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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