MARKET SENSE

ALERT: US EQUITY MKT CRASH COMING

2006-08-22T20:07:00.000+02:00

Sell U.S. equities. The interest rate rally for the stock mkt is over. Now we trade world wide slowdown with recession in the U.S. Hold on tight!

No, actually I was wrong

2006-08-09T13:54:00.000+02:00

Thanks for the e-mails congratulating me on my correct call of the Fed but actually I was wrong. I read the statement as neutral with only lip-service to the inflation notion at the end.

We are in a new chapter of market history. Signs of economic weakness no longer drive the equity markets higher. The multiple expansion segment of the interest rate/equity cycle is over. That's why the market sold off after the Fed.

The talking bank heads attribute the sell-off to the last paragraph of the statement. Balderdash! No one thought we would get a statement without some mention of the risk of inflation. In that context, the statement was mild.

We saw it on our opening as well: weak data in Germany/equities sell off; strong machinery data in Japan, strong Nikkei.

The markets are telling you that the weakness in the US economy is more than the ISI-heralded mid-cycle slowdown. As I have been suggesting for a while, sell equities.

Beckner Again

2006-08-07T16:37:00.000+02:00

I probably overanalyze these things but I see today's column by Steven Beckner to be very revealing of the market's general attitude: "A strong case could be made for continuing to tighten monetary policy at Tuesday's Federal Reserve policy meeting, but the Fed probably does not have to raise interest rates again this time to preserve its anti-inflationary credibility when there are also defensible reasons to take a pause."

In other words, the Fed's mission is to preserve its credibility with the bond market in the short term. Why? I guess in a James Carville kind of way: the bond market is the most powerful player in the US economy.

I don't buy it. I've drunk an ocean of ale with bond market participants from brokers, to traders, to salesmen, to investors, to portfolio managers. Not the most thoughtful group of people in the world. Momentum traders, all of them.

The bond market's short-term reaction to the Fed has little impace on Elm Street. In the end, it is the US consumer who drives economic activity.

I've made my bets

2006-08-06T19:38:00.000+02:00

I'd be willing to bet serious money (I have, I guess) that the US Federal Reserve will not raise rates this week. They will aver that there is reason to pause but will reserve the right to raise if the data indicate such. Why? Because they have nothing to lose from such a statement and much to gain, i.e., credibility. This has been about Mr. Bernanke's credibility all along.

Awakening this weekend, I discovered that the US equity markets had quite a turnaround on Friday afternoon. In my view, the market isn't voting on whether they should pause in August but on whether they should have paused this spring when housing accelerated to the downside.

The US economy is consumer-led. To suggest that the downturn will be sustained by capital expenditures by businesses is to ignore history. And don't expect we Europeans to become the engine of global growth. We're just a few quarters behind the States. It took us longer to recover and we're still coasting down the hill. When momentum slows, we'll find it just as difficult to climb the hill of higher interest rates and higher energy prices.

Bottom line: weaker everything through the first quarter of 2007. The market's interest rate rally is officially over. So is the bond market's. The curve starts to steepen here as the Fed gets closer to its next move: a cut in the Federal Funds target.

Self-appointed Expert #5: Paul Krugman

2006-08-04T21:22:00.000+02:00

Paul Krugman is another in a long line of arrogant professors of economics at Princeton University (Sandy Grossman comes to mind). That Krugman knows everything there is to know about the U.S. economy and the international value of the dollar- OK, he has grounds to make that claim. That he's an expert on what the U.S. voter should do, quite a stretch. That he should lecture Israel on its military policy? Absurd!

Beckner Redux

2006-08-02T18:10:00.000+02:00

When it comes to the U.S. economy, Europeans seem to lurch from talking head to talking head. The legendary John Liscio OBM was the guru of choice through the 1990s. I've always shared Alan Greenspan's fondness for Caroline Baum, one of the clearest thinking journalists I've ever followed (I first heard of her through Dr. G. some years ago). Randall W. Forsyth has had his moment in the sun doing the Current Yield column in Barron's.

Ms. Baum has never advanced the notion that she has the Fed's ear or that they have hers. Just good hard analysis informed by the facts (she's only available on the Bloomberg service but I've heard her on the radio on trips to the States).

Greg Ip and Steven Beckner, however, are in the "I-heard-it-from-senior-sources-at-the-Fed" tradition. We all know how far that goes (Maria, call your producer).

I have been asked to comment on today's Beckner article (circulating through the market). As usual, not much meat. A single idea: the Fed has the choice to be a central bank and manage yesterday's problem (hat tip to Keynes) or be forward-looking. Nothing new here.

I'd rather analyse the ADP report than speculate on the same choice for the thousandth time. New Yorkers, take a water bottle with you. My colleagues tell me it's hot out there.

I think they call it "chutzpah"

2006-07-28T16:36:00.000+02:00

It's not a word we use at the club. I'm afraid we don't have any members of the Hebrew persuasion, not that they are not welcome but no one ever applied (sounds weak, I know). It's the most appropriate word, though, to describe the world's arrogance(if a Gentile can display chutzpah).

When the Russians moved missles aimed at Washington and other major American cities 90 miles away in Cuba, America took the world to the brink of nuclear war. Even though not a single missle had been fired, the U.S. refused to live in the shadow of Russian missles. And the world understood.

Israel has rockets raining down on them daily. They are taking steps to remove those who would fire at them from 12 miles away. The world demands a ceasefire.

Those who would restrain Israel from self-defence exhibit an arrogance that is associated usually with .... Americans. That the French pursue their self-interested oral ministrations to the Arab world is not surprising. That the self-hating socialists in the U.K. revert to their anti-Semitic anti-Israel rhetoric is not surprising. That even some Americans call on Israel to negotiate is nothing short of chutzpah.

But then again the Jews are different, aren't they? They don't apply to our clubs and they don't really belong. It would be much better if they just learned to get along. What's a few dozen deaths anyway?

Now that's chutzpah.

Great Expectations or a Tale of Two Cities?

2006-07-27T18:19:00.000+02:00

The Fed's mantra for the past several weeks (and the market's which has dutifully and unthinkingly followed the U.S. central bank) has been inflationary expectations. Here's the idea: U.S. policymakers must vigilantly guard against moderate price increases becoming baked into consumer expectations. If consumers think prices are going up, they advance purchases to avoid future increases.

A neat idea: if you're an economist. It doesn't work that way in the real world. Grandfather's brewery lifted the price of a cask of beer whenever the market would bear it. It didn't matter what the consumer expected. Prices went up when the calculus of cost and volume indicated the brewery would make more money. Prices were stable when a price increase would hurt profitability through decreased demand.

Expectations had nothing to do with it. The U.S. economy is less a matter of great inflationary expectations and more a tale of two cities: the one in which economists reside and the real one where you and I live.

Shalom in the Fed

2006-07-21T21:20:00.000+02:00

When Professor Ben Bernanke was appointed Chairman of the U.S. Federal Reserve, he promised greater transparency in the Board’s conduct of monetary policy. Over the quarter just past, the markets were treated to more talk but considerably less transparency than the volume of voices might have indicated. An orchestrated chorus of Fed speakers followed Dr. Bernanke’s April hint of a May pause with expressions of discomfort with higher readings of U.S. inflation. The markets reacted accordingly and rates headed sharply higher.

All this occurred on the background of a dangerously weakening U.S. housing market. In the past two quarters, the U.S. homebuilder stocks have become the dot coms of 2006. The bubble is not losing air; it has already sunk to the ground fully deflated.

With the release of the June FOMC minutes just yesterday, we know now that the Fed has been much more worried about the economy than they were willing to verbalize. In fact, the June rate hike was much more controversial than the litany of inflation fears might make us think.

In our view, the Fed has exacerbated what was already a difficult situation for the U.S. economy. We disagree with the small contingent of economic forecasters and strategists who see a mild pullback in U.S. GDP. The United States is headed to recession and investors should prepare accordingly.

The Secret of My Sometime Success

2005-03-23T17:31:00.001+01:00

The best market calls are where a trend is still unfolding but one detects declining momentum. When the market blindly reads a piece of unfriendly data incorrectly because it is emotionally invested in the trend, the opportunity for big profits abounds.

Any subsequent data is automatically read as friendly to the new trend. This is where we stand with the U.S. Dollar right now. Take this afternoon's release of oil and gas inventories in the States. Tight supplies would be interpreted as Dollar-friendly due to prospects for heightened inflation. Looser conditions would similarly be interpreted as Dollar-friendly: less pressure on the currency as fewer dollars go abroad to pay for oil.

In the end, long-term fundamentals and short-term technicals are the best combination. These opportunities come along more frequently than one might believe.

The Secret of My Sometime Success

2005-03-23T17:31:00.000+01:00

Would you like to work for me?

2005-03-23T14:42:00.000+01:00

For all those economists parsing the Fed's policy statement: Why not get a real job? I have need of a gentleman's gentleman. Use those nimble fingers to make a Windsor knot. Apply that keen eye to culling my wardrobe for the perfect suit and shirt. Exploit those risk management skills by ensuring my hosiery does not develop a run that might look unslightly when I cross my legs over the FT at the club.

God knows you need a real job. Please spare us the reasoned analyses of the alleged in-house debate. It's all very simple. The nanny explained it to me last evening. If the Fed had removed the word "measured", it might have sent the markets reeling. Better to prepare the markets that the day is coming. No intrigue. No fanciful scenarios. Simple, commonsensical stuff.

BTW, Alan, it didn't work. The market is a forward-looking animal. If you telegraph what is going to happen, the market reacts now.

Thanks one and all for the kudos on the Canadian Dollar. You can see from the date and the time of the post that the Canadian Dollar was indeed on its highs when I made the call. Check your Reuters against UK time, Charley.

What you need to remember is that currency strategists design their calls based on where the currency has just been. It's just momentum, that's all. It takes a real strategist to actually read the economic reports and think clearly.

Here's a mega opportunity

2005-03-22T16:47:00.000+01:00

The Canadian dollar is at the top of its recent trading range. Here's why it should be sold:

1) Today's retail sales number is due to.... gift cards. It's just delayed Christmas sales reported in January when the cards are cashed. It's the first increase in months. Growth in the fourth guarter was 1.7%. The Canadian economy is not firing on all cylinders and rates aren't going up.

2) Meanwhile, the currency has strengthened. We already saw a deteriorating trade picture in the statistics released last week. They can't afford more strength.

3) The source of the flows are abating anyway. The CRB has clearly peaked. Oil is looking frothy (money chasing money). The hedge fund community rides the waves. This wave has run its course.

The real story is momentum, not fundamentals. Yesterday was just a hint of what's to come. Sell the Canadian Dollar against the U.S. (not the Euro).

1.1985 as I publish this post. You can track my success (or lack thereof).

From our mailbag

2005-03-21T15:39:00.000+01:00

Dear KR:
Good call on the dollar. You seemed so sure. What's going on? How about a little more color? Do you manage money? You seem like a trader.
JVP

Dear JVP:
It's not interest differentials, it's not an improvement in the current account. Here are all the pieces of the puzzle in one place. The stock market is going down because it is discounting the end of economic growth. The effects of earlier stimuli like tax cuts are dissapating. Prices are going up because the world reflated in the face of absolutely ridiculous forecasts of deflation (if you want to make money, fade Bernanke- he is the ultimate lagging indicator). How could the market have been deflating and the stock market rallying 20% at the same time? It was foolish. We are now paying the price.
As U.S. economic growth pulls back, the flow of dollars outside the U.S. declines. It runs totally counter to the flow of FX corporate salesman who talk about interest rate differentials. Think back to what happened to the yen when Japanese aggregate growth unexpectedly came in stronger a week or two ago: the dollar rallied. It's the same effect.
UBS, Bernanke, Bloomberg TV... they muddy the waters so clearthinking investors can make money.
Good luck,
Karl

Where the U.S. is headed

2005-03-16T13:44:00.000+01:00

The Stock Market is a forward looking animal. The U.S. economy may be the strongest among the fully developed economies but it is head toward recession. The waning effects of the tax cuts and the fiscal stimulus of the Iraq and Afghanistan wars have carried the U.S. economy about as far as it can go. This is what declining U.S. vehicle sales are telling you.

The market still doesn't get the dollar, though. Slower U.S. growth will result in a sharply higher dollar. Look out, UBS! You got it wrong. More to follow on the dollar.

The Dollar: another piece of the puzzle

2005-03-14T15:40:00.000+01:00

It's not oil that's moving the markets. That's been such a familiar story and can be used as an explanation for just about anything. Crude has been stalled, albeit at high levels, for a few days. We saw this happening late last week when the oil and oil services stocks started to get hit.

The biggest clue to what's actually happening occurred last night: pundits are shocked that the Japanese markets and the yen went down after the release of further evidence that Japan is coming out of recession.

Here's the deal: high interest rates don't necessarily make for a strong currency. The dollar has suffered because its growth has run ahead of its trading partners. Any signs of growth here in Europe and in Asia or economic weakness in the U.S. will reverse the direction of the dollar. That's what's happening. The Euro and the Pound, among the most overvalued currencies in the history of mankind, are declining today. So is the yen. The wider interest differentials will play a part as growth accelerates abroad until the momentum players drive the dollar too high again.

We are at the beginning of a big dollar rally. It will come in fits and spurts. But it is happening- and no one believes it.

The Running of the Bulls

2005-03-11T07:49:00.000+01:00

Sell Intel, sell the Semis, sell the S&P, sell the Canadian Dollar.

How many times can Intel pull the same wool over the same eyes? Probably forever, given the fact that it has so many enablers in the game of stock market dominance. The Street consensus was for a revenue number of 9.15; Intel raised the lower end to 9.2 billion. Net result: billions of dollars of market gap are created. Sell Intel.

The semis trade because security analysts think they can call the market. They time their upgrades to what they perceive as market opportunities. I'm praying for the day that some smart journalist realizes this and blows their cover. Wait, scratch that. I'd rather continue to trade and make money.

So the S&P goes up on Intel? Ridiculous... tech hasn't led the broader averages for months. Sell the S&P.

Friends tell me that the market got long the dollar on interest rate differentials before the U.S. employment report last week. The dollar then has to go down because interest rate differentials don't trump capital flows and deficits.

But: anecdotal reports are that Canadian manufacturing is suffering and that the Canadian trade numbers won't be go for the Canadian Dollar. If they weren't good at 1.25, they are certainly not good at 1.20. The incremental info we have is that the currency rate is hurting an export-dependent economy. The whole trendfollowing world is long Canada. Sell the C-$ Dollar.

Back from the U.S.

2004-10-05T01:28:00.000+02:00

Well, if I had followed my own advice, I wouldn't have been able to afford the ticket back to Heathrow. Yes, the S&P did dip after I made my recommendation but I never said to cover, hence you're short a lot below the market if you listened to me.

I did sell today, though (mostly by buying calls and selling e-minis). There are three possibilities:

1) We're on the new leg of a bull market sparked by new money that's been sitting on the sidelines.

2) We're in the process of failing again at a lower high and in the early stages of a bear market.

3) We're just in the same trading range we've been in all along.

Scenario 1 means we're off to the races. Scenario 2 means we're off to the crapper. Scenario 3 means we're heading lower. All three- something happens with a cyclically low VIX.

Cheers.

It's the Semis Again

2004-09-28T20:54:00.000+02:00

What was it Santayana said again? Cypress is out with yet another warning. They were predicting an improvement in business that never materialized. I guess their slice of the economy hasn't been "gaining traction." They were early last time and will probably be followed again by others. The end of September was probably as bad as the beginning.

But the S&P 500 has bounced because "it failed on a test of the 50-day." Moving averages are not important unless we put in a lot of work at that level.

Sell the S&P 500 right here at 1111.50 in the Dec Mini.

From my weekend reading

2004-09-26T08:38:00.000+02:00

"It's a very positive outlook, with benign inflation, a pickup in growth and a continuation of productivity gains,'' said Gary Rolle, who oversees $20 billion as president of Transamerica Investment Management LLC in Los Angeles. ``It's an ideal predicted environment for equities.'' (Bloomberg)

The S&P 500 shed 1.6 percent in the week to 1110.11, erasing its gain for the year. The Dow Jones Industrial Average fell for a second straight week, shedding 2.3 percent to 10,047.24. The Nasdaq declined 1.6 percent since last Friday to 1879.48, for its first weekly drop in three. (Bloomberg)

"Oil hitting new highs like it's been doing is not good for earnings down the road,'' said Jon Erdner, president of ITS Asset Management LP, which oversees $300 million in Washington, Pennsylvania. ``These factors have caused investors to pull back from the market.'' (Bloomberg)

Consumer-products companies were the benchmark's worst performers after Colgate-Palmolive Co., the world's largest toothpaste maker, said second-half profit will miss analysts' estimates. (Bloomberg)

It's a very positive outlook but stocks are flat for the year. Oil is driving up oil service stocks; consumer-product companies have their own problems. (Popper)

Right two days in a row? I better go home

2004-09-24T18:23:00.000+02:00

No, I'm not selling the Semis. Yes, they did instantaneously conform to my forecast. Checking with the authorities that be, though, there has been no unusual activity on my blog. Today we saw the normal amount of hits although there has been an increase in e-mailing posts. We can't see who's doing it, just that it was done. For all I know, I have only one reader who accesses the same post dozens of times a day. Maybe a toddler somewhere with limited point-and-click skills.

We're still right in the middle of the trading envelope in the Semis. Lots of room to go down.

The time to buy is when the explanation hits the tape. The rumor is there was a negative call on PCs by the Gartner Group but no confirmation as yet. Maybe it was just the bad weather; it's everybody else's excuse.

That's it for the week. I'll be in and out of the office next week: meetings all over the Continent. If I think of anything intelligent to write, you'll read it here. As a matter of fact, you'll likely read some not-so-intelligent stuff as well.
Cheers!

Oh, the Semis

2004-09-24T10:39:00.000+02:00

I just love TheStreet.com and CBS Marketwatch. If you want to know what's already happened, read their "forecasts." Here's how it works. Take the last move in a particular market or sector. If it was up, go to your box and find the contact information for a long-only manager in that sector. He or she will be glad to tell you why the market is severely undervalued. If it was down, go to your card box and find a hedge fund. He or she will be glad to tell you why this is only the beginning. Then you "forecast" the correction of the major trend which has already happened.

So we saw in the Semis yesterday. One of their young,sincere columnists collected the wisdom of long technology investors which basically reduced to this: when a market's down alot, you should buy it. That's pretty deep. The promulagation of wisdom like this is why I have continued to make money trading over three decades on this horribly confining little island.

The problem with hanging one's hat on such sparse, biased analysis is that when more solid evidence of a problem in the sector, the kind of problem that started the market down in the first place, crops up where does one go? If the market continues to bounce on bad news, then perhaps we do have an oversold situation. But buying just because it's down? That's like scaling Mt. Everest just because it's there.

Of course an OBE said just that, didn't he? Cheers!

OK, I got lucky

2004-09-23T23:13:00.001+02:00

Yes, for once I was right. And thanks for noticing! Usually us bloggers only get e-mail when we're wrong.I did in fact call the market almost exactly for the UK close. And yes, I'm still bearish.

You want to know why so I'll say it again. Equity values are dependent on two factors: earnings and the rate at which they are discounted. Security analysts (I used to be one many years ago) are assymetrically compensated. A good forecast doesn't get them paid any more but a bad one can threaten one's job (particularly if it comes frequently). The kick in the rear hurts more than the pat on the back feels good. They recoil from their last error, these unfortunate lagging indicators do. If they were fooled by optimist guidance and earnings come in well below their estimates, they lowball it next time around. If earnings came in well above forecasts... (you get the picture).

Because they were surprised last time around, they have been slow to lower estimates even as companies guide the Street lower. The result: bottom-up forecasts of aggregate earnings have been slow to come down. They do certainly not reflect many companies' own gathering pessimism.

RESULT: Earnings growth deceleration is bad for stocks.

Interest rates are going higher. Analysts are slowly coming to the conclusion that constantly forecasting changes in the trend is a fool's enterprise.

RESULT: Lower earnings discounted at greater rates.

So while the rest of my building sleeps in cloudy old Knightsbridge, I'm prowling the bear's den unable to hibernate in the cold of a declining market.

One day does not a bear market make

2004-09-23T15:22:00.000+02:00

In the trading channel in which the U.S. equity market has been mired since it high above SPX 1150 earlier this year, we have seen a series of lower highs and lower lows. While I have a difficult time accomodating any notion of causality linking graphical patterns and investor behaviour, I do find technical descriptions of market action richly descriptive of current events. We have been oscillating between two poles, both of which are slowly sinking. Each time we fall, the bulls require lower prices before stepping in to send the market upward. Each time we rise, the bears require lower prices before stepping in to stop the rally. It happened early in the year above 1150; in mid year in the 1140s; this week (if the pattern holds) in the 1130s.

I must note my jobber friend Colin's observation that the ebbs and flows recently have coincided with those of the Mr. Bush's reelection campaign. Though we have a visceral hatred of the U.S. President here in London (despite Mrs. Thatcher's legacy, we're still Socialists at heart with a natural disposition toward appeasement), the market in the U.S. fears Kerry (the end of favourable tax treatment for dividends, capital gains, etc.). I believe I wrote in this space (if I didn't, I should have) that Mr. Bush probably peaked in the week following the convention. It had to get tighter. All human behaviour operates like the market with pendulum swings to and fro. It is the nature of the beast.

This afternoon in NY: a slight bounce brings out willing sellers just above yesterday's close and we trade to 1108 by London close.

I'm biting my tongue

2004-09-22T16:26:00.000+02:00

It's hard trying not to spew a mess of bearish vitriol this afternoon since I have been bearish the entire time we've been trading between 1110 and 1130. I even contained myself yesterday when talking heads (to be distinguished from thinking heads) invented rationales for the post-Fed short covering that took us back to the top of the range.

But I do have a view. What could the Fed have said but that the economy is gaining traction? There was nothing new in yesterday's release that we didn't hear from Mr. Greenspan on his last jaunt to Capital Hill just days ago. Here you are in the middle of an election campaign. The papers over here have repeatedly mentioned the conventional wisdom that Greenspan may have helped Bush Sr. lose his bid for reelection. He doesn't want to end his career with another accusation that he failed Party, country, and ideology (the man is, as the Guardian has noted, a loyal Republican).

Is it? The only evidence has been the last employment report which was, as we noted after its release, mostly seasonal adjustments. We are moving into earnings season with most analysts still reluctant to lower forecasts. The top down number is much more bullish than the bottom up analysis.

Some smart people do think the market is undervalued. Most of them are long-only managers, though. I prefer the reasoned views of the three Ts (Tom, Tobias, and Tony).

Seasonal patterns before a weak earnings season- lower.

Welcome me back

2004-09-21T21:15:00.000+02:00

I've been ailing a bit for the best week and haven't had the strength to venture from my flat to the office or even from my bed to the computer. Thank you for the many posts asking for me! I'll try to get back into the swing of posting now that I'm feeling a smidgin better.

A good chum tells me that the natural tendency of stocks is to rise unless they're falling. Now this is presumably something very wise since he claims to have heard it from the venerable Sir John Templeton, known everywhere but Omaha as the greatest investor who ever lived.

It must mean something. I've tried to make sense out of this oracular pronouncement without much success. About all this puny mind could come up with at first is that most participants in the market play from the long side. That doesn't make much sense to me, since the leverage in derivatives allows other participants with much less in aggregate funds but much more risk appetite per pound to sell the market in equal measure. Yes, most investors don't lend their shares and they don't go short either. But their brokers do and derivatives allow those who don't have commodities to short them with impunity.

Maybe all good Sir John is saying is that stock prices, like all prices except for skilled labor in this man's economy, have a natural tendency to rise. The way up is the natural direction unless countervailing forces are present.

Or maybe he never said it in the first place.

Misses bigger than a mile

2004-09-15T17:38:00.000+02:00

So what do we know this week that we didn't know last week? We know that Xilinx (they make programmable circuits) is having an awful quarter. We know Celestica (electronics manufacturer) is having an awful quarter. We know business inventories were up for the more than expected in July. We know last week's downgrades in Coke were more than justified. They'll have a terrible quarter. All bad.

We know Best Buy came in a penny ahead than analysts' expectations. We know Oracle came in with revenues as expected and a penny ahead in earnings. We know the Empire Survey of Mfg was stronger than expected but still just a weak bounce from an awful August. All okay to a little good.

Meanwhile, the semis opened the day about 11% and change higher than they were a week ago.

What do you think we should do?

Sorry, Mr. Hulbert

2004-09-14T16:06:00.000+02:00

A friend forwarded me a piece on the VIX by Mark Hulbert on CBS Marketwatch. He writes: "There's just one problem [with the bearish argument on a low VIX]. Low VIX readings have not reliably been followed by below-average market returns." He amasses a lot of data back to 1996 to make his case.

There have been major changes in the options world over the past few years. We have many more sellers of naked puts among hedge funds as interest rates have declined and spreads have contracted. Over the past year or so, the VIX has been an excellent indicator, even on the bearish side. UBS reports that every time there has been a new low in the VIX this year, the market has traded down 3-4% over the next 20 or so sessions.

But why am I sharing this? Better to just buy cheap protection on the equity market in October and November S&Ps.

While we wait for the U.S. to open

2004-09-14T14:52:00.000+02:00

I usually enjoy the afternoon lull in Europe while we await the arrival of the U.S. traders. The handoff to them is often quite revealing. You can see it in the S&P 500 Minis as activity begins to pick up after lunch (the early hedge fund guys positioning ahead of numbers and the open). The lull, though, is what I savor. It's an opportunity to put together my thoughts for the rest of the day. The U.S. is clearly the engine that drives the markets.

It's also the engine that drives the global economy. We saw that in the ZEW figures this morning out of Germany. We saw it last week in the Japanese numbers. The "slow patch" in the U.S. (which is broadening like the bald patch on the top of my colleagues' heads) has affected the rest of the world. China and India are on their own growth paths. They are not yet large enough to offset weakness across the Atlantic.

The Beige Book made it clear that the U.S. economy has suffered more than just a hiccup (how many metaphors can I sneak into one post?). Meanwhile, the market got ahead of itself, having discounted U.S. weakness too quickly and too steeply.

Now we've bounced back with all kinds of theories about why. All I see is that I can sell the S&P 500 7% higher than I could a month ago with all kinds of incremental weak information. I don't see any move through the highs of early January.

When a market sector like the Semiconductors gives a string of negative reports such as the ones we've seen, a three-day bounce from terribly oversold levels doesn't make me want to go long. I think yesterday was the top. The market action in the afternoon even before LSI was weak as we retreated from highs.

In retrospect, perhaps all the semis did was rally from the bottom of their trading envelope to test the fifty-day moving average and fail. This is technical talk for recovering from oversold levels to trend and then beginning a more orderly descent. That's my view. Please don't take it personally.

Preannounce bad news and rally? Not this time!

2004-09-13T22:03:00.000+02:00

Finally, a semiconductor stock preannounced a large rollback in its revenue forecast and (surprise, surprise!) traded down. LSI just preannounced a 15% cut in their revenues (based on the midpoint of their forecasted range). The stock is down 7% on the first move. The first rational reaction in the semis since before TXN. Is this the turn? Is short-covering over?

Maybe. I'm always encouraged when pundits offer an explanation for behaviour they never anticipated. Today it was 2005- investors have written off this year's remaining earnings and they're focusing on 2005 now. I'm bearish because I'm focusing on the next quarter's earnings announcements, something I know is coming. I must be terribly foolish.

What's happening outside of U.S. equities?

2004-09-13T15:11:00.000+02:00

Market participants are always looking to climb on a long-term trend just beginning to unfold. We all want the easy opportunity where prices have a fundamental reason to go just one way and they never go against us enough to shake us out of our positions.

It rarely happens. There are too many of us looking for those opportunities. We all pile into oil and then it falls. It may be going up long term but we can't stand the pain of an 8 dollar drop so we're shaken out.

The same thing has happened in Silver. There are lots of reasons to be bullish on the metals. There is, of course, the fundamentally weak position of the U.S. dollar vis-a-vis capital flows and trade. There is the industrial demand for the metal. There's India and China. Silver was in a uptrend from early May. It stalled, though, and then corrected on September 7th. Last week, speculators started to liquidate (see the CFTC Commitment Reports).

The fundamentals haven't changed. The weaker players who don't have a long-term commitment to the metals market, the flies attracted to the stench of a aging trend, have buzzed away. They are looking for another trend.

One needs a longer term fundamental perspective informed by shorter term technicals. The balance between the two is difficult. The rewards are too great not to try.

The U.S. Dollar has been consolidating against the Yen for almost a month. Realized volatility is negligible, leading many to sell option volatility. This period of consolidation is about as long as we see in the short run. Expect a move in the US Dollar/JPY in either direction soon. I suspect marginally up for the Dollar but I don't have a strong feeling.

Recapping the week

2004-09-10T21:53:00.000+02:00

Even though it's Friday and trading was rather light the entire week, there may be some accessible content in the breakdown of index movers. The defensive stocks are the ones that underperformed this week, e.g., pharmaceuticals, brewers and wine, tires and rubber, soft drinks, REITS, and healthcare distributors. The strength was in electronic equipment mfg, semiconductors, semiconductor equipment, office electronics, communications equipment, application software, and internet software. Message: investors have decided to take more risk since it returned. Yes, volume was light and some of the best performers have been in a steep downtrend. The beginning of something big? I don't think so but I must point out the elements of the rally that do not support my bearish message.

So am I wrong on the Semis?

2004-09-10T16:56:00.000+02:00

Some hedge fund blokes have checked in with comments that border on the mean-spirited. While I've been advising caution, the Semis have bounced significantly. Won't I even consider the possibility that my bearishness here is misplaced?

I always try to be objective. Three sessions ago, SMH was at the bottom of its trading envelope (if you're a Bloomberg screen jockey, put up the index with the function TE; you can run Bollinger bands on other technical systems and see the same effect). Yes, following the INTC announcement, the index was below its envelope. It almost always has a significant bounce when so oversold.

This is the second day of the bounce. Does it reflect a changed environment? I don't think so; to me, it's just an oversold market recovering a bit before resuming its downward move. It's did this in May, June, the end of July, the middle of August, and now at the beginning of September. Meanwhile, it's moved from the end of May from 39 bucks to about 30.

Am I a perma-Bear or just objective? I can't always make the short-term call. In fact, I usually don't have a clear idea where things are going in the next 24-48 hours (I'm better on 24 minutes than 24 hours but better again on 24 days).

So: I admit to having underestimated the bounce but am unshaken in the belief that TXN's CEO can't turn the market on an optimistic conference call. Value will out.

Let's look inside the U.S. PPI

2004-09-10T15:02:00.000+02:00

I'm trying to find reasons to join the party. It's a lot easier to get through the day when you're not frustrated by the market. Like my friends on the Left Coast in the States, I'd also like to be laid back, mellow,and unflappable.

So I try to clap my hands with delight at the lower inflation numbers in the U.S. Then I have to spoil everything and look past the headlines and read the report. The biggest drops: down 5% in gasoline prices, down 1.2% in automobiles, and down 1.7% in computers.

Bullish? Hardly. First, gasoline. The entire bullish argument for lower gasoline prices is that the summer driving season is coming to an end. Prices won't have that much upward pressure anymore because people are driving less. Conclusion: gasoline will figure less in the consumer mix. A drop or a rise makes less of a difference once the season is over.

Second, automobiles. This is not because U.S. auto manufacturers are getting more efficient. IT'S BECAUSE THEY CAN'T SELL CARS WITHOUT HUGE INCENTIVES! Hardly bullish for GM, Ford, and Daimler Chrysler.

Third, computers. By now you get the picture. This can't be bullish for the entire chain from semiconductors to personal computer companies to software.

I'd like to sit in the corner of the bullish party and absentmindedly watch stocks trade higher, content to have my attendant wipe the drool from the corner of my mouth, but I can't. I've been cursed with the greatest prescription for unhappiness in this man's market: the predilection to think.

Follow the leader

2004-09-10T13:45:00.000+02:00

Another wonderful example of how the U.S. ebbs and we flow: this morning Europe has been bidding up the semiconductor stocks that principally trade here to catch up with the relief rally in NSM and TXN yesterday in N.Y. Meanwhile, the tidal flow of negative warnings from semiconductor companies in the U.S. continue. The U.S. houses are telling their clients to sell into strength. I'll bet more than a few quid that the semiconductors will trade lower in the U.S. this afternoon and we'll be catching up again Monday.

It's another way we finance the capital accounts in the U.S. We sell low, they sell high. We buy high, they sell low. One way to make money in the markets is to learn to ride the waves that start out on the other side of the Atlantic and crash naive investors on the rocks around this forsaken island.

In the still of the night

2004-09-10T02:36:00.000+02:00

It's early Friday morning and the jobbers are all safely tucked in their beds. I've gotten up to dial into Bloomberg from home and check the Asian markets. Surprise: global growth is slowing! Japan's GDP was supposed to be 3.4% (at least that was the median forecast of the herd of economists who log estimates in Bloomberg's survey). The actual number: 1.3%.

Now stop me if you've heard this one but does the succession of disappointing news never end? Market strategists (that means shills for long-only managers who devise outlooks that match the last big move in the market) have a never-ending succession of explanations why this is all good for the market. A character from State Street gets the award for the most creative. In an interview with Bloomberg yesterday afternoon, he argued that weak economic growth is a plus for stocks because it will eventually lead Greenspan to slow the pace of interest rate increases. That's rich. Heretofore this frequent CNBC guest argued that interest rate hikes were too small to derail the bull market. Now that they may turn out to be even smaller, they'll help the market. Must have been a psychology major at University.

Just as crude oil demand didn't dry up overnight, the tech debacle didn't end yesterday. The market made a new weekly low and a lower weekly high. We're running out of excuses for bad economic data. The end is near! If the market doesn't trade down soon, look for me in Hyde Park. You know where. I'll be preaching the apocalypse.

Everybody blames the hedge funds

2004-09-09T20:20:00.000+02:00

We did our own informal survey of hedge fund managers we know. Assuming their positions (if any) reflect their views, a large segment of the hedge fund world went into the day short crude oil. This doesn't include the long-term structural players who follow energy carefully and consistently (the three I know are all long). I'm referring to the let's-find-something-hot-to-trade crowd: to a man (and woman), they are short crude. These are headline traders who need a Yukos or an Iraq or an OPEC story to turn them own. They get in for a few days and then they're out.

Meanwhile, crude is up almost $2 as I write this. A big part of the S&P's small gain today can be attributed to the oil service stocks which are having a big day (up 1.9%). Add to this the 1% gain in the Nasdaq bolstered by a relief rally in TXN (up 10%) and the Semis in general (up nearly 5%) and the 1% decline in Walmart is buried in the aggregates.

I can't take the one-day pop in tech seriously- show me more. In a consumer driven economy, the long-term picture revolves around consumer spending (slowing) and interest rates (still rising). Tech was overdone to the downside. It's still hardly in a rally but we're watching.

The whole thing looks like trader rotation- we'll move from industrials to retail to tech (just looking for something to buy). I'm still bearish.

It's starting...

2004-09-09T10:23:00.000+02:00

Markets usually do not turn on a dime (excuse the Americanism please). Because of the herd-following instinct that creates momentum, only major cataclysmic events have the force required to send things abruptly in the other direction. Normally, though, prices must slow and consolidate.

In an up move like the one we've had since Bush started to bounce in the polls in mid-August, U.S. equities have to stop and consolidate first, as they've done in the past several hours. To turn they have to stop making new highs (they have). Then the smallbreaks have to get deeper and deeper (they are) as buyers of the breaks get less enthusiastic (they have).

The next step is a bigger break and a smaller bounce. We need to make a new low today and subsequently bounce well below the previous high.

The dollar correction is probably over. Just as the Semis are my alpha-indicator of upcoming beta moves, silver is my leading indicator on the dollar. The decline appears over. I expect a 20 cent rally in U.S. terms to 6.45 today as markets set up for the U.S. trade numbers.

As Greenspan speaks...

2004-09-08T17:53:00.000+02:00

On our side of the pond, we have a tendency to take central bankers much more seriously than our U.S. counterparts. We forget that the U.S. economy is far less centralized than others. The Fed chairman has no more access to information than private economists (in fact they have, as a group, considerably more resources than a government agency).

Greenspan's economic forecast is therefore just one of many. It is only more important insofar as it indicates potential FOMC policy. When the equity market rallies because Greenspan sees the weakness as temporary, they are according his forecast more weight than others. The only solid information one can glean from Greenspan's testimony is a) how he spins the economic numbers; b) and what that means for future rate movements.

I would argue that Greenspan is actually less reliable as a forecaster than many others because he must weigh the political impact of his observations. He certainly doesn't want to end his Fed tenure by helping to unseat an incumbent Republican president. The conventional wisdom in Washington circles is that the Fed hurt Bush Sr. in the months before his loss to Clinton.

The incremental information from Greenspan thus far: the rate hikes will continue. This is not a positive for equities.

Welcome back, NY

2004-09-07T15:30:00.000+02:00

As you open the market this morning, you discover that we've brought the market back to where it was before the Intel update. Since we last sat at these levels, we've gotten the first set of downgrades of the chip sector, a tepid U.S. employment report, and entered the warning season (that lovely autumnal period when guidance like the leaves on the trees spirals downwards).

While NY sleeps

2004-09-06T13:14:00.000+02:00

I've been listening to the long-only managers talking up the U.S. market on Bloomberg TV. Here's the burden of their refrain: as soon as the election picture becomes clearer, investors will step up and buy stocks. The market is cheap because investors know that rates are rising, earnings growth is slowing, and pipeline inflation has reared its head. All this is already priced in.

So: the negatives are all priced in and the coming positive isn't. Might it not be that the bounce from 1060 to 1120 in the S&P was investors noting the surge in the Republican numbers in the polls? There has not be an incumbent president this far ahead at Labor Day who has lost an election (it might still happen but we're talking about markets and their tendency to value probabilistically).

My view is otherwise (as readers of this space know). Tech is still not cheap. We are in the process of correcting the overvaluation of tech that occurred during the bubble. Intel is just the beginning.

Tech has been the alpha generator in the market. Right now, the market is being held up by energy stocks (not your classic leaders of a bull market) and financials discounting continued sluggish growth. The seasonal flows are difficult here. We've already bounced and there doesn't appear to me to be a catalyst for taking out the triple top at 1150. COnclusion: down.

Labor Day in the U.S.

2004-09-05T13:13:00.000+02:00

The U.S. does everything we do here on the Continent only to a greater degree. It is a country of extremes. In its cities, one finds great wealth only a short walk from abject poverty. Their richer are richer and their poorer are poorer than one seems to find here in London.

One of the things they do is work harder (and it's not just compared to the Gallic variety of Europeans). This is because they are largely free of the scourge of socialism. It is also the main reason I never thought Kerry-Edwards had a real chance. These two fabulously wealthy men cloak themselves in the populist message of Bob Shrum, the Democratic strategist who has been responsible for every losing Democratic national campaign in recent memory. The Old Democrats like Dukakis and Gore campaigned on class war and lost. Americans mostly believe that anyone (or at least anyone's grandchildren) can become wealthy and recoil from the "let's-soak-the-rich" mantra the wooden Kerry and fancy pants trial lawyer Edwards use to garner support among their unthinking left-wing base.

The only Democrat who rejected Shrum and the politics of hate-the-successful was Bill Clinton. He made his message economic prosperity for everyone. Gore doomed himself to failure when he sat with Larry King on CNN during the vote for the Clinton tax package and uttered his only defense of higher taxes: "But it will hurt the rich more, Larry." Bob Shrum, you belong in Europe with its chronically low growth rates and lagging productivity. We love your politics. It allows us to remain self-righteous about our moral superiority while the quality of our citizens' lives continues to lags behind those of their American cousins.

Inside the U.S. Employment Report

2004-09-03T19:52:00.000+02:00

Sitting in the pub with a group of mates and the collected wisdom of our favorite economists, here's what we see:

1. The headline numbers read well for Mr. Bush and that's bullish if you buy into the tax on dividends argument. A minor plus for the market.

2. The drop in the unemployment is entirely due to 150K or so people dropping out of the workforce, at least according to the by-now discredited household survey. The percentage of the population working actual dropped.

3. The jobs created were almost entirely due to favorable seasonal adjustments.

This is more of a Big Bad Wolf than a Goldilocks number: strong enough to justify another rate hike, weak enough to raise concerns about continued weakness.

Conclusion: sell S&P's now and avoid the rush.

So Why are the Futures Higher?

2004-09-03T15:13:00.000+02:00

OK, stop e-mailing me! I heard you. Yes, the futures are higher. Here's the bullish argument: the RNC Convention is over in NY with no stumbles for Bush and no terrorism in the U.S.; the Olympics also ended without incident; the economy isn't falling off a cliff; the macro environment looks okay.

Hold on! The two most direct factors in the valuation of equities are earnings and the interest rate at which they are discounted. Prices go down when the numerator (earnings) gets smaller or the denominator (rates) gets bigger. It's a double whammy for equilibrium valuations: earnings growth decelerating and rates going higher. The market had forecast much stronger earnings growth. That isn't in the cards anymore. Sell.

The Obvious and the Not-So-Obvious

2004-09-03T14:45:00.000+02:00

Two easy conclusions from this afternoon's U.S. Employment Report:

1) the Federal Reserve will definitely raise rates in September and probably in November.

2) John Kerry is in trouble. He tied his wagon to the U.S. economy and it led him down the primrose path.

Two less obvious conclusions:

1) the U.S. stock market has no where to go but down. This morning when we opened we were perched at a tipping point: if the numbers were very weak, we were going down hard. The Intel conference call in the middle of the night provided an abysmal picture of tech earnings for the next quarter. Tech is the bellwether alpha generator in the U.S. equity market. The futures may be climbing back in Chicago this afternoon but wait until the cash market opens and the non-macro non-hedge fund players have to decide what to do with their tech stocks. All we did yesterday was get back to unchanged in the S&P 500 for the year. It's what Jim Cramer calls forgiveness time. If you watched your portfolio deteriorate since late spring and now you can get out, take advantage of this zone of mistake above 1110 in the S&P: cut and run!

2) the U.S. bond market has run ahead of itself. The Benny Hill trade allowed some relief. Bonds are probably okay here for the near future.

A technical observation courtesy of JP Morgan: the seasonal adjustments in August turn zero gain into 100,000 so the number ain't that strong. The bonds will wake up first and climb back to 4:18. The equities will follow later. The foreign exchange jobbers will be the last to wake up (the FX market still reacts to minor changes in the unemployment rate which are largely due to rounding).

The Benny Hill Trade

2004-09-02T21:35:00.000+02:00

Let's put all the moving parts together: weak economic data today so no reason to sell bonds or buy equities. Tomorrow is the grande dame of monthly economic reports, the U.S. Employment data. The U.S. 10-year has been sold down by 22 thirty-seconds and the S&P 500 is up about 1%. Conclusion: Benny Hill's in the market again, spec-ing on a strong employment tomorrow in the only way he knows how, the old Goldman asset allocation trade. With the S&P near technical pressure points, why not sell bonds and buy stocks to see if you can drive it through?
Cheerio, Benny! Nicely done. But what happens if the numbers don't suit tomorrow?

Focus on the big picture

2004-09-02T15:31:00.000+02:00

As traders lurch from big idea to big idea, investors might do better to focus on the big picture:

1) Energy prices are in an uptrend. The sustained upward movement we saw in crude oil does not end in a single week. Trending markets in commodities often get ahead of themselves as hobbyists enter the market attracted by news stories and telly talk. I've noted in the past the effect of contract expirations and the need to settle accounts as the catalyst for profit-taking in commodities that trade at a backwardation. The expiration of the September contract in New York forced some liquidation of longs and that snowballed as the dabblers saw paper profits turn to signficant losses. The shakeout now appears to be over. Whether we go through $50 now or later, the price of crude is in a uptrend.

2) More signs of a slowing economy appear daily. Meanwhile, the Federal Reserve has painted itself into a corner; if it deviates from its schedule of measured rate increases, it sends a signal in the last 50 days of a presidential campaign.

3) There is no more low hanging fruit for U.S. corporations. Productivity is slowing and the earnings comparisons get more difficult from this point onward.

The big picture: anemic to negative market returns as far as this eye can see.

More of the Same

2004-09-01T16:41:00.000+02:00

Today's ISM report offers the same lukewarm porridge served up by the Chicago crowd: slowing sales, rising prices for raw materials, gains in inventories. So why is the U.S. market back to the August highs? There is still an argument to be made for a slowly rising stock market and it seems to go like this: we got past the Olympics without incident, the Republican Convention in NY looks like it will not only come off without a hitch but give President Bush a boost in the polls, Kerry looks like a deer in the headlights (an American expression I particularly favour- Brits, read fox instead), and the bounce from August lows looks real.
I don't buy it but I won't fight the tape. If long, lighten up.

Now the Bears Can Get Excited

2004-08-31T16:05:00.000+02:00

Could there have been a worse combination of factors in the Chicago Purchasing Managers report moments ago? More than the larger than expected drop in the headline Business Barometer, look at the breakdown: Prices paid surged to 86.6 from 77.6; it's now at the highest point of this year. Pricing power for corporations? I don't think so- New orders were just about the lowest level of the year. These numbers bring us back to the lethal combination of two months ago. The June report offered the same frightening picture of a weakening economy no longer boosted by tax rebates. Right now, the oil companies are helping to hold the broader index but look out below.

Lest the Bears Get Too Excited

2004-08-31T00:50:00.000+02:00

Why is today's decline in the U.S. equity indices more significant than the last two weeks of rally? Answer: it may not be. While I strongly believe that we have been in a downtrend since February, Monday's decline came on low volume just like most of the up move since mid-August. Market success demands objectivity; let's not call a spade a diamond.

While market forecasts can only be proven right post facto, I do think there are reasons to ascribe greater significance to today's decline than a one-day countertrend correction. First, the overall trend remains down. We remain way below the double top in the mid 1100's and the tech indices are all significantly below trend.

Second, the S&P 500, with the disproportionate weighting it gives financials, can obscure short-term shifts in the market price of specific risk. I find the tech stocks, in particular the Semiconductor Index (SMH), have led the market up and down. Price patterns for the Semis are much easier to read, in my opinion. This bear was impressed by how the Semis ran ahead of the general market most of Monday's session. It was only very near the close that we saw any divergence: the Semis had a slight bounce while the S&P made new lows. One important signal that the recovery in mid-August had the potential to be more than a two-day phenomenon was the fact that tech (and the Semis) generally led the market higher. One important signal that the broader rally was stalling last week was the crack in the Semis and tech in general. Today's action in the Semis (albeit on a light volume day) puts the broader market in lockstep with its leading sector.

Third, later moves are always more significant than earlier ones. Since they incorporate information generated by earlier price action, today's selling is potentially more revealing than it might have been earlier in August.

Fourth, it comes after the market rallied to its trend (for me the neighborhood of the 50- and 200-day moving averages). We have alleviated an oversold condition and can now move lower.

Nevertheless, making money is never easy. One must respect a two-week rally that lifts the S&P 500 3.75%. That's impressive, even on anemic volume. I remain bearish but watchful.

What Must Steve Ballmer Be Thinking?

2004-08-30T16:06:00.000+02:00

When Microsoft announced its higher dividend, one-time bonanza, and stock buyback, the S&P was just about where it is today. The closing price before the announcement was $28.32. The S&P 500 is about 30 basis points lower today; Microsoft shares are changing hands about 3.7% lower.

This must be astounding to the folks in Redmond, Washington. It has to be even more surprising to viewers of CNBC Europe and Bloomberg TV who were treated to a endless parade of smug Microsoft holders trumpeting the stock. One portfolio manager: "These shares are effectively guaranteed to rise." The CNBC Effect?

Markets are forward looking. Whenever one is tempted to follow the crowd, rest assured that the cliff is only metres away.

The NY Times Effect

2004-08-30T12:09:00.000+02:00

When I traded foreign fixed interest for an American money centre bank, I became aware of a phenomenon I call the NY Times Effect. Whenever a major move is underway in the financial markets, the NY Times eventually catches up with it. When they are certain it is a real story and not just market noise, they begin to pay notice. At first, the coverage is tentative- a mention here or there in the daily wrap-up. As the move becomes more pronounced, it begins to show up in the Business section headlines. Eventually, when they are certain it is a major story, they do a front page piece, either at the top of the Business section or even in the A Section.

This is usually the kiss of death. By the time the venerable paper's editorial committees have decided it's a real story, it's already happened. The NY Times reports market history; it never helps make it.

The tell-tale sign that the NY Times has entered the final phase of market coverage is the prominent highlight of a price objective. Notable examples: the Japanese Yen below 80.00, Sterling/Dollar parity, the Dow at 5000.

Only worse than the NY Times is Time Magazine. Any favorable mention of one of my positions in Time Magazine and I'm out faster than Abby Joseph Cohen can say "Buy" on a Goldman conference call.

There are subtleties to playing the NY Times Effect. At the first mention of a definite price objective, e.g., $50 crude, cut positions. After the ensuing sharp correction (NY Times readers throwing in the towel), buy for the next leg. Keep an eye on the NY Times, though. If the move is sharp enough, the staffer assigned to the story might give it another go.

The NY Times is retail. Their readers are the proverbial doctors and dentists who feed the Street.

Last weekend, the NYT indicator was flashing "Sell" for crude. The ensuing 8% drop has shaken out the hobbyists. The next move up has probably already started.

Hey, Beachcombers!

2004-08-29T21:20:00.000+02:00

Perhaps you were in the South of France or on the Isle of Wight or in the Hamptons when last week's revision of the U.S. QII GDP report was released. If you read the headlines on the major market news services, it was a total snoozer. Wrong: there was an incredibly important piece of data for the international equity markets below the radar of most headline-focused traders: the rate of growth in quarterly earnings has dropped precipitously.

My flavour of the month in economists is the group at Goldman Sachs whom I read religiously (to read religiously means to read regularly, pretend to follow, and guiltily ignore). They were warning last week that the growth rate would slow sharply from 32% to about 24%. Here's the actual number: 16% and change, i.e., a 50% drop.

Here's why I think this is more than a little significant: Goldman's stature as a firm and deep penetration of the institutional investor market gives their research the status of conventional wisdom among a certain body of large investors. Others get Goldman's research distilled through the smaller banks that liberally borrow from this giant (remember the lack of originality and courage in the financial community, not to mention its highly challenged ethical sensibility). I think it's safe to say that the consensus view was for a much milder fall in corporate earnings.

We now have incremental new information that the drop was much greater than previously thought. The numerator in the earnings per share number will likely grow much less than market participants in aggregate had assumed. Ceteris paribus, stock prices must be lower.

The Incoherence of Markets

2004-08-27T17:13:00.000+02:00

Investors are wont to speak of "The Market" as if there is a single commodity that we all buy and sell. We find this comforting for at least two reasons. First, it makes the task of understanding the incomprehensible multitude of individual markets appear simpler by reducing it all to a single phenomenon. Second, it allows us to foist the burden of our fallibility onto a single third party, a leviathan called "The Market" which, like God, giveth and taketh away. This rhetorical apostrophe lets us forget that our losses are others' gains; no other human has bested us. When we lose, it's because a towering monster has illogically preyed upon us. We are passive victims rather than the active perpetrators of crimes against our own financial being.

In fact, there is not a single market but many markets. Over thirty years as a trader, investor, and manager of institutional portfolios and balance sheets, I have learned to read the messages these markets convey through the best and only true mechanism of information, price. It is the intersection of supply and demand, the only true barometer of the collective will of bulls and bears.

This is not to say that there isn't important information to be gained from fundamental analysis of the economy and companies. I remain, however, a mild skeptic about the former and a confirmed agnostic about the latter. Most of my observations will likely first centre on price movements and their dynamics. Only then do I consider fundamental information if at all.

Why this skepticism about economic and other fundamental data? Most economic releases are subject to broad revision. By the time we see a final number, the information is old. It can be very powerful when it differs from the general consensus of short-term players but this is usually not the case.

Earnings data is too subject to manipulation by those who are compensated for good numbers. I haven't been able to wean myself from the intoxicating vibration of after-hours trading when major earnings releases hit the tape. I sit glued to my computers like any screen jockey on a dealer desk. This is an unbreakable habit created by two decades of riding the waves. In the last ten years, though, I've learned to control the impulse to climb on my own board. Nevertheless, I can't stop watching lest I miss important information (which almost never comes).

Why price movement instead of price itself? There is no absolute price for any security or commodity in the entire world that can be defended on the basis of supply and demand alone. The twin towers of fear and greed inject emotional premia into prices that greatly impact them for indeterminate periods of time. Just try and put a number on twenty years of inflationary expectations and tell me what a long-term gilt-edged security is actually worth.

I focus rather on incremental movements in price, assuming that the last close for whatever relevant period represents the marginal equilibrium of buyers and sellers. What I want to understand over whatever period I am watching is how prices moved from the last stopping point.

Therein lies the opportunity. Because there are so many markets, price movements in each of them are subject to whatever micro factors have affected its principal buyers and sellers. While all markets are ultimately interrelated through a daisy chain of common participants, the principal participants in each determine short-term price movement. When price movements convey inconsistent messages, the disconnect is significant, highly revealing, and often tradeable.

At this juncture in these laziest days of the market year, we have one major disconnect in the financial markets that leaps out from my screens. Fixed interest securities in the United States have been in a dizzying rally while U.S. equity indices have bounced hard from their mid-August yearly lows. This is incoherence at its best. The message of the former is that June-July weakness in the U.S. economy is not the pause that refreshes; the message of the latter is that it is. One of these two is moving in the wrong direction.

I put my money on the bond market where the connection to macroeconomic factors is much cleaner (I started as a bond trader and have great respect for the institutional clients from whom I earned pence while they collected pounds). Over the past week and a half (only after the stock market had already bounced), I've watched the long only talking heads on cable television in the U.S. and Europe trumpet the post-election rally that they believe has already started (Jim Cramer being the notable exception). Meanwhile, volume is more than anemic; my hedge fund friends who usually get the direction right but are always early have been throwing in the towel and covering shorts. At the same time, they are selling huge amounts of puts on the various indices naked in order to generate some return in a moribund environment.

A close friend who invests in a long volatility fund with downside protection for equities tells me that even his most stalwart fellow investors are beginning to question whether protection is worth the slight drag on returns. This is the sign of a market top. If the bond markets are right about the economy, then this low volume recovery is the deadcat bounce that either will or has already cleaned out the shorts and stocks in the U.S. are headed much lower.