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Less Convincing


New York, and much of the East coast, is picking up after Hurricane Irene. While the hurricane itself delivered less punch than it was expected to, it was enough to cause serious disruption in the pace of everyday life – and in the financial markets. New Jersey Transit was inoperable on Monday, which means that most of the Wall Streeters who live in New Jersey probably took it as a ‘snow day.’ Connecticut was hit harder by the storm. In the entire commuting region, in fact, there was a lot of cleanup to do.

So, relieved of the adult supervision, the stock market jumped.

I never know how to think about huge moves on very thin volume when many of the main traders are out. These happen at the end of the year sometimes as well. It is of course a bad approach to pay extra for liquidity when it isn’t necessary, and bid up a market that will probably still be there tomorrow. Are the bulls (in this case; it isn’t always the bulls, though) so impatient to get long that they would lift any price today? The S&P rallied 2.8%, and the NASDAQ – which has more of the smaller stocks that hedge funds like to manipulate into month-end – was up 3.3%. Volume, despite the large gains, was only 870mm shares (and nearly one-third of that came in the final ten minutes).

It may be that bulls are that anxious to get long. Bloomberg today had a headline “U.S. Stocks, ‘Massively Undervalued’ as Gold Gets Bubbly.” The description comes from a report from a little-known firm; apparently, to get on Bloomberg’s “TOP” news you just need to be really strident about being bullish. Now, for stocks to be “massively” undervalued, considering they’re only 12% below the highs of the last several years, this firm must have believed in May that they were already considerably undervalued, and none of the intervening information – weak economic data, the end of the Fed’s QE2, the collapse of Greece, and so on – changed the fundamentals enough to matter. I’m assuming here that “massively” undervalued is at least, say, 30-40%? I suppose that if you think stocks are undervalued by that much, then you might buy aggressively today so as not to miss the rally. Then again, if you think that stocks are undervalued by that much, you’re probably already quite long. From, for example, May.

I do confess to my own sense of frustration, although it isn’t acute yet. Stocks are too strong to aggressively short, and bonds seem to be as well. Moreover, the fixed-income market is coming into the strongest seasonal period of the year, and as a rule I need a darn good reason to get short bonds in September. I don’t have such a reason, although I suspect that 2011 is not going to be typical and we will see rates rise. It’s just hard to position for that right now.

One factor supporting stocks and TIPS, in the short run, and serving as a negative for bonds, is the fact that the ECB’s stance on inflation (according to President Trichet) is going to be “reassessed” by the ECB. Previously, the ECB was tightening into a financial crisis, which was insane (as I pointed out here among other places). While the inflation risks haven’t receded in the slightest, by pointing at headline inflation and saying that they have receded, Mr. Trichet can back off of his prior cuckoo stance and avoid repeating the errors of the 1929-30 Federal Reserve. Earlier this month, the ECB was pumping liquidity into the banking system in the form of LTROs and MROs “as long as needed,” which wasn’t consistent with the hawkish stance of policy; so, it is necessary to adjust the hawkish stance of policy.

All of the world’s major central banks are now providing easy money with inflation on the rise. Let me repeat that: all of the world’s central banks are now providing easy money with inflation on the rise. It is therefore not surprising to me that TIPS yields are only 0.19% at the 10-year point (though that’s too expensive for me), or that equities are having trouble going down since many investors believe that inflation is good for stocks. But I sure don’t understand why 10-year note yields are at 2.27%!

After mulling it over for a while, I think that the rally today is unconvincing. I wouldn’t spend a lot of time mulling it over except for the fact that technically the S&P settled above the high from mid-August, and that suggests further upside. If the S&P hadn’t finished on a technical break, I’d probably be interested in getting short against that level. But a marginal break on extremely light volume is not where I want to jump on board! I may still be proven wrong and see the indices move to new highs, but I still think the low for the year has not been set.

The data calendar is not going to be kind to stocks or bonds. Tomorrow Consumer Confidence for August (Consensus: 52.0 from 59.5) ought to decline to a 10-month low. Of more interest to me is whether the “Jobs Hard to Get” figure (last at 44.1) rises appreciably. If confidence falls, but Jobs Hard to Get doesn’t rise much, then that will blunt the impact of falling confidence. Also tomorrow the minutes of the FOMC meeting will be released at 2:00ET. Since this meeting appears to have been contentious, it will make for interesting reading. Remember that many investors believe QE3 has been effectively promised for late September. I think that the minutes will dent those hopes, and that will tend to steepen the yield curve and drive rates generally higher.

Maybe a tactical bond short isn’t such a bad idea after all.

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Categories: Stock Market
  1. Mike Thorson
    August 29, 2011 at 8:44 pm

    Lighten up, Francis.

    And take off the blinders… The lead headline for about 4 days on bbg was some economist saying there was better than 50% chance we’re headed for recession. So, maybe people are just figuring out that, well, really we’re not in that bad a state as the doomsayers felt a week or two ago. Wall Street tends to be both selfish and schizophrenic…they only care about and trumpet what’s important to them and that changes daily.

    Meanwhile, turns out it aint as bad (nor is it rarely as good) as Wall Street thinks. The bad data of the past quarter is slowly improving, and if you look at interbank rates, the ECB has already eased 50 bps from their misguided hikes.

    And September isn’t all that great a time to be short of anything, as you pointed out.

    • August 29, 2011 at 10:29 pm

      The data over the last week has been generally better than expected 2 weeks ago, and lots worse than expected 1 month ago. So you have the acceleration right, but I don’t think the velocity ever got negative enough. In other words, the market has not yet discounted a 20-30% chance of a recession, and something more like 90% is appropriate. Or, if you like, it WAS appropriate a week ago, and maybe now you’d have to revise your chances to, say, 60-70%. But that still implies a lot further down from here than we ever got.

      It is interesting, though. There’s no doubt that investors confuse acceleration (‘better than expected’) for velocity (‘better than is priced’) repeatedly. Probably a good trading model to be had there somewhere…

  2. Marshall Jung
    August 30, 2011 at 9:15 am

    Correct me if I’m wrong, but China’s central bank is following tightening policies. So, while it may not matter as much as, say, the ECB doing the same thing not all CB’s are easy these days.

    • August 30, 2011 at 6:53 pm

      I very carefully couched my comments to say “major” central banks. According to the IMF (here: http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal) ) the GDP of China is 5.9 trillion. By comparison, the EU GDP is 16.4 trillion, the US is 14.3 trillion, Japan is 5.5 trillion, the UK is 2.2 trillion. (I am not sure if the EU figure includes the UK and the Swiss, I assume so even though they have separate central banks). Moreover, all of those economies have much bigger money multipliers, so the relationship is even more skewed. China can tighten all she wants and it won’t mean much if central banks with 10x the heft are easing!

      I should have clarified what I meant by “major” central banks.

  3. Jim H.
    August 30, 2011 at 9:25 am

    ‘I sure don’t understand why 10-year note yields are at 2.27%!’

    It seems that for the past decade, bond yields have been lower than one would have expected under similar economic circumstances in prior decades. Didn’t Magoo once call it a ‘conundrum’? He might have posed it, but he sure didn’t explain it.

    One explanation might be the giant global dollar recycling loop. But owing to its circular nature, one encounters the same problem as Archimedes, searching for a solid fulcrum on which to base a valuation. The circular process works until it doesn’t, which tells us little except ‘be prepared.’

    Another explanation might be that if nominal sovereign yields roughly shadow nominal GDP growth, then low yields simply reflect lack of growth and investment opportunities.

    Even if one could tease out which of these explanations dominates, the timing for either one to reach an inflection point remains opaque. All one can really do, I suppose, is to watch for outbreaks of ‘bond fever’ — the widespread, unshakable conviction that long Treasuries will RALLY TO ZERO YIELD — AND BEYOND!!!

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