It's been two months since I posted one of Lance Lewis' missives. He's been on target lately and tonight's is especially good.
dailymarketsummary.com
Stock Bulls Finally Notice That The Bond Market Isn’t Playing Along With “Goldilocks”
Asia was mostly lower for a change last night (but not by much). Japan fell a touch, and Hong Kong fell a percent. China’s Shanghai Comp was the lone big loser, as it fell 4 percent in the wake of a mild government warning about a potential overheating of the market as well as higher-than-expected inflation data.
Europe was off half a percent this morning, and the US futures were off just a touch.
We opened down in the S&Ps and edged lower while we awaited the December existing home sales data. December existing home sales fell just 0.8 percent, which of course prompted all sorts of bottom calling as usual. Inventory fell 7.9 percent to 3.508 million units. The median home price was unchanged, holding at $222,000. For all of 2006, home sales slipped 8.4 percent, the sharpest decline since 1989, when they fell 14.8 percent.
The reaction in the bond market to the data was a virtual cave-in, and the yield on the 10yr spiked back above its 200 dma on the charts for the first time since last September, which you will recall was when all of this Goldilocks nonsense first began.
After over a month of rising long-term interest rates, the S&Ps finally appeared to choose today to notice that the bond market was falling out of bed (or at least that appeared to be the proximate cause), and the S&Ps started slowly grinding lower. That grind finally accelerated into a freefall around mid-afternoon and hit bottom just ahead of the last hour with a loss of a little over a percent.
The last hour was spent basically flopping around on the lows to go out just off the very worst levels of the session. Yes, you read that correctly: there was no closing rebound this time. Shocking isn’t it. Volume was extra chunky (1.8 bil on the NYSE and 2.2 bil on the NASDAQ). Breadth was over 3 to 1 negative on the NYSE and over 2 to 1 negative on the NASDAQ. Amazingly, new highs still swamped new lows (248 to 24) on the NYSE and the NASDAQ (92 vs. 31).
The chips were mostly lower by a percent or so, although there were a few gainers. TXN rose over a percent, and XLNX was up a freckle. The equips were mostly lower by a percent or two. The SOX fell half a percent, although keep in mind that it was up a couple percent early on this morning.
EBAY “beat the numbah” last night and exploded about 14 percent on the open this morning. As the day wore on though, it gave up a good chunk of those gains to end up just 8 percent.
MSFT fell over 2 percent ahead of its earnings tonight.
The rest of tech was mostly lower on a day that was the complete opposite of yesterday’s pandemonium to the upside. Whether it means anything is different or not remains to be seen though.
The financials were mostly lower. The BKX fell over a percent, and the XBD fell over 2 percent. GS fell over 3 percent, and MER fell over 2 percent. The derivative king fell a touch. C and BAC both fell over a percent. GE fell just shy of a percent.
GM rose over a percent after F rose a hair in the wake of reporting its biggest loss in its history. AIG fell over a percent. MBI fell 3 percent after the company postponed its earnings release (scheduled for tonight) until next week with no explanation. ABK was hit for over a percent in sympathy. The subprime consumer lenders were mixed. ACF jammed 3 percent to the upside, while COF fell 2 percent. The mortgage lenders were down across the board by 2 to 4 percent on the back of the rise in long-term interest rates. NDE even lost 7 percent. The mortgage insurers were down across the board by a couple percent. FRE and FNM both fell half a percent.
The retailers were mostly lower, with the RTH falling over a percent. Has the RTH double topped with its August 2005 peak, which coincided with the peak in the housing market? It sure appears that way, and it’s no coincidence since rising long-term interest rates should now begin a whole new phase of ugliness in the housing market. WMT and BBY both fell a percent. TGT fell over a percent.
The homies were down across the board by 3 to 4 percent. BLDR fell over a percent. Both RYL and BZH spit up more bad news, but I suspect it was the break in the bond market that finally got people’s attention in this sector (even though long-term yields have been rising for over a month now)
BZH reported a loss this morning for its calendar Q4 thanks to land and option charge offs. BZH then added, "[We have] yet to see any meaningful evidence of a sustainable recovery in the housing market." BZH fell nearly 6 percent
RYL reported a big land and option charge overnight, reducing shareholder equity by 2 percent. RYL’s margins fell by nearly 50 percent, and its order backlog fell by slightly over 50 percent. RYL fell over 4 percent on the day.
The following chart is of the 10yr yield in orange and the HGX housing index in black. Given that mortgage yields are tied to the 10yr treasury, there’s an obvious relationship here. Back in the summer of 2006 when yields peaked, the housing stocks bottomed out within about a month. And with yields now turning back up again over the last month and a half, I think it’s reasonable to assume that the homies are flaming out again and rolling over, because I do think long-term yields are headed quite a bit higher (more on that below).
We’ve also had months of Goldilocks-calling and bottom-calling (despite plenty of data to the contrary, like today’s RYL and BZH reports for example) while the homebuilders have slowly worked their way higher over the past 5 months. Thus, the sentiment backdrop has also shifted to one of “hope” vs. the extreme pessimism that we saw back in July and August. Therefore, that hope should now be set up to be dashed by a continued avalanche of facts to the contrary, because the pain for the homies is far from over in my opinion.
I guess what I am saying is that it may just be safe once again to be short the homies now. For those that care, I bought a few July and Aug put options on a handful of the homies today. Tomorrow we’ll get December new home sales.
Crude oil fell $1.14 to $54.23. The XOI fell over 2 percent. The XNG fell just shy of 2 percent, and the OSX fell nearly 3 percent. The XLB materials index fell a third of a percent.
The GSCI fell over a percent, and the CCI-CRB fell just a hair.
The base metals were mostly higher again. Copper rose 2 percent, and nickel rose over a percent to another new all-time high.
April gold (now the active contract) began the day in the US up about $5 and rallied up to as high as $661.20 and just shy of the $661.50 Q4 peak for the April contract. But as oil rolled over from unchanged and into the negative column, gold was dragged down once again. Nevertheless, the yellow metal did manage to resist crude’s decline to some degree and only go out down a dime to $654.40. Spot silver rose over a percent.
The HUI fell just over a percent, although there were a handful of gainers on the day.
Our junior basket held up even better and rose just a freckle. NSU rose 3 percent, while MRB rose a percent. CGR, GSS, and MFN were all off just a half percent.
That Q4 peak in the gold price that we hit today was the resistance that we’ve been eyeing, and it’s not too surprising to see the metal repelled on the first attempt to get through it. We could now have some sort of pullback over the next 3 days into the FOMC next week, or maybe today’s intraday pullback is all we’re going to see? There’s no way to know, but I don’t believe that resistance is going to amount to anything more than a short-term rest at present. If we do have a pullback in the metal that lasts for a few days, it’s also very possible that the shares could rally even as the metal declines (which is common ahead of big upside moves in the metal), so that’s something to think about as well.
The fact that the bond market is finally beginning to gain some downside momentum should actually add to the bid under gold, not detract from it. After all, this is the long end pushing yields higher, not the Fed-fearing short end. In other words, this is the market pushing up interest rates, and I believe it’s occurring because of a combination of reduced foreign demand for dollar denominated treasuries and rising inflation fears. Chronic weakness in the dollar and the ongoing explosion in commodity inflation may have just finally caught up with the bonds, which spells even more trouble for housing and the US economy.
Under that scenario, it’s difficult to see how the dollar will have much of a bid. Thus, foreign central banks will likely come under increasing pressure to support the dollar for the good of the system, and the winner in all currencies as a result is going to be gold. This is the stage of the game where I have always felt that gold would truly outperform but was never certain as to when it would occur. Given that gold is increasingly trading not off the dollar or off of oil, perhaps we are close? If we’re finally getting there, it’s going to open up a whole new chapter for gold, where gold is likely to increasingly trade on its own and not off of something else, as has been the case up until now.
The US dollar index reversed early weakness and rose just a hair, apparently on the back of the rise in US interest rates. The yen was the only G7 currency to end higher on the day and rose just a hair, while the euro fell a hair.
While the Asian currencies (ex- the yen) continue to have a bid under them, the euro, pound, and some of the other G7 currencies could very well correct some more and push up the dollar index a little further as bond yields rise and make the US fixed income market more attractive, but it’s by no means a certainty. If the Fed tries to sound more dovish next week and yields in the short end (and only the short end) weaken as a result (i.e.- the curve steepens), I doubt such a rally in the dollar would stick.
The yen was not the only Asian currency to rally today either. The ADXY (Asian currency basket vs. the dollar) rose to just shy of a new multiyear high today. And the dollar actually begin a near-crash of sorts against the Thai baht today (see the weekly chart here). Recall that Thailand imposed currency controls back in December in order to try and support the dollar. Unfortunately, the apparently weren’t enough to support the US peso.
Treasuries were thumped, with the yield on the 10yr rising to 4.877% and a new high for the move since the December low. That also puts the yield above its 200 dma on the charts for the first time since September when the Goldilocks nonsense first began. The 2/10 inversion narrowed another 2 bps to -10 bps, as the curve continues to be led by weakness in the long end.
Goldilocks is based on the idea that inflation has peaked, long-term yields will continue to fall as a result, and the Fed can then ease and create a soft landing for the economy. What will Goldilocks believers say if long-term yields continue to rise and break the long-term disinflationary trend that has been in place since the 1980s for US bonds? That’s exactly what I believe will happen, although it may not right away. The point is, as I have repeated probably more times than readers want to hear, this is not 1995’s Goldilocks. Inflation has not peaked, and rising mortgage rates are going to put even more pressure on the US consumer and the economy, with the eventual destination being a recession and stagflation. It’s going to take time to fully unfold though.
The 10yr junk spread to treasuries narrowed 1 bp to 280 bps over treasuries and another new 6-month low. Obviously, this fact calls into question whether today’s selloff in stocks is anything other than a pullback sine stocks rarely experience a meaningful decline when the credit markets are well bid.
The VIX jumped 13 percent, and the VXO jumped nearly 20 percent. So, that’s a little reminder for those that have selling put options as “free money” that things can change in a hurry.
Today was the first one percent down-day in the S&Ps that I can recall occurring in a long time, although I’m not sure it signals anything is “different” just yet (even though as an equity bear I would certainly love for it to be). My own rule of thumb continues to be that anything other than a 2 percent down-day (something we haven’t had since July of 2006) is basically noise, and that’s served me well over the past 6 months. So, I am going to stick with that rule for now.
If we are now finally entering a phase of increasing bond and currency weakness, where inflation finally gets some respect, then housing, retail, and even some financials could come under pressure going forward. But the rest of the stock market could very well continue to rally for a while longer, with stocks that benefit from inflation (like the gold shares) leading the way. That’s sort of the stage of the game that I think we could be at, but I want to see how the market responds to the Fed next week, especially if the FOMC tries and reassure everyone by moving to a neutral stance.
If the FOMC were to surprise people and move to a neutral stance next Tuesday (something former Fed-head Wayne Angell actually suggested they do on Heehaw today), it could cause a temporary pullback in long-term yields given how oversold the bond market is, even though I don’t believe the current weakness in the long end has anything to do with the Fed. If that pullback in yields were to occur, not to mention the likely collapse in yields at the short end, it would no doubt trigger another rally in the equity market.
Basically, I think we have to wait and see if the decline builds any momentum. But for now, today’s slide looked like a more-than-overdue selloff that used the bond market’s slide as an excuse rather than any sort of potential exhaustion having taken place. That doesn’t mean that stocks can’t keep sliding, because a correction is more than overdue, especially in the wake of yesterday’s giddiness. But it remains to be seen if people are finally giving up on the Goldilocks myth for good just yet.
While I cannot provide personalized investment advice or recommendations, I welcome feedback and observations by subscribers. You can email me at Lance Lewis.
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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