The brokerage firms such as Merrill Lynch have conducted a survey among the global fund managers and all have reached a common conclusion: the investors are afraid the most about "Geo-political" crises. The Geo-political crises are namely the shooting down of the Malaysian passenger aircraft over the Ukraine, Israel's actions in Gaza which could create reactions in the Muslim world. While all these have been realized, the spot market has reacted weakly to them. In the derivative markets which provide an insurance against such risks, a complete insensitivity is raging. This insensitivity is called complacency syndrome and the actual mental state has become the threat number one to the capital markets. Complacency is a windfall for the states such as Turkey which are following nonsense economic policies. Bubbles will soon begin to take shape in the world capital markets. Then what could end this complacency and when will it occur?
The world is crawling. ISID's victories in Iraq and Syria are causing thousands of mujaheddin to come to the region and the actions of Israel in Gaza is causing a reaction in the Muslim world with an increasing pace. In such an environment, if a 9/11 type terrorist attacks repeat, one should not be surprised. Also, the ISID which has repulsed the Iraqi army should be expected to undertake an offensive towards Baghdad and Kirkuk in which case, it will create a panic in the Brent oil market.
According to the Western states, the Malaysian passenger aircraft was shot down by the East Ukrainian separatists with the missiles and tactics provided by Russia. Accordingly, we may see the announcements of new sanctions against Russia which will target the energy and financial sectors. Putin will not stand empty-handed; the world is drifting towards a new Cold War.
But the reaction given by the financial markets to the shocks that could potentially change the history of the world is very weak and transient. When the crises abrupt, the markets sell a day or two, and then continue their journey to the peaks of 2014. This apathy is understandable in the spot market. Even if the large funds understand the medium-term risks, they cannot explain them to the customers to whom they are making sales without the reflection upon the economic parameters. Because the "Geo-political" issues are raising uncertainty about the future, one would expect the investors to purchase insurance in the futures and options markets. Perhaps what is happening in the Middle East and Ukraine did not change my expectations of a positive return on shares but I can say that the uncertainty as to my expected return has increased. I would protect my portfolio by buying puts and by shorting the index futures. Furthermore, the premium to be paid for such insurances is historically low. But the investment funds are not tempted by these insurances, and if they did, we would have seen jumps in the volatility indices, mainly in VIX.
That's what we call behaving as if there were no imminent and obvious risks. There are several reasons for such complacency. First, there is the common perception that the Fed and ECB will preserve the the financial system in case of an occurrence of adverse shocks. Second, financial asset prices other than "junk bonds" are not very expensive.Third, the world economy has an accelerating momentum and the investors think that the Geo-political crises will not suffice to curb this momentum.
It is very easy to predict the consequences of complacency. For a few weeks, the S&P 500 and other global stock exchanges will test new highs with the coming of strong sales and profit figures compared to the past. Then re-acceleration of the world economy will be priced in the marketplace. When October is reached, this complacency will turn into a bubble i.e. speculative pricing in the critical financial markets. In October, with the official start of the Fed's exit from QE and/or the heavily indebted Euro-zone states are such a bad shape that not even ECB will be able to save them is understood, a disturbance will begin. As the prices are too high, panic sales will follow in case of a bad news or a slight shock.
Of course, the markets will anticipate this, thus the panic sales may start in September but may be delayed until the end of the year. But one thing is for sure: the result of any complacency has always been a bubble and a financial crisis and in the process, we are now very close to point of no return.
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