Good Evening: Our capital markets entered Wednesday with heightened concerns about our economy in general and the technology sector in specific. By day’s end, however, these concerns were in retreat on both fronts and stocks went out at their session highs. While there was precious little in the way of actual positive news for investors to seize upon, hopes continue to rise because many parts of our economy are worsening at a slower rate. And, if “less bad” becomes widely accepted as the new “good”, then our capital markets may continue to work higher for a spell. The decision facing investors who are agonizing over whether or not to chase the ongoing rally in U.S. equities may come down to just how true are the claims that “recovery is just around the corner”.
Stock index futures were lower early this morning after Intel’s earnings report last night. Because it supplies so many other technology companies, Intel is widely seen as a barometer for both the technology industry and the U.S. economy. INTC’s report had its pros and cons, but the overall theme was pretty clear: Tech is still struggling, and any bottom in that industry is a forecast about the future, not an observable fact from the recent past.
Also out before the opening bell were a flurry of economic statistics, some of which brought historic readings. Mortgage purchase applications dropped in the latest reporting week, but the first big news was that headline CPI is now negative on a year over year basis for the first time since the 1950s. The so-called core figures are still well in the green, which begs the question that follows. If the prices for core items in the CPI can’t drop in this environment, then how much could they rise if and when the cycle does eventually turn? The Empire manufacturing data was negative, but much less so than had been expected. Some analysts hailed this report as indicative of an economic turn, despite the horrendous national readings that were released a mere 45 minutes later. Industrial production was down 1.5%, leaving this statistic with its weakest yearly performance since just after our troops were returning from World War II. Capacity utilization was no better; at 69.3%, our nation’s factories, mines, and utilities are now operating at their lowest capacity since records started being kept 42 years ago.
Equities opened 1% lower after digesting all of the above, with the NASDAQ leading the way to the downside. But this early sell off proved to be the lows for the day, as some took reassurance from the TIC data that showed a bit of renewed buying of Treasurys by China and Japan. Stocks recovered and then meandered above and below unchanged until just after lunch. Volume was fairly light until a few news items encouraged market participants to clamor for shares of all shapes and sizes into the closing bell. First came a rise in the Housing Market index, which rose to an awful 14 from a ghastly 9 in the previous month. Since 50 is neutral, it may take a while for the housing market to return to the good old days of 2005.
Then, at 2pm edt, came the release of the Fed’s Beige Book. This compilation of the latest economic data from all 12 Fed districts, described our economy as one that is slowing down at a more gradual pace than before. Somehow believing a slower rate of economic descent means an ascent is imminent, most analysts and investors welcomed the news (with the exception of BAC-MER, see their take below). Finally, American Express announced that while charge-offs were still rising, they are doing so at a gentler pace. AXP spurted 12% and its rally encouraged market participants to chase other financial names as well. Let’s just say that as Wednesday progressed, the risk appetites among investors were focused less on the risk and more on the appetite.
Not wanting to be left behind if indeed this notion of less bad becoming the new good starts to take root, investors pushed stocks higher into the close. In scraping out the barest of gains, the NASDAQ (+0.007%) was the underperformer, while the Russell 2000 (+1.8%) turned in the best performance among the major averages. Treasury market participants agreed to disagree with the economic interpretations of their equity market cousins, and Treasurys managed to edge higher. Yields were mixed to down a basis point or two. The dollar rose 0.5%, but commodities had a fairly ho-hum day. Most sectors within the CRB were little changed as the index itself fell a modest 0.15% today.
Nothing sows the seeds of doubt in the minds of money managers quite like a bear market rally. Thoughts like, “Is the bottom in?”, and “Am I missing a once in a generation buying opportunity at the beginning of a great new bull market?” cause institutional investors to reach for the antacid tablets. For many of them, losing money in a bear market is no sin, as long as everyone else is taking on water, too. But missing out on the gains of a bull market is a career-threatening problem. As such, large investors are all competing to strain their eyes in looking for Ben Bernanke’s “green shoots”. They almost hunger for the early bits of growth that often presage an economic recovery. What they forget is that many of these green shoots will turn out to be weeds, or, what’s worse, be lost to a spring frost.
I’m not trying to be an eternal pessimist, either, since there are indeed some hopeful signs. As you can see from the articles below, the credit markets are starting to pick up. Even if prices in the dicier parts of fixed income aren’t up as much as are stocks since March 6, they are starting to tick higher. LIBOR continues to recede, high yield bond issuance is climbing off the mat, and even carry traders are beginning to feel safe enough to re-establish risky positions. With all the cash now gushing out of Washington, I suppose these nascent signs of improvement should be both expected and welcomed. But since one of the primary goals of these scribblings is to offer a perspective that is ever mindful of risk management, I would like to call everyone’s attention to the fact that these same hopeful signs were on display in the autumn of 2007 and the spring of 2008.
The spring of 2009 may yet bring more upside for investors, but they should be mindful of the fact that when individuals, corporations, and even some countries all try to delever on a global basis, false springs are more the rule than the exception. After the 1929 crash, the Hoover administration spied similarly hopeful signs in the U.S. economy. “Recovery is just around the corner”, is first attributed to economist, Irving Fisher, but Team Hoover repeated this phrase and variations of it right up until he was crushed by the landslide election of FDR in 1932. It is true the U.S. economy in 2009 has yet to see the massive reversals suffered during the Great Depression, but the root causes of each period — easy monetary policy and an over-reliance on debt — are the same.
What’s different this time is that Mr. Bernanke and the successive Treasury Secretaries he’s teamed up with have long since ditched conventional policy responses. It’s been said, and I agree, that trying to foster sustained growth in an economy weighed down by too much debt is like trying to start a sustainable fire using wet logs. The matches and gasoline (some stimulus and a low funds rate) didn’t work on our debt-soaked economy, so Mr. Bernanke is resorting to the blowtorches and rocket fuel (a lot of stimulus and quantitative easing). I don’t know enough about the chemistry of combustion to accurately predict what will happen next. But my advice would be to stand well back and wait to see what happens next. I’ll risk being underinvested during this rally. Even if he’s successful, Mr. Bernanke might set fire to more than just the logs.
– Jack McHugh
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