Today will be day 12 of 13 (or something just as silly) that the market has been melting up on no volume: yet another truly ridiculous statistic in the anals of momoism. As David Rosenberg points out: "the market has been able to digest California, Dubai, and Greece" - and this has all been offset by what? Merely promises of ever increasing liquidity and bailouts by the Fed, first domestically, and soon internationally. Have people really forgotten yet again that this is precisely what got us on the verge of a historic collapse in the first place? Yes, the Fed bailed capitalism out last time around (with about 3 hours to spare), but this time it has gone dodecatuple all in, and unless intelligent, and very rich life, on Mars is discovered pretty quickly, this will all end in ruins (certainly those of the Marriner Eccles building).
Speaking of momentum, as everyone rushes to find ever greater fools (no scarcity these days), the economic condition is forgotten. But the market is a leading indicator skeptics will say... Perhaps, in every other Keynesian situation that did not have global sovereign default on the other side of the crossing. We are now truly in a unique situation where the market is a leading indicator of nothing but greed and stupidity (in retrospect, that's not all that unique). Here is a good recap of where we have been, and where we are, courtesy of Rosie (who we hope is sufficiently inebriated at this point to note the humor in the current situation).
The equity market at any given moment of time is one part reality and three parts perception. Our friend, Brian Belski at Oppenheimer was on CNBC the other day and claimed that this was turning into a normal economic recovery. And that is what many market participants seem to believe until they don’t believe it any more. Their resolve has been impressive. But if this were a normal cycle, then:
- Employment would already be at a new high, not 8.4 million shy of the old peak.
- The level of real GDP would already be at a new cycle high, not almost 2% below the old peak.
- Consumer confidence would be closer to 100 than 50.
- Bank credit would be expanding at a 14% annual rate, not contracting by that pace.
- The Fed would certainly not have a $2.3 trillion balance sheet
- And, the government deficit would not be running in excess of 10% of GDP or twice the ratio that FDR ever dared to run in the 1930s.
If this were a normal cycle, then there would be a ‘clean’ 5-6 months’ supply of homes on the market, not the 21 months overhanging as is the case now when all the shadow inventory is included from the foreclosure pipeline.
If this were a normal cycle, then the funds rate would not be near zero and one in six Americans would not be either unemployed or underemployed.
If this were a normal cycle, then mortgage applications for new home purchases would not be down 13.9% year-over-year (just reported for the week of March 12) on top of the already depressing 29.4% detonating trend of a year ago.
But the perception that this is turning out to be a normal sustainable expansion is strong and pervasive, although the reality is that this is just a brief statistical bounce aided and abetted by unprecedented government bailouts and intervention.
While we are inundated with that old refrain about “not fighting the tape”, in our view, this is just a glib excuse to stay long the market because of the herd effect, and to be honest, we heard that same trite rhetoric over and over again back in the spring and summer of 2007.
This is not the time to live in the moment but to plan for the future. It is a time to reflect not what the talking heads have to say on bubble-vision but on what history teaches us in the aftermath of a busted asset and credit cycle. The Nikkei enjoyed 260,000 rally points during its post-bubble era and yet the market is still down 70% from the peak; the rallies were to be rented, not owned.
The Dow in the 1930s saw no fewer than 30,000 rally points that would get investors periodically juiced up that the post-bubble economy was heading back on track from the New Deal stimulus. But go back and you will see that the next bull market did not begin until 1954 even if the ultimate lows in the Dow were turned in 22 years earlier. It was a multi-year tumultuous period that was racked by volatility and manic market performance. The key to success over the long haul was to immunize the portfolio from the massive ups-and-downs, ensure that you were getting paid to take on risk as opposed to paying for taking on risk, and a pervasive focus on capital preservation, dividend yield and dividend growth among blue-chip stable cash flow companies, and income-generating securities, including corporate bonds for those entities that had the capacity to survive.
Despite massive attempts at monetary and fiscal reflation, which did produce periodic sugar-high influences on growth, government bond yields did not bottom until 2003 in Japan and 1941 in the U.S.A. — over a decade after the initial credit collapse. This is not the story that a ‘live in the moment’ investor may want to hear today, but even as the market lurches forward, the economic outlook is more uncertain than is commonly perceived and we believe investors are taking on too much risk to be overweight equities at this time. The primary trend towards consumer frugality, liquidity preference and deflation has not vanished just because of the impressive bear market rally in risk assets that has occurred over the course of the past year.
Yet nobody cares, as the Pied Piper of Monetary Insanity once again leads the Wall Street rats to the euphoria of irrational exuberance, followed promptly by the guillotine. But everybody forgets the inevitable second part.
And speaking of the credentials of the Pied Piper, it would be useful if at least the Fed could keep its swan song song consistent.
What is most interesting is to see how the Fed’s view of the housing market has changed over the past four months (then again, it’s run by the same Chairman who told us that the problems in housing and subprime mortgages would be contained just a short three-years ago):
- November 2009: “Activity in the housing sector has increased over recent months.”
- December 2009: “The housing sector has shown some signs of improvement over recent months.”
- January 2010: No comment.
- March 2010: “…housing starts have been flat at a depressed level.”
So where should we look to for the next focus of risk flaring? Why, to our beloved creditors of course.
So far, the market has been able to digest California, Dubai, and Greece, but what about China? That could be the next shoe to drop (before Iran — have a look at Israel and the Crisis with Obama on page A21 of the WSJ) specifically the new spat between the U.S. and China over currency policy. Make no mistake, if China does not make a move away from the peg with the U.S. dollar over the next few weeks, there is a very good chance that trade sanctions are going to come our way. April 15 looms large as that is the day when the U.S. Treasury could well declare the Renmimbi as being “manipulated”.
Gold will be a very nice safe haven in this environment (also have a look at Martin Wolf’s article today on page 9 of the FT — China and Germany Unite to Weaken the World Economy). Also see Prompted by Economy, Lawmakers Press China to Address Value Of Its Currency on page B3 of the NYT.
Who cares about any of this, one may ask. The market can only go up, up, up. Yes, if one considers price discovery to be a function of micro volume block buying by algos who have only been programmed to bid the market up. We broke key resistance levels in the past 2 days, and nothing: no major short covering spree, no influx of new buyers. The market has become a stealth melt up mechanism, driven by who knows what money (mutual funds are out), with shorts out. This is precisely the environment that allowed the market to go bidless overnight in 1987. When will this happen - nobody knows. Although if we continue to antagonize the only major foreigner who has allowed the Fed and the government to embark on its ludicrous policy of fiscal and monetary insanity, we will surely find out very soon.