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Markets Marry Fantasia And We Play Musical Chairs

Monday, September 01, 2014

The market “correction” came and went, with market participants choosing to dismiss the ever-expanding global conflicts, in addition to economic ailments that continue to surface. Yes, we continue to be flooded with the idea of how healthy a correction truly is, but what are they saying? That the market is wrong and needs to correct, while embracing the notion that market prices are a reflection of all information available? Is it a “correction” when the market rises? It should be! We as a group accept some of these dumb terms and concepts without reservation and then wonder why we don’t get it right. Call it what it is: a market decline or advance is a reflection of changed present perceptions about the future, which may or may not be supported by data and/or events. It can also be a simple positive or negative reaction to a few words uttered by well placed bureaucrats, or “Draghiisms,” although they always stand powerless to actually fix whatever it is that needs to be fixed. European sovereign debt, anyone?

Then there’s the endless talk about present and forward P/E, CAPE and other measurements. In my world, a P/E of 5 is at the high end because I would expect a 20% return on any business investment with its inherent risks, but that is not how the stock market works. We’ve been instructed that a P/E of 15 is within reason, mostly because there are too many fish in the tank and not enough stock certificates to go around. I doubt that anyone would be happy with a 6.67% return on any risky investment in the real world, and let’s take the stock market at face value: it’s an unfriendly game of poker.

The pervasive wisdom in today's ZIRP environment, courtesy of the Fed, is that there's no real alternative investment other than the equities market. Chasing yield is all the rage, but having thought through the concept, something is amiss. Yield as it applies to bonds is known by the coupon rate, further adjusted by the price paid, and, barring default, remaining constant to maturity. The higher the yield one wants, the “junkier” the bond. In the equity universe one must assume that somebody else will subsequently drive prices up to achieve an unknown yield, which is only captured through the closing of positions, and shall remain “vapor-yield” until then. Thus far it has become a self-fulfilling prophecy for a variety of reasons. Certainly there are dividend paying stocks, but they hardly account for the overall market appreciation on their own.

QE created the expectation of future inflation and an eventual better economy, and although that fallacy continues to be worshipped, the outcome is only visible in higher equity prices, which wasn’t the initial intended consequence. There’s also this undying expectation that analysts and economists get it right. To highlight a point, do a search at bloomberg.com for the word “unexpectedly,” a favorite journalistic adverb at the site without a doubt, and you’ll get over 18,000 results, such as “Italian manufacturing unexpectedly shrank last month.” Then ask the question: “Unexpected to whom and why?”

One of main topics continues to be the American labor market and I’ve read plenty of stories about how the healing process is in place, as proven by the unemployment rate, job openings and jobless claims. Everyone knows about the unemployment rate and its relationship to the labor force participation rate by now, and there’s no need at this juncture to further explore the subject. On the job openings front -- JOLTS -- the celebration continues as indicated by the headline “Job openings hit 4.7 million in June, vs. 4.6 million in May.”

Employers posted 4.67 million jobs in June, up 2.1 percent from May's total of 4.58 million, the Labor Department reported Tuesday. The number of advertised openings was the highest since February 2001, a positive sign that points to a strengthening economy.

The problem with the quote above is that while the job openings number was the highest in 13 years, and still short of the 5.2 million in January of 2001, the civilian population has grown by 32 million people since then. Context my friend, context! Then there’s the historic comparison of jobless claims, and how the 300,000 mark is indicative of economic strength. The WSJ provided an interesting explanation.

But more recently, most of the fall in jobless claims has been driven by a decline in the number of the newly laid off who don’t bother to apply for government benefits in a generally improving economy.

In short, if one is laid off, jobs are so abundant that there isn’t a need to collect a few monetary crumbs from the government, even for a few weeks. Wonderful, indeed! Meanwhile, “More car buyers struggling to make payments” despite stellar auto sales which will leave lenders holding the bag. Ah, that reemerging subprime addiction and necessity that was addressed last year. But let’s get back to jobless claims and add context to the data, which is seldom accomplished by the main stream media for the sake of expediency.

As the chart above demonstrates, one cannot expect a 300,000 jobless claim count to have the same meaning today that it did in 2006, after the labor force participation rate cratered over 3%. Certainly the fewer people that have jobs as a percentage of population, the fewer layoffs and subsequent claims, because unless businesses close up shop, there are minimum levels of human resources required to operate, while serving a larger population.

Furthermore, while the civilian population expanded by 21 million Americans since January of 2006, the civilian labor force only grew by 5.8 million. Worse yet, since the depth of the housing crisis in January of 2009, the labor force has grown by 1.8 million, while the civilian population increased by 12.4 million. That is almost a 7:1 ratio and I don’t know too many families that gave birth to five kids in five years, and assuming there’s only one working parent. This is a statistical fact and not a political statement because the condition transcends all politics.

Demographics has been the most recent explanation for the unemployment problem, only because the Fed must always supply some form of purported intelligence, while the “skills gap” is yet another intellectual bright idea, except that they forgot to add “at the right price.” And, once again, where are the skills produced by over $1 trillion in student loans, or about 55% of India’s GDP? Do we really need more H-1B visas? Never mind, but one cannot continue to push a higher education as a social right, finance it until the cows come home while universities exponentially overcharge for their services, and then complaint that there’s a skill shortage.

The call for a market crash is growing louder, and the flip side is that the vast army of short-sellers with a short-term conviction and weak hands actually provide the reverse impetus. Short-sellers are not the pesky market devils as idiocy would have one believe, because, more often than not, they’re instrumental in driving prices up beyond reason. Or do people think that they always make the right bullish calls without fail? Although the mantras about “the new normal” and “this time is different” continue to be played, that is only a reflection of the predictability of basic human behavior which repeats instinctively and without instruction from generation to generation.

At the core of the current environment lies the unraveling of the change that was outlined in “1959: The Year Economics Changed And Nobody Noticed.” As it stands, we have a long-term three-act economic play, with the dot.com era being Act I, the housing debacle shown in Act II, and Act III still waiting to be performed. Intermission is coming to an end. Although, and contrary to many, my opinion based on cycles is that we’ve entered another period of economic frailty, markets are laggards mostly because the widely broadcast narrative always centers on the glass half-full. Like sex, that is what sells! When Bear Stearns gave the first hint of major trouble in early 2007, the market still raced to a record high in October of 2007, dismissive of the undercurrent that would choke the economic engine.

As a last note, Fed projections, and everyone else’s for that matter, never anticipate a single future negative economic period, as short as it may be, while claiming that they are avid students of history and proudly wallpapering their offices with diplomas and awards. Then it’s a black swan, although these events are nothing more than vivacious yellow ducks. I’m not a bull or a bear, and couldn’t care less about the silliness of the labels because this is not a game with opposing teams, although some players change jerseys every five minutes. Always think macro and play micro because this ceased to be my parent’s game a long time ago, and although old fashioned market internals and stock fundamentals cannot be entirely ignored, they have taken a back seat to disruptive and undisclosed new criteria that is at the heart of the market action and rattle investor psychology: fast and furious algorithms!

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