We concluded our last “Rear View Mirror” suggesting our readers to allocate a greater than usual portion of money in cash. Considering cash instruments as a valid asset class to invest in, has been some of the best advice that we provided. Surely it is not the cheapest one since we are living in a negative interest rate world, but at least it allowed us to save some money. We have limited our losses from one of the worst stock market sell-offs since the financial crisis of 2008. To sum up, the price for a barrel of OIL fell from 37 dollars in early January to a low of 26 dollars in February. On the other hand the 30yr US Treasury yield and the 10yr UST yield fell respectively from 2.95% and 2.2% in early January to a lows of 2.49% and 1.66% in February. All major stock markets were trading in official bear markets.On February 11 the Euro Stoxx50 closed at 2680.35 points, with a loss of more than 30% since its 2015 high. The MSCI World lost 20% from its high rather than the major US indices were the notable exceptions. They resisted in entering in a bear market correction.
We are approaching three decisive meetings in March: the market is expecting further easing from the ECB (10 March) and BOJ (14 and 15 March). Regarding the Federal Reserve (15 and 16 of March) it is reasonable to say that March is still off the table. Looking forward, June is still on the table but not likely. The latest jobs report, on Friday the 4th of March, have shown 242’000 jobs were created in February, with a higher revision (+30’000 jobs) in January. As former Philadelphia FED President Charles Plosser point out after the report, the next hike, whenever it comes, could be 50bps. This could be in line with a stabilization of risky assets, a lower volatility and Oil has progressively rebounded back above 36 dollars per barrel.
Of course we are not completely bullish, but at the same time we cannot disconnect our logic. Furthermore we cannot be affected by myopia when we are going to decide our asset allocation. The main objective is still to preserve our capital. As suggested during the two last months, we offset a potential market correction by entering long in a volatility trade and, by staying long cash. May be now is the time to go long inflation. The movement into the 5yr5yr forward inflation expectation has been already strong and consistent with the scenario previously described. The rate was trading at 1.42% on February the 11th and reached 1.70% area by the end of last week. Whilst I am writing this issue of the Rear View Mirror, the BIS (Bank for International Settlements) has came out with its quarterly review. Claudio Borio, head of the monetary and economic department at BIS, warned that the narrowed range of tools which central banks can offer to resolve sluggish growth could be inconsistent as interest rate are persistently stuck in negative territory and the existence of the unsustainable debt burdens. All point to a “gathering storm”.
I strongly believe that now the market is testing the central banks credibility. The risk is that market players could react badly and contrary to policymaker expectations. We can switch into a world where monetary policies and central banks could potentially become the problem and not the cure. To summarize since I believe market timing is everything, I suggest waiting for the ECB and BOJ outcomes in order to play a high conviction trade. Being long on inflation could be negatively affected by lower yield if the ECB first, and the BOJ later, are going to deliver something that the market is not expecting yet. A wait and see mood as the FED is doing, is the best advice right now.