Are Stocks Pricing OUT Duration of Slowdown?
A: Shorts are getting absolutely murdered on this latest rally, right at the same time bad news is being reacted to positively, and complacency slowly seeps in; the VIX is near 35 now and falling. This is not a normal stock market folks because we are bouncing from an unprecedented cliff dive, so don't interpret the euphoria that comes with a sharp bear rally to mean that any form of a V shaped recovery is at hand. That is the concern here. As stock prices rise, expectations rise with it that future growth prospects are brighter. The higher the stock price goes (forget for a moment what other forces are powering the move), the less of a value it becomes on a P/E basis - makes sense right; if AAPL stock rises from $78 to $125, would you say the stock is cheap right now after a 47% move? Depends on the future growth prospects and earnings. In my opinion, stocks are PRICING OUT THE DURATION ELEMENT of this slowdown - and that may come to hurt us later on as expectations are changed. Its the duration of this slowdown that I think will disappoint the stock market down the road.
There are real reasons why this market is rallying considering the cliff dive we came from: credit is much tighter, new home sales surged, pace of decline seems to be slowing, banks handling stress test and dilutive news positively, etc.. Its NOT the severity re-pricing that I think is wrong, rather, its the pricing out of the expected DURATION of this crisis that I think will prove wrong here.
The bottom callers on CNBC are getting their 3rd, 4th, and 5th chances to call a bottom since the equity decline began in the 4th quarter of 2007. Keep on calling it, and eventually you will be proven right. Only Mark Haines had the cahones to actually come out and call his first bottom on March 10th, with the Dow trading at 6,926. Everyone else waits for the markets to bounce 10-15% and then they say the bottom is in for fear of calling it on or near the lows.
Here are some recent news breakers and how I feel the street is interpreting it (envision a V-shaped recovery):
Citi/BAC CDS Widen on Report More Capital Needed --> No problem, its priced in. As long as this is the last round of capital raising and the government will not allow either to fail which would see common wiped out, and haircut to preferred and bondholders - no problemo!
GDP Contracts 6.1%, Worse Than Estimates --> No problem, its priced in. As long as pace of decline is slowing, inventories are being taken down, and consumers are starting to spend again, its a clear sign that the worst is behind us and future growth may in fact lie ahead. Besides, if it we don't grow that much, we can always get our government to give us another stimulus package. Consumers obviously can and will keep on spending, and that is a very good thing with no possible side effects. They will only spend more as things improve.
Bank Stress Tests Reveal 6 of 19 Banks Need More Capital --> No problem, its priced in. As long as ONLY 6 banks need capital, and this is the last feeding from the trough! The good thing is, this should be the last round of capital raising. After this, its full gears ahead! So what if rates may rise down the road and consumer credit quality is deteriorating, that won't stop us banks from churning out loans!
Commercial Crunch May Reach $1 Trillion --> No problem, its priced in. As long as it is ONLY $1Trillion, what is a few trillion amongst friends anyway!
Just to name a few. We must ask ourselves whether or not an environment of rising unemployment and deteriorating home/commercial prices will allow for a bottom in bank losses and a sustainable rise in consumer spending?
With each rally, more complacency sets in and more shorts get murdered. Shorts start out by shorting more, dollar cost averaging their positions, until they cant take it anymore and liquidate the position adding fuel to the buy side pressure. Before you know it the momentum and program trades get crowded, and forces outside of normal fundamentals start controlling the stocks markets. People scratch their heads wondering if equities have it right or wrong, hedge funds scramble to make sure they don't miss the run, and retail investors get sucked in with the hope that the economy is finally turning with growth on the horizon. Confidence is magically restored and the world is all better again only 2 months after everybody thought the world was ending! But is the world all better again? Is debt service down? Are bank balance sheets cleansed and fully capitalized?
I fear that stocks are in the process of pricing OUT the duration element of this recession - and moves are powered more by short term trading forces. What I mean is, they got the severity of the recession right by taking stocks down 57%-60% or so from peak over the course of 16 months. But now that we have rallied 30% from those lows, I fear that stocks are in the process of pricing OUT the duration of this slowdown, and instead are beginning to trade as if future growth prospects are assured. As the rally continues this sentiment grows, and so does euphoria with it - the trade is perceived as being crowded and less and less of a value discounting future growth potential - unless the growth really is there! The stock market is a discounting mechanism, nothing more, and is not always right!
Equities discounting vision was very wrong in late 2007, when credit was telling a much bleaker story, and stocks were wrong again in May 2008, when the Bear Stearns 'elimination of systemic risk' rally assured investors that the fed can & will always save the day. So, don't interpret stock rallies to mean that all is well again when they got things wrong big time twice in the last 18 months alone. I see Mish & BR talking about technical indicators of an overbought rally, but to me, it just feels like the market NEEDS to go higher right now because of the trading forces at play right now - quants, shorts, momentum traders, hedge funds getting in on the move, etc..
But did the fundamentals all of a sudden get better? Are consumer debts cleared out? Are banks all better again? And what about side effects of policy down the road? Ignoring the possible unintended consequences of policy actions taken to stem this crisis, is to believe that there are always free lunches to the tune of trillions of dollars with no side effects. The fed has seriously compromised its balance sheet by taking on riskier assets via short term credit facilities and is on a mission of printing money to buy agency MBS and treasuries right when demand might slow from private sector; the last option at their disposal to expand the money supply and keep rates as low as possible. Who knows what Pandora's box that may open later on.
In the meantime, stocks seem to be pricing in a bottom with the worst behind us - with short term and program trades ruling the field. Perhaps on the severity front, stocks may be right - the worst may be behind us. But is growth, and more importantly, sustainable growth really on the horizon? What happens to banks when good assets start turning bad? What happens when off balance sheet toxic assets and accounting tricks no longer can hide damage? What happens when fed credit facilities are removed, rates are raised, and treasury yields start to rise? How do higher borrowing costs and higher taxes as a side effect from all these steroids, affect businesses/consumers trying to increase profits and decrease debt service? State budget concerns? All those unemployed? This is why I think stocks pricing out duration are wrong!
Comments (18)
I understand that the market doesn't necessarily accurately reflect the economy, today or six months down the road. But reading the spin that the media has put on this reminds me of another time when nothing was bad, everything was good, until it was not.
I feel like I'm living in Bizarro world. If there's another major drop, morale is going to nose-dive. This is a dangerous game the market is playing.
Posted by brenda | April 29, 2009 3:23 PM
brenda - that is what I fear too. The next collapse, if/when it comes, will kill hope and confidence making the last wave down the worst.
Posted by Noah | April 29, 2009 3:30 PM
I'm still livin in the twilight zone, but at least i have a few friends who also can't understand how everything they see is being interpretted in reverse. Noah you do a great of explaining how this works. The market is not being terribly unpleasantly surprised anymore(not thet its being very pleasantly surprised either) so it goes up. That is until expectations get ahead of themselves....which I believe that they are getting to be and we corrrect again. One of the big issues to me is, are we really out of the way of fear of systemic danger, if we are the sell off from this run up will be milder and we will have a successful retest of the lows, if we even get there. If not we could yet go crashing to new lows. My guess is it will be the former. But don't forget Japan has grinded sideways....and down for years now. So even a good final bottom put in now, could be broken through in a couple of years if things stay totally moribund. What I am looking for more than anything is..... Where is growth for the USA going to come from after the rebound from deep recession?
Posted by jeff | April 29, 2009 4:16 PM
our economy clearly still has a long way to go, But as pessimistic as I've been about our economy, I really have very little idea where the market "should be". Over the last 2 years or so the SP500 has ranged from 1550+ to 650 or so. 1550 is obviously too high, is 650 too low? Should the market have settled around 800? 900? 1000?
Personally, as I've expressed in the past on this site, i believe that the market has given us an opportunity to buy select companies at prices that seem cheap to me. It's up to us to do our due diligence. I really think there are still deals to be had. I recently bought Sanofi -- hope they can keep it up.
Sectors as a whole seem to have been overreacting left and right. Back in November excellent companies in the restaurant industry such as chipotle, buffalo wild wings, and whole foods (not a restaurant i know) got absolutely crushed. I bought some of these names, and despite selling them at a profit, sold them way too early. They seem to be too pricey right now though.
I think the banks have run up too far -- but I mean are the tech names really that over priced? I know they've made a big run, but these companies have pristine balance sheets and tons of cash, but might have trouble looking forward due to a weak economy -- what PEs should companies like MSFT, CSCO, EBAY trade at and companies like RIMM, AAPL, GOOG what should they be trading at right now? They are sort of in the opposite situation as the banks, who have been handed an easy means of making money -- but who knows what in their balance sheets.
A lot of energy names seem to be reasonable risk/reward bets here despite the bursting of the commodity bubble. So is the SP500 too high? maybe... but I still think there are good companies to gobble up. (i've been writing some covered calls on some of my dividend generating stocks to help reduce my cost basis).
On a separate topic,
I might take a piece of cash to take advantage of the small arbitrage opportunity in JAVA. What do you guys think of that is it worth it? Keep in mind, this cash would otherwise be sitting in a 3% interest bearing account. I should be able to make an absolute return of 4% here -- just 3 months or so -- that's not too bad.
Posted by RegularAnon | April 29, 2009 4:20 PM
Here is a great article to pull together the issues facings banks.....which is really the whole story regarding the economy's continuing risks. I wish i had written it.
http://www.minyanville.com/articles/GS-C-citigroup-bac-CVC-aig/index/a/22445/p/2
Posted by jeff | April 29, 2009 4:42 PM
MGM was halted, rumor is an asset sale -- i'm really curious to see which property is sold and for how much.
Posted by RegularANon | April 29, 2009 4:50 PM
unemployment numbers is May 8th...if that is worse than estimates, then it may push the adverse scenario of stress test # into 'meaningless' territory and raise some nerves.
chrysler bankruptcy a test for GM? That wont spark a roll over I dont think. I wonder what the spark may be
Posted by Noah | April 29, 2009 4:54 PM
Noah ! Regards!
Quick question ...... u think its too late to short SLG ??? maybe buy some 18 $ puts..
what do u think ... i know you had mentioned that the trade was over but I think there might be some meat left in there .....??
Posted by johnny | April 29, 2009 5:49 PM
maybe buy some SRS... i know how it behaves , but at 20 $$ looks like it could at leat double one more time ????
Rgds
Posted by johnny | April 29, 2009 5:53 PM
sure, i like that trade. ease into it in case rally lasts and give yourself a few months as nobody can time when another wave may or may not.
Posted by Noah | April 29, 2009 5:54 PM
agreed.. got some today at 23 and some of " The FAZ " too!!
Posted by johnny | April 29, 2009 5:58 PM
i got some srs, mzz, eev, skf calls but slowly been nibbling for about 6-7 days now. Down like 7-10% on each position. Going to wait to see if we rally more to add. If we dont, thats fine by me. Too dangerous to have full short positions on now.
Posted by Noah | April 29, 2009 6:07 PM
Jeff - I watched with curiosity how the dollar and treasuries rallied Monday at the open on quasi-armageddon swino flew. It reminded me that the US despite all the rhetoric about the end of the world is and will continue to be the last safe harbor on the planet when push comes to shove. The reason why equities are rallying in my opinion is two-fold: (1) shorts don't see much upside at these levels and (2) you want to be a buyer when severity peaks. The bears will have to wait another two months to see if we've troughed or not but all bulls need is another month of decent PCE. IMO time to start buying commodities, emerging markets (latam in particular) and energy. RE has another two years IMO.
Posted by Fred | April 29, 2009 6:10 PM
what i havent been able to figure out is, why the over reliance on the stock market. the dow jones can be 14000, and the s&p could be 1400 again and nothing would really change the situation we are in. a bunch of (C)MBSs have yet to fail. anything that has been securitized is going to affect balance sheets for at least a couple of years. we cant really say banks have been growing until they pay back taxpayer loans, chrysler will probably declare bankruptcy any day now, GM is unlikely to fare better with or without credit infusion, and more so than ever, the idea that housing starts are finally faring better is simply over shadowed by the fact that developers owned these lands are still paying high supply prices and barely turning any profit. the point is with the media playing this OMG BOTTOM game, the consumer is only being coaxed into living beyond their means again, and pricing out duration is another way to put a mask over the consumer's eyes in light of confidence.
this reminds me, conspiracy theorist or not, but according to a friend who worked for GS in 2007, they were talking about becoming a bank holding company right around then. they all knew what was going on, and they still know there are problems, yet they continue to manipulate the market based on their market cap and share holder value.
"Where is growth for the USA going to come from after the rebound from deep recession?"
jeff it will come from green technology and infrastructure.
Posted by Azret | April 29, 2009 6:16 PM
thanks Noah .. EEV also a good one to have ... guess we keep buying as they keep making new lows and wait for the Irrationailty to end. I agree we can go higher... And Ive been watching gold weaken significantly over the time of the Stock Market rally ... there are a few forces pulling strongly in both directions in that market at the momnet but some smart people I know have mentioned that " Patience " is the key ... was long some SLG at 11 ish but got out this morning on their recent downgrade. Looking to short outright in the AM as well. Thanks again fot the digs!!
Have a gd evening
Posted by johnny | April 29, 2009 6:25 PM
I try not to let my positions(way long here) determine my bias but I see lots of upside left. I am not one to scale into positions but instead let price action determine my entry point and go all in. I think it is way too early to be buying inverse etf's. I have been scanning charts of these etf's and on the daily, weekly and monthly charts and they have no support. I have no idea when this rally will end but as a pattern day trader I will let the charts tell me when to exit my longs and go short. I could care less about "fundamentals", it's all bulls@@t. Just harken back to the internet boom. Companies went public with no prospect for earnings yet they usually were triple digits stocks by the end of the trading day of their IPO's. I love it when stocks climb a wall of worry. If you're long it just means you are in early.
Posted by cfranch | April 29, 2009 8:08 PM
cfranch - totally have to keep emotion out of it, and I agree the market NEED and FEELS like it has more room to fly here!! Everybody has there own strategies, and its impossible to time every turn perfectly.
I still have some long left, but only like 35%. Sold the rest already, too early I guess. Holding those for when we reach 950 or so.
Posted by Noah | April 30, 2009 5:46 AM
I guess my question to everyone would be -- if the market never hit 650 and it just plummeted to this level right now... would we still think it's too expensive? I don't have the answer to that question.
There were definitely great (buy out) arbitrage opportunities last year for the retail investor. I'm not trying to paint the picture that the bottom was established, just asking -- how everyone is determining where good values are found.
At least we can probably all agree that this is a very INTERESTING market indeed!
Posted by RegularAnon | April 30, 2009 8:32 AM