A Slightly Longer Fuse

By: Michael Ashton | Tue, Aug 2, 2011
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I think it was Billy Joel who said something like "you can't trade trashy until you spend a lot of money."

Today, the Congress finished inserting a longer fuse into the bomb, and it seems that whatever relief rally we were due on the deal was experienced during a five-minute period on Monday. Coming into today, stocks were a little weak in the U.S. and abroad, but bonds continued to be very strong. There is something more going on here than the debt-ceiling deal, and it is the increasingly-sketchy funding markets in Europe.

As I noted yesterday, as attention moves away from the debt-ceiling debate it moves back towards Europe, and the news there is not good. Italian yields reached new highs again today, along with 10bp selloffs in Spain, Greece, Portugal, and Hungary. Spain's 10-year yield is about to join Italy's at new highs above the July spike highs. Another ECB meeting is scheduled for Thursday, but no one expects anything out of the European central bank other than (hopefully) a decision to stop tightening into an economic crisis. When the history of the European Union experiment is written some day, I hope there is a whole chapter on the flaky behavior of the ECB.

Global growth is simply slowing everywhere, even as inflation fears rise. The latest reminder of that in the U.S. was today's Personal Income and Spending data, which surprised on the downside. Spending contracted in June for the first time since early 2009 (with the exception of a brief spike-and-reverse around the cash-for-clunkers program). A small bounce higher in auto sales, which were released throughout the day today, lessened the impact of that discouraging news but the tenor of the data continues to depress. The chart below shows the Citigroup Economic Surprise Index. What is amazing about this chart is not the level of the index, which shows that there has been a long run of significantly negative surprises - the worst such run since 2008 - but the amount of time the index has stayed low. Ordinarily, after data comes in lower than forecast for a while economists tend to overadjust and to be surprised the other way. The fact that this index has hardly bounced at all signifies that either economists are staying uncharacteristically un-dismal (perhaps because they attribute the misses to the Japanese tsunami or some other passing factor) or that the data is getting worse faster than economists can get dismal.


Economists have been too optimistic for quite a while now.

Bonds are receiving inflows from money market investors who have been hearing that their funds are invested in European bank paper. They are receiving inflows from global investors seeking safety from the implosion in Europe or by bond managers who are benchmarked against global indices and trying to underweight the sick countries (which admittedly is a shades-of-gray exercise at the moment). They are receiving inflows from momentum investors, from fundamental investors who are tracking the downward revisions in growth expectations (TIPS yields fell again today, although only 6bps at the 10y point to 0.26%). And they are receiving inflows from equity investors.

Stocks plummeted today, erasing the balance of the year's gains (the S&P was -2.56%) and posting the lowest closing level of the year at 1254.05. The S&P pierced the 200-day moving average and the long uptrend-line convincingly (if you didn't see yesterday's comment with the S&P charts in it, you can find it here. If you want to get the comment in your email every day, when it is first posted rather than when it is syndicated, be sure to sign up on that site). The market broke the "neckline" of the widely-watched "head and shoulders" pattern, and fell below the June low. There's really only one important support level left, and that's the year's low prints at 1249 - a mere 5 points away.

Volume was heavy, by 2011 standards, clocking the heaviest numbers (other than at a month-end or triple-witching, when there is a lot of artificial volume) since March. Declining stocks on the NYSE outnumbered advancers by a disturbing 14.8:1.

The only rallies of the day happened when investors began to talk about "what the Fed might do." For example, Bloomberg ran a story entitled, "Fed May Weigh More Stimulus on Flagging Recovery Signs." That's amazing. Are we so accustomed to the Fed riding to the rescue that we expect them to add additional stimulus just because growth is a little slow and stocks are unchanged on the year? (Especially since the last stimulus was ineffective except for increasing prices?) If stocks mount a rally on that chimera, then selling into the FOMC meeting will be very easy. There is nothing more coming from the Fed, folks, unless a systemically-important bank fails or some other huge calamity threatens.

But frankly, I don't think the market will be able to mount a rally on that.

I must admit, with shame, that on days like today I turn on CNBC just for the entertainment value of watching the pundits explain the market action without using the terms "overvalued," "recession," or "bear market." The lunch hour is especially enjoyable because they get lots of people on the program to talk about how they're "playing" the market. I was tickled today when a strategist from Raymond James called stocks "deeply oversold." That's deeply oversold, seven trading days from being near 1350 and close to the year's highs. If he means oversold on a day-trading time frame, then I guess he might be right but retail investors watching the show probably shouldn't care. If he means oversold on a medium-term time frame, then he's just crazy.

One of the CNBC guys said "I am buying. Being a bit of a contrarian here." Again we have some linguistic imprecision. I suspect he thinks that buying when the market is going down makes him a contrarian, but if he means what he says in the true sense of being a contrarian - buying when everyone else is bearish - then he is simply delusional. Equity markets are not falling because everyone is bearish, but rather because almost no one was bearish, and now some of those people are deciding they should pull in their bull horns. When everyone is bearish, the market will also be cheap and not sporting a Shiller P/E of 21.2!

Of course, maybe the market is going down for the reason that Bill Griffeth, I assume in jest, suggested. "Maybe," said Bill, "Wall Street is sending a message to Washington." Does he really think Wall Street has that kind of power? Does he really think that Wall Street would evaporate billions of dollars of wealth to "send a message?" Hey, this is America. When Wall Street wants to send a message to Washington, they write a check and put the message in the "memo" field.

All in good fun. I recognize that it is hard to fill the programming day with good content, which is why I am going to reach out to my old media contacts soon and see if they want some good content.

Not all of the news today was bad. (In fact, the market reaction was really out of step with the amount of bad news there was, out of Europe and in the Personal Income report. I think it is an overstretched rubber band that is just pulling back). After the debt-limit deal was signed, Fitch expressed the opinion that, essentially, this represents a good first step and if further cuts follow in the near future there may not be a downgrade of the U.S. credit. Two weeks ago, that would have been worth a 200-Dow-point rally.

On Wednesday, the ADP number (Consensus: 100k from 157k) and the ISM Non-Manufacturing Report (Consensus: 53.5 from 53.3) are both due to be released. Last month, the 157k figure from ADP was viewed as a high surprise, but there's a decent chance of another surprise in that direction. The current level of Claims, while a very coarse indicator, would be consistent with a 160-175k print. To be sure, there are lots of other indications that the jobs market is weak, and just two months ago ADP showed a +36k, but I think we may start the day with some sunny news

I just don't think it will be enough.

 


 

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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