“We are a people who do not want to keep much of the past in our heads. It is considered unhealthy in America to remember mistakes, neurotic to think about them, psychotic to dwell on them.” - Lillian Hellman (1905-1984)
Simple Concept - Complex Reality
Taking out large bank loans, deciding to bail out institutions, covering up and delaying previous losses, betting on complex products, or blindly investing in misunderstood instruments, leads to some sort of ugly outcome. Similarly, when governments borrow a lot the same principle holds true. Those are simply the basics, however, most fail to agree to accept or focus on mistakes. Plus, simple concepts are not so easy when considering complex political systems and agendas. Clearly the Eurozone is stuck debating the postmortem of failures, and deadlocked Washington illustrates this point further when short-term reelection efforts overshadow reasoning. Even the Federal Reserve is split on interest rate policies. Awkwardly enough, politicians are trying to reform the role of the central bank in a period where the government’s role in business is a contentious topic. Somehow the simple concept of borrowing and repayment leads to chaotic responses of all kinds. Perhaps it takes time to realize, accept and make sense of bitter facts.
At this point, we should mostly go beyond the ‘recognition’ phase, as a collective acceptance of mistakes is not as easy as it seems. Greedy and reckless practices are evenly spread across policymakers, regulators, investors, and consumers alike. After all, any seasoned money manager knows to contemplate mistakes rather than boast about two or three amazing trades. As markets teach us, one or two themes end up being cycle winners over the long-term (i.e. owning Apple shares, betting on declining rates and going long on Gold). Catching waves, like any simple concept, appears very difficult to time and execute.
In contemplating excess debt issues, some would argue that risky bet troubles are abated by issuing warning labels. Perhaps the words “risk management” are overused and grossly misunderstood or applied. Typically in bull markets, basic common sense appears blurry and is clearly a reoccurring human trait. The unfolding drama of a collapsing market ends up being a valuable lesson on “risk,” especially for those building new economies and gearing up for new cycles or financial systems. After all, the last three years provided basic lessons on the use of leverage, understanding inefficiencies in rules and systems, fragility of financial institutions and importantly how intervention is unavoidable.
Early Hints
The message from active markets today is to risk moderately trading at a discount, while fear is not as pricey as before. It is hard to visualize it this way, but if the playing field is not disrupted and financial institutions do not collapse then cycles would seek bargains through purchases of shares at cheap prices. The results from the current earnings season can refute or confirm the much discussed hazy macro environment. This upcoming week 1/3 of S&P 500 companies will showcase where they stood last quarter versus expectations. After several irrational trading levels and patterns this summer, quarterly results can provide a better read on market pricing. Thus, it is not an accident in the last two weeks, where participants repositioned investment ideas ahead of a long-awaited sentiment shift. In fact, October 4th marked a peak for volatility which has declined gradually. Similarly, that same day marked a bottom for US 10 Year Treasuries at 1.71%, which showcases a mild shift away from safer instruments.
The Search for Good
Typically markets find a way to constantly seek "good news" while remaining at times overly sensitive to bad news. Now, the hopeful are waiting for the European resolution combined with the jobs bill as well as bigger initiatives by the Federal Reserve. All this reflects anticipation of results or causes that spark good outcomes. While typically the argument of historical charts state that US equity markets end up higher. The common thought has been severely challenged in the ‘lost’ decade and potential system breakdown. Buying cheap is a familiar point that has backfired in previous months as the usual buyer revisits their luck.
On valuation basis, fundamentals appear favorable for buyers; for example, when looking at earnings yield. “The S&P 500’s earnings yield is 7.5 percent, close to the highest level since 2009.” (Bloomberg, October 17, 2011). Relative to other asset classes, buying stocks is not as bad when considering the low rate environment. That may work if earnings actually moderate and showcase some stability. In terms of inflation and interest rates, both are expected to stay low based on the recent Federal Reserve message. Now, looking into 3-5 year projections, this might change while surprising us with high inflation; but, most are focused on trying to survive the next few weeks.
The S&P 500 index turned slightly positive for the year as this feeds into the growing appetite for a year-end rally. Interestingly, the Nasdaq 100 is few percentages away from making 10 year highs. Two major sell-offs in spring and summer, reflected weakness of all sorts but indexes have an illusory feel to them. The buyer appetite is looming as early evidence of momentum picks up. “77% of S&P 500 stocks are now above their 50-day moving averages, which is the highest level seen since the April highs. Bulls have been waiting for a nice expansion in underlying breadth for confirmation of a rally, and now they seem to have it.” (Bespoke Investments, October 14, 2011). Yet many wonder if bad news is fully digested or merely tiresome. For example, Spain’s credit rating downgrade did not affect the market that much since it was the third occurrence in the past three years. The optimist will argue that we’ve been battle tested and bruised at this point. Rehashing false optimism is not that surprising, rather the duration of mild cheerfulness is the rewarding mystery.
Article Quotes:
“The Government Debt rose over $5.5 trillion since 2008, but the Private Debt declined by close to $5 trillion during the same period of time. This is the first time since the Great Depression that private debt declined at all-even a dime. A significant part of Private Debt came from Consumer Debt where the revolving and credit market debt declined about $140 billion (from $2.6 tn. to $2.45 tn. ) and the total household debt declined from $14 tn. to $13.3 tn. ……We find it incredible that there was not one quarterly decline in household debt since 1952 (as far back as we could find data) until the third quarter of 2008 from where we've had 12 consecutive quarterly declines. We didn't even have one quarter of decline during the worst recessions since the Great Depression (up until the recent Financial Crises in 2008) in 1973-74 and 1981-82-- NOT ONE!! During the period from the year 2000 to 2008 household debt rose from 68% of GDP to 100% of GDP. But, since the 3rd quarter of 2008 we had 12 consecutive quarterly declines as total household debt declined by almost $1 tn.” (Comstock Partners, Inc October 13, 2011)
“Qu Hongbin, chief economist for China at HSBC, said in a research note that the debt crises in the US and the eurozone had dampened global consumer confidence for Chinese goods, leading to a slower expansion of the nation's exports. In the first half, exports contributed nearly zero to the growth of China's economy, while gross domestic product (GDP) rose 9.7% in the period. GDP may grow by 8.5% to 9% this year, and stay at that level over the next few years, Qu estimated. This compares with 9.5% growth in this year's second quarter compared with a year earlier, 9.7% in the first three months and last year's 10.4%. Chinese exports grew 24% year-on-year to US$874.3 billion in the first half, compared with 35.2% growth during the same period of 2010, according to the General Administration of Customs. Year-on-year export growth has been declining month-by-month during the first half, dropping to 17.9% in June from 37.7% in January.” (Asian Times, October 14, 2011)
Levels:
S&P 500 Index [1224.58] – Trading at the higher end of recent consolidation range between 1100 and 1200
Crude [$86.80] – Bottoming phase builds mildly. Next key resistance level stands at $90.
Gold [$1678.00] – Early signs of re-acceleration after holding at $1650 range. Collective buyer showed interest around $1600 and mostly sold at $1800. A breakout or breakdown can spark a noteworthy trend for momentum traders.
DXY – US Dollar Index [76.63] – Struggling to sustain last months’ strength in US dollar. Perhaps this reinforces that the strengthened dollar theme has yet to develop.
US 10 Year Treasury Yields [2.24%] – Last few weeks are witnessing a rise in yields from annual lows. The current move appears stretched as confirmation is desperately required.
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Dear Readers:
The positions and strategies discussed on MarketTakers are offered for entertainment purposes only, and they are in no way intended to serve as personal investing advice. Readers should not make any investment decisions without first conducting their own, thorough due diligence. Readers should assume that the editor holds a position in any securities discussed, recommended, or panned. While the information provided is obtained from sources believed to be reliable, its accuracy or completeness cannot be guaranteed, nor can this publication be, in any Publish Post, considered liable for the future investment performance of any securities or strategies discussed.
Monday, October 17, 2011
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