Market Comments as of November 4 : Ursus Extinctus ?

November, 07 2013

Ursus extinctus ?

 

It continues to be untrue that ‘no-one likes this market’. In fact, we don’t know about any other year in which the market has been loved as much as in 2013. We can see it in this year’s Barron’s ‘big money polls’, we can see it in sentiment surveys and in actual positioning data, including record high margin debt.

Of course the bears have been quite wrong so far this year. Simply following the herd was clearly the thing to do (and it should be noted that since sentiment is in large part a function of price trends, one should expect sentiment to be net bullish in uptrending markets). Nevertheless, when sentiment and positioning data consistently produce new extremes month after month, it tells us that the eventual backlash is likely to be quite a doozy.

The financial markets have long been seen as a gauge of future economic activity.   As the stock market rises the economy has also risen.  However, that has not been the case over the last several years with the economy stuck at a sub-par rate of growth.  Today, with the high degree of correlation between the Fed’s balance sheet and the financial markets, it is getting increasingly difficult to make the case that the markets are reflecting anything but themselves.

The increase in the monetary base in the form of idle excess reserves. There is a credit crunch, as banks with insufficient capital do not want to lend to risky borrowers, while slow growth and high levels of household debt have also depressed credit demand.

As a result, all of this excess liquidity is flowing to the financial sector rather than the real economy. Near-zero policy rates encourage “carry trades” – debt-financed investment in higher-yielding risky assets such as longer-term government and private bonds, equities, commodities and currencies of countries with high interest rates. The result has been frothy financial markets that could eventually turn bubbly.”

Given that money printing continues as before, it is admittedly hard to see what could trigger a reversal – but this is also a ‘hook’ that is likely to eventually mislead market participants. They have become so used to the ‘Bernanke put’ supporting the market, that they can no longer imagine that it may one day not work as advertised anymore. And yet, it is a near certainty that this day will come. Stay tuned.

QE taper back on the table.

In the 1977 Eagles song, Hotel California, a luxury hotel appears inviting and offers a tired traveller comforting relief from his journey. It turns out to be something of a nightmare, however, and he finds that “you can check out anytime you like, but you can never leave”.

Does that sound a little bit like QE and the Fed? The FOMC signalled its intention to check out of QE at its June meeting, but by September, it found it could not leave. The backup in yields that the announcement had sparked, together with worries about fiscal fisticuffs in Washington, was damaging an already not-very-vigorous recovery and hurting confidence. So, the Fed took a rain check. Is that not just like QE1 and QE2, the scheduled ends of which had to be reversed within relatively short periods?

The question now is whether or not we should expect repeated market obstacles to a QE3 exit. Infographic”Taper Exit explained”

In the wake of the Fed’s latest policy announcement on Wednesday, both bonds and stocks dropped, suggesting that investors saw something more hawkish in the central bank’s statement. The Fed made no change to administered rates, its pace of asset purchases, or its forward guidance for either.  There was no change in policy, but there was a change in wording of its statement that suggested a December or January taper of Quantitative Easing (QE) might occur.  There was no change in policy, but there was a change in wording of its statement that suggested a December or January taper of Quantitative Easing (QE) might occur.  SEE THREE TAKE AWAY

We also don’t see any meaningful upgrade to the Fed’s qualitative assessment of the economy relative to the last policy statement in September, when the Fed defied market expectations by holding off on tapering. And in any case, the most important thing to remember is that the timing and speed of tapering is ultimately data dependent. At his press conference in September, Chairman Bernanke forcefully made this point to investors.  And we don’t think there will be enough strong or clean data available over the next six weeks to convince the Fed that the economy has improved enough to warrant tapering in December.

SEE :  Bubbles, Bubbles Everywhere By John Mauldin