For whom Debelle tolls?

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Every now and then something jumps out from the noise of the 24 hour media cycle. This month, we had one of those moments.

Dr Guy Debelle is Assistant Governor (financial markets) of the Reserve Bank of Australia. Essentially, his speech on Wednesday 14 October, presaged a "violent" sell-off in the markets. "Violent" because liquidity is less than is commonly thought. He indicated that people think "they can get out in time" and observed "History tells us that this is generally not a successful strategy. The exits tend to get jammed unexpectedly and rapidly" and "one should never underestimate the role of mechanical rules or mandates" in driving market behaviour. 

Debelle said traders appear to be underpricing risks around Middle East and Eastern European tensions, potential changes in US interest rates, policy uncertainty in Europe and Japan and rising concerns about China's economic health. Why did he make this speech? What is the market data telling us?

The Australian stock market has had a dip, but is recovering (S&P/ASX200: from 5658 on 2 September to 5155 on 10 October, and back up to around 5,450 on 29 October). The US S&P500 has been in a similar pattern during October: down 148 points since 18 September and rebounding 6.6%,  now back to where the index started the month. The VIX (Chicago Board Options Exchange SPX Volatility Index): hit 26.25 in mid-October, its highest point all year up from 10.32 at the start of July. (However, note significantly lower than Aug 2011 when it was at a level of around 43). US 10 year bond yield dropped below 2 on 15 October, falling the most since 2009 and Treasury trading volume reached the highest on record. Bloomberg reports this is being interpreted that traders are dropping bets that the Federal Reserve will raise interest rates in 2015.  Is it due to the weakness in data, geopolitical risk, a turn in consumer sentiment and consumption which is leading to increased volatility? Is it the reawakening of the European debt crisis as Greece, Portugal, Ireland and Italy experience surges in their 10 year bond yields?  Will Mario Draghi and ECB do "whatever it takes"? We can't be certain.  

Alan Kohler wrote on Business Spectator, 15 October about Debelle's speech.

...for five years Europe has been lurching from crisis to despair, but markets have been untroubled beyond annual, short-lived corrections (apart from last year) because of what the Fed was doing. America’s vigour trumped Europe’s pathos.
But now Europe is slipping back into recession and investors are beginning to price in the prospect of long-term stagnation and deflation. That’s what last week’s action was about.
If the ECB doesn’t respond to this by launching QE, and Germany continues to force fiscal austerity on the rest of the Europe, markets will eventually tank and Guy Debelle will be proved right. 

To return to Debelle:

One should always be careful of looking for too much rationality in trying to understand market dynamics.

On the flip side, Ian Narev, CEO of the Commonwealth Bank of Australia,on 15 October gave a list of positives, including:

living in an economy with 22 years of consecutive growth (even though that can foster complacency), the fact Australia still has GDP growth, household savings rates having strengthened, business balance sheets looking good, business credit quality looking good and a government that understands the risks of excessive borrowing. 

We also have state and federal governments committed to spending on infrastructure and a central bank that manages monetary policy "exceptionally well", he says. 

Better than exepected company earnings and signs of a recovering economy in the US have led to good consumer confidence numbers at the end of this month.  Globally, however, signs of economic slowdown and low growth abound.  Sage Advisers continues to keep a close eye on all market indicators and we continually and actively keep clients' risk profiles in mind when advising on their exposures and investment allocations.