Central Banks: the “Buyers of First, Last and Only Resort”

August 26, 2012

In a stunning development, the US equity markets were allowed to dip last week, so the S&P500 managed to shed 0.5% on rising volume. Volatility rose, as one would expect when prices actually do manage to fall. Breadth was bearish; the McClellan Oscillator eroded markedly, as did the new highs-new lows weekly index. So while market prices are near their highs of the year, the market internals are not following along.

Meanwhile the US economy continues to limp along. The Chicago Fed Index, existing home sales, initial jobless claims, and durable goods orders (ex-transportation) all disappointed by missing consensus expectations. And while new home sales were slightly better than forecast, those sales came at the expense of prices which fell 2.5% on a year-over-year basis.

Technically, the S&P500 is still very over-bought on the daily charts. And as noted, the behind the scenes, market internals are not healthy or strong. It appears that the US equity markets are poised for a greater pullback, if only prices were allowed to fall.

ZeroHedge summed up the situation very concisely. Today’s “new normal market….has long since given up discounting fundamental news, and merely reacts to how any given central banker blinks, coughs, sneezes or otherwise hints on future monetary injection plans…” “It is in this playing field where the price of any one ‘risk asset’ is no longer indicative of anything more than monetary, and in a world in which politicians have long been made obsolete by central planners, fiscal policies. It also means that capital markets are only whatever the various central bankers want to make them….and nothing else.”

And that is certainly the prevailing belief in the US equity markets today, namely, don’t worry about being long stocks or buying more on dips, because the Federal Reserve will never—never—permit prices to fall very much, and certainly will never let them crash.

So there’s nothing else to do except buy! Bad economic news? Buy, because that will only spur the Fed to pump in more monetary stimulus. Bad corporate news? Buy, because the Fed has your back on this little problem too. And if good economic news gets announced? Well, then buy even more because then the fundamental dictate that you should take on more risky assets like stocks.

In short, always buy. Never sell. All will be good.

And whatever you do, pay no mind to all the actual market crashes that have occurred under the Fed’s watch over the last 99 years, especially the most recent two crashes over the pat 10 years where prices collapsed by over 50% in each case.


Because this time is different. The Fed has gotten smarter and better at supporting the markets. The Fed won’t let pesky things, like crashes, happen again.

We’ll see.

It Doesn’t Make Sense, but Don’t Fight the Tape

August 19, 2012

The S&P500 inched up another 0.87% last week, on abysmally low volume, meaning that there is very little conviction behind the buying. In fact the volume was so low that it resembled what you’d normally see around the winter holidays, not a typical summer week. Adding to the concern about the lack of volume is the utter lack of volatility. The VIX index fell to a multi-year low last week, and this happened in the face of a slew of building global risks—a hard landing in China, continued recession in Japan, a broad and deepening recession in Europe, and now a slowdown in sales and earnings in the US.

The players in the equity markets appear to be saying “what, me worry?” as they blissfully continue to march prices higher. On Wall Street, traders are openly admitting that the steady move higher “makes no sense” but then they add “don’t fight the tape”, which means that they admit that prices should not be moving higher, in the face of all the evidence, but since prices are moving higher anyway, then a good trader must simply accept the situation for what it is and join the party.

The thinking is that if, or when, the party ends then a good trader will have plenty of time to find the exit before any big selling begins.

The problem with this thinking is that NOT all traders, good and bad included, will possibly be able to exit the party before the big selling begins. Inevitably, most will get trapped and suffer big losses.

So the best analogy to today’s price action and to those traders playing the game is picking up nickels in front of a steam roller. The upside rewards are small (nickels) yet the downside risk is huge (getting caught and crushed by the steamroller).

Good luck to those who choose to play this game with the bulk of their money.

In the meantime, most sensible investors are just saying no to the rigged casino. For the third consecutive year, investors have been pulling more money OUT of the stock market than IN. Yet even though stock prices have been climbing higher, it seems that the average investors are sticking to their guns and refusing to jump back into the manipulated stock markets, preferring to put more money into bond funds, money market accounts and even simple bank accounts.

Technically, the stock market remains highly overbought on the daily charts. Breadth is not strongly positive. And upward momentum, although still in tact, is weakening. Conditions like these typically do not last for very long and call out for a strong pullback.

Overall, the market temperature is very warm. P/E multiples have been expanding lately, holders of equities are not rushing to sell, credit spreads are very tight, and overall capital is not difficult to get.

This translates into a current market environment where prospective returns are low and—at the same time—risks are high. Without making any projections about the future, it reasonable to argue that today is NOT a favorable time to be hugely exposed to US stock markets.

The timing of any possible pullback is impossible to predict, but the likelihood that a pullback will occur is high and rising, rising every time the US equity markets inch higher.

Be careful.

Observations from Seth Klarman

August 12, 2012

Yes volume collapsed, and volatility only dipped slightly, but that didn’t stop the stock market from doing what it’s seemingly programmed to always do–go up. So the S&P500 inched up another one percent last week. It’s not that the average retail investor is buying into this rally; nope, he’s long since abandoned stocks for bonds. Instead, it appears to be the work of algo traders who lately have comprised over 70% of all stock market trading in the US.

All the while, the world’s leading economies are still slowing down. China had very disappointing export numbers. Japanese GDP growth is collapsing, when compared to the brisk growth it enjoyed in the first quarter. We all know that the periphery states in euroland are in deepening recessions, but now even the titan of Europe is showing signs of slowing—Germany’s economic numbers badly disappointed last week. Even here in the US, there’s nothing really encouraging to point out. Consumer credit is back in contraction mode. Wholesale trade is crumbling. And unit labor costs are spiking.

And US corporate sales and earnings continue to disappoint. Sales are now stagnating, when compared to last year. And earnings have stopped growing. So the ever-optimistic snake oil salesmen on Wall Street, also known as analysts, are now backed into projecting an incredibly massive 15% quarter of earnings growth in the 4th quarter. Why 15%? Because that’s what will need to happen for the annual earnings growth for 2012 to come in at a respectable level.

How interesting. This is almost exactly what happened in the middle of 2008 when poor first half earnings were supposedly going to be “made back” in the final half of that year. Instead, as we all know, not only did earnings not rebound, they collapsed.

Technically, the S&P500 is very overbought on a daily basis. As much as interest rates appear to be pinned down by the Federal Reserve (by its own admission), the US stock market appears to be pinned up at lofty levels (also explicitly endorsed by the Fed), levels that border on the surreal…..especially given the context of deteriorating global economies and corporate earnings.

Seth Klarman, one of the most successful hedge fund managers in the world, recently summed up the situation as follows (via ZeroHedge):

“The market roller coaster of 2012 continues. Speedy ascents. Sudden plummets. Unexpected twists and turns. Gut-wrenching volatility, only to end up where you began.”

“It is a strange world we inhabit. One where economies remain extremely depressed yet almost no companies go bankrupt, while low interest rates encourage holders of capital to speculate. One where global turmoil mounts while the world passively watches. One where nearly every member of Congress will insist that we need to rein in deficit spending, while collectively Congress accomplishes virtually nothing. It would be absurdly funny if it weren’t so incredibly tragic.”



The Can’t Lose US Stock Market

August 5, 2012

After dropping for the first four days of the week, the S&P jumped on the last day and erased the earlier losses. While the S&P ended the week up only 0.36%, volume fell off and near-term volatility fell only slightly. But since volatility was already near multi-year lows to begin the week, another small dip simply means that the US stock markets are even more complacent than they were the week before.

What led to the huge spike on Friday?

A better than expected jobs report. Investors were perfectly willing to overlook the fact that the magical add-backs of seasonal adjustments and birth/death adjustments took a NEGATIVE 200 thousand jobs figure and spun it into a “better than expected” positive 163 thousand figure.

What’s even more startling is the mood that’s settling in on Wall Street. If news is better than expected, then markets should rally, because a better employment picture leads to a better economy and better corporate earnings. And if news is worse than expected, then markets should also rally, because the Fed will certainly step in with massive monetary stimulus which leads to a better economy and better corporate earnings.

Although it’s hard to believe, a “can’t lose” mentality is starting to pervade the risk markets. And with yields on government and corporate bonds driven into the ground, the other pro-equities argument is naturally—buy stocks because bonds yield too little income.

If only this were really possible. And HOW do we know for sure that it’s NOT really possible? Because, if it were, then no equity market crashes would have ever occurred in the 99 years since the Fed was created, and certainly not over the most recent decade when the Fed has benefited from the wisdom accumulated over the prior 89 years.

And yet, stocks crashed in 2002-2003 and again in 2008-2009.

And they will most certainly crash again.

Will the next crash look just like the last crash in 2008-2009? Probably not. They always seem to differ in their degrees and their duration. But crash they will.

This time is not different, no matter how many times you hear that from pundits on CNBC and Bloomberg, and lately even from people affiliated with the Treasury and even the Fed itself.

Remember, the four most dangerous words in investing are “this time is different”. And when you begin to hear this sermon, and observe that it’s becoming commonly accepted, then you know that the end of good times, or high prices, is closer than most people think.

Today, prices are generally high. Corporate profits are at record highs. Bond yields are near record lows. Complacency is very high, and most asset owners are happy to own; they’re certainly not happy to sell.

This means that prospective returns, today, are unusually low. And market risk is unusually high.

And while it’s impossible to predict exactly WHEN this unfavorable set of market circumstances will express itself, it’s very possible to predict with a high degree of certainty that they WILL express themselves, in the not too distant future.