What’s going on?
Higgs boson creation. Source: CERN
The “Theory of Everything” was a sweet biopic that came out about a year ago. It’s about how physicist Stephen Hawking and Jane Wilde fell in love in the ‘60s, and how their relationship galvanized him to move forward in his academic career even as his body collapsed. The title is a word-play on the search for a grand unified theory in physics, a single, coherent theoretical framework that could fully explain all the physical forces in the universe. Hawking has been a key player in that search.
In markets right now there’s a search for a unified explanation as stocks around the world are suffering sharp selloffs. One day’s explanation has to be discarded when markets veer in the opposite direction. First, the strong dollar squeezes US exporters’ profit margins, causing equities to go down. Then, a weak dollar is a sign of flagging domestic demand, causing equities to go down. The ECB institutes negative interest rates and the Euro falls. But when the Bank of Japan does the same thing, the Yen goes up. It all seems so irrational. So far, global stock markets are down over 10%
There are several factors at play. Some of them are working at cross purposes—so the markets are responding in different ways. First, the restructuring of the Chinese economy have many concerned that their authorities will have to depreciate the Yuan, putting deflationary pressure on goods prices around the world.
Second, low oil prices—deflationary themselves—are have largely been considered a supply shock. But low prices don’t seem to be stimulating additional consumption. Add to that general weakness in a broad basket of commodities and you have fears that global demand has weakened. Third, fears of generalized weakness and deflation are hitting banks around the world. Fast money went into banks last fall when the Fed raised rates; that money is coming out now the Fed is saying rates may stay lower for longer.
Finally, low oil prices are hitting emerging economies around the world. There are fears that the US economy—currently the strongest in the world—will be dragged down by a global recession. No economy is an island, and as global demand has slowed, US exports have slowed as well.
Crude Oil Prices, Last 12 months. Source: Bloomberg
In physics, there is currently no grand unified theory that explains everything. Star Wars notwithstanding, there is no Force that “ties the galaxy together.” Some theorists think that math and physics are inexhaustible. No matter how many problems they solve, there will always be new problems that can’t be addressed with existing rules. Stephen Hawking has said that this is what he now believes.
That’s certainly the way that markets behave. As soon as you figure out the rules of the game, they change the rules.
Douglas R. Tengdin, CFA
Chief Investment Officer