Thursday, October 15, 2009

Market Breakout, Bonds, Oil and Earnings

Third quarter earnings have been seeping out this week, mostly to critical acclaim. Thus far, profits from the big financials appear to be mostly concentrated in proprietary trading (again). And once again, there's very little transparency to the banks' actual balance sheet due to the suspension of mark to market accounting. The plan is that these rules will be reinstated by yearend, and the consequences to earnings are quite obviously ground-moving. Cynically, it should be assumed that these banks will throw untold millions at lawmakers to have the rules postponed again. But the real question is not necessarily the rules themselves, rather the willingness of speculators to take the risk.

Risk appetite trumps fundamentals.

I wish I could be bullish on the economy. But I do not see the proper characteristics for sustainable economic growth. Money is being piled into the old bubble sectors (FIRE - Financials, Insurance, Real Estate), which themselves produce no wealth. Meanwhile, small businesses, startups and individual consumers are starved for both capital and access to credit. I struggle with how this could go on for so long, but I then think back to '07 when everything was similarly levitating in the face of the blatantly obvious. The necessary deleveraging was also avoided in '01-02 and continued for years. So while I prepare for the possibility that this lasts much longer than anyone expects, I don't foresee it doing so.

One thing I do expect is confusion. Lots of it. I expect to see some major separation from previous positive correlations. For instance, long term interest rates have risen substantially over the last two weeks (30 yr treasury yield up 43 basis points), and I have a feeling that this may be a more permanent sort of move. I would not be surprised if the long bond starts trading as a risk asset on any subsequent market decline. Rising rates are also something that has the potential to kill what many are calling a bottom in the housing market (I think not).

Oil may also be something that finds some separation from its recent 'beta' with the stock market. It seems like forever, but there was a time when rising oil prices were seen as a bad thing, and every tick higher in crude was matched by a tick lower in stocks. Oil broke out above new highs this morning above my long standing cited resistance around $75, many technicians see it with little resistance up toward $100. Whether the market reacts to this negatively or not, it is going to start putting big pressure on consumers. And if there is one thing that angers populations more than anything, it is rising gas prices. It would be sweet irony if rising oil prices, at first thought to be a harbinger of economic growth, eventually killed the rebound in social mood and sapped the willingness of consumers to consume - just as we edge into Christmas shopping season.

Traders and investors become married to correlations. When they break, they cause chaos for weeks at a time while managers reposition their portfolios for what seems like the "new normal." The present correlations have held for quite a while, likely lulling many into complacency. Watch them carefully.

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dacian said...

matt, we also call oil "the economic killer". I'm positioned for higher prices in oil (based on technicals) and I think as you: this thing will start to scare people again.

Speculation is rampant and the weekly advance since March is very steep; I don't want to think how it will look if it turns down.

For now, yhere are no leaders in the market; thos who advance most are the leaders of the previous bubble; this isn't how a new bull is launched (it might be different this time?) or maybe Wall Street is short of ideas for the next bubble :)

Anonymous said...

Oh boy, interest rates need to rise now.

Willy2 said...

It was brought to my attention that a number of indicators seem to have turned a corner.
1) The $TED spread is going up.
2) The gold/silver ratio seems to be turning up.
3) IQI (a municipal bond fund) has cracked.
4) LQD has broken the uptrend.
5) IRX went down as well, again.
6) Baltic Dry index is heading down.

In combination with a declining USDX it could signal a complete breakdown in the US markets. But both the EUR/USD and the EUR/Yen seem to point another way.

Willy2 said...

I must correct something: Both the EUR/USD and the EUR/Yen seem to point to a breakdown of the USDX but when the carry trade unwinds both currency crosses could be going thew other way again.

I watch a number of bankstocks indexes as well e.g. the Dow Jones EURO Stoxx 50 banks index.

Anonymous said...

Last time when oil ascended rapidly consumers were loaded with cash from easy credit and rising real state, hence were slow to react to rising gas prices. How can that happen now in the middle of the credit crunch????? If the end user demand remains poor, how can oil reach $100????

Even speculators have limits!

Matt Stiles said...

thanks for the comments, folks.

Willy2 said...

When I look at oil from 2000 to 2007 I see that the rising price was the result of genuine increasing demand. The move in oil from late 2007 through june 2008 was a speculative bubble. The move from $ 35 back to $ 75 seems to me a response to the giant break down from $ 140 down to $ 35 in the 2nd half of 2008. I think the movement of oil this year is quite modest, it doesn't signal a bubble because then it would have gone up in a straight line like it did in late 2007 and the first half of 2008.

The bubble today is the stockmarket and the corporate bond market

Roger J said...

Great thoughts there, Matt. Sounds like a great scheme especially if you think the evil way. Use correlations to deceive the big two opposite groups.

E.g. on oil, if it keeps rising while commodity stocks are going down, people may be deluded to think it's a great buy or that oil is going up & stock market down is a positive divergence which should propel the stock market higher.

Kind of reminded me of October 2007 - July 2008. In November 2007, oil started diverging from the equities. Then in March 2008, oil going up together w/ USD. Wacky, if you looked back. But USD's rise wasn't particularly stellar so it avoided the radar. Until July 2008, when everything was revealed.

By the way, at least the last several days, the emerging markets have not been behaving like it used to (rising sharply along w/ oil's rise). It's been relatively weak compared to the US market. Could be just a blip, but could also be signifying something crucial.

Have been quite active on Kenny's, haven't you? LOL. That and Daneric's have been such great sources to improve my TA skills. Very grateful for them.

Roger J said...

In addition to those I mentioned, to someone used to correlations (me included -- but trying to find/develop new ideas), the JPY actions must be very puzzling.

It seems to start moving together w/ other risk-seeking currencies. Any thoughts on this from fundamental perspective?

Dacian said...


"Even speculators have limits!"

Are you kidding me? Never ever...

Matt Stiles said...


Yeah, spending more time on the TA blogs has been helping my EW skills as well. I float around various places for a few weeks, then disappear. There's plenty of good ideas out there from various folks. Unfortunately the good places eventually get infiltrated by children and it all goes to pot.

Almost mentioned the Yen in this post as well. Now that interest rates are near zero globally there's not much special about it anymore. Their carry trade will take years to completely unwind, but I wouldn't be surprised if it tags along with the euro, pound and loonie henceforth. This would likely prove to add volatility to the DXY.

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