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It has been a great libertarian idea that Bitcoin could be established as independent currency which could be used globally outside of the central banks’ systems and governmental control. It had all the flows from the start which clearly made Bitcoin unacceptable for global transactions.

Bitcoin had unintended consequence. It begun a new quest by banks, independent fintech companies, governments and above all central banks. The idea is simple. The technology behind Bitcon, blockchain, can be used for a government and central bank controlled crypto currency.


This idea and the dawn of crypto currencies do have the ability to reshape the world not even envisioned by George Orwell or the creators of sci-fi films. The crypto currencies based on blockchain technology could permit the governments and central bankers to exert a full control over all financial transaction and money movements.

This idea is further promoted by the current discussion if physical money, notes and coins, have to be phased out. Electronic payments and finally crypto currencies would take their place. The formal discussion targets criminals and makes people believe that once physical money is gone, crime can be controlled and combated more efficiently. At the current moment the criminals are even able to trick central banks to transfer money to illegitimate accounts.


Anyone who bothers to look at the current credit card fraud, electronic money transfer fraud and direct successful cyber-attacks on banks will realise that crime is part of the cyber age and that criminals have discovered more than one way to thrive in the cyber world. This means that removing physical money would not really impact the criminals.

Control can be exerted with crypto currency. Investors and ordinary tax payers will become fully transparent allowing insight into the behavioural side. Every payment can be verified and followed. The total control over the tax payers freedom will be possible.

The ultimate idea is to create a system which can survive without boom-and-bust cycles. The utopian phantasy depicts financial world with no crises and full macro and micro control of the financial systems.

Banking system as we know it today will stop to exist. Commercial banks will not be necessary to process payments. Accounts could be held directly with the central banks. Investments could be facilitated directly from central bank account via digital connection between two parties without the need for one or numerous intermediaries.


Let us follow this utopian idea till the logical end. Brokers could become obsolete as the electronic platforms based on blockchain could verify the owner of the assets and the purchaser. The transaction would be secure and virtually free of charge. Banks and credit card operations could be largely phased out. The software based on central bank account keeping could easily transact the volumes of payments.

Our financial system would change for ever. Financial sector will do anything to survive and thrive in this environment. Thus not all the efficiencies of the blockchain technology and the crypto currency will come to fruition.



Fed against markets

Now the equity and bond markets are very content in predicting economic demise and the next downturn. Some strategists are very eager to predict an even bigger demise in equities. Some Like RBS are saying sell all equities and hide. The only place to hide could be gold or bonds as properties are already highly priced globally.

Bank of America believes that we are already in recession


Bonds are not really an alternative investment. European yield curve is mostly in negative territory with Japan finally following the European example and falling below zero along the yield curve. Here investor is basically guaranteed to lose money when invested.

Federal Reserve employs enough economists and researcher to publish an incredible wealth of economic papers. It even publishes its own GDP approximation to see if the recession already arrived. The Wall Street claims this is all to no avail as the Federal Reserve appears to miss what the financial markets already know. The recession is here.

GDPNow calculates quarterly GDP basically life and appears to be well correlated with the quarterly GDP number published. Following the latest release it appears that the economy is well and GDP even rising toward 2.5% growth in the current quarter.


If the Fed is wrong a real restructuring of the Fed would be necessary as it is already demanded by some market participants. If the Fed is right and the market wrong the reorganisation of the markets would be the consequence. We shall fallow the upcoming publications on the outcome of the tug of war.

Now there is some more attention as some strategist recognise that there is something amiss.


Markets after all may not always be right. They are prone to numerous behavioural traits which may now come to hunt them.


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Chinese economy talking

There is continued barrage of news and information why this market needs to go down and that it is at risk from China economic slowdown. China is the culprit which is commonly understood to be over-debted and heading for a major economic disaster.

History is a good guide to ponder. In 1990 Japan collapsed and is mired in economic challenges since. The Fed funds were at 9.75% and inflation above 5%. US exports to Japan in 1990 were 0.8% of GDP. Today exports to China re around 0.7% of GDP. China’s economy has relatively the same size compared to global economy as Japan back in 1990. The size will change as chine continues its devaluation policy.

China is clearly in a transition. A very swift transition and a transition which possibly has not been experienced by any other country in this magnitude and speed ever before. Industrialisation and industrial production are approaching saturation. The growth levels need to slow down.

Now is the time of the consumer. This is a time when services will gain economic importance and industrial production will lose relative value.

Transition is not easy and transition is mired in traps and trepidations. It is never smooth and it need to be understood and accepted.

At the moment investors are having issues with the current transformation. China was and is the production hub for the world. We all get used to view China as a fast growing economy based on industrial production feeding the world all the cheap goods which the consumer in the industrialised countries long for. From Apple phones to clothing.

Now China changes to the global consumer. Chines cities are populated by millions of consumers who now turn their attention to electronics, better food, healthier living and entertainment.

This clearly changes the economic dynamics of the country and will do so for years to come. The following chart shows major changes. Investor are worried about the slow-down in manufacturing (black line in the graph). At the same time PMI services (red line) are very strong and positive. Today the new published number shows a 6 months high.


Caixin China Manufacturing and Services PMI

China PMI 2016-02

Source: Bloomberg

This graph shows clearly the divergence between the perceptions of industry focused China and the reality. Services are winning ever bigger share of the economy and appear to me grossly underestimated by the global Investors.


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On the first days of the year it is an interesting exercise to look into the murky crystal ball and try to figure out what could go wrong in the coming 12 months. Following I will attempt to single out couple of low probability events which none the less have a great impact on the markets.

Surly not many investors did expect that the year 2015 will be the year of central banks which surprised us too many times. But will 2016 also be a year when central banks will surprise us positively but hopefully not negatively. Surly central banks will remain in the spot light.

  1. Federal Reserve could reverse the interest rates increase which it fought for nearly a year to advertise and implemented finally in December.
  2. ECB will be forced to increase its efforts to fight inflation as weak Euro and QE did not make it happen. Not to mention if Euro should strengthen.
  3. The last 2 years were greatly impacted by falling oil prices. Despite strong expectation that the global economy will follow soon, very little happened. The falling oil prices were not driven by exceptionally weak demand but by exceptionally high supply. The balance between supply and demand in 2016 could shift gradually leading to higher energy prices. Oil could rebound back toward 60 USD.
  4. Current rising tension in Middle East have been largely neglected as economic influence. There has been a general consensus that tension in this region could potentially lead to higher energy prices. An open conflict between Saudi Arabia and Iran could actually lead to higher prices. This would additionally support the scenario 3. On the other hand defence spending globally could lead to government spending beyond expectations. Government spending in Europe increases dramatically as European countries try to cope with security issues ranging from terror threats to refugee crises.
  5. Security issues, Middle East and refugee crises are a leading political subjects in the upcoming US election. A surprising outcome could see Mr. Trump winning the election which would impact US and global developments well beyond the 2016.
  6. Many of those developments would have a profound impact on the global currencies. Investors are focused at US-Dollar strength. This could however be the great surprise if US-Dollar weakens toward 1.20 or 1.30 against Euro
  7. Looking for particular spot on interest rates surprises. Negative interest rates are not a surprise any longer. The only surprise could come from other countries like Japan or US. Japan continues to print money and QE has been intensified with the new announcement in December 2015. If Federal Reserve would need to lower rates during 2016 a new scenario could materialise which would drive rates especially on the short-end of the duration toward zero or even into the negative territory.
  8. Finally equity markets could return very positive performance for 2016 in. Not easy to see but a confluent of events could bring what investors do not expect. Most expectations are focusing on weak commodities, strong USD, no inflation, central banks running out of bullets, China economy slowing down or even imploding, high yields seen as harbinger of disaster upon all the commodity sector. All those worries remain and impact the financial markets currently. If those worries do not materialise equities will receive the much needed breathing space.

It will be a very interesting year 2016 and in December I shall review all those possible surprises.


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Unexpected events change often the fate of the world and financial markets. Investors’ expectations are currently even stronger anchored then before. Especially central banks do have the tendency to move markets. Either by design or chance.

The recent ECB decision might have been one of the occasions where a well laid out path had to be altered. The alteration had some short-term unintended consequences. The long term consequences are more predictable.

The simple alteration make the predictability of the outcome even more perilous as the anchored expectations have been directly impacted. The unhinging of expectations had a very violent and profound impact on the financial markets.

ECB continues to print money as before. The QE continues and was even extended till March 2017 with a possibility of further extension. This was the good news. The market expected more. A bit like addict who needs a new impulse to take him to a new level.

Now even lower rates are a bit in doubt. The Swiss experience may not be realised after all. The inflation is not here to be seen but economic dynamics are improving. Even credit action in the European Union is picking up. Over all some more QE paired with better fundaments are not a bad combination.

However, the subsequent market reaction did change – at least in the short-term – the general picture treasured by so many Investors altered. Weak Euro, weak energy and by definition also weak commodities leading to a weaker Emerging Markets and weaker Emerging Market currencies.

As the subsequent charts show the Euro suddenly does not play by the rule. It begs the question is it just a short term aberration or fundamental change. Stronger Euro has been related to stronger oil and commodity prices in the past. The unanswered question is which is the fundamentally leading variable.

Euro vs. Oil daily Chart

Euro Oil 2015-12-09

Source: Bloomberg

JP Morgan Emerging Markets Currency Index vs Thomson Reuters Commodity Index

EM FX 2015-12-09

Source: Bloomberg

Relationships do not break overnight. The following days and weeks will show if the relationship actually fell apart. This would cause some major changes to the strategic asset allocation. However, if the relationship remains the implication will be even more interesting.

Either the Euro will need to weaken again or the commodities will rise. If this happen it is very much likely that EM currencies and EM equities could follow. This would clearly be also a large surprise to the markets.


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The heat is back on that following September inaction the Federal Reserve decided to move on with interest rate increase announcement for the coming December.

This has been taken by the market at the face value and at least for one day investors are convinced that we are finally heading toward an initial lift off.

The discussion rages on if the labour market is too tight or not. Depending on the argumentation the relationship between labour market conditions and the wage pressures can be either very strong or non-existent.

If there is no relationship between lower unemployment and the wage pressures, the Philips curve is not working. This would implicate there is no translation of higher employment into higher wages and higher inflation. See the following link:


NBER argues that the relation exists and tighter labour markets will lead to higher wage growth – real and nominal – and finally to increasing inflation pressures. See following link:


Depending on the camp Federal Reserve would need to increase interest rates immediately to protect the economy from inflationary pressures or refrain from it for a long while.

Following from the various Taylor Rules which are used the current Fed Target Rate should be somewhere between 1% and 3%. This could clearly indicate a continued tightening once Fed get the cycle going.

However, the relationship between unemployment and wage growth may not be what it used to, due to the change how employees are remunerated. The major change can be due to bonus and stock payments which are not part of the current calculation of the wage growth.

A growing proportion of the remuneration in the US economy is derived from bonus and stock options/payments especially due to the growth in the service industry, IT, internet and technology.

There is a chance that US interest rate cycles are not driven by inflation and wage pressures whatsoever. Our work shows that since 1970 interest rate cycles were closely aligned with the employment ratio.

As employment ratio increased so the interest rates followed. Currently the employment ratio started to increase in 2013. The interest rates did not follow.

It may be now time for the Fed to drop “inflation” from the wording and focus like in the past on employment ratio.

December looks increasingly like the start of the new cycle.

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Cyclical move in gold

There has been a lot of deliberation if a new bull market begins in gold.

A very tempting idea since fewer and fewer investors are interested in gold investments. There is clearly a continued interest in gold coins but the general attitude to gold investments has changed temporarily.

Central banks continue to print money as economic growth slows down globally. The cautious attitude toward the paper currencies deepened over the last 6 months as emerging market currencies depreciated dramatically in some cases.

This event, however, did not encourage any major added demand for gold, which has been seen by many as a long-term hedge against the currency depreciation and central bank money printing.

Now that the equity markets corrected from their highs and emerging markets were shown the red card from investors’ gold appears to be gaining some ground. However, the capital flows into the gold ETFs have not been dramatic.

There was not widespread call to reallocate assets away from equities into gold. Most investor did move assets away from equities and bonds to money market products and short term investments.

Nonetheless gold experienced a good cyclical move off the lows prompting calls for the end of the bear market and a turn toward a bull market.

Gold price weekly

Gold 2015-10-16

Source: Bloomberg

The chart shows clear downside trend channel which exists since mid-2013. The recent retest of the channel bottom around 1100 USD per oz. called for a temporary cyclical rally possibly toward the top of the range around 1250.

This would obviously be an ideal picture which would confirm the channel in place and the continued persistent downward pressure.

The cyclical moves in the price of gold show that the secular price erosion continues as long as there is no clear bottom to the current long-term price descent.



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Car manufacturer

Following the recent scandal around VW’s manipulated software there are many questions about the health of the European car industry and the future. The possible fines which has been calculated by various sources could bankrupt VW or at least strategically cripple the company in the long-term. This could clearly lead to some unparalleled destruction of value not seen since BP’s environmental scandal or Enrons account fraud.

It is clearly not easy to debate when the price of the company did already discount all the bad news and the bottom of the valuation range is reached. Particularly in cases like VW where there is very little past experience how such a scenario could work out. Additionally, there could be some substantial collateral damage on the various suppliers particularly in Germany. Thus it is not real great surprise that investors are reluctant to pick up the broken pieces. As more companies in Europe are dragged into the event the uncertainty grows. Particularly as for most investors it is difficult to shift through the barrage of news supplied overeagerly by the press. The feeling is that all car companies are involved and there is no place to hide as the car manufacturing in Europe appears to be tainted for a long time by the environmental blunder.

Single stock pick can be very difficult in such an environment but some clear issues can be still distilled.

People will continue to buy and drive cars

Diesel may be hit but not destroyed

New hybrid solutions could become the choice over diesel in the medium to long term

Any market share lost by VW in the wake of the development will be picked up by other manufacturers.

European car manufacturers will continue to be important in the overall context

Stock picking in Europe will be more difficult in the sector.

People looking for exposure could turn to diversified ETFs for an exposure to the now badly bruised car sector. It is not easy to fish in muddy waters at such an important junction for the whole car industry. There will be winners rising from the rubble.

STOXX 600 Automobile and Parts Index weekly Price

SXAP 2015-09-30

Source: Bloomberg


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VIX to show the way

Volatility picked up as markets are being caught between China and Federal Reserve. China surprised the world with more flexible currency policy. The Fed may surprise markets independent if they do or they don’t increase interest rates. It is a greatly difficult situation for the Fed. Catch 22 may be the best description of the current situation. If interest rates are going to be increased than markets may be spooked if they are not the same will happen. This is the uncertainty how the Fed will respond to a sudden unexpected development which might have a direct impact on the US economy. The degree of the impact cannot be estimated with any degree of certainty as the models do not exists and all new models will have no historical data to work with.

Let me assume that at the current moment we do not head for a 2008 style event which would bring a recession and a major historical market correction. Barring such a profound event it appears that we are back in a market environment which has been here back in 2011.

During the recent sell off in the market various volatility developments reminded of the 2011 market event. Although the market correction in 2011 was much higher than recently. Nonetheless the volatility on a lower percentage correction was equally large. In 2011 the correction from end Juli into August low was 17%. At the same time the recent correction from 18.8 till 28.8 was 11.2%. In both respects the volatility measured by VIX spiked to 48 and 41 respectively. In the past this level of volatility has been associated with important market lows even in a profound bear market like 2001 and 2002.

S&P 500 Index and VIX Index

VIX index 2015-09-09

Source: Bloomberg

Backwardation is playing out. The VIX forward curve has been inverted as strongly as during any market correction bar 2008. This means that investors has been very busy protecting the downside risk. Much stronger than during the past when compared to the market correction.

S&P 500 Index and VIX backwardation

VIX back 2015-09-09

Source: Bloomberg

The market action today appears to verify my finding but nonetheless it is an interesting lesson about oversold conditions and crowd psychology.

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Get ready to buy

Now we are back in the volatile equity markets predicting the next big correction. As the following chart shows we had numerous of those predictions since the bull market started back in 2009.

S&P 500 Index weekly chart

SPX weekly 2015-08

Source: Bloomberg

There were few important corrections:

2011 as the European financial crises intensified and the Euro crises was pronounced to begin, folloed by US credit Rating downgrade

2013 worry about the end of QE in the US and the uncertainty related to monetary expansion

2014 in October Fed exits QE3 and pronounced that next interest rate cycle will begin in 2015

2015 Greek financial crises and Chinese economic worries

Each of those events lasted but a month and the recovery took less than 2 months. The equity investors did not get their way and the next lag higher developed. Now the bull market is proclaimed dead and the new bear market should unfold. The reasons are well documented. However, let me explore what could go wrong with the current picture.

First of all the sentiment is extremely negative. Depending on the sentiment indicator used nearly all of them are at some extreme level, with put/call ratios or bull/bear ratios already at extremely elevated levels. The CNN Greed-Fear indicator which pulls together few of the most popular measures show extreme pessimism.


Markets usually do not enter bear market territory based on profound skepticism.

US Dollar begins to soften as markets discount the possibility that interest rates may not rise in 2015. Central Banks globally did not even begin any tightening and the Fed may refrain from it altogether. Bear markets are generally caused by capital constrains and monetary tightening. None of this is visible and the old saying still has it validity “never fight the Fed”.

Bonds are also an area which has been abandoned by investors. Gold has shown some signs of life as few astute investors made it very public that they invested heavily into the yellow metal. The current exodus out of equities appears to be moving to cash. As equity market sell-off continues investors move from equity to cash. It is estimated that some 8.2 bn USD abandoned equity funds and seek shelter in little profitable money market funds.

In the face of little or no return in the money markets funds and profound negative sentiment the equity market sell-off may not last much longer and any further exaggeration offers a good entry point for new investments into equities.

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