Party Like It’s 2007
Today’s market vibe brings back memories of late 2007. Back then we saw extreme exuberance in certain segments while warning signs flashed in others. History never repeats itself as precisely as we might wish, of course, but the comparisons can be instructive.
Consider Facebook. The now-ubiquitous social network opened its doors to the general public in September 2006. By October 2007, it was popular enough to entice a capital investment from Microsoft, very near what turned out to be a stock market peak.
Also in late 2007, the housing market was in the midst of unravelling in a process that would bring the banking system to its knees only a year later. The demise of institutions like Bear Stearns and Lehman Brothers was unthinkable. Yet it happened.
Now in mid-2012, we have Facebook set to become the hottest IPO in years. The stock will likely be valued around 125 times its $800 million earnings. We also see cracks in the armor at JPMorgan Chase (JPM), whose status is not unlike that of Bear and Lehman five years ago.
While we are not predicting doom for JPM, we do wonder why people keep calling the $2 billion loss a “hedge” gone bad. A hedge transaction, by definition, cannot result in a significant loss. Any decline in a hedge’s value should be offset by a gain in the asset being hedged. If money was lost at the firm’s bottom line – which it clearly was – then the transaction was speculative. If JPM is speculating in this way, it is legitimate to wonder who else on Wall Street may be doing so. Inquiries into that question will be key to the banking industry’s future.
Of more immediate note, Greece now seems all but certain to exit the Euro currency soon, whatever happens in next month’s election re-try. For Europe, this will be at least as significant as the collapse of Lehman was for the U.S. The flight of capital to the U.S. is pushing Treasury yields down and the greenback up. Ten-year yields closed below 1.77% today.
That the U.S., for all its problems, can be considered “safe” reveals a great deal about the severity of conditions elsewhere. That Facebook is about to be worth $100 billion says a lot about investor mindsets. One way or another, the picture will be much different a year from now.
Only three sectors have their heads above water in today’s table. Given the recent pullback in stocks, it is not surprising that they are the historically “defensive” groups. Utilities, while hardly exciting by most standards, leapt from fifth place to take the lead. It was also the only one of our 33 equity categories to gain momentum since last week. Health Care held its #2 position, and Consumer Staples moved up a notch to third. The seven remaining sectors all show negative momentum. Formerly leading Consumer Discretionary is now in fourth place. Within that sector, retailing and homebuilders held up well as leisure and automotive stocks pulled back. Telecom moved up a notch. Financials, weighed down by the JPM “hedging” loss, fell to #6. The bottom four sectors look much like they did a week ago: Technology and Industrials are nearly tied while Materials and Energy are far below. Falling crude oil prices suggest Energy may stay in the basement for some time.
A week ago, seven out of eleven Style categories showed mildly positive momentum. No more; now everything points down. Relative positions are even more compressed with only nine RSM points separating the strongest from the weakest. Consistent with the sour market mood, Mega Cap stayed on top of the chart. Large Cap Growth held its #2 position while Mid Cap Value edged up to third place, helped by a large allocation to Utilities. Large Cap Value could not do the same, probably because of its heavy exposure to Financials. The three Small Cap categories remain on the bottom, with Small Cap Growth once again worst of the worst.
The U.S. remains on top of the world but lost the slightly positive momentum score it held last week. The kindest thing we can say is that the U.S. is the best of a bad lot. The U.K. is a distant second place. World Equity and Pacific ex-Japan are close behind, so in effect we have a three-way tie for #2. EAFE and Japan form the next tier, ahead of another clique consisting of China, Canada, and Emerging Markets. Europe, despite all the scary headlines, still managed to climb a notch in the relative rankings. Latin America is now in last place. Brazil is nearing its October 2011 low. The next major support level dates back to 2008, and a trip back down would be a painful experience.
“We know we were sloppy. We know we were stupid.”
Jamie Dimon, CEO JPMorgan Chase, May 2012
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