puzzle nearly solved?
January 28, 2004
The Fed Throws Foreign Dollar Holders A Bone
Asia was lower overnight, with Japan falling a percent and Hong Kong falling 2 percent. Europe was up a touch this morning, and the US futures were higher as they always are. We gapped up at the open and spent the entire day in a sideways chop up until “Fed time” at 2:15 EST. The Fed’s statement hit the wires, and “surprise, surprise” they removed the “considerable period” bit in their statement and downshifted instead to one that read, “The Committee believes that it can be patient in removing its policy accommodation.” Obviously, Uncle Al and the boys want to try and make the process of weaning off the market from the Fed’s ultra-easiness as painless as possible, and they’re trying their best to ease the market psychologically back to a neutral bias without this nice fat asset bubble in stocks that they’ve rebuilt to some extent falling apart on them. There’s no doubt also a lot of international pressure to prop up the dollar, but I’ll have more to say on that topic below.
In any event, the market’s reaction to the dropping of “we’ll leave rates low forever” bit was immediate. The dollar surged higher, interest rates rose sharply all across the curve, and equities tanked. The S&Ps quickly plunged about half a percent, bounced, and then spent the rest of the session tumbling to new lows for the day into the close, taking us our right on the very worst levels of the session. Volume was extra beefy (1.8 bil on the NYSE and 2.3 bil on the NASDAQ). Breadth was over 2 to 1 negative on the NYSE and nearly 3 to 1 negative on the NASDAQ.
The semis were off another percent on average, after obviously being pounded pretty hard only just yesterday. The equips were beat up once again also, with NVLS falling another 2 percent on top of its 15 percent decline yesterday. So, we’re seeing follow through selling, which is something we haven’t seen in a very long time. The SOX fell half a percent to a marginal new low for the move.
The Internet trash was smacked. The tier 1 junk was busted, despite AMZN getting everybody excited and having reported its first annual profit last night. That’s right ladies and gentlemen, AMZN made money last year. It now actually has a trailing 12-month PE, and that PE is only 745x. Now that we can actually slap an earnings multiple on this retailer its valuation looks even more ludicrous. AMZN slumped 7 percent. Elsewhere, PCLN joined in leading to the downside, as it also fell 7 percent. Over in the tier 3 trash, things were red across the board. Among the Chinese net trash, SINA, SOHU, and NTES were all down 5 percent. CMGI fell 6 percent, and BVSN fell 5 percent. For the first time in a long time, we saw the garbage stocks get thumped across the board, and that’s worth noting.
Financials were mostly lower. The BKX fell 2 percent, and the XBD fell 3 percent. The derivative king fell 2 percent, BAC also fell 2 percent, and GE fell a percent. The mortgage lenders were whacked across the board on the back of interest rates moving sharply higher. The usual high beta suspects had the biggest downside moves, as LEND fell 7 percent and NCEN fell 6 percent. FRE fell 4 percent, and FNM fell over 2 percent.
Retailers were lower across the board, with the RTH falling over 2 percent. Homebuilders were annihilated on the back of a triple punch of data. First, we got the December new home sales data this morning, which were down for 5.1 percent on top of a decline in November too. That means that new home sales are now down 12 percent from their June peak. Yet, housing starts just made a new high in December for the second month in a row. How can housing starts be diverging from sales? Obviously, we must have a good deal of spec building going on, as we’ve been discussing.
Secondly, the Mortgage Bankers Association said this morning that its market index fell for the week ending Jan 23 by 5.2 percent to 868.9. That compares with the previous week's 916.1, the highest level since the week ended Aug. 1. The group's purchase index fell 10 percent to 451.6 from last week's 501.6, which was the highest level reported since the group began its weekly survey in 1990. The group's refinancing index slipped 0.9 percent to 3,296.7 from previous week's 3,327.3, which was the highest level since the week ended Aug. 1. So, as we were expecting, we got a significant decline in purchase activity as long-term interest rates ticked up last week.
Thirdly, interest rates backed up significantly today in the wake of the dollar’s rally and the FOMC statement. Thus, the homebuilders were hit with a triple whammy of data, sending them all careening lower by 5 to 7 percent. NVR actually even made a new low for the move. So, it appears that the market is once again reaffirming that the housing bubble is about pop, as the recent bounce in the homebuilders appears to have ended.
Crude oil fell 50 cents. The XOI fell a percent, and the XNG fell 3 percent. The CRX fell 2 percent and appears to be rolling over from a failed rally, as we’ve been anticipating. The CRB fell a percent. Gold opened flat in NY on the back of a dollar that was just a touch higher. From there, the metal flopped around for a bit and then squirted about $5 into the close to close on its best levels of the day before the FOMC made its statement. The catalyst for the metal’s rally in the face of a slightly stronger dollar appeared to be some statements overnight coming out of Japan’s MOF. Tanigaki, Japan’s finance minister, told a parliamentary committee he thought it might be a good idea to begin diversifying assets in Japan's foreign reserves, which are mostly made up of dollar-denominated assets. When asked about gold, he said he would think about it carefully. He said, "There are various discussions about the positioning of gold in foreign reserves, even among currency authorities… If I say something too simply, I think there could be a large effect on gold markets...so I would like to consider it carefully." Gold bulls were obviously glad to see this, and I think this sort of talk is certainly bullish for gold in the bigger picture.
As a long-term gold bull, I think central bank diversification out of dollars is going to contribute immensely to gold’s bull market. However, in the short-term, I think a statement like this was geared more towards sending the US (primarily the Fed) a message. There have been all sorts of pre-G7 meetings going on over the last couple weeks, and clearly currency has been a big topic. Both the Europeans and the Japanese are very concerned about the rise in their currencies due to the damage that it does to their export-oriented economies. And they have no doubt lobbied for help from the US (as Japan did back in 1998 as well, when the yen was falling uncontrollably), but for a variety of reasons which we have discussed before, the US clearly would like to see a lower dollar. The message from Tanigaki last night may have in fact been a veiled threat that Japan means business about stopping the dollar’s fall against the yen, and Japan wants help from the US… or else.
Obviously, with the Fed having no foreign currency reserves to speak of, it can’t intervene to prop up the dollar even if it wanted to. The only tool that the US has to prop up the dollar is interest rate policy. Clearly, the Fed doesn’t want to raise interest rates due to domestic economic pressures, but the international pressure to keep the dollar propped up is equally intense. And the Fed’s move today may in a sense be a compromise between the two. By removing its “considerable time” bit, it can give the market a catalyst to turn the dollar and interest rates temporarily in order to “turn the market” and give the dollar a bounce, without actually having to act and officially raise short rates.
Thus, in the short-term, a statement like this out of the Japanese may have the opposite of the effect that one would think on gold, due to all the other things going in the background at the moment, namely the international cooperation to inspire some sort of bounce in the dollar and halt its accelerating collapse.
So anyway, that’s my take on that bit of news. As for the gold shares’ reaction to the FOMC today, they were slapped around pretty hard. The HUI fell 3 percent, slipping back once again to its low for the week. Again, since I think stocks in general could be about to have a big problem, I think the gold shares may be about to have a big accident as well, as the short dollar/long stocks and commodities trade that everybody has on essentially blows up all at once in everybody’s faces.
The US dollar index rose nearly a percent and back to its high for the week. The yen slipped just a touch and continues to be the last G7 currency to resist a move lower, as the forex market continues to appear to be trying to carve out some sort of important low in the dollar against the major G7 currencies. The euro fell a percent and back to its low for the week. Big turns in the currency markets usually take time to develop, so we may not see the dollar really soar (assuming I am correct in that it is going higher) until after the G7, but we should continue to see the rest of the financial markets begin to discount that eventuality (i.e.- gold shares continue to edge lower, the CRX continues to edge lower, and interest rates continue to rise in anticipation of less and less intervention related buying coming in from Japan and Asia).
Treasuries were hammered. The catalyst was the FOMC changing their statement, but I think everybody knows that the Fed won’t actually be raising interest rates anytime soon. Instead, the anticipation that the dollar would rally and effectively end one of the bond market’s chief sources of buyers (the BOJ and other Asian central banks that are intervening on a daily basis) was more likely the real driver behind today’s rise in interest rates. The yield on the 10yr rose to 4.19%, and I believe we will also be seeing new highs in yield in the coming weeks.
I’d also note that credit spreads widened a bit today. DHY, which is one of the largest junk bond closed end funds, fell over 2 percent, which is its largest selloff in months.
Investor’s Intelligence sentiment survey was basically unchanged, so I am not going to waste time talking about that, but I am going to mention the fact that Ned Davis’ daily crowd sentiment amazingly hit a new all-time high in bullishness in recent days, beyond even that which we saw at the peak of the craziness back in 1999 and 2000. When looking at a chart of this sentiment gauge, it truly is “off the chart” so to speak. So, once again, I think the sentiment picture is about as extreme as it can get.
We finally got some follow through selling in stocks today for the first time in a long time, and I think it is significant, as it is likely indicating that the blowoff is in fact over. I’d also note that the VXO has broken its downtrend going back to October, indicating that stock prices should soon follow with a similar trendline break, since volatility typically leads price.
Again, as we’ve been discussing, the real damage in stocks should occur as the dollar makes a new high for the move and interest rates continue to move higher. We should continue to see the commodity-oriented stocks (CRX) and the housing stocks (HGX) lead the move lower in the general stock market. So, I am watching closely for when these two indexes make new lows for the move and confirm the end of the “inflationary trade.” Obviously, as the mortgage bubble pops (which we’ll know about based on the way the housing stocks trade), the US consumer and US economy (which is also driven by the twin asset bubbles in housing and stocks) is going to be in a world of hurt, and we should see the retailers begin to come under more pressure too going forward. Basically, I think we may be finally seeing something different in the stock market. So, bears may want to be on their toes going forward, as we could finally be seeing the end of the widely embraced inflationary trade and the beginning of a much nastier deflationary trade. Let’s see if we get more follow through selling again tomorrow...
Disclaimer: Lance Lewis periodically publishes columns expressing his personal views regarding particular securities, securities market conditions, and personal and institutional investing in general, as well as related subjects.
Mr. Lewis is the president of Lewis Capital, which manages a hedge fund in Dallas, Texas. This fund regularly buys, sells, or holds securities that are the subject of his columns, or options with respect to those securities, and regularly holds positions in such securities or options as of the date those columns are published. The views and opinions expressed in Mr. Lewis' columns are not intended to constitute a description of the securities bought, sold, or held by the fund. The views and opinions expressed in Mr. Lewis' columns are also not an indication of any intention to buy, sell, or hold any security on behalf of the fund, and investment decisions made on behalf of the fund may change at any time and for any reason. Mr. Lewis' columns are not intended to constitute investment advice or a recommendation to buy, sell, or hold any security.
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