10-29-08 The 1% Solution
How many different ways can we say “Extreme Volatility?” Tuesday’s nearly 900-point gain in the Dow, most of which came in the last hour of trading, did an excellent job washing out short-sellers, but really had more to do with a sharp drop in the Japanese Yen. Indeed, the financial headlines are quickly moving overseas as the U.S. and European problems infect emerging markets. Not that the U.S. is out of the woods – far from it. Signs of a deep recession continue to add up every day. The Conference Board’s Consumer Confidence Survey reached a new all-time low in October – a very bad omen for retailers and the entire economy. With so much confusion and fear in the air, the public is pulling in its horns and cutting back on spending.
Meanwhile, the Treasury Department’s new Bureau of Bailouts is spreading the wealth as quickly as it can in an attempt to salvage some semblance of a banking system. Banks appear happy to take the cash, but for the most part are either hoarding it or using it to finance takeovers of weaker competitors. The resulting lay-offs would seem to be inconsistent with the Treasury’s stated goals, but maybe they have other goals, too. As we predicted, other industries have begun lining up at the trough, with insurers and automakers in the lead. We suspect they will receive some sort of help but probably not the amazing largesse that is being granted to banks.
Treasury yields jumped over the last week but remain well below the highs set last summer. There is some bottom fishing going on in the corporate bond sector, but non-sovereign debt is still a tough sell almost everywhere. Today the Fed cut its interest rate target by 50 basis points to 1%, bringing the U.S perilously close to ZIRP – the Zero Interest Rate Policy pioneered by Japan in the 1990s. The committee probably felt it had no choice. Credit markets are thawing out only slightly, and tomorrow’s Gross Domestic Product report will probably show the U.S. economy shrank in the third quarter. Plunging commodity prices have ameliorated the inflation threat, but now deflation is quickly becoming the buzzword. The silver lining: equity markets discount the future, and thus tend to bottom out well before the economy recovers. Whether that is now or much later remains to be seen.
Irrationality has struck the inflation-protected “TIPS” bond arena. Yesterday, the “plain” 5-year Treasury yielded 2.73% while a 5-year Treasury with “inflation protection” yielded 3.79%. Normally, TIPS yield significantly less than standard Treasury securities, such is the price for the inflation protection. Perhaps it is fear of deflation that pushed the yield so high on TIPS. However, that line of thought appears irrational because if held to maturity, TIPS have no penalty for deflation, only a bonus for inflation.
While relative rankings were mostly unchanged this week, the record for extreme downside sector momentum was once again shattered earlier this week when the Materials sector posted an RSM value of -235. This implies that the entire sector is going to disappear within months. That seems unlikely, but in a year like this we hesitate to rule out anything. Absolute momentum fell across the board, and Technology moved ahead of Financials. The tech-heavy Nasdaq 100 Index managed to post a slight weekly gain, something we haven’t seen much lately.
Large Cap benchmarks are trying to push to the top of our rankings, and they would be there if not for the even larger Mega Cap category. This is consistent with the continuing flight to quality – though anyone who bought multinational energy or financial stocks in the last month thinking they were a safe haven has been sorely disappointed. All the safe havens appear to be “Standing Room Only,” which is impractical when you just had your legs cut off.
Japan and the U.S. remain the least-weak global stock markets, but this is good news only in a relative sense. Latin America, China, and other emerging markets are dropping even faster. With so much pain everywhere, it seems like a recovery must be near. Yet many investors have had that feeling for several weeks now – and they were wrong. The bottom, wherever it is and whenever we arrive there, will likely go unnoticed until weeks or months later.
The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.
“Politicians are a lot like diapers…
they should be changed frequently and for the same reason.”
BTIG’s Chief Marketing Strategist (from Barron’s 10/20/08)
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