Hello Patron_anejo_por_favor, here is something from a comrade missing in action and stuffed in a Box
April 20, 2004
Lance J Lewis
The “Reflation Trade” Feels The Squeeze Of Interest Rates
Asia was mixed overnight, with Japan picking up 1.6% and Hong Kong losing half a percent. Hong Kong continues to drift dangerously close to a major breakdown on the charts.
Europe was up just under a percent this morning, and the US futures were higher. We gapped up at the open and briefly tried to rally. That rally quickly fell apart, and we edged lower. From there, we flopped and chopped for a couple hours while we waited for Uncle Al to give a speech to the Senate Banking Committee. Tomorrow’s appearance before the Joint Economic Committee is the really important speech that everybody is keying off of, but this one today was sort of a “warm-up,” where nobody really expected him to give any outlook on inflation or what the Fed was going to do with short-term interest rates.
When the text of Uncle Al’s speech hit the wires, we sure enough saw that there was no mention of monetary policy but there was a reference to US banks being well prepared for rising interest rates. He also said deflation was no longer a concern for the Fed, which no doubt spooked some of those with the “reflation trade / the Fed is our pal forever”-type of trade on. Uncle Al’s exact words were: "It's fairly apparent that pricing power is gradually being restored and, as I'll indicate tomorrow, threats of deflation, which were a significant concern last year, by all indications, are no longer an issue for us."
Now, it doesn’t really matter what Uncle Al thinks, because the market is the one that sets interest rats, not the Fed. But, with this statement, it also clearly shows us that Uncle Al doesn’t feel the need to drop money from helicopters anymore (for now anyway), and that means the Fed will no longer be on the side of those that are chasing any and every asset that is moving up in price. Remember, Uncle Al is trying to walk a tightrope here and juggle two markets. The bond market is in some sense more important than the stock market, and he must keep it appeased in order to keep rates down and prevent a collapse in the mortgage finance bubble, as well as a potential derivative meltdown (the interest rate derivative market is much larger than in the equity market). But he also wants to try and prop up the bubble in stocks as well. Having used up all the Fed’s bullets and credibility, he’s now painted himself into a corner, and he may be about to have both markets blowup in his face because of it.
The reaction to Uncle Al’s speech in the markets was immediate. The bond market tanked, the dollar surged, and stocks rolled over and took out the lows. The S&Ps kept on sliding right up until the last hour, and once the bond market had closed, the S&Ps tried to bounce for all of about 10 minutes. But the selling pressure was too great, and the rally attempt quickly collapsed. That gave way to chain selling into the close and took us out right on the very worst levels of the session. Volume was chunky (1.5 bil on the NYSE and 1.9 bil on the NASDAQ). Breadth was over 3 to 1 negative on the NYSE and over 2 to 1 negative on the NASDAQ.
The semis were down anywhere from 2 to 5 percent, with MXIM being the big loser and falling 5 percent to a new low for the month. The equips were also beat up, and the losses there were in the 3 to 5 percent range. Of note, KLAC fell 5 percent to a new low for the year ahead of its report later this week. So, we’re seeing continued deterioration in the charts, which is all that is keeping a good number of market participants in the market at the moment. The SOX fell 4 percent to a new low for the month and closed back below its 200 day moving average again for the first time since its March low (which is not that far away now, I might add).
TASR has been one of these short squeeze/momentum stocks that left the solar system in terms of valuation long ago. It reported earnings this morning. What the company reported is pretty irrelevant when you have a stock that is trading at nearly 350x trailing EPS and 68x revenue. All that really matters is when it exhausts itself, and today, that exhaustion appeared to set in. TASR plunged nearly 30 percent (down $34.50 on the day) and closed on the very worst levels of the session after making a new high only just yesterday. Now, this stock has been somewhat of a poster boy for the rampant speculation that has been propelling us relentlessly higher for the last 18 months. Even as the rest of the market topped out in Q1, this stock was one of the few to keep going. With TASR now finally going into freefall, I take it is as another sign that the market in general is potentially about to enter a whole new stage of ugliness.
Financials were lower. The BKX fell over a percent to just shy of a new low, and the XBD fell nearly 3 percent. The derivative king fell 2 percent, BAC fell over a percent, and GE fell 2 percent. The mortgage lenders were ripped once again. LEND fell 4 percent, and AHH fell 5 percent. But that was nothing compared to the big loser of the day, NFI, which fell 18 percent to a new low on the news that SEC is going to look into them. FRE and FNM both fell 2 percent.
Retailers were mostly lower, with the RTH falling half a percent. The homebuilders were all down 3 to 4 percent across the board, with many making new lows for the move. The IYR REIT index fell 4 percent to a new closing low, although it’s intraday low last week remains quite a bit lower.
Crude oil rose 18 cents and continues to sit just off its highs. The XOI and XNG both fell 2 percent. The CRB fell a percent to a new low for the move, and the CRX fell 3 percent. Gold opened down a couple bucks in NY to below $400. After sliding to a marginal new low for the move around $396, the metal managed to recover a little and spent the remainder of the session flopping and chopping about a dollar or so off the lows to end down $2.90 to $398.20. The gold shares were crushed. HUI slid right from the open along with the metal and kept on sliding with the equity market once the metal had closed. Like we saw in the stock market in general, the last hour was a brutal selloff in the gold shares that took the HUI out on very worst levels of the session, down 7 percent to a new low for the year and back to levels not seen since September of last year. NEM, the blue chip of the golds, fell 6 percent and also made a new low for the year. The silver shares were crushed as well. CDE fell 7 percent, SIL fell 6 percent, and PAAS fell over 9 percent (all were new lows for the move).
My downside targets remain the same in the metal and the shares. Thus, unfortunately, I think it could get a lot bloodier in the gold shares before this selloff is over. On the positive side, we should be looking at some substantial bargains in the very near future, but we’ll have plenty of time to see things settle out and step in and buy the golds again when the time is right. For now, rising interest rates and the unwinding of the “reflation trade” are likely going to continue to put pressure on the metal and the shares, and I expect them to break even lower along with stocks in the coming days.
I took a good bit of grief (and quite a bit of hate mail) from readers that are gold bulls for getting bearish on the gold shares when I did late last year (and no doubt many of them cancelled their subscriptions too), but hopefully those that followed my advice and sold out to the crazy people who were panicking into the shares at nutty valuations late last year will have more money to put work once the metal and the shares finally do settle out. Gold is in a bull market, but no bull market goes straight up, especially not one that is going to last. And some corrections can last a while, as we’re seeing now in the golds. But the fundamentals remain solid. Things just got way ahead of themselves, and far too many people were buying gold and gold shares for the wrong reasons.
The US dollar index surged over half a percent to a new high for the year and just shy of its 200 day moving average. The yen was flat, and the euro fell a percent and back to its low for the move. US interest rates continue to be the main driver in currency land. Again, note the large tops in every G7 currency. With most nearing a breakdown, one can logically assume that if US interest rates continue to move higher in the near-term (which I think they will until the selling in stocks becomes of a panic nature), we’re likely going to see some massive breaks in these currencies against the dollar in the coming days.
Treasuries were hammered back to their lows for the move, with the yield on the 10yr rising to 4.41% and just shy of a new high for the year. The last time that the bond market broke down from a several day flag on the charts like we did today, the following day was a huge decline off the unemployment number. Should the pattern repeat, Uncle Al’s speech to the Joint Economic Committee tomorrow could be a catalyst for another big break to the downside in price for the bonds and push yields above their Summer 2003 highs in the 2yr and 5yr, and maybe even in the 10yr as well. The key here is to remember that what Uncle Al says or doesn’t say really doesn’t matter. The market determines rates, not the Fed. The “mother of all carry trades” continues to unwind, and it’s going to keep pushing rates up until it is fully unwound and then some. Sure, the bond market is oversold, but it got oversold last summer too and just kept on falling. I think we’re seeing something similar unfold now, and this time the BOJ isn’t going to be there to absorb the selling with intervention-related buying. Without a wipeout occurring in stocks, there’s absolutely no reason for anyone to charge into the bonds and play hero.
So, we’ve got the bond market pushing rates up sharply and threatening to make new 52-week highs in yield, which is also pushing up the dollar at the same time. Thus, much of what has driven earnings and the economy over the last year (forex gains boosting revenue and earnings, and mortgage finance related income supporting the consumer) is now going up in smoke before our eyes. The bulls will say that the economy can handle 3 interest rate hikes before stocks and the economy stumble. That’s typically true during a bull market and a real economic expansion, but this isn’t a bull market. It’s a bear market, and this has been a bear market rally and economic expansion have been based on leveraged speculation and the inflation of asset bubbles in real estate, stocks, and commodities. It doesn’t take much of a rise in interest rates to pop these bubbles due to all the leverage that is being employed. Let’s not forget that an increase 100 bps in Fed funds to 2%, is a 100% rise in borrowing costs. Once these bubbles pop, they can lead to a rapid decline, not unlike what we saw in the NASDAQ back in April of 2000.
Tomorrow, we’re going to get the real meat of whatever Uncle Al has to say, and the bond market will continue to do whatever it is going to do as the carry trade unwinds, which for the moment (barring a collapse in stocks overnight) appears to be another move lower. Again, barring a collapse in stocks, there’s not much incentive to buy bonds when you’re coming off a 1% fed funds rate with nowhere to go but up in rates. The NASDAQ and S&Ps moved back to their lows for the month today and appear to be set to potentially accelerate lower tomorrow along with the bond market. Commodities in general also appear to be poised to move sharply lower (especially copper and many of the other industrial metals).
Basically, everything we’ve been talking about appears to be potentially finally coming together as rising interest rates accelerate the unwinding of the “reflation trade.” We should see stocks return to their lows in the coming days, just as the HUI did last week. The golds have been the top-performing sector as the Fed has inflated over the last several years, and they have “led” in a sense on the way up, and I think they’re leading again on the way down as rising interest rates crush much of the asset and commodity inflation that has occurred and the market perceives that deflationary forces are once again in the very early stages of reemerging.
So, the March lows are the next line in the sand and major support for the all the major stock averages. After that, there’s not much but air underneath (much like when the HUI broke down below it’s March lows). I don’t want to put the cart before the horse, but my hunch is that things could be about to get very nasty in a very short period of time. Let’s see what happens 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. |
