Feb 05/15 – Don’t say there were no warning signs…

2015-02-05 9am EDT  |  #crude #EU #Germany #Greece #volatility

I continue to be amazed at the lack of concern with respect to the crazy volatility we are experiencing across a wide array of different asset classes. The latest gong show is the crude oil market, which in the space of two days rallied over 25%, only to give up 20% in a little more than 24 hours.

Oil should not be having multiple 5–10% single day moves on a consistent basis. There is nothing happening that warrants this sort of volatility. It is not like we are in the middle of a war.

But oil is jumping around all over the place, and it is not alone. Volatility is going up in lots of different financial assets. For example, stock markets are experiencing large range expansions. And these range expansions are not the boring grinding up affairs of the previous couple of years. No, these range expansions are out of the blue quote jerking big moves.

Everywhere you look volatility is going up. Whether it is the forex market with surprises like the Swiss Franc debacle, or even the previously old boring Japanese bond market which recently has decided to hop around like a dot com tech stock.

This expansion of volatility is not a good thing. Volatility is often a precursor to a large accident. Think about all the crashes over the years. Apart from external events like 911, the market gives you a big warning sign that all is not well. That warning signal is increased volatility.

As a trader I love this sort of action, but the investors out there should be battening down the hatches getting ready for the big storm. I don’t know when the storm is coming. It might be tomorrow, it might be next week or it might be six months from now. But make no mistake, this increase in volatility is an ominous cloud that is forming in the distance.

Greece vs. Germany

Yesterday’s late day volatility was the result of a headline from the ECB declaring that they would no longer accept Greek bonds as collateral:


This produced a big knee jerk panic out of risk assets. Of course by this morning most traders have figured out that Greek banks are able to get all the funding they need from the ECB’s emergency liquidity facility. Therefore although this is definitely a warning shot, it is far from a fatal blow. So just like that, the bull stampede into risky assets has resumed with the S&P 500 future regaining all it lost in yesterday’s final hour of trading.

I continue to think the market is overly optimistic about the outcome of this stand off.

I know it is easy to dismiss the Greeks as a bunch of delinquent dead beats trying to milk their European Union neighbours for as much as they can extract, but if you spend the time to listen to what the Greek ruling party Syriza is trying to accomplish, you would be hard pressed to argue that this is merely more of the same. Have a look at the open letter to the German citizens that Alex Tsipras published in a leading German newspaper. This is a definite change in direction from the previous extend and pretend. Although I do not agree with all of their policies, I think that the new Greek government has taken the correct tack regarding the debt. The Greeks are bankrupt. The finance minister has openly admitted it. There is no way that the debts are going to be repaid, so the question is not whether this reality should be ignored and more lent to the Greeks, but instead how do you constructively reorganize your society’s finances?

So far the Germans seem to be taking the hard line regarding the debts. I can’t seem to find the poll, but I read recently that the vast majority of Germans do not favour any debt forgiveness for the Greeks. Ahhh… the irony of Germany refusing to ease the shackles from an unrealistic debt burden is beyond words.

The Germans would be wise to listen to the words from their famous philosopher and think back to the conditions that ushered in the terrible events leading up to the Second World War.

The money that Germany (and the rest of the EU) lent to the Greeks is gone. They can try to pretend otherwise, but they are fooling themselves and merely making the problems worse. The Greek economy has experienced a contraction that is actually larger than the US Great Depression of the 1930s. They do not need more of the same policies. The German solution is not working.

I have been wondering how long it would be before the people rise up and say enough is enough. Inequality is rising across all developed nations. This trend cannot continue forever. Eventually the majority realizes that they are being duped. I know I sound a little like a crazy left wing socialist, but I am merely acknowledging the obvious. This trend of the rich taking an ever increasing slice of the slowing economic growth is not sustainable. Regardless of who you think is right or wrong is not relevant. What is important is to realize that it will hit a tipping point where the trend will reverse abruptly.

We have hit that tipping point in Greece. The government will not acquiesce to the status quo. They were elected on the platform of changing the system. Although other leaders have mouthed these sentiments before (a certain leader whose campaign message of “change” springs to mind), in the past as soon as they have taken power they have sunk into a slightly different version of the previous government.

This Greek government is different. The market has not realized that they will not bend at the last minute. They have nothing to lose and everything to gain.

And as for the Germans, they are stuck with a bad case of sunk cost fallacy. They are fixated on not allowing any more write downs of the debt. And I guess I understand why they feel that way. Once you make an exception for Greece, the rest of the struggling nations will be knocking on the door.

The market is assuming that both sides will compromise. I think the market is vastly underestimating the chances that Greece exits the Euro. Even if I am wrong and someone blinks at the last moment, it won’t be until the markets really freak out. Right now the markets are much too complacent. This will get much, much worse before it gets better.