There was a time when things were much simpler–when your portfolio and assets were subject to just two primary risk factors: corporate revenues and interest rates, both of which were subject to the supply and demand of the market.
Now, things have changed. It seems as if the Fed steps in to protect the markets every time it gets a sense that a correction is coming. But this interventionist approach created a serious problem: nobody can tell when prices reflect the true value of their underlying assets. The market has become too obscured.
Now, with the Dow Jones having surpassed 24,500, the irony is that although the VIX has sunk to record lows–indicating a significant absence of fear–there are still plenty of risks on the horizon; risks that most people don’t see.
Torsten Slok, Chief International Economist at Deutsche Bank, sees the big picture.
Whereas investors once had to watch out for only 2 risk factors, Slok warns of 30.
Among the risks are rising inflation rates, a Bitcoin crash, a US equity correction, consequences of the Mueller probe, Brexit reversal, and North Korea. Slok suggests we view these risks “not only as potential VIX-boosters but also as potential sources of faster or slower growth than what we have in our baseline forecast.”
Ultimately, this means that even if no single risk balloons into a major crisis, it’s still highly unlikely that our GDP expansion will have enough power to sustain itself into next year.
According to Slok, the biggest concern is inflation, which he feels may spike in 2018. He sees the low unemployment rate, GDP growth projections, and other financial indicators pointing to an inflationary increase. And he’s not alone, as almost every bank including Bank of America, Goldman Sachs, and Barclays have also warned that a spike in inflation would derail any of the optimistic projections they may have held in the past, as such an event would prompt the Fed to raise rates much faster.
In terms of the current geopolitical situation, escalated tensions with North Korea can easily agitate the market’s already fragile state. There are also other international factors that Slok mentioned including the ECB’s announcement of its QE exit, real estate bubbles in Canada, Australia, Norway, and Sweden, and the exit of Haruhiko Kuroda from the BOJ.
But the main question, couched in rhetorical terms, is “are markets ready for a small correction”? The US in particular has not had one in a very long time.
Another way to ask this question: how well are investors positioning themselves at the end of the stock market bubble?
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