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March 15, 2004
Beware The Ides Of March
Asia was mixed overnight with no big moves in either direction. Europe was off over 2 percent this morning to a new low for the move, and the US futures were also lower. We opened down, stutter stepped for a bit, and then began a slow grind lower. We leveled out just shy of last week’s lows around noon and proceeded to flop and chop for the most of the afternoon. As the last hour rolled around however, sellers came back for more. We rolled over and took out the lows in the final 30 minutes to take out last week’s lows and give us a new low for the move in all the major indexes as well as a close on the very worst levels of the session. Volume was fairly light once again when compared to the heavy levels that we saw during the selloff last week (1.5 bil on the NYSE and 1.7 bil on the NASDAQ). Breadth was nearly 3 to 1 negative on the NYSE and over 4 to 1 negative on the NASDAQ.
Initially, the semi complex held up pretty well, but as the day wore on, it got heavier and heavier. The semis were lower across the board by 2 to 4 percent. The equips were lower by 3 to 5 percent. The SOX fell 3 percent to a marginal new low for the move.
The Internet junk was beat. The tier 1 trash was off from 2 to 6 percent. IACI’s 6 percent decline led the way. Over in the tier 3 junk, things were even uglier. The Chinese net junk was splattered for between 4 and 10 percent. SOHU fell 4 percent to another 10-month low. CMGI fell over 8 percent, BVSN 6 percent, etc. I think you get the idea. The trash continues to point to lower prices for the rest of the market.
Financials were lower. The BKX fell a percent, and the XBD fell over 2 percent to a new low for the move off the recent peak. The derivative king fell over a percent, BAC fell a percent, and GE fell a percent and back to its low for the year despite having reaffirmed EPS estimates for both Q1 and Q2 this morning. The mortgage lenders were off 1 to 2 percent. FRE and FNM both fell a percent. FNM also announced that it had shrunk its mortgage portfolio by 14.6 percent in January, and another 6 percent in February. I guess Uncle Al’s warnings got their attention?
Retailers were lower across the board. The RTH fell 2 percent. Homebuilders were mixed (up or down a percent). People may need to see mortgage purchase applications consistently falling in the face of falling rates to get the message that the housing boom is in trouble no matter where rates are. Why is the boom in trouble regardless of rates? The answer is because incomes and jobs are not expanding. We saw the homebuilders consistently ignore lower interest rates last week and sell off, but I’m not quite ready to say that people have begun to change their psychology in this sector yet. If investor’s become worried about FRE and FNM paper, we may also see mortgage rates rise, despite any leg down in long-term treasury yields. That could also be a potential trigger to change psychology.
Crude oil jumped $1.25 to $37.42 and just shy of a new high. The XOI fell half a percent, and the XNG rose a hair. Oil and gas appear set to correct with the rest of the equity market if the selloff continues. Should we buy the dip? Maybe. It’s something that I plan on discussing in more detail, but I am beginning to look at the oil complex more closely for potential investment for those that have an interest there. The CRB surged nearly a percent and a half to just shy of a new high. The CRX fell over a percent and back to its low for the move.
Gold gapped up about $4 this morning in NY on the back of a weaker dollar. After momentarily flirting with the $400 level, the metal gave back a couple bucks as the dollar index strengthened back to nearly unchanged. The metal then worked its way back up to near the open in the latter part of the session. With about 20 minutes to go in the session, a story hit the wires that the BOJ was going to cut back on its dollar intervention after the end of its fiscal year in March, and that spiked gold momentarily over $400, as the dollar promptly fell out of bed against the yen and most of the other G7 currencies on the story. Upon further review, one saw that this was not the BOJ announcing this policy shift but instead a Japanese newspaper speculating that this shift might occur. The yen’s spike quickly reversed (as did the rallies in the other currencies), and gold’s spike also reversed, sending it out up $4.00 to $399.80. Gold is still moving lockstep with the dollar. Despite the strength in gold, the HUI traded more with the equity market once again and spent the entire day in the red. The HUI fell 3 percent, going out on its lows and closing below the key 217 level that has been support on every selloff for the past month. This breach tells me that the HUI could be about to accelerate to the downside along with the rest of the equity market.
The US dollar index lost a touch, as it marked its fourth day of moving basically sideways near its high for the year. I’m still expecting the dollar rally to continue, and we could potentially accelerate higher off of the FOMC tomorrow (see below). The yen was up over a percent on its highs, but gave most of that back to end up only half a percent. The euro was up just a touch and continues to flop around near its lows for the year.
After the all the poor economic data of late coming out of Europe, the selloffs in its various equity markets, and the terrorist attack in Spain, one wonders if we might get an ECB surprise rate cut soon? It would be a bit out of character for the ECB, but not out of the question given the news of late. This would likely put more pressure on the euro and remind people that the economies overseas are much weaker than the US right now and more rate cuts are likely on the way from them, as the global economy slows once again. Recall what we said many months ago about the current economic blip not being sustainable because a drop in the dollar, while beneficial for the US in a small way, was going to cause all sorts of problems for foreigners, whose economies had become unbalanced to the export side of producing goods in return for dollars in the late 1990s.
It’s all part of the ongoing unwinding and restructuring process that must occur in the wake of the bubble, and it’s nowhere near over. Policy makers have attempted to reinflate the old broken structure through rate cuts and "liquidity" (printing money), but humpty dumpty cannot be put back together once he's broken. The bubble busted,a nd its time to take our medicine. Creative destruction is what is necessary, but that involves economic pain. And politicians and central bankers continue to try and avoid it, making the eventual pain the global economy must endure that much worse.
Treasuries were flat. The yield on the 10yr rose slightly to 3.76%. The yield curve continues to flatten, as rates in the short end creep higher, while rates in the long end slide. I seriously doubt the Fed will raise 25 bps tomorrow (to put it another way: “I’d be shocked if they did”). However, based on what I am seeing in the markets and the Fed’s rhetoric of late, I do think there’s a chance that we could see the FOMC remove the word “patient,” indicating another minor step toward a tightening in the hopes that the markets might do some of their work for them without them having to actually raise interest rates. It’s a rather silly word game that they’re playing here, but it’s their game to play I guess. The continued rise in oil has to be a concern to the Fed, even though Uncle Al and the boys would never let on that it is. A further change in the FOMC statement would be the easiest way to get its message across, as it did at its last meeting on January 28th when it pulled the “considerable period” language and replaced it with just “patient”(you’ll recall that news broke the NASDAQ back to its lows for the year and completed its peak).
How would the markets react to the Fed removing the word “patient” from its statement tomorrow? Stocks and commodities would probably not like it at all, and the dollar would likely soar. Interest rates in the short end would rise in anticipation of a rate hike sooner rather than later, while rates in the long end might actually decline further due to the fall in stocks and the eventual drag the equity selloff would place on the economy. Basically, the curve would flatten and the reflation trade would accelerate its unwinding in the equity and commodity markets. So, we’ll see what happens tomorrow.
We made new lows for the move today in all the major indexes, completely reversing Friday’s short covering rally. With the top being in for all the major indexes and building momentum to the downside, the case can now be made that we’re potentially on the cusp of some sort of acceleration to the downside. With it being an option expiration on Friday, any highly motivated selling off of news is going to trigger more selling exponentially due to the delta hedging of options (as it most often does to the upside during rallies). But, that sort of motivated selling that sets off the delta hedging dominos is probably going to require some news in order to stampede the herd. So unless something happens (and I’m including the Fed removing “patient” in that “something” category), the odds would probably favor a bounce into Friday’s expiration (since that’s what normally happens) and then another leg down in stocks on into April. However, like I said, I do think there’s a strong chance that we could get some “news” that could spark further selling right here and now. A further rally in the dollar off of a more hawkish FOMC statement and/or a surprise rate cut from the ECB are both potential triggers. These events would both accelerate the unwinding of the “reflation trade” and put even more pressure on a lot of hedge funds that remain short the dollar.
The reflation trade continues to slowly unwind, but that unwinding could accelerate at any time now. As crazy as things got on the upside in stocks over the last year, some sort of symmetrical violent downside is a high probability. So, we can’t rule out some sort of “accident,” although it’s always difficult to anticipate such a move. Anyway, the next four days could be very wild depending on the news flow, so let’s get past the FOMC before we try and think too far ahead.
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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