Consensus Sept15

Financial markets are slowly descending into chaos.  The process began in China over the summer, and has now started to impact Wall Street and other developed markets as the Great Unwinding of policymaker stimulus continues. The problem is that successful investment, whether in financial or chemical markets, requires the combination of

  • A clear understanding of the outlook for the product or asset (the ‘fundamentals’)
  • A clear idea of how the market already values this asset (‘sentiment’)
  • And, perhaps most importantly, the courage to take an unfashionable position and wait for it to work out

It is very difficult to make money over the medium to long-term if everyone has already had the same idea.  But one doesn’t need to be brave to simply follow the crowd and do what everyone else has already done.  This, of course, is a key reason why many investors and companies invest at market peaks, and don’t invest at market bottoms.

The chart above highlights the linkages between movements in the S&P 500 Index (black line) and the Consensus Index (blue) – which tracks market sentiment:

  • Before 2000, sentiment used to peak before market tops, and was a good leading indicator
  • But from 2000, central banks began to destroy the market’s role of price discovery via their stimulus programmes
  • As a result, players began to ignore market fundamentals, and focused on central bank activity instead
  • Thus peaks and troughs in sentiment have coincided with peaks and troughs in the markets themselves

This pattern has become more extreme since the vast central bank stimulus programmes began in 2009.  Companies and investors were convinced that policymakers had become all-wise and far-seeing.  So they only needed to read central bank statements in order to know what would happen next.

But since the summer, people have begun to take off their rose-tinted glasses and started to realise that reality is quite different:

  • In China, for example, the consensus now no longer believes in the published GDP figures
  • It is also alarmed by the failure of policymakers’ attempts to support the stock market during its recent 40% fall
  • Over the past month, similar worries about developed country central banks have begun to surface
  • Thus ratings agency S&P downgraded Japanese government bonds last week, saying not much had yet been achieved by Abenomics

Last week also saw investors start to lose faith in the US Federal Reserve.  It has constantly told investors that the US economy was recovering and that interest rates would increase this year.  But now it has failed to act either in June and September.  Naturally, investors are starting to worry about whether the Fed knows what it is doing.

The problem is that the market no longer knows what policymakers believe about the outlook.  As the Wall Street Journal reports, market insiders had 4 scenarios for last week’s Fed meeting:

  • The base case was “the Fed would keep rates steady but indicate that a rate increase was right around the corner
  • Others believed the Fed “would raise rates but indicate there wouldn’t be any more increases coming for quite some time
  • A third scenario was “the Fed would raise interest rates and indicate more were coming in short order. That was seen as a real outlier”
  • Then there was the most unlikely outcome, that “would have the Fed standing pat and toning down the language on future rate increases

And the last scenario turned out to be what happened.  So suddenly, investors began to worry about how they could have been so wrong.  In turn, this led to concern about how the market is currently valuing different assets.  If the Fed doesn’t know what it is doing, and the economy is weaker than it expected, then have investors overpaid when buying at peak consensus sentiment levels?  This is a worrying thought.

It also highlights the rocky road ahead as the Great Unwinding continues.  Investors now have to start to re-learn how to form judgments for themselves about the fundamentals of supply and demand, and suitable valuations for these. They can’t just trust the Fed, buy Exchange Traded Funds, and sit back to wait for the profits to roll in.

As we have seen in China, once confidence is lost in the markets, they can become chaotic very quickly.

WEEKLY MARKET ROUND-UP
My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments: 
Brent crude oil, down 54%
Naphtha Europe, down 52%. “Demand remained stable and a few cracker operators have increased their run rates as margins remain workable”
Benzene Europe, down 63%. “Given the current macroeconomic bearishness stemming from the recent jitters seen in China, it was no surprise that end-user demand was down, adding more length to the global benzene market.”
PTA China, down 43%. “Textile demand is being be driven by the year-end consumption boost for fibre products, however, total gains may be capped as PET demand would likely start to decline sometime in October”
HDPE US export, down 36%. “Prices slipped a few pennies during the week on sporadic trading, with many buyers continuing to wait for lower prices”
¥:$, down 16%
S&P 500 stock market index, unchanged