Oily, Easy, and Incumbents

By: Michael Ashton | Thu, May 27, 2010
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It always confuses me when the market responds vigorously to the denial of a rumor that I hadn't heard, or thought peripherally important at best. This morning, we came in to find the stock market aggressively higher because China's central bank denied that it was thinking of selling it Eurobond holdings. I had heard this rumor late yesterday, but didn't even bother mentioning it in my commentary because first, the market didn't seem to react to the rumor and second, it is an absurd rumor - China can no more divest itself of Euros than it can divest itself of dollars, unless it wants to stop running trade surpluses as well (this is not to say that it must buy sovereign bonds with that currency, however!).

But it was enough: on a comparatively quiet trading day (it was only the 6th trading day this month with volume under 1.4bln shares; in April there were 18 such days) before a long weekend for Memorial Day, no one seemed to have the heart to sell. It was the biggest up day since the Monday after the "flash crash," with the S&P finishing +3.3%. The economic data was no help, with Initial Claims still firmly in the range at 460k (a trifling amount above expectations), but Barton Biggs may have been.

Barton Biggs said that the stock market is ready to "pop" any day now because it's "very, very oversold." Mr. Biggs thinks that partly because at the top he was looking for another 10%, and we're down 10%...so of course he thinks it's oversold. "I wouldn't be surprised to see us go to a new recovery high, just to make everybody squirm," he said. Everybody squirm? It sounds like he thinks the market is short. The squirmers are the bulls right now, and at new highs I think the vast majority of investors would be dancing in the streets. After all, by definition in markets for corporate claims (bonds and stocks, as opposed to swaps and futures) more people are long than short. And how exactly do we get the rally of 2009-2010 if everyone was getting short? At least the people who think this is "panic selling" have it right that the market was net long to begin with.

There was also a bit of a sigh of relief when the Coast Guard reported the Gulf of Mexico oil leak has been at least temporarily plugged (BP, however, would 'neither confirm nor deny,' which sounds like the lawyers picked up the phone). I'm not sure that this should have much market impact, but it does remove something that could have been a potential negative down the road (if the leak stays plugged). The environmental damage is enormously tragic, but the long-term issue is really what the whole episode does to the future prospects of energy exploration. A friend of mine had what I thought was a pretty even-handed - and brief - analysis on the econo-political ramifications at his blog here.

I think it is unrelated, but energy markets jumped 3-5% today, helping to support inflation markets where breakevens were up 5-10bps across the curve. Most of that rise, though, was due to the beating inflicted on rates generally. The September 10y Note futures fell 27/32nds with the 10y note yield up to 3.34%. It didn't help Treasuries that all three note auctions this week (2y, 5y, 7y) had tails, although the bid to cover ratios weren't bad. I take that to mean probably that at these yields, bidders just wanted a little more cushion but overall demand seems adequate.

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If you need a reason to be optimistic about stocks and bearish about fixed-income over the next couple of months, consider that the mid-term elections are fast approaching and I would guess that no one on Capitol Hill is relishing going to the polls with Unemployment still over 9% and people staring a "second dip" of the recession right in the face. Both fiscal and monetary authorities are starting to ramp up already. There has been talk about another "mini-stimulus" bill of "only" a couple hundred billion dollars (son, I remember when a couple hundred billion was a major stimulus!), although I presume it would be enacted in a way to generate the most votes (targeted spending) rather than the most economic advantage (delay the huge tax increases slated for next year), and that means it is likely to be more spending to no good advantage. Of course, we haven't seen the bill but are you confident it will be a good one that spends money wisely and well?

At the same time, I feel fairly confident the Fed will be trying to resuscitate the money supply. I have been surprised, and a little scared, that the central banks around the world have not only eased back on the monetary throttle but have applied brakes on the quantity of money. Year-on-year M2 growth reached 1.1% in March; while inflation is caused by longer-term swings and this slow growth merely dampens the huge spike of the prior year (M2 growth was 10.4% year-over-year by late 2008, and much faster than that of course an an annualized basis quarter-over-quarter), I am surprised that the monetary authorities have let this happen while bank credit is still contracting and the signs of a resurgence in money velocity are still fairly uncertain.

However, it's a cinch that won't continue into the elections, and over the last four weeks the M2 money supply has been growing at a 19% pace. It's a short sample, but I doubt that's entirely unintentional. Faster money growth helps the situation in Europe, and it also helps the good folks in Congress fend off the election of the Ron Paul brigades who would like to "End the Fed."

I'm still not taking a position, because it isn't clear to me that impotent (that will get caught in some spam filters) taxing and spending from Congress and surging money growth will do anything more than pressure bond prices. But I could be wrong, and being short quality assets (Treasuries) and long risky assets (stocks) doesn't seem like it has a payoff sufficient to compensate for the not-insignificant chance that investors suddenly figure out the long-term picture ain't bright.

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This commentary will not be published on Monday as it is a national holiday; since my experience has also been that almost no one reads the commentary that is right before the long weekend either, I won't be publishing on Friday either. I'll write again on Tuesday. In the meantime, have a contemplative Memorial Day.

 


 

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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