Who’s Buying Stocks? The Answer Is….

December 25, 2010

In a holiday shortened week, the S&P500 crept up 1.0% on extremely low volume.  Interestingly, the VIX rose over 2% for the week; it seems that traders are willing to buy more insurance “just in case” the stock market hits turbulence when they’re on vacation.

The flow of economic data was light, but mostly negative.  The final revision to Q3 GDP came in well below (2.6%) expectations of 3.0%, and by far the largest factor behind the entire 2.6% growth was inventory growth–which is completely unsustainable as a source of GDP growth.  Existing home sales also came in well below expectations.  New home sales also disappointed vs. expectations; they were also 21% lower than last year’s November figure.  Durable goods missed.  Initial claims came in exactly as expected, but as usual, the prior week’s figure was revised negatively.  Consumer sentiment was worse than expected.  Personal income was slightly better than expected.  Personal spending was slightly lower. 

Needless to say, the technicals are all pointing to an overbought equity market, both on the daily and the weekly charts.

So what in the world can possibly explain the continued melt up in stock prices?  Especially when, as reported by ICI, stock mutual funds have suffered from net outflows for 33 consecutive weeks?  In other words, all data is strongly suggesting the average retail investor has been running away from the stock market for most of the year.

Charles Biderman, of TrimTabs Research has some ideas.  A year ago, he asked the same question.  When interviewed on CNBC, he expressed sincere confusion when he explained the numbers didn’t add up.  He pointed out that almost all of the traditional money flow sources pointed to funds leaving the stock market.  Yet prices were rising.  His conclusion a year ago?  Someone, someone big, was buying.  His guess:  the US government.

Flash forward to last week.  In a follow up interview at CNBC, Biderman updated viewers on the money flows in the stock market.  He noted that “retail investors are not coming back to the US.  Those investors that are investing are buying global equities and are buying commodities.  We are seeing lots of money going into commodity ETF funds, gold, silver…”  He added that “pension funds and hedge funds don’t really have that much cash to invest.”

So who’s buying stocks?

The answer, courtesy of Biderman, is: “if the only buyer is the Fed, and the Fed stops buying, I don’t know what is going to happen…when I was on your show a year ago, I was saying the same thing:  we can’t figure out who is doing the buying, so it has to be the government, and people said I was nuts.  Now the government is admitting it is rigging the market.”

Wow.  There you have it.  Finally a widely respected market analyst coming out and stating the unspeakable–not only is our government artificially propping up stock prices, but pointing out the obvious conclusion:  this market rigging cannot last forever, and when it ends, then the US stock market (and most likely all other international stick markets) will crash.

There, that ought to make you feel better.  Go ahead, the government is daring you not to buy stocks.  Just be sure to get out the day before they stop buying, or else you’ll lose everything you’ve made, and then some.

Suspended in Mid-Air?

December 18, 2010

Not much changed last week, literally.   The S&P500 was almost unchanged; it nudged up by 0.28% for the week.  Volume was not strong, and certainly much lower than it was during the sell-off during the late spring and early summer.  The VIX (or fear) index dropped, interestingly, to lows last seen during the weeks before the Flash Crash and during the spring of 2008, after Bear Stearns crashed, but before Lehman blew up.

On the macro front, inflation data sent a mixed signal: while producer prices rose by more than expected, consumer prices came in lower than expected.  The key takeaway is this–firms’ material costs are rising, but they can’t pass on these costs to consumers.  Soon, we should start to see corporate profits getting squeezed, and surprising to the downside.  Retail sales were slightly better than expected, again because of the continuing largesse of the federal government (with its record high transfer payments).  Housing starts were pretty much as expected; housing permits (further upstream from starts) were well below expectations.  The Philly Fed survey came in ahead of forecast, but prices paid and inventory builds point to profit pain around the corner.  The leading indicators were slightly worse than expected.

Technically, the divergences continue to build.  As prices touch post-crash highs, momentum, oscillator, money flow, and breadth indicators are all flashing caution signals.  The ICI report on equity mutual fund flows, last week, confirmed that more money left stock mutual funds than entered–for 32 consecutive weeks. 

Yet stock prices have continued to melt up, despite the huge array of fundamental and technical pitfalls that have usually been associated with weaker performance.

It’s almost as if stock prices are suspended in mid-air, and daring anyone to prove that the ground beneath them is a mirage. 

The stock markets are taunting naysayers by telling them that the music at the party is playing, so they’d better get out on the dance floor. 

And just what could possibly turn off the music?  Especially right now, now in the distant future?

The bulls say nothing can really shut down the party.  Just keep dancing.

The bears say the Eurozone is on the verge of collapse.  After Portugal falls, Spain will be next, and if the Euro survives the demise of Spain, then it certainly would not survive the implosion of Italy which would be next.  Japan is teetering on the brink of a sovereign debt crisis; government debt to GDP is over 200% and looking to pile on much more.  China’s financial system is a government-controlled house of cards being stressed by runaway inflation; if China cracks, Canada, Australia, and Brazil will get suck down with it.  Finally, the US government is spending, borrowing and printing like there’s no tomorrow.  State and local governments are facing a fiscal Armageddon; they can’t print money to temporarily paper over the problem.  The US banking system is completely insolvent; the too-big-to-fail-banks have never properly accounted for their real estate security losses, and the federal government will not be able to provide life support indefinitely.  Corporate profits are near all-time highs, but that’s because government-sanctioned accounting forbearance artificially inflates corporate profits by almost 30% in the S&P500, making the oft-claimed argument ” but the S&P is cheap; see the P/E ratio is under 15″ a total joke.

But other than that, even the bears could agree that there’s nothing to worry about.

Are the Bond Markets Crashing?

December 11, 2010

The S&P500 melted up another 1.3% last week, on the heels of one of the worst jobs reports this year.  Volume was light, when you remove the non-recurring volume we saw when the government unloaded a big chunk of its Citibank shares.  The VIX index dipped very slightly to its lowest levels since April. 

The economy appears to be improving, but only because the federal government is still–almost three years after the Great Recession started–keeping it on life support.  Just about all of the so-called recovery over the last year has occurred only because of the government’s massive fiscal and monetary stimulus.  Last week–more of the same.  Consumer credit was reported to have risen slightly; but that’s only because the government’s student loan funding soared by $32 billion.  Without that huge spike in loans to students (who never in history have been burdened by more student debt), consumer credit would have plunged by almost $29 billion.  Initial jobless claims came in at a still dreary 421,000 level.  Consumer sentiment was slightly better than expected, but even this reading is far below those printed during normal recoveries.

Technically, the stock market is melting up, to form a possible long-term double top, where the first top formed in late April.  Volumes are still not confirming the price rise–volumes after late April on the way down were much higher than those on the way up this fall.  Momentum indicators and oscillators are still diverging bearishly.  Breadth is also diverging; it was much stronger in April’s peak than it is now, meaning a fewer number of stocks are participating in this rise than earlier this year.

Something very interesting started happening in the capital markets a few weeks ago, but not in the stock market.  Bond prices started to fall.   And not just in one corner of the bond market, but virtually across the board–in the US and internationally.

At home, municipal bonds fell hard, for several reasons:  lots of supply, the upcoming end of the Build America Bond program, and worries over deteriorating state and municipal fiscal conditions. 

At the same time, the US Treasury market started eroding, gradually at first, and then almost crashing last week.  Yields on the 10 year note are up almost one full percentage point from the one year lows set only a couple of months ago. 

Investment grade corporate bonds are also plummeting.  The large bond ETF with the ticker symbol LQD has dropped almost 5% in four weeks, erasing about half a year’s worth of gains.  In bond land, this is a huge drop.

Overseas, emerging market sovereign debt is also falling hard.  PCY, also an ETF, has lost over 5% of value in less than a month. 

As a result, in the bond markets across the globe, hundreds of billions of dollars have been lost in only a few short weeks.  In the US, the Fed has declared that lower Treasury yields are one of the key goals of monetary policy and specifically quantitative easing, both the first and second editions.

The Fed knows that with lower rates, the price of housing and all other risk assets will be supported.  If rates rise, the support goes away.   This would crush the fragile economy.

So here’s what’s scary:  the Fed is losing control of interest rates.  And not only will the economy suffer, but the US government would be more vulnerable to a fiscal funding crisis if rates shot up to high (higher rates on the ballooning federal debt load would mean that more and more of the annual budget would need to be shifted to interest payments).

What does this mean?  If the rates keep going up, the Fed will be faced with a stark choice.  Like the little Dutch boy plugging the dyke with his finger, the Fed has been doing the same with the bond market–suppressing the interest rates to boost the economic growth and the government’s finances.  But unlike the Dutch boy, the Fed has also been plugging another dyke at the same time–the stock market.

What happens if the Fed can’t keep both dykes intact?  Which dyke will the Fed sacrifice if it had to let one fall apart?

Arguably the Fed would be forced to defend the Treasury market and direct all its fire power to keeping rates low, otherwise the Treasury’s financial situation could blow up.

That means that the Fed might have to let the stock market go.  By doing so, the rush of hot money out of stocks would flood into the deepest and most liquid market in the world: the US Treasury market.  This scared money would bid up Treasury prices and drop yields–possibly–to new secular lows (with the 10 year dropping below 2.0%).

The Fed may never announce that it’s doing this (ie. taking back its support of stock prices and other risk assets, support declared by Ben Bernanke in a recent Washington Post Op-Ed).  No, the trigger would ostensibly be exogenous–a Eurozone default, a North Korean conflict, etc.

But this would be the perfect excuse to get interest rates back under control and buy the federal government more time, to get its fiscal house in order.

Oh and by the way, the same bond market declines that we’re seeing today happened not too long ago…..in the spring and summer of 2008, several months before the stock markets around the world crashed.

Economy: Down, Stockmarket: Up

December 4, 2010

The S&P jumped almost 3% last week, almost all of it on Wednesday and Thursday, even though there was no strongly bullish news.   Complacency rose back to levels almost as high as those last seen in April this year.  Volume was on the lighter side.

The real economy, on the other hand, showed signs of slowing down–again.  Housing is officially in a double-dip mode.  The largest asset class in America (far larger than the stock market) recorded a 0.7% price drop on the Case-Shiller 20 city index, when only a 0.3% drop was expected (September over August).   Per S&P which publishes the report, the results were very weak and disappointing.  Even worse, housing prices are expected to drop much more over the next six to twelve months.  ISM Manufacturing came in as expected; ISM Services were also as expected.  Chicago PMI was slightly better.  Initial jobless claims were much worse than expected–back up to the near 450,000 range that’s solidly in recession-level territory.  Factory orders fell even more than expected.   The biggest number of the week–and the ugliest–was the jobs number for November.  Nonfarm payrolls rose only 39,000, when 150,000 were expected.  This is the biggest miss in over two years.  The headline unemployment rate jumped to 9.8%, and not because folks re-entered the labor force (that would be a good reason for the rate to rise).  Average hourly earnings were unchanged; they were projected to rise. 

Technically, the stock markets are defying gravity, much like they did in April of this year and in the fall of 2007, when they continued to rise in the face of negative fundamental headwinds.  The negative divergences on the daily charts are still strongly evident–just as they were in the fall of 2007 and April this year.  The equity markets are overbought, yet the continue to levitate partly on the basis that NO news is bad for stocks:  if good economic news comes out (which isn’t happening) then stocks should rise; if poor economic news comes out (which is happening), then stocks should rise because the Fed will print more money (think QE3) and push stocks higher anyway.  In short, the pervasive feeling–reflected in the low VIX readings and the high bullish percentage readings–is that stock prices CANNOT go down.

So the question becomes, can this perception–rooted in hope and faith–be an actual foundation for rising and well-supported stock market prices?

Or is this just a re-run of a movie we’ve seen before?  A movie that ends in tragedy.

Alan Abelson, in this week’s Barron’s, offers a some evidence that it could be the latter.  He cites Paul Volcker, the outspoken former chairman of the Federal Reserve, who warned last week that we “in the most difficult economic circumstances of the post-World War II era and so is almost all the developed world.”

He continued with: “we are faced with broken financial markets, underperformance of our economy and a fractious political climate.” 

But somehow, the Wall Street salespeople, notes Abelson, managed to get the stock market to ignore the ugliness of the jobs picture and rally anyway.  Joblessness to soaring and already near 75 year highs.  Home prices, still almost 30% off-peak, are now falling again. 

But somehow, stock prices grind upward.  As Abelson notes, the markets are ignoring reality and ignoring the lessons of the past….

….at their peril.