Thursday, August 22, 2013

The Morning Call--No confusion in bond land

The Morning Call


The Market

            The indices (DJIA 14897, S&P 1642) remain out of sync on their short term trend.  The Dow is in a trading range (14190-15550) while the S&P is still within its short term uptrend (1628-1783).  Both finished within their intermediate term (14603-19603, 1553-2141) and long term uptrends (4918-17000, 715-1800).

            Volume was anemic, breadth terrible and both of the Averages remain below their 50 day moving averages. The VIX was up 7% but is still trading within its short term trading range and its intermediate term downtrend.  I am a bit surprised that the VIX hasn’t advanced more aggressively given the current pin action; whatever the reason, it is a plus for stocks.

            GLD fell but remained above the developing very short term uptrend.  However, it also closed well within its short and intermediate term downtrends.

                Bottom line:  the Averages are not only out of sync but also their pin action is lousy.  Not a technical scenario that encourages me to spend cash reserves.  One of the rules in our Buy Discipline is to take no action when the indices are not trading in unison.

            What the credit markets are telling us (medium):


            Yesterday’s US economic data included weekly mortgage claims (down), weekly purchase applications (up) and July existing home sales (much stronger than anticipated).

That should have been enough to put a positive spin in early trading.  However, overseas markets were again in turmoil plus investors likely didn’t want to place any bets ahead of the release of the FOMC minutes in the afternoon.  Once they were out, volatility kicked in with stocks trading down on the news, recovering dramatically and then rolling over.

Judging by the price action in the equity markets, there was clearly some confusion among stock investors.  While I have no claim to any special insight on what is happening, I do have an opinion; and it is this:

(1)                           the stock guys might be confused but the bond guys aren’t.  Bonds were down, period.  I think that this means that the fixed income markets have decided that there will be ‘tapering’ and it doesn’t matter exactly when.  What matters is the transition process from easy to tight money; and until bond investors have certainty as to how the Fed intends to manage that process and that it has a reasonable chance of being successful, then doubt and lack of confidence stemming from the Fed’s prior inept record of bungling the transition process is now being priced into bonds---and it is not likely to stop until there is certainty regarding about the outcome of the process.  

I am not arguing here that the Fed will again botch the transition process [though I think that they will]; I am arguing that investors don’t know whether or not it will, that they have every reason to be skeptical and until they do know, the bond market is not apt to be a source of strength for the stock market.

(2)                           investors in foreign stocks also don’t seem to be confused.  Witness the whackage in overseas markets.  As I noted yesterday, a lot of money that has been invested in foreign and lower quality stocks and bonds has been a function of speculators using cheap Fed money to chase high returns elsewhere. 

In most cases, what is driving these investments is the spread between the cost on money and the yield on investments.  Fundamentals---fugitabotit.  Since this is all being done on leverage, when the cost of money is rising and/or the price (return) on the investment is dropping, the investors start losing money fast. This is the carry trade; and while we know that the trade is now going against the speculators, what we don’t know is how large that trade is, i.e. how much more will have to be unwound.  Given the massive source of funds [bank reserves], the number could be big---meaning this could get ugly.

            Canada no fan of ‘tapering’ (short):

            Is the junk bond bubble breaking (short):

Bottom line: I speculated yesterday that we were nearing the point where our thesis that the Fed’s incompetence when it comes to a transition from easy to tight money was close to being put to the test.  The price action of most markets yesterday supports that view.  To be sure, it is only one day’s performance and conditions could turn on a dime.

            However, if I am correct, given the extent of equity overvaluation (as calculated by Valuation Model), the resolution of the validity of our thesis could be a painful process even if the Fed is overwhelmingly successful in the end. 

Not to belabor a point, but notice that all my comments have been on the transition’s impact on the Markets not on the economy.  QEInfinity did little the help the economy; so its unwinding may do little to hurt the economy.  On the other hand, QEInfinity has driven the prices of many assets into nose bleed territory; so as I noted, the come down could be ugly.

Our Portfolios remain cautious and better sellers.

More on valuation (medium):

            Counterpoint (medium):

     Subscriber Alert

            The stock price of Phillip Morris Int’l (PM-$84) has fallen below the lower boundary of its Buy Value Range.  Hence it is being Removed from the Dividend Growth and High Yield Buy Lists.  It remains above its Stop Loss Price, so no action will be taken.

            The stock price of Tim Horton (THI-$56) has traded into its Buy Value Range.  Accordingly, it is being Added to the Aggressive Growth Buy List.  However, no action will be taken at this time, 

Steve Cook received his education in investments from Harvard, where he earned an MBA, New York University, where he did post graduate work in economics and financial analysis and the CFA Institute, where he earned the Chartered Financial Analysts designation in 1973. His 40 years of investment experience includes institutional portfolio management at Scudder, Stevens and Clark and Bear Stearns. Steve's goal at Investing For Survival is to help other investors build wealth and benefit from the investing lessons he learned the hard way.

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