Focus is on Fed but Europe politics in chaos, Asia tensions high

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The Fed has always been a shortcut for discussions of financial market developments. So, the argument goes, liquidity is drying up for high-yielding assets because the Fed is allegedly poised to raise the federal funds rate by 25 basis points. And then, it's anybody's guess what they will do next.

The price of oil (WTI) crashing to $35.62 on Friday is also seen as an ominous stock market event, despite the fact that the crude's 44 percent decline from the year earlier is a huge bonus to consumers' real purchasing power. That is what some analysts think of a great gift from the Saudis and the Russians, whose onshore marginal production costs ($3 and $13 per barrel, respectively) still allow them to make money while driving high-cost competitors out of the market.

These views are puzzling. The declining demand for high-yielding assets, for example, simply means that they are not offering adequate risk-adjusted returns.

Should we blame the Fed for that? Maybe the Fed will needlessly validate these rising risk expectations. But, so far, the Fed can only be accused of "sins" to come.

Indeed, in spite of the fact that it shrank its balance sheet by $128 billion since the end of October, the monetary base as of December 9 was still $3932.4 billion, almost exactly where it stood at the end of last May. And at the market's close last Friday the federal funds rate was trading at 0.14 percent, only 3 basis points above its year-earlier level and roughly where it opened up at the beginning of this year.

That does not seem to be reason enough to push the S&P 500 down 1.95 percent during the Friday's trading, or 4 percent since its most recent peak at the beginning of this month.

Not the Bavarians' 'person of the year'

Could it be then that investors are worrying about the dwindling customer traffic in Europe's department stores and restaurants during the main shopping season of the year? Maybe they will also worry about huge losses caused by emptying shopping malls last Saturday in Tampa, Florida, Hackensack, New Jersey, and Farmington, New Mexico, in response to bomb threats.

These would be entirely legitimate concerns as terrorist attacks, an intractable migrant crisis, civil unrest, the killing fields in Central Europe, military standoffs in East Asia and EU's radical political changes give pause for thought and keep the hands away from wallets and "buy" buttons on smart gadgets.

Who would have thought, for instance, that in an apparently disciplined and orderly Germany, whose leader extended a generous invitation to refugees and migrants, we would now be seeing violent protest marches and sharply rising approval ratings of a xenophobic and extreme-right AfD (Alternative for Germany) political party?

It is shocking to learn that 70 (as of this writing) law enforcement officers were injured last Saturday (December 12) in Leipzig – that quaint city of Europe's high culture – as moving street clashes opposed thousands of people.

And all that was happening against a background of political attacks within the ruling coalition partners. Social Democrats (SPD) blamed Chancellor Merkel, the leader of the Christian Democratic Party (CDU), claiming she supported the rise of extreme political movements in Europe with wrong-headed austerity policies and an unmanageable migrant crisis.

More of the same is likely to happen during the CDU's conference in Karlsruhe on December 14 and 15. I was stunned to see on German television how the Bavarian Prime Minister Horst Seehofer (a big man and a chairman of the sister party Christian Social Union or CSU) was severely criticizing Chancellor Merkel, who was standing next to him looking down like a scolded high-school student.

The German government is on the ropes; the present governing coalition may even disintegrate well before the general elections in the second half of 2017.

French PM fears 'civil war'

France is in an even worse shape. The country will probably remain under an indefinite state of emergency as it continues to face threats from home grown terrorists. The extreme-right party, Front National, is polling at nearly 30 percent, well ahead of a disoriented Socialist-led governing coalition and a largely clueless right-of-center opposition. The situation is so desperate that the prime minister was peddling the fears of civil war to get votes in Sunday's regional elections.

That is the predicament of Europe's two political tenors who are supposed to lead the continent's economic, political and social agenda.

Investors and more than 22 million of EU's unemployed have to keep saying, prayerfully: Thank God for the ECB. But for how long?

Things can snap at any moment. Hate and distrust is driving European neighbors to cut their railway connections and to protect themselves with walls of barbed wire. There is no peace in Ukraine; fighting continues and its prime minister is manhandled in the parliament by what he called "mentally retarded" deputies. And there is no end to armies of migrants from the Middle East and North and Central Africa as Germany et al. keep arguing about who will call the shots in the name of Western values.

Meanwhile, another fatal accident in the crowded skies of Syria is waiting to happen. Russia has handled a flagrant casus belli (the shooting down by Turkey, a NATO member, of its fighter bomber over Syrian territory) with restraint, but it has warned, with the finger on the trigger, that it will "destroy any threat to its armed forces operating in Syria."

[As I was writing this, the message came over the newswires that a Turkish "fishing boat" was coming straight into a Russian destroyer in the Aegean Sea. The Turks reportedly changed course only after the warning shots were fired from the Russian warship.]

People are talking about the "powder keg" of high-yielding assets in the U.S. financial markets, but they are ignoring the threats where the destiny of the world literally hangs on a thread.

Daily confrontations on the Korean Peninsula and in the South China Sea are another fatal accident waiting to happen.

North Korea's recent claims of having developed an H-bomb are dismissed as mindlessly as Pyongyang's boasting many years ago about its budding nuclear arsenal. As a result, they now have both the nuclear warheads and short- and medium-range vehicles to deliver them. And there are no credible diplomatic efforts under way to disarm North Korea and to bring it into the mainstream of a peaceful and prosperous East Asian community.

Further south, there is arguably the world's most dangerous military theater, because the control of the South China Sea hinges on an apparently impossible Sino-American power sharing.

But, don't worry, we are told: Cool heads will prevail.

That's what people thought until the Turks bombed the Russian airplane.

Now, think of the cool heads we need in the European theater where there are allegedly 200 nuclear bombs pointed at Russia, and an unknown number of Russian nukes ready to respond – or anticipate a nuclear attack.

There is probably a very similar – or even a more robust – nuclear standoff in East Asia.

And then, think of this: Can we expect that there will just be a limited regional scuffle between countries staring at each other with nuclear warheads at the ready?

Investment thoughts

A disintegrating EU and seemingly irreconcilable strategic differences among the key nuclear-armed powers are existential dangers in our investment universe. They are neither dormant nor benign. They are actively invoked because some countries are ready to use preemptive nuclear strikes.

We can only hope that points of no return won't be crossed and, again, that cool heads will prevail. The emphasis is on hope, an entirely appropriate thought in this Holy Year of Mercy.

Or we can ignore all that and focus instead on market implications of a possibly less accommodative Fed and a continuing monetary expansion on the part of the ECB, the PBOC and the Bank of Japan.

That, in fact, has been my main line of thought for a long time. You may wish to do the same thing.

But, whatever you do, remember that as you are reading these lines radically new and destabilizing political and economic events are unfolding in Europe. The Middle East, North and Central Africa and East Asia are also facing new power structures where vital, and conflicting, interests are playing out while the financial community continues to worry about the Fed's impact on emerging markets.