Brian Reynolds at Minyanville
BTW it is primarily his commentary, Succo's commentary, and Reamer's commentary that keeps me a subscriber.
Below is a pretty big snip from today's commentary.
The strength of stock prices had many of our contacts, both bull and bear, in amazement. We had a number of people ask us yesterday if we thought things could get any crazier. We answered, in all seriousness, yes. Over the last few months, we've noted how junk spreads have kept moving to the lowest levels since before the Asian crisis. That normally brings us questions from our contacts about if we are about to have another crisis. With the economy and markets so leveraged, that is always a possibility, but that is not the point we were trying to make. What we have been trying to convey is that junk spreads are the narrowest since the craziness that existed in corporate bonds from late 1995 to the spring of 1998 (the Asian crisis didn’t hit stocks until the summer of 1998, after the financing markets froze that spring) that led to the debt-fueled stock market bubble of the late 1990's. In other words, the last time spreads narrowed like this, they stayed narrow for years (and got even narrower than they are now) and fostered an environment of seemingly limitless financing for M&A activities and buybacks. While a panic is thus always a possibility, we think the odds are greater that we are moving into a 1995-1998 financing environment (with the potential of a more severe 2000-2002 type of environment to follow if companies keep replacing equity with debt). We keep seeing more and more CEOs saying that buying back shares is their best use of cash. As an investor, you may or may not agree with that view, but you must respect it as long as those CEO’s have unfettered access to the bond financing to implement it.
As an example of how crazy things are getting, we noted early yesterday morning to our sales force how a troubled, debt-laden company announced a $500 million drive-by debt offering. The firm’s press release actually stated they were issuing this debt to reduce debt. We joked that this was going to inspire us to go on a diet of eating more food to lose weight but we also, in all seriousness, noted that this deal would likely be warmly received by the market.
Then, Ford (F:NYSE) announced disappointing sales, followed by an even bigger sales disappointment by General Motors (GM:NYSE) (as usual, this is not a recommendation to buy, sell or do anything with the securities of these companies; as 2 of the biggest debtors, we are looking at their impact on the macro environment). The worst that F debt was hit on the day was only 1 basis point, and the worst that GM debt got hit in response to the news was just 3 basis points as bond investors figured the lackluster sales would just produce another round of cost cuts. We remarked to our sales force that if that if those bonds would not crack on that news, then stocks would likely move higher on the day, and stocks went on to make new highs.
So, we are left trying to figure out what could stop the feeding frenzy in corporates. There are three immediate financial market possibilities that come to mind (in addition to the usual macro worries like global tension, oil prices, etc).
We'll continue to monitor the auto situation for signs of debt trouble there, as we always do every day. A market perception of downgrades in the auto names to junk would likely be a negative for stock prices. Payrolls on Friday could present another challenge but, with the consensus up to 190k (with a range of 135k to 300k), we think we’d need to see a number well in excess of 350k to unnerve the bond market. A number in the 200-250k area would likely keep the bond market calm and the feeding frenzy ongoing while presenting enough of a growth picture to keep stock investors happy. A wild card is the Fed. Most investors are looking for signs of when the Fed will take a break from tightening. Just looking at the economy and our view that manufacturing is slowing (reinforced by yesterday’s auto news), a halt to the tightening would be justified.
However, the feeding frenzy in corporates would be an argument to continue tightening. In 2002, when most economists were trumpeting the reviving GDP numbers, the Fed took extra easing measures due to the sorry state of the corporate bond market. Given how unbelievably strong the corporate bond market is now, an argument could be made for continued tightening. If we had a vote on the FOMC the week after next, we would vote for a 25 basis point hike, and a change in the language that we would consider accelerating the pace of tightening (i.e. 50 basis point moves) if the ultra-robust financing markets did not slow down.
That's a strong statement for us, as we have preached over the years that we focus on what we think the Fed will do (and more importantly, what other investors think the Fed will do), not what we think the Fed should do. We make this statement more to focus on how close we think the corporate bond market is to launching another stock bubble.
Turning to what we think the Fed will do, we think they will tighten by 25 basis points and leave their language unchanged. But, at some point in the next few months, if the corporate market and stocks stay strong, the Fed Funds futures contracts have a good chance at pricing in more tightenings than investors now currently assume. That change in attitude would likely lead to at least a small drop in stock prices from whatever level stocks have reached at that time. Whether or not that drop will be temporary will partly be determined by whether bond investors continue to keep up their willingness to fund companies. If so, we could have a 1999-early 2000 situation, where seemingly no amount of Fed tightening could slow the bubble.
So, there’s plenty to think and worry about but, as long as corporates remain strong, they will likely generate more M&A and share buyback activity designed to try to continue to power stocks higher. We'll see if the next few weeks change that outlook.
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My Comments:
Not only do I think we replay the stock market crash of 2000-2001 but we have a housing crash on top of it. The longer this goes on, the deeper the crash.
questions:
Can they keep this insanity going long enough to sucker in Social Security funds?
Will it continue until every last bit of cash has been used for asinine stock buybacks at absurd levels?
Mish |
