David Rosenberg as usual, is spot on.
If you can keep your head when all about you
Are losing theirs and blaming it on you,
If you can trust yourself when all men doubt you,
But make allowance for their doubting too;
If you can wait and not be tired by waiting,
At times like this, I find the opening lines to Rudyard Kipling’s “If” inspirational and soothing. That and a tall glass of Dalwhinnie, 15 years old, on ice.
In span of a few weeks, and based on a set of spurious set of economic data (like the fact that nine States had to guesstimate their level of jobless claims in last week’s “improvement”) a new consensus view has emerged that the double-dip scare of July and August was somehow just a bad joke not grounded in anything real, and that everything from housing, to employment, to consumer spending is doing just fine, thank you very much. Let’s all take a deep breath and respect the fact that the equity market and bond yields both peaked in April, not unlike how they both peaked in 2007, 2000, and 1990 (and we can go on). These are very important market signals in terms of what they are telling us about the future direction of the economy — future information transcends what private payrolls or transportation rate indices are telling us, which is only about the present. And, as is always the case coming off peaks in equity valuation and bond yields, the markets do not move in a straight line down and volatility is the watchword.
There is nothing untoward at all about the recent backup in Treasury yields. The bond market is correcting from deeply overbought levels as net speculative long positions at the yield lows have been closed (the net speculative position is now, thankfully, flat).
As for the equity market, well, the shorts had a field day in August; however, the net short position in the NYSE soared 4.5% in the second half of the month, so it would stand to reason that a lot of this push-up in the market reflects short-covering on very light volume, which have exaggerated the price gains of late. But you see, pundits need to have something to say so they look at the recent runup in yields and in stock prices as a sign that there are no recession risks at all and that everything is going to be hunky dory after all. We’re all going to muddle through.
We wish it were that simple. The reality is that Treasuries are deemed by the elite to be the enemy because nobody really wants to contemplate the message that Mr. Bond is sending the growth bulls when yields out to the 10-year part of the curve are firmly ensconced in sub-3% terrain. It’s much easier to dismiss it as a “bond bubble” instead of looking at it from the standpoint of a market signal — a signal that the economy is still struggling as it unwinds all the debt and spending excesses of the prior bubble condition.
But let’s assess the recent action and put it into some sort of context.
First, on the Treasury market, we just completed the third losing week in a row and the yield on the 10-year Treasury note has climbed from the late-August closing low of 2.47% to 2.80% for a 33 basis point backup. Exactly two months ago, the yield was sitting at 3.15%, so this is no big deal. Nothing moves in a straight line, and it is true that at the lows we had some significant capitulation from long-standing bond bears who had been calling for a 5-handle for some time. Even my old shop (BoA/Merrill Lynch) dramatically sliced its forecast all the way down to 1.5%, which was probably the forecast on the books when yours truly stepped down.
At the same time, investors seem to have fallen back in love with the pro-risk trade and it looks to us as though this spreading view that the economy will not double dip just because it is not contracting at the moment is completely wrong even if it has now become the dominant view in the marketplace. We have received analysis suggesting that the +67k print in private payrolls in August was a ‘game changer’ and that truly does beg the question as to how that can be when in November 2007, a month before the onset of the so-called Great Recession, private payrolls were up 97k. Great leading indicator, indeed.
In any event, the market is as manic as ever — across bonds, stocks, currencies and commodities — and the consensus opinions on the direction of the economy are changing every few weeks or even days. To think that three weeks of gains in mortgage applications for new home purchases is barely noticeably up for three weeks in a row when they are down 40% from a year ago — and that year-ago level itself is down 30% year-on-year — is hardly something to get whipped up about.
The good news for us bond bulls is that it looks like the net speculative long position in the Chicago Board of Trade (CBOT) has been wiped out. The non-commercial accounts, who were betting against the downtrend in yields all year long, went net long 888,858 on 10-year T-note contracts as August drew to a close (just as yields were bottoming) and have since closed out their positions and are now flat — this should help eliminate one recent source of selling pressure. The commercial banks, however, are still net buyers and acting as sustained sources of support — buying a net $14 billion in the week leading up to the Labour Day weekend.
What about the equity market? It is fascinating to watch how emotions shift so suddenly. There is this view that the economy is turning some sort of corner — how can it not with the stock market rallying so much in September. Well, keep in mind how great the equity market behaved in the summer of 2000, the fall of 2007, the spring of 2008 and the fall of 2008 too — all huge headfakes. It doesn’t feel good to get head faked, but Mr. Market has made a living doing this to people.
So we are at 1,109 on the S&P 500, still about 20% away from levels we would consider to be compelling value. Now, we don’t want to hurt anyone’s feelings by mentioning that we were also at 1,109 back on April 1, 1998 (no joke) but for the here-and-now this is also the same level the S&P 500 closed at back on November 16 of last year. That is 10 months of nothing and the general belief is that we are still in a bull market (now that is a joke). And, over that 10-month period of a do-nothing equity market, the S&P 500 has crossed above the 1,100 mark no fewer than 15 times. Talk about a meat-grinder. We seem to be stuck in this 1,050-1,130 band and it would seem to us as though the odds favour a break below rather than above that range. But we will avoid being dogmatic; be flexible and keep an open mind — if we are wrong, we will let Mr. Market be the arbiter to tell us so instead of some bullish Wall Street pundits. That is, if we do go to a new high (see more below) and how it is that we get to that high (the market internals — divergences to be exact).
From our vantage point, the worst close for the S&P 500 this year was the 1,022 level it hit back on July 2; it was just a year earlier that it was sitting at that level as positive ‘green shoots’ were being discounted by the market. So how, at this same level in early July, the market was pricing in a double-dip recession just doesn’t hold water. The same level that got people excited over a recovery a year ago all of a sudden becomes a level commensurate with a renewed economic downturn? Come again? More than likely, what happened during that slide off the late-April highs of 1,217 to that 1,022 nearby low in early July was the growing view — and an accurate one — that there was not going to be an “V” in the shape of whatever recovery we were going to experience. But to suggest that a “double dip” was ever really priced in despite all the rhetoric is just not true. We strongly believe that we will come back and revisit this one before too long.