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MARKET OBSERVATIONS
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MARKET OBSERVATIONS - 6/15
CP I Can't Believe It's Not Butter...Is the BLS serving us margarine and telling us it's butter? The economic numbers simply seem to taste so good. Wednesday's CPI report was something we would have expected to see in a Third World Dictatorship where the government has control of the media. The readings in the components that shape the overall reported number simply don't connect with what seems to be happening in "real life". A decline in energy prices? Please. The natural gas component up .7% when natural gas spot and futures climbed double digits? Rental values of homes (the component largely responsible for the "shelter" calculation) up .2%? Possibly a severe case of California Dreamin'. Jimmying the economic numbers to induce the Fed to forestall rate increases only increases the consequences of the inevitable outcome. Stretch the mania for a while longer and hope to God the rubber band doesn't snap. In the meantime we'll think of something to solve this. Just give us a few more minutes.
Tim has prepared the following charts as a little reminder of just what has happened to the CRB in "international terms" over the last year and one half:
U.S. investors may want to fully discount a perfect "soft landing", but we're wondering if our international brethren are so inclined within the context of the above charts. Remember, they are holding our debt and our IOU dollars. Do you think they buy the bull spin?
The market knows the CPI and PPI numbers are a hoax. Stocks aren't getting the "lift" one would expect from friendly economic stats such as these. We continue to suggest that you watch the US dollar and the price of gold (inversely related to each other in our book). Lie to me once, shame on you. Lie to me twice, shame on me (for listening). It "feels" that the market is figuring this out. We can think of nothing worse for US financial markets than a situation where economic numbers coming from the government become widely mistrusted, both domestically and from an international perspective. After all, what collateral other than trust underpins the US dollar? (Answer: Nothing.)
Off Color...Wednesday's Biege Book report was also a spin-op for Wall Street that seemed to meet with little "play". Mixed messages were clearly present by simply reading a bit of the report. According to the report, there are signs of slowing, but the economy is still pretty solid. We're always particularly interested to see the labor situation. From our perch in the San Francisco Bay Area, labor appears to be tight as a drum. The report mentioned that "base wages of permanent employees are not said to be accelerating." As you know, this does not take into account bonuses, stock options, upfront sign on goodies, etc. For all of the other economic statistics that seem to be adjusted into meaninglessness, why don't wage cost calculations take into account non-base wage factors? It's just a question.
The Fed seems to have all the ammo it needs to take a pass on an interest rate hike in late June. The bigger question remains whether this is built into investor expectations or not. We have the feeling it's a good ways there already, but we would not be surprised in the least to see a last week of the quarter (window dressing) rally directly attributed to a Fed no-show. Be prepared. A fed pass on rate hikes will not only signal a Fed willing to "give it some" time, but more ominously that Greenspan really wasn't targeting stocks after all. Maybe that's even more scary.
The Write Side Of The Trade...An interesting development is occurring. We sincerely thank our friends at Ned Davis research for explicitly pointing it out. The development is the sentiment of the "smart money" versus that of the public and speculators at large. As you may know, there are a good number of large commercial traders in the S&P 500 index futures market. For them, this isn't some game or dream of retirement riches. It is a day to day livelihood. It's much more than serious business. These are pro's who are experienced, know the market well, know what the money flows are and where they are coming from, and are anything but gamblers. These firms take very large positions in both the S&P futures and cash markets. By many, these are considered "smart money". Based on history, for good reason. According to the latest data put out by the CFTC, the commercials have a record net short position in the S&P futures. At the same time, what are considered the public and the speculators have a record net long position. We're going to find out who's right and who's wrong before long. Significant divergence in sentiment between the commercials and the speculators/public is not something that happens everyday. In fact, these occurrences have happened in 1998, 1991, 1987 and 1986 prior to market weakness. Interesting, don't you agree?
As you know, the public has been pouring money into the mutual fund complex this year. Despite the type of market volatility seen maybe once every two generations, the public appears to have become emboldened. Another anecdote of dichotomy is that the NYSE specialists are increasing their short positions while the public is increasing its long exposure. Our friends at the Fed just published the quarterly Flow of Funds report detailing much of this data, along with debt and credit data. You can be sure we'll be bringing you up to speed very shortly on this crucial, telling and mostly overlooked by the Street, report.
Tech Tock, Tech Tock...If a slowdown in growth really takes hold, we see two large problems for the market. Of course earnings growth becomes questionable. That's simply low hanging fruit in terms of a potential outcome or byproduct. What may be more important to the stock market is the effect on the technology sector. In a recent study from the University of Texas, it was estimated that the "Internet industry" accounted for 650,000 news jobs in the US last year. This is 25% of total jobs created in the US. Moreover, the Commerce Department has estimated that 30% of this country's economic growth last year was fueled by the Info Tech industry (as it describes it). Simple question. How can a slowdown in the economy not effect the tech sector significantly? Crazily enough, we could envision a scenario where a slowdown in tech further exacerbates an overall economic slowdown. After all, isn't it mostly tech dough (both company and stock market gains driven) that is fueling high ticket item purchases and high end real estate values? Of course it is. Simply put, a loss of momentum in technology may have negative self reinforcing influences on the macro economic scene.
Dollar Daze...We've said it before, but can't help mentioning it again. We view the dollar as crucial to the mania puzzle staying together. A real slowdown in the US will have an effect on the dollar plain and simple. Imagine, if you will, that the economic B2Bomber we have created simply can't achieve the desired soft landing and heads nose first into the asphalt. A recession in the US almost overnight makes US dollar denominated assets the world's least attractive repository. The Fed knows this. It is conceivable that even in the event of a recession, the Fed may simply have no choice other than keeping interest rates higher than may otherwise be needed. How else do you solve the problem? In tried and true fashion, the Fed would simply open the monetary spigots again. Flood the system with liquidity and shock the patient back to economic life. Economic problem solved. Dollar problem solved...for a while. Sound familiar?
Wise Guise...Prosecutors a few days ago arrested about 100 alleged mobsters in what they called the "largest securities fraud takedown in US history". We found the incident nothing short of hilarious and at the same time darkly tragic from an overall market standpoint. Allegedly those involved in what prosecutors cleverly dubbed "Operation Uptick" (and here we thought the PPT had already secured that domain name) swindled investors out of $50 million. Don't get us wrong. That's clearly a lot of money to some of the poor innocent victims. But, what seems to be the dark comedy of it all is that this simply pales in comparison to what happens openly on Wall Street everyday. Why aren't prosecutors investigating the investment banking/research connection at major Street firms? Why aren't Street analysts who were dutifully pumping Microsoft to their unsuspecting clients prior to a $275 billion drop in the value of the company "hauled in for questioning"? What about investment banking houses that floated dotcom paper for companies that promptly went bankrupt in less than twelve months after issuance? Why aren't they held accountable? Didn't their analyst's issue "strong buys" as professional investment opinions on these firms? Didn't the investment bankers represent that due diligence had been done prior to issuance of securities to the public? What about mutual fund managers/companies that ram the prices of their large stock holdings higher at month and quarter end using mutual fund shareholder money to jack up performance, fees and personal bonuses? On Wall Street, the losses recently have not been measured in millions, but in hundreds of billions (and more). It's simply ironic to us that prosecutors are chasing small potatoes while the real crimes may be being committed in the prosecutors' own institutional pension funds. For their sakes, we simply hope that "Operation Uptick" does not morph into "Operation Upchuck" during the next bear market.
Wake Of The Flood...Our pals at AMG reported an $8.6 billion inflow into mutual funds for the week ended 6/14. Incredible. We can't remember, but something tells us this is a record one week number. Is the public anticipating the quarter end mark up? Maybe it's the feeling that it's OK to get back in the water now that the NAZ has recorded a double digit gain since late May/early June and has held. Maybe it's the public falling for the summer rally rhetoric spewed by Street strategists (after the index move, of course). With this kind of financial ammunition pouring into mutual fund coffers, a run to or past the old highs on the S&P is a real possibility in the next few weeks. The Dow is a toss up. We'd have a hard time seeing the NAZ hit old highs. After all, the NAZ double top was almost picture perfect. In the following charts we look at each. In every case the stochastics say the indices are overbought (although not wildly so in the DOW). Just remember, the stochastics can remain in overbought territory for a spell if they wish. This is clearly the lesson of the mania.
The S&P has clearly broken its declining series of highs and lows for the moment, although the short term channel between 1350 and 1525 remains intact.
The descending highs and lows in the NASDAQ from the top have been broken, but we'd be stunned to see a return to the highs in short order.
The DOW is a toss up. It seems to have worked its way into a triangular wedge.
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