As I view the markets, everything is in a giant holding pattern. Whether it’s debt, equity, currency, or commodities, investors appear to be reevaluating the stories upon which they have built their asset allocations to this point. Though there has been a fair bit of volatility in the equity markets the past three weeks, the chart of the S&P 500 presented below shows quite clearly that this uncertainty has yielded a market that’s gone virtually nowhere. Today’s price action was yet another example of this phenomenon as the S&P 500 seemed primed to sustain a sharp move lower, but again saw bidders return in the last hour of the session. And with so much of the September-October rally underpinned by the expectation of another round of monetary stimulus from the Federal Reserve (and to a lesser extent by Republican gains in the House and Senate), we are nearing the point where the story will finally be told. Whatever Tuesday has in store, odds are that we are likely moving back to a trading environment that is more focused on corporate earnings and the economic outlook. Sure, there will likely be some lingering concerns about the Fed’s action/inaction that will push prices around slightly, but the biggest question mark overhanging the marketplace (the size, scale, and duration of monetary stimulus) will finally be out of the spotlight and fully discounted in asset values.
As to the story that will be told next week, my view is that the market will ultimately be disappointed by any announced Fed action. With solid corporate earnings continuing to roll in, long-term concerns about the expansion of the Federal Reserve’s balance sheet being espoused by FOMC members, and comments from Chairman Bernanke that appear to clear the way for a modest, systematic, and somewhat data-dependent program, the likelihood of a huge injection of stimulus appears to be falling. Having priced in such action in the weeks leading up to Tuesday, this sets up nearly all markets, except for the U.S. Dollar, for a sharp, quick pullback. If I’m wrong in my expectation, though, I see little reason for the equity market to continue the current move higher. The only exception to this would be the continued expansion of corporate earnings, which have been strong of late. As I’ve said before, after pricing in a sizable round of stimulus, it would take a significantly larger stimulus program from the Fed to truly move the needle. $500 billion has been widely talked about as the likely scale of the coming intervention, which means that something on the order of $600 to $700 billion would probably be needed to reignite the rally. Even if this occurred, though, there is one major caveat that will likely keep any near-term rally in check.
One of the primary reasons why so many investors have looked to additional monetary stimulus with starry eyes has been notion that such action would be able to reinvigorate a domestic economy that is seen to be slowing down. Quarterly GDP figures clearly show this weakening trend with growth sinking to 1.70% in Q2 2010 from the 5.0% level seen at the end of 2009. However, any action by the Fed that eclipses that which is expected would imply that the economic fundamentals are indeed worse than expected at this point in the economic recovery. And while additional action could help stem the effects of this deterioration, the sharper than expected slowdown would likely trickle into the earnings performance of corporations in coming quarters as well as many of the widely watched economic indicators, thus putting pressure on share prices. To be sure, much of the earnings performance we’ve seen of late has been attributable to the sizable portion of revenues that corporations now generate outside of the United States, which makes domestic economic performance somewhat less relevant when estimating share values. That said, the notion of decoupling was proven to be an out and out farce in 2008, so assuming that the rest of the world can grow their economies while the United States languishes seems just as nonsensical to me. This is just another reason why I see the bulk of the risk in the marketplace skewed to the downside, which demands a cautious posture at the very least.
Taking a more technical look at my thesis, it appears as though the U.S. Dollar Index (DXY), gold, and the Treasury market are mirroring some of the concerns I’ve been espousing. In a scenario where expected stimulus fails to materialize, one would expect the DXY to climb (as less currency would be created), gold to fall (in part due to dollar strength), and Treasury yields to increase (due to reduced Fed purchases). But does the economic logic of such action match up with the technical set up for each of these markets? Looking at the charts below, I would have to say that they are echoing these calls rather loudly.
As an aside, I would like to thank each of you for your readership of late. Looking at the numbers for the month of October, it appears that we’re on track for the biggest month in FT’s short history. More than the actual numbers, this growth tells me that many of you find the comments and insights I post here worth a small sliver of your time, which is quite flattering. I work pretty hard to keep the content of this blog as fresh and timely as possible, so seeing that you are coming back time and again to see what I’m saying makes the effort truly rewarding. As always, please feel free to pass along FT to your friends and colleagues as I would love to expand readership to even more market-focused individuals. Also, don’t forget that your feedback is always appreciated, so don’t hesitate to let me know what you’re liking and what you’re despising. Feel free to post a comment or email me directly (click the envelope under a particular post). Ultimately, it makes the blog better for us all. Again, thanks for making October a great month!
Until tomorrow.....
No comments:
Post a Comment