Notes From the Rabbit Hole
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Pivotal Events
By Bob Hoye February 5, 2010
The
following is part of Pivotal
Events that was SIGNS OF THE TIMES: Last
Year: "A
nation cannot prosper when it favors only the prosperous." –
President Obama, January 21, 2009 "You
Feel God is Speaking to You" –
Inaugural attendee, CNS News, January 21, 2009 Obama's
crash in popularity is at record, if not Biblical, proportions. Although
described as progressive, his "Shock
and Owe" policies are extremely intrusive and
increasingly costly. This is prompting what could be described as
the Second American Revolution. Perhaps, like the "Glorious Revolution" in England in 1688, the public
can reform a disastrous experiment in authoritarian government
without bloodshed. Fortunately, there is recent example of such
reform as symbolized by the Berlin Wall in late 1989. The
independent "Tea Party" movement will continue to gain
influence (Massachusetts is a critical example) and will eventually
find its own leader. *
* *
* * This
Year: "I'd
rather be a really good one-term president than a mediocre two-term
president." –
Barrak Obama, January 25, 2010 The
second alternative seems unlikely, and it seems too late to be
hopeful about the first. "High-yield
corporate bonds may help investors maximize returns." "Now
it is about cherry-picking great high-yield companies." –
Financial Post, January 23, 2010 We
would expect that "great" high-yield bonds are the ones
that never go down in price. "Investors
are so concerned that Greece won't be able to finance its budget
deficit that it now costs the government more to borrow for two
years than Germany pays to raise funds for 30 years." –
Bloomberg, January 21, 2010 One
of the promotions of the European central bank was that unified
discipline would lower overall costs of borrowing as it narrowed
spreads from one county to another. Some believed that, for example,
yields for Italy and Germany would be the same. Long Term Capital
Management (LTCM) was a hedge fund staffed with brilliant PhDs. The
pedigree was so good that most senior central banks eagerly lent it
money and even the Bank of Italy took an equity position. The
wager was that legislation would narrow all European sovereign
spreads and culminating in 1998 LTCM bet beyond prudent limits. The
problem was that the whole spread market became overdone and a
seasonal widening of spreads trashed the fund, many reputations and
prompted some best-selling books. Before
that collapse we pointed out that a gold standard would provide a
fiduciary discipline beyond what could be imposed by the Euro
central bank. Even with
that discipline in the 1800s, spreads between such as Spain and
England were distinctive. With this, we thought the fiat experiment
in narrowing spreads would not work. Lately,
some sovereign spreads (Greece) have been widening. "China
has told some banks to limit lending and will [move
to]
restrict overall credit growth." –
Bloomberg, January 20, 2010 "Japanese
demand for bank loans dropped the most in more than five years as
companies stopped spending."
–
Bloomberg, January 21, 2010 There
is considerable irony in China talking about tightening credit late
in 2009 and continuing into January. Japan's policymakers did the
same in late 1989 and into that fateful January. The Nikkei set its
remarkable high on the last trading day of that decade and the start
of the bear signaled the beginning of a long contraction. *
* *
* * STOCK MARKETS As
The Economist wrote under similar conditions in the 1870s "A profound change came over
the markets in the past week." There has been what
appears to be a profound change and it began two weeks ago when the
resource-driven Toronto index recorded an outside reversal to the
downside – on the weekly basis. Last
week, the Dow and the S&P suffered the same reversal from a rush
to get in to a sudden call from Mister Margin. Such a reversal from
a more than a month of very high sentiment readings would have to be
described as profound. Particularly
when within the turn-of-the-year period when a number of outstanding
speculations have completed. Interesting
setbacks have occurred in junk bonds, spreads and commodities.
Copper is working on the big reversal – on the monthly
basis – a study will be sent out by Saturday. What
next? As
Ross has been mentioning, this unified move in the formerly hot
games could have some respite at the 20 week moving averages. This
was reached yesterday and taken out. We
have been looking for a "rounded top" to the stock market
followed by an intermediate decline. Instead, the buying surge
accomplished an "over-thrust" from which the initial
decline has been rather hard. So
hard as to change our outlook from an intermediate decline in the
NYSE senior indexes to the possible resumption of the global bear
market. The
key indicator is the gold/silver ratio rising to 67 today. This is
distinctively above the level of 65, which we have noted would be
the warning on the next phase of liquidity concerns. The
last time the ratio gave the warning within a rounding top pattern
for the stock market was in August 2008. The previous and critical
example was in June 2007. The attached chart reviews the pattern.
The gold/silver ratio has a long and reliable record in anticipating
change. This time to the downside. Not
a comforting picture and it is worth adding a personal comment. Lois
and I were close to downtown early Saturday evening and decided to
drop into Hy's Steak House. This has been a favorite within the
brokerage community since the late 1950s and it was like going back
in time. Without a reservation we were content to sit in the
bar-lounge. As we were savouring a nice Amerone, a couple sat
nearby. He was a regular and while waiting for his table was on his
mobile phone. I
had no inclination to listen, but the words "margin call"
came through – briefly – had that problem in 1969. Last
week was bad in most markets, and this week's hit to copper is
riveting. Investors
could take money off the table and traders can play the short side. INTEREST
RATES The
115 level was expected to provide support and it did. Once there,
the rebound could bounce to a trading range between 118.5 and 119.5.
The high has been yesterday's 119. Today's drop to 118 seems in
sympathy with general selling pressures. Beyond
trading bond swings, it is worth noting that the swings have been
describing a rising trend for long rates. The low yield was 2.55% in
December 2008 and now it is at 4.55%. In a precarious credit market
and economy this is not good – a particularly if rates do not
significantly decline as commodities weaken. Going
the other way, the decline in corporate yields as commodities soared
has been remarkable. The yield for the Baa has declined from 20.7%
in March to 8.53% on January 14 as the CRB commodity index has
soared from 200 to 293 on January 6. On the same move junk went from
42% to 11.85%. Clearly,
high-yield corporate bonds have been hot participants in the
resumption of asset inflation. A proxy (CYE) set both weekly and
daily Upside Exhaustion readings, that when registered on most price
series sets an important top within a couple of weeks. From
the low earlier in the month, the high-yield has increased 30 bps to
8.53%, as the spread widened from 382bps to 428 bps. Junk yields
increased 63 bps to 12.36%, as the spread widened from 723 bps to
781 bps. This
is an important step in ending an unusually aggressive employment of
the carry trade. It will take a test to confirm the trend change,
but the hit to copper is suggesting the resumption of weakening
business activity. Weakening
commodities indicates weakening pricing power for business and that
reduces earnings, which reduces the ability to service debt.
Eventually, this is noticed by credit rating agencies. Currencies:
The Dollar Index continues its rally which is on forecast and it is
beginning to chill a number of the formerly hot games. In
looking at the chart, there is minor overhead resistance at 80 and
more substantial at 85. Reaching 80 would derail the ability of
speculators – including central banks – to boost prices.
Reaching 85 would really finish the great rebound out of the first
post-bubble crash. It would again severely damage the reputation of
interventionist economics. This
seems to be the case for the yen, which has been strong against the
US, which makes it THE currency. Deflationary pressures continue,
and Tamisuke titled our book "How
To Make Money In Kyoko". Kyoko means the long contraction.
Other than the title, the book is in Japanese.
bobhoye@institutionaladvisors.com
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