Now that we have had a day or so after the Dubai “default” announcement let us have a look at how markets have taken the “storm in the desert”. Let us be frank, we have absolutely no inside knowledge when it comes to Dubai. Furthermore, it goes against our grain to speculate on what might or might not happen. All we can do is look at how the market is reacting and try to understand what the market is telling us.
We have been rather surprised at how “Dubai” has gripped the world over the last few days. It seems everywhere or every-which-way that one turns there is “expert” commentary on the Dubai Default. We cannot help but feel that most if not all of the default is already reflected in the prices of securities globally.
It seems that everyone, including the U.A.E, is painfully aware of what happened after Lehman’s “default” went unchecked. We suspect that the powers that be in Abu Dhabi know that they possibly have as much, if not more, to lose if Dubai World actually defaults (remember for the time being at least they have not defaulted). We have no idea of what deal Abu Dhabi and Dubai will strike but know that the deal that will be struck will be one that saves Abu Dhabi and by “default” will save Dubai and world financial markets from a melt-down.
While every man and his economist would have you believe that the Dubai Default is an enormously bearish thing and the one event that will ultimately prove to be a tipping point for world markets……….world markets themselves are not really taking the Dubai Default seriously. Yes let us have a look at how US markets reacted to the news on Friday:
- The Dow closed down by 1.5% but closed well off its morning low. A fall by 1.5% is far from being out of the ordinary. In fact the Dow has fallen by more over the last few months on fundamental data such as employment reports etc.
- The Russell closed 2.5% lower, but as with the Dow rallied well off its lows…….and don’t forget a 2.5% fall in the Russell is not serious, a fall of over 5% is!
- Europe fell hard on Thursday but rallied back on Friday.
- Emerging market bonds (PCY EMB) and Junk Grade corporate bonds (JNK HYG) fell by less than 1% after a strong comeback rally after the opening. Again this behaviour is totally inconsistent with a market that is taking a default of this magnitude seriously. We were expecting that these ETFs would have fallen dramatically (well in excess of 3%)…….
- Commodity markets were somewhat unchanged on the day after a big comeback. OK yes the ETFs DBC and DJP did fall by 1% but that is nothing outside random noise! As of midday in Asia commodities are up well over 1%.
- US Treasuries (TLT) rallied but again the movement of 0.37% was not what one would have expected given the level of “risk aversion” commentary in the media.
- Emerging market currencies (CEW) fell by 1.2% against the USD, again they rallied strongly after the opening and a fall of 1.2% is hardly “panic” behaviour for emerging market currencies.
- The USD Index advanced 1% but this was well down on its intra-day high, again so much for a flight to safety!
- As of writing on Monday afternoon Asian time Asian stock markets are up strongly along with the Aussie and Kiwi dollars, pegging back most of their Friday losses, again not what you would expect to see if markets were genuinely bearish.
Here are our 8 charts again……we think that all the macro trends at play right now are nicely wrapped up in the following 8 charts. We have drawn our battle lines……….above the line = bullish, below = bearish. Of course you may see things from a different point of view and needless to say, that is what makes a market. Do you see any change in trend?
Over the last few months we have seen the market react more aversely to employment data or even a negative earnings report from a mid-sized company – in short the market does not seem to be taking the Dubai Default too seriously. Could things get a whole lot more serious…….could this really be the tipping point for world financial markets? Yes it could, a “wholesale” breakdown in emerging market currencies(CEW), junk grade bonds(JNK), small cap stocks (IWM GWX EWX), and emerging market bonds (PCY EMB) would spell disaster for the bulls…………but until then, until we see enough evidence to the contrary, we maintain the bullish course and conclude – this is a storm in a tea-cup!
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