest chaos. Yes, China is slowing. Commodities are in the toilet, and the Fed is determined to raise the bar for interest rates, but those issues had already been factored into market prices.

Does anyone have a real clue as to what might happen next? Is recession imminent? Is the dreaded liquidity crunch crouching beneath the horizon? Headlines are all over the map, and no consensus is forming. The lack of plausible arguments and a logical framework for the near-term future has analysts rushing back to the archives, in search of some kind of historical perspective that will suddenly light the way. The prophetic words of George Santayana seem to be ringing in everyone’s ears – “Those who cannot remember the past are condemned to repeat it.”

For analysts under the age of 30, or 40 for that matter, a decade or two of history is not a broad enough base to recall the myriad possibilities that market conditions might be suggesting. And the issue is not only one about historical ignorance. Human psychology is also playing a large role in the present day confusion. A therapist might call it “willful ignorance” – the ability to see what you want or expect to see, instead of a careful interpretation of the facts that would yield a truer view of reality. Fear is running rampant in the streets. The following chart added fuel to the “fear” flames in 2015:
Chart of the Day

As luck would have it, the S&P finished down for the year, a good thing, since now we do not have to hear that 2016 will never be the eighth year in a row. Officially speaking, the S&P 500 broke a 3-year streak, while the Dow shattered a 6-year streak in 2015, if we only follow the final values of these two indices. If we added back dividends, then we might have an awkward situation where 2016 could be another pivotal year, after all. By the way, the Nasdaq did finish the year with a gain, so not all is bad with the world.

More forex market news and forecasts

What are the so-called historians saying about our current situation?

The wisdom from the white-haired gentlemen that comprise the intelligentsia of our financial market infrastructure has begun to find its way into the public sphere of consciousness. Yes, we are living in unusual times, dominated by central banking extravagances that have never been witnessed to such a degree in prior economic settings. Our knowledge of financial markets is being severely tested, but, as Mark Twain so aptly put it, “History does not repeat itself, but it rhymes.”

Various roundtables have been assembled over the past few years in an effort to probe history firsthand from the experts that witnessed prior action and survived to tell about it. The beauty of these varied observations is that they are timely. You may not get an exact repeat, but, if you noticed the rhyming aspect of the situation, then you might have an advantage, the necessary ingredient for performing better than market averages. Here are a few tidbits of the wisdom of the ages:

1)    The underperformance of the experts in 2015 will be debated for some time, but one historical take was that the majority of traders did not realize the cumulative effect of many changes and how those changes might have made old approaches less useful. Major institutions and investment banks, due to the constraints of the Volcker Rule and Dodd-Frank, have had to reduce capital allocations to their trading departments. As a result, algorithm trading has been given an advantage. Keeping abreast of current information has been discounted in favor of high-frequency position trades that cost less to execute. Central bank actions have also skewed markets in a negative way, forcing foreign exchange rates to mirror manipulated and unintended capital flows in the market.
2)    The herd mentality often prevailed in 2015, and under these circumstances, it is rare that the majority is right. When markets are underperforming, the slightest advantage can lead to an upset or direction shift that no one expected. In these cases, it is just as important to weigh changes with competitors, as well as with the perceived leading position that was supposed to be a sure thing.
3)    Can we predict when the next meltdown will occur? Students of history are quick to point out that Ben Bernanke was able to navigate the treacherous waters of the Great Recession because he had studied the Great Depression at length. The jury is still out as to whether his policy decisions were the correct ones, but it is accepted that his insights prevented many bad decisions from ever being made. Historians also noted that we have really been through a series of crises that date back some four decades to when currencies began to float. The Bretton-Woods agreement after WWII did achieve a stability of sorts, but it also set the stage for monetary problems down the line. Who remembers the crises in Argentina, Mexico, or Thailand, or even Enron or Worldcom? Whenever these crises occurred, the response was to add liquidity, which was then followed by leveraging up the debt load. If you look about the globe, there are several economies where the debt loads do not match up with current population demographics. Something has to give.
4)    Another lesson is that no matter how sophisticated our theories or economic models or the software that makes them so proficient, these theories and models have their limitations, especially at the extremes. Three standard deviations are supposed to represent situations that can only prevail about 1% of the time, but the term “fat-tail anomaly” has been heard more times in the halls of academia and in corporate boardrooms than we would care to count. The real world beats to its own drummer, not to the dictates of some theory or carefully crafted model. We have to recognize the extremes when they are upon us and weigh the related risks and opportunities using good old-fashioned judgment. Reliance on sophisticated computer programs to show the way can be a recipe for failure when extreme conditions are encountered.
5)    Lastly is the issue of willful ignorance – “People see what they want to see, not necessarily what is there.” We tend to follow what the experts say, but many of these people studied the same materials, passed similar certification regimens, and are well educated. The tendency is to reach similar conclusions based on the facts at hand, but history shows us that the successful investor is usually the one that thinks differently. A famous quote from George Patton comes to mind – “If everybody is thinking alike, then somebody isn’t thinking.” Analysts and economists are also suggesting that the reliability of current data releases is suspect, and they are not just speaking to data from the Peoples Republic of China. Fed projections of GDP growth have consistently overshot the mark for several years. Is the Fed’s desire to build confidence in the economy overly influencing their data representation methods? Many experts feel that data accumulation processes must be reformed.

What is different this time around in the global economy?

Yes, we are living in confusing times. There are a number of issues that keep coming up in these historical reviews. The following chart illustrates one concern:
Chart of the Day 2
For the first time in nearly two decades, real GDP growth in the U.S. has approached that of emerging markets. Yes, much of this result has to do with central bankers manipulating interest rates, expanding money supplies, and causing mayhem in our global financial infrastructure, but we have not witnessed this situation in some time. Can our service-driven economy pull the rest of the world out of its ditch? How many of you lived through the nineties and can recall how this phenomenon was possible?

In the not too distant past, technology was always the savior when bad times threatened. It is technology that has enabled the greatest redistribution of wealth across the planet over the last fifty years. It is also technology that has created millions of new jobs, while destroying others in its wake, but the issue today is that technology is destroying jobs faster than it is contributing to future growth. Is this situation just temporary, a timing lag of sorts, or is it a permanent condition of this new wave of change? There is also a more disconcerting nature about the financial impact of modern technology on wealth distribution – It actually concentrates wealth in fewer and fewer individuals. The latest projections predict that 1% of the world’s population will control over 50% of the wealth of this world sometime during 2016. Even the IMF has focused on these misgivings.

One final point to be made is that when stock markets suddenly react negatively, the process is not a sudden one. The markets tend to be very volatile, with violent swings in both directions. The following chart presents an historical perspective for our last two “bubble-bursting” periods:
Chart of the Day 3

Concluding Remarks

The last three weeks have shocked investors and awakened them from any holiday slumber that may have set in. Fear is alive once more, and the press is pumping out doom and gloom scenarios to beat the band. Are our financial markets teetering on a precipice and about to crash? Is another global recession on the near-term horizon, much larger and broader than the one before? It was barely a month ago that the tone of articles was positive about prospects for 2016. Recession was only a 5% probability at most. Growth was to be gradual, but steady. The U.S would lead, and the rest of the world would follow.

Suddenly, the tone has turned harsh. A careful review of history, however, may temper the rush for the exits, but investors are jittery. Uncertainty breeds volatility, but that volatility has yet to be seen in our forex markets. Major pairs versus the USD are stuck in tight ranges at the moment, a sign that caution is really in the air. Perhaps, the present condition is a delayed reaction to the Fed’s normalization policy, an aftershock, so to speak. In any event, be prepared for chaos and the opportunity it provides.

Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.

Popular Brokers