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Home“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
What Are the Credit Markets Telling Us?
Posted by Larry Doyle on August 18th, 2009 7:59 AM |
Are the credit markets sending us a warning signal about our economic landscape?
Recall that in 2008 all but the safest assets (U.S. Treasuries) declined significantly in value. In a similar fashion in 2009 risk-based assets, both equities and bonds, have experienced a healthy rebound, albeit of varying degrees. Are we starting to witness a disconnect in this lock-step relationship?
I highlighted yesterday the recent significant downward move within the high yield bond space in writing “Everybody Out of the Pool.” I pointed out:
Within specific market segments, the one sector that has outpaced almost every other is the high yield space within the bond market. An ETF which I reference for market performance is COY. Prior to the recent selloff, this specific fund had risen almost 50% on the year. It has given back approximately 6-7% over the last few days.
The Wall Street Journal picks up on this theme this morning and reports, Some Wobbles for the Financial Markets’ Tandem Ride:
Since the nadir in March, U.S. stocks have gained close to 50% and investment-grade credit spreads have halved.
The two asset classes have rallied in tandem as panic over a financial collapse has dissipated. But with the focus now on economic recovery, despite Monday’s global stock-market selloff, a disconnect is developing.
Credit-default-swap indexes that usually move in line with equities have begun to follow their own tune, one with a more downbeat tone on the outlook. U.S. stocks hit new 2009 highs last week before losing some ground, while the investment-grade Markit CDX and iTraxx indexes underperformed sharply.
Even with a 0.6% decline on the week, the S&P 500 closed off the week’s lows, while the 0.12 percentage point widening in the CDX took the index back to a level unseen since July 24.
Equity investors appear focused on the surprising resilience of earnings and the potential for punchy profits if revenues rebound. Credit Suisse forecasts a 20% rise in 2010 S&P 500 operating earnings, giving the market a price/earnings multiple of just 14 times, below the long-run average.
Credit investors seem more concerned about how sustainable any recovery might prove, and are inclined to require more proof that demand is picking up. Cash bond spreads are now comparable to levels seen in the 1981-1982 and 2001 recessions, rather than at 1930s Depression levels. But defaults still are climbing and credit deterioration continuing.
Credit markets are concerned about consumer demand. A key driver for last week’s credit selloff was the disappointing U.S. retail sales number for July. Stocks seemed to shrug off that data when it emerged, focusing instead on strong corporate earnings, even though many results are being driven by cost-cutting exercises; witness Wal-Mart’s profits holding up while it missed sales targets.
![[Markit CDX North American Investment Grade Index]](http://s.wsj.net/public/resources/images/MI-AY294_Credhe_NS_20090817183624.gif)
With all due respect to equity managers and investors, I have always viewed the credit markets as a better indicator of market health and direction. Why? The credit market operates on the premise of an entity’s ability to service debt. As such, the credit market puts a greater discount on the accounting smoke and mirrors that are utilized to raise equity capital.
Is the recent price action in the credit market forecasting a problem on our economic landscape?
Sense on Cents will be monitoring closely.
LD
