Public Sector vs. Private Sector

Since the onset of the financial crisis in late 2007, so much of our political rhetoric has been focused on the respective roles of government and the private sector.  Naturally, those who view the appearance of this crisis as a product of a lax regulatory environment and excessive greed look to government as the means of righting these issues.  Conversely, private sector leaders claim that it was misdirected government policies and asleep-at-the-wheel regulators who bear the majority of the blame for our current state.  To an extent, this is simply another iteration of the normal push-pull between the two groups with each side possessing some legitimate claims. 

More interestingly, though, has been the manifestation of this public vs. private antipathy in the financial markets over the past week or so.  As I said near the outset of Q3 earnings season, investors were likely to push aside their focus on macroeconomic data and hone in on corporate earnings reports.  However, this supposition has proven incorrect in relative short order.  Federal Reserve policy expectations are consuming nearly all of the market’s focus, which, in turn, places macroeconomic data right back in the sights of investors.  And strange though it may be, deteriorating macroeconomic data is exactly what most risk-based asset class investors are looking for as this would suggest that Fed monetary stimulus measures are more assured and possibly greater in scale than currently expected.  As a result, what the public sector is doing at this point in time is, apparently, more important than any other data point we are getting.

This singular focus on federal action completely discounts much of the information we are receiving from corporations in their current releases.  And while I have been an unflinching bear when it comes to equity prices and have espoused real concerns over corporate earnings, the fact is that the numbers that have been reported so far have been fairly positive with correspondingly positive forward guidance.  For example, Catepillar reported $1.22/share earnings before the bell and raised it guidance for both revenue and earnings for the remainder of the year (In the case of revenue guidance, the range was simply narrowed rather than moved to a new high.).  This is clearly a positive report and one that is indicative of what has been seen of late.  While it’s true that much of the growth is being driven by markets that lie outside North America (this is not a Catepillar-specific phenomenon) and earnings are still not approaching the levels seen in late 2007, the fact remains that revenues and earnings have continued to grow.  But, confusingly, this sort of development doesn’t seem to matter for now.  It’s all about the Fed.  In fact, this morning’s jobless claims data, which saw slightly higher readings after considering prior week adjustments, was basically cheered by the market.  Not because it was a positive development for the economy, but that it appears to ensure that Uncle Sam will still show up with his big bag of money next month.

So while the S&P 500 is off to the races yet again this morning (much to my surprise), the question that needs to be asked is whether or not the recent rally is fundamentally-based or federally-based?  Again, a public sector vs. private sector debate.  My read is that we are still in a stimulus-induced rally period that is vulnerable to the whims of bureaucrats rather than the underlying fundamental and economic outlooks.  As such, speculation on potential policy shifts has a swift and meaningful impact on asset values.  As we’ve seen just this week, the mood has changed from reduced Fed stimulus to expanded Fed stimulus in short order, with equity markets swinging nearly 4% from top to bottom.  This is the kind of environment that can hurt a lot of investors and part of the reason why the VIX has been unable to break to new lows despite higher share prices.

As I tweeted this morning, after seeing some significant pressure during the overnight session, the U.S. Dollar Index managed to claw its way back to near the unchanged line and above trend line support.  However, pressure has continued so far this morning with a significant amount of trading occurring right around the 76.95 level.  This is kind of the proverbial ‘line in the sand’ for the index.  A hard break below this level will open the door to the sharp downward move so many have been looking for.  While I don’t think this will happen in the near term, the Federal Reserve’s policy announcement in early November will likely end up being the catalyst for either a breakout or a break down.  Keep an eye on gold today.  Despite another soft day for the greenback, bullion prices are at a virtual standstill.  Though currency fluctuations are not the only driver of gold prices, the fact that the response to the downward pressure in the Dollar has been as muted as it has been suggests, as I’ve been saying for a while now, that the bullish momentum has run its course for now.  I continue to look for a pullback near the $1,250 level, but as with any market, we’re going to need some sort of catalyst to get it there.  As a result, those looking to hedge currency exposure may consider owning crude oil in here given its unusually higher correlation of late.

Until later…..