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Posts Tagged ‘yield curve’

“Nobody Has Ever Seen This Market”

Posted by Larry Doyle on November 12th, 2009 8:22 AM |

“I’ve seen this market before” is a very commonly used phrase by Wall Street professionals to compare and contrast different periods.

For example, when the Treasury yield curve is steepening or flattening, many market pros will project what will happen in different segments of the market based on discounting cash flows under the steepening or flattening scenario. Similarly, when credit spreads are in a widening or tightening trend, market pros will project how higher or lower rated investments will typically behave.

These projections are all based upon prior experience. The pros are utilizing a combination of market fundamentals along with investor sentiment to make forecasts. They will overlay their current forecasts against similar trends during prior cycles. Not that markets are ever perfectly symmetrical, but ‘having seen a market before’ is often a strong indicator of current and future price action.

Against this backdrop and given the challenging nature of the current market price action, I would challenge any market analyst or pundit who would utilize a similar approach today.

The simple fact is, ‘nobody has ever seen this market before.’ Why? Because this market has never transpired previously. Certainly, we have seen bull markets. We have seen low interest rate markets. We have seen accomodative Fed policy. We have seen bubbles. All that said, we have never seen a market in which global cross currents combined with ongoing fiscal stimulus have impacted markets to this extent.

In fact, I think one could make the case that the market is doing better as large parts of our domestic economy and the global economy are actually doing worse. While traditional schools of thought would view that correlation as perverse, the economic strains are compelling global governments to keep stimulus programs in place.

What is the result? A rallying market with increasing potential that the market develops into a blowoff. The irrationally positive nature of a blowoff is akin to a wholesale dumping of securities in a selloff.

Keep your head and stick to disciplined investing. Respect the price action, but do not get overly enamored with those analysts telling you what will happen . . . because ‘nobody has ever seen this market.’

LD

October 24, 2009: Month to Date Market Review

Posted by Larry Doyle on October 24th, 2009 7:32 AM |

Did the market merely take a breather this week or is the ‘little engine that could’ getting tired? Are we distinguishing the winners from the laggards? Are the cracks in our economic foundation repairing or are some just too large to hold back the flow of red ink, i.e. embedded losses? Perhaps we are experiencing all of the above as we continue our journey along the new and varied trails of our economy. Let’s review the major economic statistics for the week, along with the month to date returns across a wide array of market segments.

I thank you for reading my work, and now let’s collectively ‘navigate the economic landscape,’ the mission of Sense on Cents. If you have any questions, please do not hesitate to ask.

ECONOMIC DATA

I largely discount positive news on the housing front as I view them largely manipulated by Uncle Sam while delinquencies, defaults, and foreclosures move ever higher. This may be an oversight on my part, but so be it.

Aside from that, I believe the most meaningful news this week was the GDP report from the UK. Please see my Friday morning commentary highlighting how the UK remains mired in recession.

Let’s move along to market performance. The figures I provide are the weekly close and the month-to-date returns on a percentage basis:

U.S. DOLLAR

$/Yen: 92.08 versus 89.68, +2.7%
Euro/Dollar: 1.500 versus 1.4635, +2.5%
U.S. Dollar Index: 75.44 versus 76.72, -1.7%

Commentary: the overall U.S. Dollar Index declined marginally this week. The dollar has improved versus the Japanese yen, but remains decidedly weak versus the Euro. The U.S. Dollar Index did break below 75.00 at one point early Friday. The correlation between the U.S. Dollar Index and the equity markets remains quite high. Both markets ended the week close to unchanged. Have too many people bought equities and commodities while having sold the U.S. greenback? I have been asking that question for the last month so no reason to stop now. The biggest impact of the weak dollar is seen in the commodity markets and long term interest rates. Commodities continue to trade with a firm tone while interest rates move higher.

I reiterate my comment from previous weeks: while I think Washington is not disappointed in a relatively weak dollar, although they should be (“Dollar Devaluation Is a Dangerous Game”), other countries are not overly keen about further dollar weakness. Why? A weak dollar puts those countries in a marginally less competitive position in international trade. On this topic, please read “Brazil Wants A ‘Real’ity Check.”

COMMODITIES

Oil: $79.65/barrel versus $70.39, +13.1% REMAINS VERY FIRM
Gold: $1055/oz. versus $1008.2, +4.6%
DJ-UBS Commodity Index: 137.32 versus 127.683, +7.5%

Commentary: I repeat from last week, unless you grow your own crops or have your own source of energy, you should expect to get increasingly squeezed as prices at the supermarket and gas station are likely to head higher. While Washington will not address this development, these price moves are directly correlated with Washington’s weak dollar policy. The banks and others able to borrow cheap money for trading and investing benefit from the weak dollar. American consumers and savers get stuck with the bill.

The  Baltic Dry Index once again moved higher and got back above the 3000 level. Is the improvement in the non-Japan Asian economic bloc for real? Certainly the economies in Europe and North American remain decidedly challenged.

I continue to believe these commodity tea leaves are an indication of inflationary expectations in these ‘inputs,’ while we encounter deflationary pressures in wages and real estate. (more…)

May 2009 Market Review

Posted by Larry Doyle on May 29th, 2009 11:23 PM |

Welcome to the Brave New World of the Uncle Sam economy! Let’s review the price action across the market, add some analysis as we look behind the numbers, contrast these returns with developments in the economy, and chart our path forward as we navigate the economic landscape!!

may-2009-market-review2

Market Returns:

Equities: while market analysts continually measure the market from March 6th, unless one purchased the market on that date and at that point, it is much more intellectually rigorous to measure returns on a YTD (year-to-date) basis. Although I will incorporate short term movements, focusing solely on the short term increases the risk that we “miss the forest for the trees.”

The equity markets posted solid returns for the third month in a row. Although the returns in May were positive, they were not as largely positive as the prior two months. Year to date, the DJIA is slightly below unchanged while the S&P 500 is slightly positive. The tech heavy Nasdaq continues to outperform and is solidly positive (+12.5%) on the year. Why? Many tech companies have significnatly less debt burden and refinancing risks.

Bonds: the high yield sector continued to outperform (+9.7% MTD, +24.3% ytd). The mortgage and municipal sectors largely marched in place. The front end (shorter maturities) of the U.S. government bond market held steady as the Federal Reserve indicates they will keep the Fed Funds rate at 0-.25% for an extended period. The long end (intermediate to long maturities) of the government bond market sold off dramatically (+35 basis points on the 10 yr) under the weight of very heavy supply.

Currencies: the U.S. dollar had a very difficult month relative to almost every other major currency. The greenback gave back almost 4% relative to the Japanese yen, although it remains within the trading range for the year. The dollar particularly suffered versus the Euro on concerns of a potential downgrade of U.S. government credit due to the ongoing fiscal deficit. 

Commodities: this is where the real action occurred this month. Commodities, in general, posted their largest monthly gain in 34 years. Oil was up 30.1% on the month and 55.6% on the year. Gold rallied 11% on the month and is up a like amount for the year. 

Looking Behind the Numbers . . .
As I view the monthly and annual numbers, I am drawn to a comparison of a football pass thrown in a game. That is, when the football is thrown, three things can happen and two of them are not good. The pass can be completed, fall incomplete, or be intercepted.

Similarly, our economy can gradually improve with credit lines opening, housing and employment stabilizing, and markets improving – much like a completed pass.

Our economy can stumble under the weight of a surge in delinquencies and foreclosures in the residential space, a wave of commercial real estate defaults, and a double digit unemployment situation – much like an incomplete pass.    

Our economy can stabilize with enough traction to create velocity in the growth of the money supply. Given the trillions of dollars injected both directly and indirectly, a hint of velocity will likely spark a sharp increase in the expectation of inflation even prior to actual signs of inflation. The price action in the commodity and currency space are sending warning signals on this front. This development is akin to an intercepted pass. 

Economic Review . . .
As I look back on the wealth of economic data, I am continually struck by the downward revisions to prior months’ numbers. Although consumer confidence has increased, in my opinion, virtually every other statistic both here and abroad shows ongoing caution signs. These numbers include retail sales, housing, employment, and industrial production. Overseas the export data is decidedly weak.

Perhaps the markets are discounting an expectation of improved economic data due to the $780 billion Stimulus Bill starting to kick in later this year. The major money center banks have clearly been stabilized, although it took a fabrication in their accounting (via a relaxation in the mark-to-market) to do so.

The movement in commodities is clearly indicating a sign of improved economic activity and/or heightened inflation, or both. It is not inconceivable that our economy does get inflation sooner than later combined with minimal credit flow due to ongoing writedowns on delinquent or foreclosed loans. Combine these two components and we have a very real chance of stagflation over the next few years.   

The Path Forward . . . 
The steepening of the yield curve (rates on short term maturities relative to long term maturities) is very positive for our banking industry. The banks can continue to borrow money at extremely low rates and earn significant interest on almost any sort of lending that occurs. That said, new loan demand is not strong while demand for refinancing is quite strong.

My concern currently is not with the major money center banks. I am VERY concerned with the non-bank banks (Freddie Mac, Fannie Mae) and the Federal Home Loan Banks (FHLBs). Given the ongoing surge and expected high levels of residential loan defaults, these institutions will bleed money. The insurance sector, despite some recent improvements in their stock prices, also concerns me given their commercial real estate holdings primarily.

I do believe longer term interest rates will continue to work their way higher under the weight of supply of global government debt, and expected ongoing heavy demand (May was a very heavy issuance of both bonds and stocks) by municipal and corporate issuers. Do not be surprised to see our 10 yr Treasury note get to 4% and 30yr fixed rate mortgages get to 6%.

The deleveraging process will continue as the economy adjusts to life without a vigorous securitization business (remember the securitization business on Wall Street provided 40-45% of total credit to our economy).

Add it all up and I think the following will occur:
   – equity markets will now move sideways in range bound fashion;
   – the bond market will move lower in price, higher in rates; 
   – the dollar will gradually decline;
   – our economy will be filled with more stops than starts.

Please share your thoughts and comments!! Thanks.

LD

The Stakes Are Raised

Posted by Larry Doyle on May 28th, 2009 7:46 AM |

The move higher in rates and lower in the U.S. dollar is nothing more than the market response to Ben Bernanke, Tim Geithner, and ultimately Barack Obama for the cards that they have already shown.

Managing one’s personal business and finances is anything but a game, but the manner in which Wall Street and Washington address economic and financial issues incorporates many aspects of “game theory.” As such, we need to adapt our own thought process and financial management accordingly.

Our leaders in Washington have shown many cards, including:

1. $780 billion Stimulus

2. proposed $3.5 trillion budget

3. multiple trillions in backstops to the financial industry (Sense on Cents’ link to Subsidyscope provides a wealth of info)

4. a trillion dollar plus commitment to quantitative easing targeted over a 6 month time horizon.

Be mindful that the “Washington wizards” are at the “table” and “playing the game” with borrowed funds. Each of us is also in the “game” whether we know it or not. We, along with foreign participants, are funding the window from which the wizards have to get the cash to stay in the game. The move higher in interest rates on the long end of our yield curve is nothing more than market participants (investors) “raising” the stakes on the “wizards.” (more…)

Is The Economy Turning The Corner?

Posted by Larry Doyle on April 21st, 2009 7:05 AM |

Markets correct by price (both up and down) and time (extended). Despite the 3+% price declines in equity markets yesterday, the markets are up approximately 20% since the market lows seen on March 6th. Some analysts believe this upward move signals an improvement in the economy largely due to the fiscal and monetary stimulus provided by Uncle Sam. I am not in that camp.

A few emerging economies, specifically China, have improved. Can the rest of the world, including the U.S., expect those economies to be the engine for a global turnaround at this juncture? I do not think so. I still see the following issues on our domestic horizon:

1. continued deterioration in loan performance on bank books

2. a banking system woefully capital deficient

3. an automotive industry which must downsize

4. municipalities which are faced with the predicamant of capital shortfalls and underfunded pensions

5. commercial real estate just starting to experience real defaults

6. a housing market with increased foreclosures pressuring prices

7. an unemployment rate clearly headed toward double digits

Earnings reports for the first quarter have been mixed. I view the recently reported bank earnings as largely “managed” via accounting gimmicks. Meredith Whitney believes the earnings for major money center banks will turn negative in the 2nd quarter. The regional banks, without the benefit of large capital market activities but facing credit writedowns, report earnings today. Key Corp just reported a loss of $1.09 eps (earnings per share) versus an estimate of -.21. I suspect we will see losses from other regional banks of a similar magnitude. (more…)






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