The tail is wagging the dog: Gluskin Sheff’s George Young explains the 2016 market turmoil

Markets have see a bit of a rally since mid-February.

If you are a frequent city driver, you’ve learned to calculate traffic flows to obtain where you need to go. But imagine that the direction of all of the one-way streets was suddenly reversed, causing bottlenecks, even car accidents. It might be chaotic.
Eventually, however, commuters would adapt and a brand new steady state would form.

Like traffic patterns, financial markets are driven by movement as well – the movement of money. Actually, the path or flow of cash through markets is paramount. Sometimes, this flow gets blocked, pressure builds up in the system and eventually we need to visit a rewiring of the financial flows to reach a brand new steady state. This is what is going on now.

There isn’t any denying the violent repricing of financial markets in the month of January and the early a part of February. What’s been remarkable about the price action wasn’t just its relentless nature, but the insufficient a simple catalyst from either the micro or macro story. As such, the moves in financial markets were greatly divorced from the incremental news flow from the real economy.

Certainly, the global economy isn’t growing significantly, but the incremental data released during the period of early 2016 weren’t alarming and they were also consistent with the overall picture in November and December: a slowdown in the U.S. manufacturing sector because of strong currency headwinds, offset by a very healthy consumer sector; the prospect of slowing growth in the Chinese economy; and continued healing in Europe supported by accommodative monetary policy.

And the earnings picture, while not spectacular, was sufficient and would not seem to warrant the negative price action in equity markets.

It’s remember this that the finance industry is there only to serve the actual economy and should be controlled and affected by it. In a normal world, the financial markets do not drive real economic outcomes and lower oil costs are a good thing. Yes, there are winners and losers, however in an ordinary economy, the easiest way to increase value-added production would be to lower input costs. Hence, lower oil has to be good on balance for the greater real economy.

But we are not inside a normal world. In our current world, the tail wags the dog. The economic climate is becoming so large and so intertwined in most aspects of our activities, the markets drive real economic outcomes. As well as in the past 10 to 15 years, the financial system has evolved and grown with different key input – rising commodity prices. As a result, all of the financial flows and channels have been created based on money flows driven by commodity appreciation. Much like our example of traffic patterns, the system has been designed around specialized financial flows that have run in specific directions for years.


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