Buy On The Sound Of Cannons?

By: Michael Ashton | Thu, May 6, 2010
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The old saying is that you should "buy on the sound of cannons, sell on the sound of trumpets." I think that adage applies, however, only if you are not in the crosshairs of the cannons; furthermore, it probably made more sense in the days when news of the cannons' firing took some time to get around.

We have recently watched politicians trying to psych out the capital markets - today, German Chancellor Merkel said they are "determined to win the battle against the markets." And later today, the markets responded.

The stock market didn't start with a huge gap down, but just kept slowly sliding; inflation breakevens on the other hand were hit early as front end TIPS especially have been rather richly valued recently (thanks to the fact that everyone wants to hold inflation protection, but no duration), and whatever else the dollar's rally does, it dampens inflation in the U.S. relative to Europe.

Stocks kept sliding, kept sliding, and the slide slowly accelerated until abruptly the market hit an air pocket. What happened next will take some time to sort out, but electronic trading systems were overwhelmed as the Dow dropped 998 points with the S&P printing a low of 1065.79 before bouncing. The prices were changing so rapidly that the "real time" ticker on CNBC was lagging behind by more than 100 points on the decline and was briefly 300 points behind when the market suddenly bounced aggressively. (This allowed Cramer to appear to be a genius when he cavalierly declared "just buy 'em" right before the market leaped 300 points; of course, to the viewer it looked like he bought the market at -980, but unless he doesn't have a Bloomberg machine he was actually saying it when he knew the market was at -650).

The CNBC crew immediately began to claim that the selloff "must have been an error," simply because "Procter (and Gamble) doesn't fall like that." No authority has yet confirmed (as of this writing, Thursday afternoon) that there was either mechanical or human error involved, although the NYSE said that Nasdaq had "a number of erroneous trades." We're waiting to hear whether Nasdaq agrees, but Citigroup, who was rumored to have made the error, says it sees "no evidence of erroneous trades." Some trades will be canceled, such as the ones where market orders hit no bid until $0.01 (on a $40 stock), but those were not erroneous but careless. Someone meant to sell, and meant to sell at the market, but failed to understand that when there are no specialists "the market" is whatever price someone has put on the screen. No one is obliged to make a market in Accenture.

So stocks rallied 650 points today, and that sure is impressive. Well, that was after they fell 998 points, but what are you - a pessimist?! The net loss on the day was a mere 3.2%. Peanuts, although it leaves the equity chart in shambles (see below). A re-test of today's lows, followed by a 38% retracement of the rally (1008 on the S&P), would not surprise me over the next few months.

SPX
Not the strongest chart in the world.

Again, it helps to remember that none of the news we are seeing is surprising. We have been watching this develop, with the progress of the crisis fairly obvious, for many weeks now. But we have watched the news move from page 31, to page 12, to the cover of the Business section, to the paper's front page, and now leading off the local broadcast news. So what is happening in Greece ought to be about discounted by now. Buy on the sound of cannons? The problem is that the stresses in Greece are starting to reveal and make plain all of the other faults. Bank solvency and liquidity issues are on page 31, moving up to page 12...(and all the while, financials are valued very highly). And that is but one example.

Oh, and lest we forget, we're still working on resolving the last crisis. Freddie Mac has said that it needs another $10.6bln from the government, and says there's more to come. In a statement it said:

"Freddie Mac expects to request additional draws. The size and timing of such draws will be determined by a variety of factors that could adversely affect the company's net worth."

Inflation breakevens were -10bps or more today (the marks were a little fuzzy). The June 10y Note rallied 1-08/32nds and the 10y Treasury note finished at 3.40%.

The economic data today is and was an afterthought. Initial Claims were slightly higher than expected at 444k. Productivity was a little higher, and Unit Labor Costs therefore a little lower, than expected, but those data get revised for years - Greenspan once opined that you need at least five years of Productivity data to spot a meaningful trend (which didn't stop him from spotting one in the go-go 90s). Some investors looked askance at the chain retail sales from ICSC, which fell to only +0.8% year-on-year from the prior +9.0%, but no one forecasts this number and it is a little early to worry about that dip.

And I daresay that the economic data tomorrow may also be an afterthought, although the Employment data is ordinarily the most important release of the month (except of course for CPI, to an enlightened few). The consensus view is for a gain of 190,000 new jobs, with the Unemployment Rate steady at 9.7%. Remember that the official data, unlike the ADP, will include any Census-related hiring.

Last month, there were 162,000 new jobs, but remember that included a weather snap-back from February. Averaging the last two months, and taking out Census workers, produces underlying jobs growth of 42,000 jobs per month. I don't know what we are expecting from Census hiring this month, but unless it is something over 100,000, the 190k forecast looks generous to me. Keep in mind that we haven't seen any real improvement in Initial Claims or in any of the other job metrics. I think there is a real chance for a disappointment tomorrow. While I think the 9.7% Unemployment Rate is a little safer, since it was 9.749% last month and we know that some Census workers will be hired, I wouldn't be shocked to see that number rise either since the approaching end of the Emergency Unemployment Compensation (EUC) program at the beginning of June will get more people out looking for work.

The market will take administrative notice of the numbers, but it will be blended with news from Greece and other EU countries, election results in the UK, and overnight equity markets. We are still in the process of moving stuff from the back page to the front page; I wouldn't fade this move yet.

 


 

Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA
E-Piphany

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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