The one-year chart shows that the bulk of the losses took place in just six weeks. From September to October 2008 the equities market gave up $6 Trillion. The November 08 low is V shaped. The more significant March 09 low is shallower in slope. More stock was traded. It looks convincingly like a legitimate low.
Both of these lows were head fakes. In November there was a fairly broad perception that the lights were rapidly going out in the global economy. Mr. Bernanke has since acknowledged that even he was not certain that the system would survive during that period. The actions by UK’s Gordon Brown turned things around when he took steps to make direct investments in British banks. The rest of the world quickly followed suit with a massive recap of the public sector financial institutions. TARPing worked. It took the, “We are falling into a hole” issue off of the front page.
By March of 09 the economic numbers were catching up with what the market was telling us in the Fall. In the first two months of the year there was evidence from every corner of the globe that private consumption was dropping at double-digit annual rates. That led to the Depression talk. At the same time there was the mistaken belief that Citi and a number of other major US financials were going to disappear. Fortunately, Mr. Geithner spoke forcefully and said, “No major banks are going under”. At the same time it became clear that virtually every major country was initiating a significant stimulus program. China, the US, EU and a number of others are throwing big money at the demand problem.
As of today the market has recovered $2 Trillion since the March low. All stocks benefited, but it was really just a massive turnaround in the financials. By way of example C is up nearly 400% off its low.
The chart of the past six months shows that we actually have been pretty flat for the period. For sure there were some big swings and percent changes but net-net a lot of stocks are not much changed in price from mid-October.
The question is what will happen next? A lot of risk has been taken out of the market. (A) We are not going to collapse into a global depression. (B) The major financial institutions that we need to weather this storm are not going to go away. Many of the systemic risks that we were worried about appear to have been addressed.
If those two statements are correct then the market has a lot of opportunities in it. Those opportunities are probably not in the stocks that have both collapsed and then surged in the last six months. Those opportunities are not in the stocks of companies whose franchises have been destroyed by the sea-changes in the economy. Those opportunities are probably in the stocks that are trading at or near their mid-October 2008 levels. I suspect there are a lot of them. That makes this a ‘stock pickers’ market. It is unlikely that the ‘buy and hold’ will make money.
Supporting the market of late is a lot of ‘green shoots’ blah blah. The talking heads are looking everywhere for ‘good news’. Even the President is seeing favorable signs. Much more important is that the folks who go to work everyday to invest money are seeing the same things, and they are putting money to work. The buy side, outside of the mutual funds, is significantly under invested at this point.
Investments should not be based on one's highest expectations or one's worst fears. Those extremes never happen. Either you take no risk and make no money or you take too much risk and get killed. Having said that it is worth keeping an eye on what could be the ‘worst case scenario’.
By my count the Treasury must raise close to $3 Trillion in the next eighteen months. This amount includes the deficits, the unfunded portion of the TARP, The TALF funding requirement, The FDIC guaranteed paper, the supplemental expenditures for Iraq and Afghanistan and a substantial portion of the debt of the Agencies. If these green shoots people are talking about actually sprout then there is going to be a problem for Treasury to raise this much money. Keep in mind that not only does Treasury have to sell this staggering amount of paper, they have to do it at historically low yields.
The Treasury bond market is now officially a ‘dirty float’. The Federal Reserve is intervening directly in the bond market on a weekly basis. They have bought paper at auctions and they have bought off the run issues in support of the yield curve at more or less the current levels. The have pledged to buy up to $300 billion of Treasury Securities. In addition they will buy up to a Trillion of Agency and Guaranteed MBS.
For now, the bond market is just looking at this new phenomenon and scratching its head. Technically the Fed has spoken for more than a third of the funding requirement. That still leaves close to $2 Trillion that has to get sold to the public. I, for one, cannot imagine who will buy this unless rates are allowed to rise to levels that would attract the money. A 2.8% taxable return on the ten-year has to be one of the dumbest investments around if you believe that the worst is behind us.
My guess is that this apparent standoff will not end softly. The intervention in the bond market that is working today will not work for long. The Fed buys $15 billion while at the same time Treasury sells $90 billion. Before too long the ten year bond market is going to make a new test of the 3% level. If the Fed meets that with increased weekly purchases it will result in only a temporary standoff. People are counting every penny that is being spent on this intervention. When that number reaches $150 billion the talk will grow that, “They are running out of ammo”. This raises the possibility that at some time in the future the Treasury has an auction and not enough people come. Either the yields will have to rise to levels that will kill the housing market and the rest of the economy or, even worse, the Fed will just buy everything that is issued in order to keep rates low. It is hard to imagine that stock prices will do well if those are to be the market conditions that we will face.
For the past eighteen months the markets have forced the policy makers hand at every turn. We created a free market system and now that same system is eating our lunch. It is unlikely that the markets are going to be suddenly tamed by Bernanke’s limited ability to intervene and control pricing.
The bond market will determine if we land softly. This is an awesome responsibility for a market whose players wake up every morning with a pessimistic outlook. If and when the ten-year yield gets to a level of 3.1% the sparks will start to fly. If at that time the Fed is unable to control the market without using up a substantial portion of its buying power we will have a new-new paradigm in the making. This is all shaping up to take place before the end of Summer, so keep your seat belts on.
This observer doubts whether the bond market will allow Mr. Geithner and Mr. Bernanke to have their cake and eat it too.
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