U.S. Equity Markets Bracing for a “Melt-Up?” Seriously? (Colyer)

Wednesday, July 18th, 2012

by Scot Colyer, Advisors Asset Management

There are many indicators that we look for that tends to define cyclical market bottoms and give us signs of an upturn. Talking heads on TV often times are just talking their book. Recent investor lack of volume and record high cash balances can also point to a change toward higher market valuations. Every day I hear about the relative cheap valuations of U.S. equities. We know that valuations can stay depressed for years, even decades. Why would we be thinking that a potential melt-up might be about ready to happen? Remember, market timing is generally ineffective and we caution that trying to time the market can be dangerous. We do believe that cash is a long-term losing position as inflation will render its purchasing power crippled over time.

Why could we possibly be bullish on U.S. equities now? After all, haven’t you heard that the United States is slowing and likely going into a recession? Europe is melting down and it appears that LIBOR was being fixed by a number of large banks (which has been true for decades). Job creation is slowing and consumer confidence is lagging. We would point out that markets always focus on the crises of the day. We would note that banks and their earnings are coming in above estimates, showing continuing progress in decreasing delinquencies. Leading economic indicators are rising (emphasis on LEADING). Housing has turned up and record-low mortgage interest rates should propel pent-up consumption. Foreclosures are now being grabbed for cash. Look at the value of housing and housing-related stocks for proof. Finally, in all of history we have never had GLOBAL fiscal easing anywhere near the level we currently have. Most major developed and emerging economies are goosing their economies with cheap money. I would not underestimate the Fed or other central banks’ resolve here! We consider them a pretty reliable bid to support higher asset prices.

Finally, today it was reported that short interest on NYSE stocks have surpassed the September 2011 bottom. As many of you know, peaks in short selling often accompany cyclical market bottoms. We are now squarely in that category. When we analyze a number of indicators together, we believe there is a very high likelihood that equity prices may be moving much higher in the short term. Highly correlated income stories could potentially include investment in business development companies (private equity-like exposure), high yield and emerging markets.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the disclosures webpage for additional risk information. For additional commentary or financial resources, please visit www.aamlive.com/blog.

Tags: Asset Price, Cash Balances, Central Banks, Cheap Money, Consumer Confidence, Cyclical Market, Delinquencies, Emerging Economies, Job Creation, Leading Economic Indicators, Libor, Low Mortgage, Market Bottoms, Market Timing, Market Valuations, Mortgage Interest Rates, Purchasing Power, Scot, Talking Heads, Upturn
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Morgan Stanley’s Complete Moral Hazard Profit Guide – “Operation Torque”

Thursday, September 1st, 2011

While we often pick on Morgan Stanley’s Jim Caron (the same guy who year after year after year keeps predicting the yield on the 10 year will soar, and not just soar, but soar for all the wrong reasons, such as bull steepening and what not), has just diametrically changed his tune, by bringing us, drumroll please, Operation Torque. To wit: “Policy makers in both the US and Europe get back to work in September, and this month will be rife with deliberations on stimulus and market support policies. In our view, a duration extension to the Fed’s SOMA portfolio is an optimal policy tool to engender easing. This can initially be done through extending the duration of reinvestments from MBS and agency holdings but may ultimately culminate in selling shorter-duration USTs in its SOMA portfolio in exchange for buying longer duration assets (‘Operation Torque’, as we at Morgan Stanley have dubbed it).” Why 2 Years? Because as per the August 9 FOMC statement, we know that there will no rate hike for the next 2 Years, and hence no duration risk. Which means that the Fed can sell an infinite amount of paper into a mid-2013 horizon without worrying about demand destruction. And by doing so it will, as we have been predicting since May, expand the duration of its portfolio, in the process pushing investors into risky assets for the third time in as many years. But there is a twist…

…Or a torque as the case may be…

As we have noted on several occasions, going aggressively after the 10 Year would likely mean an even more pronounced flattening of the 2s10s than we currently have: an outcome which more than anything will impair US banks. As yesterday’s MBA mortgage refinancing data showed, even at record low mortgage rates virtually nobody wants to refi. Perhaps a forced refinancing will help courtesy of Obama, but we think not. The point being that net interest margin, or the carry trade as it is better known, will all but disappear, and perversely QE3, call it Twist or Torque, will end up generating even more pain for the critical financial sector, without which there is no chance of a broad market rally.

Furthermore, we are amused that MS is implicitly agreeing with us: Caron says – “We believe that if the Fed implements Operation Torque, it will purchase a significant amount in the 30y sector of the curve as well as at the 8-10y point.” And it continues: “If the Fed does purchase on the long end, the belly could easily underperform with yields currently near all-time lows. We recommend taking advantage of this opportunity by positioning for the 7s30s to flatten, or trading 7s30s on asset swap as described below.” In other words, a flattener with a 10 year hump, so needed for even some incremental 2s10s steepening… Just as we have been predicting.

However, that’s not all. We are confident that when all is said and done, the Fed will realize it needs to drop the 10 Y yield modestly in order to afford some profitability for the banks, resulting in an emphasis on the Ultra longs (17-30 Year sector).

There is however a glitch: there is nowhere near enough supply in the 17-30 Year space to meet this need for 10s30s flattening even as the 10 itself floats higher. And while 10 is too short, the 30 is too long, does this mean that the Treasury will soon have to consider converting the 20 Year point on the curve from a simple Constant Maturity Series into an actual cash bond to satisfy the suddenly very picky Goldilocks environment ? Unless Geithner wants to take a chance with flooding the market with 30 year paper, for which the only buyer will be the Fed, it may soon have to.

Anyway, back to Morgan Stanley’s Operation Torque. Here is how Caron presents the three core scenarios that the Fed will undertake:

The goal of Operation Torque is to remove duration supply from the market, and not simply to push yields lower. With less supply in the market, risk premiums for spread products should decrease, driving easier financial conditions.

During QE2, the Fed removed $490bn in 10y equivalents form the market. If we use that as a baseline, we may evaluate Operation Torque under several different scenarios. As the Fed would not expand its balance sheet under an Operation Torque, there is a limited supply of short-duration debt with which to extend, and the market impact is highly dependent on where it is placed. The three scenarios below help us understand targeting purchases on different parts of the curve could impact the market.

Scenario 1: Fed sells all debt with less than two years to maturity and allocates proceeds to the 8-10y sector.

Scenario 2: Fed sells all debt with less than two years to maturity. Proceeds allocated to the 8-10y sector and 30y sector, targeting a total of $400bn equivalents removed from the market.

Scenario 3: Fed sells all debt with less than two years to maturity. Proceeds allocated in same ratio as QE2 purchases.

All scenarios assume a time frame through January 2012 and include estimated auctions. We only include USTs in this particular analysis; however, we estimate that mortgage pre-pays could add up to an additional $90bn should the Fed use those funds to extend duration in the SOMA as well.

And once again, we don’t like to gloat, but we did “tell you so” – the Fed will target not the 10 year but the 30 year:

By purchasing in the 30y sector in addition to the 8-10y sector (scenario 2), the Fed could achieve a $436bn purchase of 10y equivalents, having sold the same debt out of the SOMA. This is very close to the same level of duration removed from the market during QE2.

Finally, we may compare to an operation that has the same allocations as was done in QE2 (scenario 3). This style of operation has the least impact in duration terms at $186bn – less than 45% of the impact of Scenario 2 (Exhibit 5). Additional detail of each scenario can be found in the appendix to this report.

We believe that if the Fed implements Operation Torque, it will purchase a significant amount in the 30y sector of the curve as well as at the 8-10y point. In order to position for this Fed action, we recommend the following:

• Overweight 9-10y & 30y UST sectors
• UST 7s30s yield curve flattener
• 7s30s asset swap curve flattener ? UST 7y to underperform and 30y to outperform versus Libor

We look for trades that benefit from duration buying at the 9-10y and 30y points on the curve. In particular, we recommend duration longs to re-allocate into such as 2020 and 2021 original maturity 10s and 2041 bonds as these have a lot of par available to the Fed and are likely candidates for purchase.

Graphically:

Bottom line: Goldman, JP Morgan, Nomura and now Morgan Stanley all assume QE3 is a fait accompli, the only question is what shape it will take.

And for all intents and purposes, what the Fed will achieve, is to get investors to rush out of anything with a sub 10 Year duration, and into the longest point on the curve. And just like last time, the biggest beneficiaries will be not bonds, nor stocks, but commodities, where the marginal purchasing power is far greater, and the result will be yet another round of geopolitical shocks, this time, as we have said so many times before, far closer to the core: both in Europe and the US. As for the effectiveness of such a move on the economy and stocks, we urge readers to look at the following chart.

Below is the complete Morgan Stanley moral hazard playbook.

Market Support

Tags: Bonds, Carry Trade, Commodities, Deliberations, Drumroll, Gold, Interest Margin, Jim Caron, Low Mortgage, Mbs, Moral Hazard, Morgan Stanley, Mortgage Rates, Mortgage Refinancing, Net Interest, Obama, Optimal Policy, Policy Tool, Profit Guide, Rate Hike, Risky Assets, Support Policies, Usts
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The Economy and Bond Market Cheat Sheet (August 29, 2011)

Saturday, August 27th, 2011

The Economy and Bond Market Cheat Sheet (August 29, 2011)

The yield on the ten-year U.S. Treasury Note increased 12 basis points this week to end the week at a yield of 2.19 percent.

The Mortgage Bankers Association Purchase Index, which measures the volume of applications to purchase single family U.S. homes, fell 5.7 percent to 157.90 in the week ended August 19 from the prior week, the lowest index level since December 1996. The chart below of that index illustrates the weakness in the housing market despite near-record-low mortgage rates.

Strengths

• July durable goods orders increased 4.0 percent from June levels, above the consensus 2.0 percent forecast and the best report since March.
• The Federal Housing Finance Agency reported that its house price purchase index for June increased 0.9 percent from the prior month, above the 0.2 percent consensus.
• The Chicago Federal Reserve national activity index improved to minus 0.06 in July from minus 0.38 a month earlier, and it was better than the consensus estimate of minus 0.48.

Weaknesses

• Initial jobless claims in the U.S. rose by 5,000 to 417,000 in the week ended August 20, above the 405,000 consensus.
• Sales of new homes in July fell 0.7 percent month-over-month to an annual pace of 298,000, the lowest level in five months and below the 310,000 consensus.
• Real gross domestic product for the second quarter was revised down to 1.0 percent from the prior 1.3 percent estimate.
• The home mortgage delinquency rate was 8.44 percent in the second quarter, an increase of 12 basis points from 8.32 percent in the first quarter. This was the second consecutive quarterly increase.
• The University Of Michigan Survey Of Consumer Confidence Sentiment fell from 63.7 in July to 55.7 in August, the lowest level since November 2008.

Opportunities

• With the economy weak and concerns brewing about an additional financial crisis, the Federal Reserve will remain accommodative for some time and bonds appear well supported in the current environment.

Threats

• There is a crisis of confidence in world leaders at the moment and the potential for another financial crisis is rising.

Tags: Activity Index, Basis Points, Bond Market, Bonds, Cheat Sheet, Consensus Estimate, Consumer Confidence, Durable Goods Orders, House Price, Housing Finance Agency, Index Level, Initial Jobless Claims, Low Mortgage, Michigan Survey, Mortgage Bankers Association, Mortgage Delinquency, Mortgage Rates, Purchase Index, Quarterly Increase, Treasury Note, U S Treasury
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Warren Buffet: Recession Not Over

Monday, September 27th, 2010

This article is a guest contribution by Trader Mark, of the FundMyMutualFund Blog.

Until we take a break between QE2 and QE3 all discussions of economics and reports will simply be for theoretical and intellectual reasons.  In the end, any market is made up of supply and demand.  If you have a relatively fixed supply of stock certificates (or sugar, coffee, whatever commodity) being chased by an ever increasing amount of fiat money, anyone who took Economics 101 and lasted through day 2 of class knows what happens to price.  The U.S. market was able to rally some 70%+ during QE1 even as Americans actually withdrew (on a net basis) money from the market – so you can see the power of “the not so invisible hand”.  [Jan 6, 2010: Charles Biderman of TrimTabs Claims US Government Supporting Stock Market]

This is the template everyone is working on – again to repeat what I say each time, QE has very little to do with the real economy (don’t believe the lies coming out of that mouth) and everything to do with goosing assets of all types.  Some portion of those gains in paper assets can then be rolled into the real economy I suppose over time via the ‘wealth effect’… so the Fed simply is trying to repeat 1999 NASDAQ as the attempt to repeat 2005-2007 housing looks to be impossible.  (although we are trying mightily with record low mortgage rates, the return of 0% down mortgages – now government sponsored, paying people to buy homes via credits, and the like)

Whatever the case, this mantra has changed psychology and half the battle in the market is animal spirits.  If everyone believes act A will lead to outcome B, then it self reinforces to a great degree.  QE2 has not even begun but everyone is in a rush to front run the perceived asset inflation of all type, hence it has been self fulfilling.  Somewhere Ben is laughing watching the rat’s lemming’s in his lab experiment scurry.  So as I said, anything I post about economics go forward is to be read, processed and then discarded immediately since none of it matters until we take a break from QE2. (which again – has not even STARTED)  At which point Ben can start hinting about QE3 which should get speculators in a lather, front running assets once more… and we can keep this game going forever and ever (and ever!) Who needs a real economy anymore?  Manipulation of assets is so much easier.

To that end today around 10 AM came a very poor existing home sales number.  The market paused for a second… should it react to reality?  Nah, a permanent open market operation of dollars was going to be flooding in the market in 15 minutes, so let’s start a new leg up … and so we did.

(My only question to this “we can’t lose” idea is why did the Japanese stock market not surge to all time highs with the amount of QE they did for a decade+?)

——————————————

This story on Buffet refuting the economy is out of recession is interesting not so much for his words but some of the statistics he gave on his businesses.  The railroad companies are acting as if we are back to 2007 global trade highs (in terms of stock action) but apparently economic activity is still far below peak levels.  That said, does it matter?  There is only so much supply of railroad stock certificates with ever increasing fiat money chasing it… you get the picture right?

• Billionaire Warren Buffett says the economy remains in a recession, by his definition, because most people and businesses still aren’t doing as well as they were before the financial crisis.  Buffett’s assessment of the economy contradicts the view of experts who announced this week that the recession officially ended in June 2009. But Buffett says he uses a commonsense standard to evaluate the economy.
• “On any commonsense definition, the average American is below where he was before, or his family, in terms of real income, GDP,” (gross domestic product) Buffett said on CNBC. “We’re still in a recession. And we’re not gonna be out of it for awhile, but we will get out of it.”
• He said the government is running a federal deficit equal to 9 percent of the nation’s gross domestic product, which is providing quite a lot of stimulus.  ”It doesn’t depend on calling it the stimulus bill to be stimulating. I mean, if the government is spending $3 for every $2 it takes in, that is, that is fiscal stimulus,” Buffett said.

Here are some of the very interesting metrics:

• Buffett gets insight into the health of the economy through the performance of Berkshire’s subsidiaries.   Buffett said Berkshire’s businesses are improving but at a slow rate.
• He said Berkshire’s Burlington Northern Santa Fe railroad, for instance, is probably doing better than many U.S. businesses, and it’s only about 61 percent of the way back to its peak shipping volumes from the bottom of the recession.
• And Berkshire’s Shaw Carpet used to sell about 13 million yards of carpet a week. Buffett said that fell to about 7 million yards during the recession, so Shaw eliminated 6,500 jobs. Buffett said Shaw won’t start hiring back until the business gets back to selling at least 10 million yards a week, and so far it’s only selling about 9 million yards a week.

Copyright (c) FundMyMutualFund

Tags: Animal Spirits, Fiat Money, Half The Battle, Invisible Hand, Lab Experiment, Lemming, Low Mortgage, Mantra, Mortgage Rates, Nasdaq, Paper Assets, Qe, Qe1, Qe2, S Market, Stock Certificates, Trimtabs, Warren Buffet, Wealth Effect
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What is a Depression Anyway? (Rosenberg)

Thursday, September 2nd, 2010

The comments below come courtesy of Dave Rosenberg, Chief Economist and Strategist of Gluskin Sheff & Associates.

“A depression is a very long recession. Like the one that lasted from Q4 1929 to Q1 1933 that contained no fewer than six positive GDP quarters and even a 50% rally in the equity market in 1930!

“You know you’re in a depression when interest rates go to zero and there is no revival in credit-sensitive spending. Or when home sales go down to record lows despite record-low mortgage rates.

“The economy is in a depression when the banks are sitting on $1.3 trillion of cash and yet there is no lending going on to the private sector. It’s called a liquidity trap.

“They usually are caused by a bursting of an asset bubble and a contraction in credit, whereas plain-vanilla recessions are typically caused by inflation and excessive manufacturing inventories.

“When almost half of the ranks of the unemployed have been looking for a job fruitlessly for at least six months, you know you are in something much deeper than a garden-variety recession.

“Basically, in a depression, secular changes take place. Attitudes towards debt, discretionary spending and homeownership are altered for many years, or at least until the scars from the traumatic experience with defaults and delinquencies fade away.

“More fundamentally, in a recession, the economy is revived by government stimulus. In a depression, the economy is sustained by government stimulus. There is a very big difference between these two states.”

Indeed food for thought!

Tags: Chief Economist, Contraction, Dave Rosenberg, Delinquencies, Discretionary Spending, Food For Thought, Garden Variety, Gluskin Sheff, Liquidity Trap, Low Mortgage, Lows, Mortgage Rates, Plain Vanilla, Recession, Recessions, Secular Changes, Stimulus, Strategist, Traumatic Experience, Two States
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“You Call This Capitulation?” (Rosenberg)

Thursday, August 26th, 2010

GOLD GLITTERS

A contact of mine was kind enough to send me a copy of a speech that Ben Bernanke delivered on Japanese monetary policy back when he was still teaching economics at Princeton — A Case of Self-Induced Paralysis. Imagine that he gave this speech 11 years ago, and everything he laments in his speech is part and parcel of the U.S. macro and market backdrop today.

In any event, without getting too critical, this is the earliest piece we can find — three years ahead of his famous “What If” speech on November 22, 2002. What really caught our eye — on the same day that gold prices rose another $10 an ounce — was the section on “How to Get Out of a Liquidity Trap”, which we are clearly in considering that record-low mortgage rates have not stopped home sales from cratering to record-low levels. In particular, the subsection that contains one of the solutions to a deflationary debt deleveraging cycle, which is what he was advocating for Japan back then: “Depreciation of the Yen”. Indeed, instead of depreciating, the yen has strengthened 15% since Mr. Bernanke gave that speech, and look where Japan is today. So, it would go without saying that embarking on investment strategies that are inversely correlated with the greenback would seem to make good sense, and the gold price would certainly fit that bill (we should add silver into that mix as well).

YOU CALL THIS CAPITULATION?

Short interest on the Nasdaq down 1.6% in the first week of August?

The Rasmussen investor confidence index at 80.4? Call us when it hits 50, which in the past was a “classic” washout level.

Investors Intelligence did show the bull share declining further this past week, to 33.3% from 36.7%. But the bear share barely budged and is still lower than the bull share at 31.2%. Are we supposed to believe that at the market lows, there will still be more bulls than bears out there? Hardly. At true lows, the bulls are hiding under table screaming “uncle!”.

Yes, Market Vane equity sentiment is down to 46, but in truth, this metric is usually in a 20-30% range when the market correction ends. We are waiting patiently.

As for bonds, well, Market Vane sentiment is 73%. Now what is so bubbly about that. Call us on extreme positive sentiment when this measure of excessive bullishness is closer to 90%, and we’ll be in the correction camp hopefully by the time this happens.

In any event, the extent of the denial over U.S. double-dip risks is unbelievable. These are quotes from economists and strategists in yesterday’s print media — and just a select list at that for there was just so much surreal commentary:

“I’d be shocked if you don’t make a lot money in U.S. stocks over the next decade.”

“If yields rise, then 30-year bonds will suffer.”

“It won’t be a double-dip recession but it might feel like it.”

“There is a global perception that we are not necessarily going into a Japan-type scenario, there is a recognition of a slow recovery.”

“People shouldn’t panic.”

At market lows, the recession rhetoric becomes more intense and indeed it’s when people do panic that the best buying opportunities generally occur.

Copyright (c) 2010 Gluskin Sheff

Tags: Bear Share, Capitulation, Confidence Index, Gold, Gold Glitters, Gold Price, Gold Prices, Good Sense, Greenback, Investment Strategies, Investor Confidence, Investors Intelligence, Japanese Monetary Policy, Liquidity Trap, Low Mortgage, Lows, Mortgage Rates, Nasdaq, Ows, Short Interest, Silver, Teaching Economics
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Recession is History, Economy Back in Business

Friday, October 30th, 2009

This post is a guest contribution by Asha Bangalore * of The Northern Trust Company.

The recession is behind us. Real gross domestic product of the U.S. economy grew at an annual rate of 3.5% in the third quarter after a 0.75 drop in the prior quarter. This is the first increase of real GDP after a string of four quarterly declines. Real GDP has declined in five out of the six quarters of the recession.

The Business Cycle Dating Committee of the National Bureau of Economic Research will make the official announcement after it confirms the turning point based on revisions of economic data. This recession is the longest on record in the post-war period and the deepest also. Real GDP has declined 3.8% from the peak in the second quarter of 2008 to the trough in the second quarter of 2009. This is the largest peak-to-trough decline of real GDP in the post-war period (see table 1).

In the third quarter, consumer spending accounted for the largest part of the growth in real GDP, followed by exports, inventories and residential investment expenditures. Of these four components, exports and inventories are most likely to continue to make large contributions in the quarters ahead. Consumer spending is projected to advance in the quarters ahead but at a noticeably slower pace. The surge in auto sales from the “cash for clunkers” program in the third quarter provided the temporary lift to consumer spending.

Residential investment expenditures grew at an annual rate of 23.4% in the third quarter, after a string of fourteen quarterly declines. Third quarter spike is encouraging but it is unclear if the robust pace will remain durable. The $8000 first-time home buyer tax credit program helped boost home sales in addition to low mortgage rates and home prices.

Final sales to domestic purchasers increased at an annual rate of 3.0% in the third quarter. The 2.3% increase in government expenditures is expected to show a more robust gain in the near term, which should show the impact of fiscal spending plan envisaged for 2010. The GDP price indexes suggest that inflation is contained, again underscoring that inflation is not the primary issue at the present time.

Going forward, the lift to the headline GDP number in the third quarter is partly from future auto sales, which implies that consumer spending and GDP growth are most likely to show more muted growth in the fourth quarter of 2009 and first quarter of 2010. The Fed is hold for several months until it is confirmed the unemployment rate has peaked.

Source: Asha Bangalore, Northern Trust Daily, October 29, 2009.

* Asha Bangalore is vice president and economist at The Northern Trust Company, Chicago. Prior to joining the bank in 1994, she was consultant to savings and loan institutions and commercial banks at Financial & Economic Strategies Corporation, Chicago.

Tags: Auto Sales, Business Cycle, Consumer Spending, Economic Data, Economic Recession, First Time Home, First Time Home Buyer, First Time Home Buyer Tax Credit, Government Expenditures, Gross Domestic Product, Inventories, Low Mortgage, Mortgage Rates, National Bureau Of Economic Research, Northern Trust Company, Post War, Real Gdp, Residential Investment, Time Home Buyer, War Period
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