Gravy Train Or Bread Line?

By: Michael Ashton | Tue, Nov 29, 2011
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There are stories, perhaps apocryphal, about consumers in socialist countries who, coming across a queue, reflexively got on line because there must be something valuable going on at the front. (Although on the heels of the crazed shopping action of Black Friday, perhaps it isn't hard to believe these stories might be more-than-apocryphal after all.)

That's what today's action felt like. Investors, everywhere, jumped on line because they didn't want to miss what is promised at the end...and yet, no one really knows what we're waiting for except that it must be good.

To be sure, the weekend saw rumors and news. There was a rumor of a massive IMF plan for Italy - a plan so massive that it was considerably larger than the current size of the IMF; this rumor was duly denied by all concerned, but when investors are optimistic the denials start to sound to them "like the usual denials of officialdom when something is about to happen." More in the 'news' category was the release of 'guidelines' from the EFSF. Wiser heads than mine declared these "more confusing and more complicated than...expected." Details remain lacking...but these are guidelines! Surely they mean something? Sadly, no.

Most concretely, Germany and France are pushing for a "fast-track" process by which countries can hand over sovereignty to them. I think it's important that we keep two things in mind: first, "fast-track" in Euro circles means a couple of years (remember, the Greek crisis started in 2010 and there is still no solution to it). Second, any solution that results in most of Europe surrendering their economic sovereignty to a European body that is controlled by the largest members is likely to be voted against by the smallest members. Since each EZ member has a veto, this seems extraordinarily unlikely to result in any solution, absent the force of arms. It's worth remembering that for the framers to get small states to agree to the Constitution, they had to offer a bicameral legislature in which the small states had size-blind representation in one house plus an Amendment insuring that all powers not granted to the federal government would be reserved to the states. Others may insert political commentary here about the success of such promises, but the point here is that this would seem to be the minimum required to get sovereign countries to surrender their rights to a central committee.

Investors also took heart from strong "Black Friday" and Thanksgiving weekend sales. Now, I've been covering markets for several decades and although much is made of how long the lines are and how crowded the malls are on this shopping weekend, I can remember far more times the information was misleading than useful information. Most likely, there's a tiny signal caught buried in massive noise related to weather, the desperation of retailer sales, the number of shopping days until Christmas, and so on. There's certainly a better chance that sales will be better than was expected just prior to Thanksgiving, but in my experience these few days of great sales will have a much larger impact on expectations of sales over the balance of the holiday period, and there is therefore a much larger chance now that overall sales will be deemed disappointing after-the-fact.

But the lines formed overnight, and investors saw the markets galloping ahead and leapt to get on those lines as soon as they could. U.S. stocks rallied 2.9%. Commodities jumped 0.9%, led by gasoline (+2.8%), although prices faded throughout the day after the open. Strangely, bonds ended the day essentially unchanged. Inflation-linked bonds rallied a couple of basis points. It really ended up being mostly an equity phenomenon, and I suspect it is going to be a short-lived bounce.

As we continue to bounce aggressively on every rumor and plan, we should be wary if the bounces begin to last shorter and shorter periods of time. I learned a lot during the anthrax scares of 2001: the bond market initially would spike on each report, before selling off when it turned out to be a false alarm. The spikes got more and more ephemeral and the selloffs more and more violent, until one day there was an anthrax rumor and the bond market simply dropped like a stone without rallying first. I don't see this happening yet in the credulous equity market, but the selloff in bonds this morning didn't even last the full day. Bond traders aren't running to get onto the lines that the politicians are creating for them. Since it's the bond investors who will end up determining the success or failure of the various pla ns coming out of Europe, this is not a good sign. We may be much closer to a defining moment than the stock market rally today would suggest.



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

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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