The closing sentence in last night's post seems to be have been prophetic: Tomorrow is always full of plenty of unknowns, but that's what makes the game fun. Coming into the trading day, if you had told me that we'd get a dismal housing starts report (Housing Starts Report) as a piggy back to the sluggish earnings report turned in by Goldman Sachs last night, I'd have been pretty confident that the move lower in equities would continue in a robust fashion. At least for today, though, I was wrong. The S&P 500 closed higher by 12.23, up 1.14% to finish the day at 1,083.48 on summer-like volume of 4 billion shares. The price action was impressive. After opening down about 14 points, buyers came in and continued to bid the market throughout the day and actually managed to close the index near its highs of the day. Interestingly, Treasuries traded in a very tight range on the day and saw their yields move up only modestly despite the equity rally. Commodities were again range-bound for the day and seem to be mirroring the general the 'which way do we go' sentiment that permeates most markets right now. Currencies did much the same.
Much of the equity gains today came after 1:30 pm CDT when rumors of an announcement of a change in Federal Reserve interest rate policy began to surface. According to the rumor mill, the Fed will announce tomorrow that it is cutting the interest rate it pays banks for their excess reserve deposits to 0.00%. This rate presently stands at just 0.25%. This news sent financial shares soaring as investors considered this to be a positive development. For my part, I can't really understand why investors would look upon this news (if in fact it's true) in such a manner. Cutting the rate paid on excess reserves is merely a stealth-like form of quantitative easing. By removing the last bit of incentive for banks to maintain reserves with the Fed, this action is designed to entice lenders into extending additional credit to businesses and consumers. As a consequence, this additional credit availability would, in theory, spur economic growth and provide a needed jolt to a domestic (and global for that matter) economy that is in the midst of a slowdown. Unfortunately, the actions of most banks over the past 18 months clearly indicate that this incentive for additional loan growth will be thwarted by the Fed's own policies. With a steep yield curve in place, banks have largely chosen to take advantage of near-zero short term borrowing costs as a way of purchasing longer-dated Treasury bonds and making the spread between the two. This nearly risk-free trade enables the banks to improve their capital positions while avoiding the risks inherent in traditional lending markets like housing, consumer credit, and commercial credit. As a result, the Federal Reserve will, in effect, further monetize the expanding U.S. debt without saying they are directly doing so. Not only is this an indication that both the Fed and the banks aren't completely sold on the soundness of the economic recovery, but it also means that private banks' viability is further dependent upon the non-traditional Fed interventions. It's not a pretty picture.
Earnings this quarter have been a bit of a mixed bag. Technology companies, in particular, have reported stellar earnings. Apple, once again, reported a sizable earnings beat after the bell today and raised guidance as well. This continues the string of positive technology-related earnings that began with Intel. However, this trend has not been broad based. According to Standard and Poors, 27.5% of the companies within the S&P 500 that have reported earnings have missed their revenue targets. While this isn't all that eye opening by itself, the fact that nearly 73% of those who have missed on the top line have been in consumer-related industries is illuminating. This reinforces the data we've seen of late that suggests that consumers are continuing to reign in spending, pay down debt, and hoard cash. If this trend continues (and it likley will unless hiring picks up), companies will be hard pressed to find additional ways to grow the bottom line and likely won't be able to do it. This will almost certainly put pressure on share prices as metrics like Price-to-Earnings and Price-to-Sales begin to make companies look expensive. At some point, revenues have to grow. The better question to ask going forward may be how low do sales have to drop before they can sustain a rebound? Whether or not you believe this will ultimately materialize, its a question worth asking.
So after a day like today, where do the technicals stand? Have a look at the charts below.
As you can see, the S&P 500 is again approaching the upper bound of the downward sloping trend line that has been in place since mid-April. Interestingly, this upper bound is approximately equal to a 38.2% retracement of the top-to-bottom move over the last couple of months. (For those unfamiliar with retracement levels based upon the Fibonacci numerical sequence, it is sufficient to know that this analysis assumes that a market will typically find support and resistance at specified levels. For the move in question, these levels are indicated by the blue lines. Note the failure at the 38.2% level last week.) This confluence of indicators again reinforce the notion that the rally will be capped for now. Things can change quickly, but for now we're still just vacillating in the expected range. I continue to hold my short position and actually tried to add to it on the close today. Unfortunately, I had an administrative problem with my account that precluded the trade from going off. Frustrating to say the least.
My last point tonight will be a bit of a departure from the domestically-focused commentary I have provided to this point. Specifically, I'd like to address the question of China and its viability as an area of investment. From my earliest days in trading, which started in the cotton futures market, it was clear that China was the economic force that had among the greatest influences on prices. If there was a bumper crop in China, futures ran lower. If there was a drought taking hold, futures ran limit up. And while this relationship was well known, the thing that struck me most was the lack of accuracy associated with virtually any kind of data coming out of the country. Too often the drought report that was released from Chinese government officials proved to be worth less than the paper it was printed on. I'd like to think that this lack of data reliability was simply a product of an emerging country trying to getting its data collection methods established, but the truth was that it was more akin to outright manipulation. That perspective has stuck with me through the years and has caused me to remain skeptical of the Chinese Miracle of the last 20 years. There is little doubt that during this time, China has seen enormous growth as a result of their push to become the world's source for inexpensive manufactured goods. Cheap labor coupled with currency interventions designed to keep the yuan pegged below the dollar, forced Ross Perot's great sucking sound to move east rather than south.
With all the growth that China has experienced, it's only natural that their economy transition to a more consumer-based model in an effort to diversify their economy and control inflation. However, with the onset of the financial crisis in late 2007, China embarked upon a path of highly stimulative monetary policies (largely at the suggestion of Western economies) in an effort to unpin their economy. Banks across the country, at the direction of the Chinese government, pumped billions of yuan into the economy in the form of real estate and business loans as a means of stimulating growth. This action largely had the desired effect as GDP rebounded from its lows. The problem is that much of the stimulus that was extended by the banks during 2008 and 2009 found its way into the country's real estate sector. In a manner reminiscent of the sub-prime boom that crippled the U.S. economy, Chinese banks are now saddled with an enormous number of real estate-related loans that are highly dependent upon a stable real estate market for them to perform. Chinese officials have stated repeatedly that they have been enacting measures to ensure that the market doesn't suffer a slow down, but, again, I come back to my skepticism over 'official' statements. A recently published paper entitled Evaluating Conditions in Major Chinese Housing Markets by Jing Wu, Joseph Gyourko, and Yongheng Deng is a real eye-opener for those unfamiliar with the scale of the run up in real estate prices. While I'll leave it to you to read the paper at your leisure, I think the following excerpt says it all: "Real, constant quality land values have increased by 900% since the first quarter of 2003, with half the rise occurring over the past two years. State-owned enterprises controlled by the central government have played an important role in this increase, as our analysis shows they paid 27% more than other bidders for an otherwise equivalent land parcel." Still believing that the Chinese government is truly working to slow the real estate market? Me neither.
Again, my apologies for the late post today, but there was a lot going on that I wanted to try and touch on. I'm a little more nervous in my short, but I'm still holding on for now. I look for the market to continue it's rally through the open tomorrow (partially due to Apple's earnings), but will be watching the 1,095 level on the S&P's to see if sellers come in as expected. If nothing else, it should make for another interesting day to write about tomorrow.
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