Market Bubbles And Repulsion, Dollar Demise And Other Cogitations
Monday, September 22, 2014
The Dow Jones Industrial Average (DIA) closed at an all time high after Janet Yellen spoke her mind on September 17, 2014, and that’s important to the population at large, because that is the most visible index and the one that everyone talks about. In addition, the number itself is far more impressive than the S&P 500 (SPY) or Nasdaq 100 (QQQ) because it’s a five digit financial marvel. If you mention Russell people will think that you’re talking about candy, as in Russell Stover that is now owned by Chocoladefabriken Lindt & Spruengli AG.
Much of the discussion leading up to the FOMC’s statement centered around the words “considerable time,” with a number of interpretations as to what “considerable” actually means. I guess we must occupy ourselves with something, and the truth is that the FOMC is composed of queens and kings of nuances and semantics, giving itself plenty of room for future decisions without committing to anything. Take a job, any job, and when asked how long it will take to complete a task, please answer “considerable time” and let us know how it works out.
The immediate reaction to the word parsing exercise is depicted by the chart above, showing the S&P 500 futures swinging close to 15 points in 5 minutes (around 130 Dow points), and then settling close to where it was before the statement. Needless to say, plenty of longs and shorts were sent packing in only 10 minutes. Considering that the Fed seeks stability, maybe they should schedule their releases and press conferences for Friday afternoon after the market closes, giving everyone a chance to digest their endless words of wisdom. But I suspect that the Fed enjoys the drama because it derives a sense of purpose, which is not provided by the dull world of economics.
Keeping it simple is always key, and the Fed’s talk about normalizing policy is confusing. Isn’t a policy, any policy, always normal as it applies to the circumstances? In other words, if one is out at sea, the “normal” policy is to wear a floating device, and one should not wear a life jacket when on land. But maybe that is exactly what the Fed had us do, monetarily speaking, and the life jacket is of no use as we drive around town. A couple of days later, “Fed’s Fisher Says Better to Raise Rates Sooner and Slowly.”
“I’m in the slow and gradual school,” said Fisher, who would like a first increase in the spring of next year. “It would be a mistake to wait too long and raise rates rapidly. There is no time in history when the Fed has done that and hasn’t driven the economy into recession.”
Makes sense, if the “recovery” is not a mirage, but while there’s an economic cheer that keeps on giving, the underlying numbers and dynamics are not supportive. In addition, the Fed’s take on 2017 -- yes, 2017 -- is that “the unemployment rate will average 4.9 percent to 5.3 percent in the final quarter of that year.” That is extremely audacious for an institution to see so far beyond the horizon when it doesn’t know if interest rates will be increased in six months. What I would like to know is how they arrive at these projections, but that, my friends, shall remain locked within the obscurity of economics that will never see the light of day. However, the projected low unemployment rate may not be so far fetched for all the wrong reasons, only because plenty of people will be employed in the manufacture of ammunition and military equipment.
The game was rather simple: Fed prints money and lowers interest rates (don’t mention currency devaluation, please), and that would magically trigger growth and inflation. Except that stocks are the only game in town, inflation is nowhere to be found, and the dollar ballooned while the euro and yen dropped like stones, thanks in part to 10-year Treasury rates being now higher than their counterparts in Germany, Italy and Spain, not to mention Japan. Maybe this is the new normal! Let’s not forget that the Fed is akin to corporate R&D and it has vast resources that crunch numbers all day long, or so we think.
The good news is that “Household net worth up $1.4 trillion in second quarter,” although we don’t know exactly what households are holding the bacon -- or maybe we do. Here’s the excerpt, and please read between the lines to get the picture, although some are predisposed to seeing what’s not there.
U.S. households and nonprofits added $1.4 trillion in net worth in the second quarter due to continued higher prices for stocks and real estate, according to Federal Reserve data released Thursday. The gain in net worth to $81.5 trillion was driven by a $1 trillion rise in corporate equities and a $230 billion gain in the value of real estate. Debt outside the financial sector rose at a seasonally adjusted rate of 3.8% in the second quarter, slightly lower from 4.3% in the first quarter. Household debt grew 3.6%, the fastest pace since the first quarter of 2008. Consumer credit like car and student loans surged by 8.1%, the fastest since the fourth quarter of 2001. Mortgage debt increased 0.4% after two straight quarterly declines.
A quick note about Scotland’s quest for independence, and if the subject interests you, please read “These 8 places in Europe could be the next to try for independence.” The market appeared to be fearful of a breakup, but, in my opinion, it wasn’t so much about Scotland becoming an independent country, but about the message. Imagine that Scotland adopts a new currency, walks away from debt, and despite some rough times, life goes on. Already independent Eurozone countries may be inspired to start their own movements to secede from the euro! Now, that would be a riot!
One other consuming and controversial topic is inflation, and how QE hasn't produced any. Yet there’s a camp that swears that inflation, aside from stock prices, is alive and well and that government CPI is manipulated. Maybe CPI isn’t perfect and we should use another source to validate the assertion. In comes PriceStats (pdf) based on the Billion Prices Project at MIT, and the chart above compares their measurements with CPI. Maybe it's not reliable as well, but what else do we have? Aside from anecdotal evidence and complaints that beef increased 10%, inflation is nowhere to be found, and considering that the Fed printed reams and reams of paper money, it must be extremely disheartening. However, lower wages will produce the inflationary effect, even when prices do not move.
The replacement of the U.S. dollar as a main reserve currency continues to be touted, and the chart above has been widely circulated. Frankly it would be a good thing because despite the short-term pain inflicted, the government’s fiscal house would be forced to be fiscally responsible, among other positive effects. But reserve currencies are based on trust, not the whims of a secret schmuck society, and understanding the 500 year-long riddle contained within the chart will provide the answer. Not everything is free, you know!
In addition, the U.S. bond market is the largest and most liquid on the planet, courtesy of our government’s spending habits and serviced by the U.S. taxpayer. If the dollar was to sink where would all the export-based economies, or just about everyone else, send their stuff to? Yes, the U.S. has monumental problems, but what country and respective currency inspires the same level of trust? Look at it this way: America has the leverage because of the astronomical debt it owes, and dismantling the addiction has consequences that will not be welcome by anyone.
Lastly, I came across a chart depicting CNBC’s viewership over the last 23 years, courtesy of zerohedge.com, and I shall state upfront that zerohedge is definitely not my source of information, because it is far too pessimistic for pessimists. But every once in a while they strike a chord. After many years in the investment/trading universe, I’ve learned that knowing people -- I try very hard although it isn’t easy -- is far more important that using funky esoteric models, and that is the fallacy of economics. One potential hopeful projection is that viewership will still rise, much like the low of 2005 still preceded a high in 2008, but one must take into consideration that as the stock market races to new records, “Nearly Half of Americans Think the Recession Is Not Over,” which wasn’t true in 2005.
In fairness and in my opinion, CNBC is no worse or better than it has always been, but what is downright disappointing and extremely telling is that only a small viewership spike took place three years ago, still falling very short of previous peaks, and after the market had already recovered from the 2009 low and then inflated without looking back. If we must recall, the Fed’s adopted goal of improving consumer sentiment through the stock market, or “wealth effect,” is not producing results, much like everything else they do. Maybe, just maybe, there’s a realization that “we the people” are not coming to market and “vendors” are holding plenty of inventory that must be disposed of as the army of squeezable short-sellers dwindles.
Recently I put quite a bit of thought into the bubble debate, and a market can be a so-called “bubble” with, for example, an S&P 500 P/E of 20, 40 or 60. But it can also be 10. Bubble is a subjective attribute, and only the market’s relationship to economic reality is what matters, coupled with how market participants eventually react when the truth is finally absorbed. That is always the unresolved million dollar question in terms of timing and dimension. One of the tenets of a missing market bubble is the lack of widespread enthusiasm -- CNBC appears to validate that -- and there’s a belief in some circles that until the celebratory condition manifests itself, beads, booze and all, the market will not crater, while completely disregarding ongoing domestic issues, global economics and geopolitical discord.
Judging from historical market data, a P/E of around 5 appears to be the bottom and truly cheap, but our condition is anything but normal as compared with any period over the last 100 years, Great Depression included. The point being that while the consumer is the indisputable economic engine, we as a society blindly added the turbo option through consumer credit over the last two generations which must still be resolved. There are always consequences to everything we do, and pushing consumer credit is like a TV commercial for the latest drug that highlights the benefits with happy faces, but without spending one third of the allotted time describing the side effects. Quit smoking with Chantix, but you may have suicidal thoughts. Which one will kill me first?!
To make the bubble point, the markets didn’t deliver the goods and experienced "super corrections" -- if the preferred lingo must be used -- between 1966 and 1991 without exceeding a P/E of 20, and shaking plenty of enthusiastic believers along the way. That was a mind-numbing 25 years! Yet we still get the absolutist opinions that we’re not there yet, only because the ducks aren’t lined up according to loosely referenced history and other theories, and we shall wait to squeeze every last drop out of the financial lemon.
Here’s the conclusion: while some still wait for the bubble to form, there’s no acceptable definition of what constitutes a bubble, and a bubble is not a prerequisite to a market decline. On the flip side, I’ve read plenty of opinions that center on whether the next “meaningful” decline will be a correction or a crash, and to each his/her own. But here’s the question: can anyone tell the difference in real-time between the beginning of correction and a crash? I can’t, and if it was that easy, everyone would be a millionaire.
In closing, Alibaba (BABA) found the treasure and trades at 25 times sales, among other interesting facts. Word to the wise: the forty thieves are waiting! Listening and observing are priceless traits, and when confronted with the choice between mystical eloquence and clear practicality, I always choose the latter… for practical reasons!