BREXIT AND ECB

As a kid I spent my summers swimming in the neighborhood pool.  It was picturesque in many ways.  My friends and I road our bikes there.  Ed was at the food stand grilling up the juiciest burgers.  An ice cream truck came by ever day.  And there were cute girls abound.  It was a form of perfect I have never found since.  But there was always this problem with the place.

Off in the far corner was the black bottom deep end of the pool, and it terrified me.  Ink black water, swimming and a child’s imagination do not mix well.  Every time I dove into the deep end I found myself waiting for the moment when some monstrous sea creature would suddenly awakened from the depths, latch its tentacles around my ankle, and drag me under without a sound.  I had nightmares about that monster.  Still, I kept going back to the pool everyday.  Girls and juicy burgers.  What else is there, right?

Lately though, I’ve found myself thinking a lot about that deep end.  About the monster slithering around on the bottom, terrifying my little childhood self.  About the dread I felt every time I dipped my toes in that black, murky water.  And I think its because I feel that same sink in my stomach when I swim in the markets today.

Most of you reading this are well aware that we are in the middle of the single greatest economic experiment in the history of mankind.  By saving us from “the End” back in 2008, the Fed has, inadvertently in my opinion, pumped up asset values to unsustainable levels, perhaps creating the bubble to end all bubbles.

But everyone knows this, right?  Still, doesn’t it seem like we’re all just swimming in the deep end, waiting for the monster to drag us under?  What will that monster from the deep be?  Brexit took a sizable bite out of us.  But markets bounced back after a couple of days.  So now it looks to have been a great buying opportunity, at least for the moment.

I think we have to watch out for 2 possibilities here.

1) Will the dominos start to fall?   Will the EU crumble?  Will the citizens of other European nations start demanding referendums, and possibly vote to exit from the EU also?  I think there is a slim chance that we start to see this happening in other countries, namely Greece, Italy, France or Spain.  Now that you can just vote and leave the EU, why would a country like Greece want to stay in??  And if Greece stages a vote, other countries might do the same.  The overall risk, of course, being the crumbling of the EU and the future viability of the ECB.  This seems to be the biggest, badest Monster out there today that could potentially wreak havoc on global markets.

Currently, capital flows around the EU with ease.  But should another country vote to exit, or even bring a referendum, there could be a flight of capital from that country, causing major economic problems to their banking institutions and markets.  If that happens, any country that is viewed as potentially bringing a referendum could also see a capital flight, causing similar problems before they even begin the process of voting to leave.  The ECB would then have to provide the needed liquidity or put Greece-like capital controls in place.  While I think the above is a low probability event, I don’t think markets are properly taking into account that risk.

2) Election Year  –  In 2017 there will be a new President of the United States.  With the increase of violent, extremist attacks around the world (Orland and the airport in Turkey being the latest), terrorism has taken on a new flavor, or has been for some time.  Violent, targeted attacks, conducted by a few rouge agents that inflict serious harm to citizens and disruption to everyday life are the reality we are faced with today.  How will our new President handle this, especially if it were to come to our shores in a more perpetual fashion?

But really, when it comes to things like this, no one knows.  How can they?  All I know is that Brexit happened and the sky didn’t fall.  The sun rose the next morning.  And markets rebounded quickly.  Maybe nothing bad will happen after all?  Maybe we’ll just keep chugging along, blowing up his bubble forever.

That was me being sarcastic, in case I didn’t lay it on thick enough.

The thing about the slithering monster at the bottom of the deep end is that it wasn’t real.  We all do this.  We all have wild imaginations.  Sometimes they keep us up at night.  Sometimes they keep us out of the deep end.  Sometimes they make us sell when we should buy.  Buy when we should sell.

Psychology is a huge part of investing, and that is what this post has been about.  There are imagined monsters out there.  And real ones.  No one really knows the difference until after the fact.

But for me, I’ve been swimming in the deep end for far too long.  Feels like I’m the only one still in the pool.  My skin is all pruned up.  Ed shut down his burger joint hours ago, and went on home to his wife and kids.  The cute girls are all gone.  And I’m cold.  I think the monster at the bottom is waking up.  Time to get out of the water and dry off, my friends.  Let the sun warm me up a little as I lounge poolside.   Maybe I’ll fire up the grill, and cook a hamburger.  Don’t worry, I’ll wait the requisite 45 minutes before jumping back in again.