The World Can No Longer Ignore These Threats

As the world reels from the barbarous, but all too predictable, terrorist attacks in Paris on Friday evening, markets will also be trying to regain their balance after a difficult week. What the Paris attacks have in common with last week's market losses is that they both disabused observers of the illusions that they can continue ignoring the consequences of political and policy weakness.

Just as Western nations can no longer shrug off their borders or the fight against ISIS in the Middle East - imagining this will be sufficient to wipe the scourge of jihadist terrorism from the face of the earth - investors can also no longer fool themselves into believing that markets will defy the reality that debt-engorged economies and companies will not be able to grow.

As painful as last week's bloody reality checks were, the sooner citizens and investors use them to demand changes in how their societies and economies are managed, the better off they will be.

The Global Economy is Simply Slowing Down

The surprisingly strong October stock market rally is now going up in smoke. Last week, the Dow Jones Industrial Average lost 3.7% or 665 points to close at 17,245.24 while the S&P 500 dropped 3.6% or 76 points to close back in negative territory for the year at 2023.04. The Nasdaq Composite Index lost an even greater 4.3% to finish back below 5000 at 4927.88.

The main culprit behind all of these losses was the continuing collapse in commodity prices. The bottom dropped out of oil prices with WTI crude ending the week down 8% at $40.74 per barrel. Most likely prices will be in the $30 range shortly. Copper and aluminum prices also plunged to more than decade lows, vaporizing any hopes that China's economy is stabilizing.

The markets were also battered by weakness in the retail sector. Macy's (NYSE: M) reported numbers that were far below consensus expectations, pushing its stock down below $40 per share from its July high of over $72 per share. CNBC will have to find another company to run informercials for this Christmas season after hawking Macy's for the last couple of years.

Nordstom Inc. (NYSE: JWN) followed up with similarly terrible news and its stock tumbled as well. It is increasingly clear as I have been warning all year that consumers are not spending the money they are saving on lower gasoline prices at the mall. Instead, they are using that money to deal with higher healthcare costs and to pay for the higher prices of everything else they need to live. Only the Federal Reserve thinks there is no inflation. Those of us who reside on Planet Earth know better.

The Fed Will Have More Excuses Now

The high yield bond market is also a shambles. After rallying in October, high yield bonds are busy giving back all of their recent gains in November. Before Friday's stock market rout, the average yield on the Barclay's High Yield Index (NYSE: JNK) had already moved back to 7.81% and the average spread was back to 579 basis points. Most likely they will soon hit 8% and 600 basis points again, respectively.

Liquidity conditions in the market are nothing short of horrible. The returns of large credit funds are, for the most part, terrible this year - Though they are not as bad as the returns of large equity hedge funds which continue to sink into the red with every passing day.

Facing this backdrop, it is increasingly likely that the Federal Reserve will not raise rates in December. With the dollar hovering at a 13-year high (the US Dollar Index (DXY) closed the week at 98.80), commodity prices plunging, stock markets in reverse, the Purchasing Managers Index (PMI) at 50.1 and economies around the world faltering, raising rates in December would do more harm than good.

The time to raise rates has long passed. The October rally was fueled by hopes that central banks would once again come to the rescue of markets. The economic data is telling us that markets are beyond saving.

Add to that the Paris attacks and markets are likely going to see further stress. Investors should behave accordingly and reduce their equity holdings immediately. We may be about to retest the September lows.

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About the Author

Prominent money manager. Has built  top-ranked credit and hedge funds, managed billions for institutional and high-net-worth clients. 29-year career.

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