My Diary 320 --- Mr.Market,Bull&Bear Fight and Pert-up Your Ears

My Diary 320 --- Mr. Market, Bull&Bear Fight, Pert-up Your Ears and Squeezed Yen

(Notes:  thanks to many friends’ encouragements on the market diary. I will try to live up with your expectations. For previous diaries, you can find them in my blog at http://blog.wenxuecity.com/myblog.php?blogID=1016  At mean time. I sincerely welcome your feedbacks and comments on the market as I can learn from you and we can learn from each other. Again, I will be out of office for a tightly scheduled trip, there will be no diary until Sept. 3rd.)

August 25, 2007

I can’t help returning to office to have a look on what’s going on overnight in the US. Surprise, Surprise, all data are out of market expectation. Hey, Mr. Market never follows the analysts’ forecast, this is one more example.

Durable goods equal to durable performance?

Last night, Commerce Dep. announced that US durable goods orders climbed 5.9% in July and purchases of new homes increased 2.8% to an annual pace of 870,000, all exceeding the best estimate in Bloomberg survey. As a result, w-o-w US stocks posted their biggest advance in five months, S&P500 Index +2.3% to 1,479, the steepest gain since March. DJIA +2.3% to 13,378 and Nasdaq + 2.9 % to 2,576.  In the debt market, the longer-dated, new issue corporate market is operating as General Mills issued 5YR $500MN notes to partially pay down CP balances.

Now, it looks like that market is riding its track back to normal. It also seemed to me that the recent credit market crisis (including the CP market) is a classic confidence crisis which, if unchecked, could threaten real business. However, the central banks have the right moves by injecting liquidity and most importantly Fed rate cuts could accelerate a return-to-normal in the system.  So, more orders flows for our sell-side friends next week?

Time to get back in the water?

Over the past week, Mr. Bernanke has proved his attention to bank liquidity needs by lowering the discount rate and Fed’s actions appear to have calmed the markets somewhat and overall market conditions appear to be normalizing, although I expect it may take a while before the photo becomes fully apparent.  But some signals seem to point to a thread of light.

Here are some comparison data over a month period as July 26, 2007 is another bad memory day to me. I clearly remember a post in the website on that day asking: “Will there be a stick save today, Dave?” The web master response, “The bears scored an empty netter today!”

1M Change(Since 7/26)è VIX: down 0.13 // S&P: down 4 (0.3%) // XO8: -120bp // 5Y Swaps: -1.5bp // Lehman Credit OAS: +21bp

The implications are: 1) we're now more or less unchanged over a month in a range of risk markets, which has to be some sign of stability; 2) the volatility and liquidity fears present over the past month are not backed up by current economic data.  The unemployment rate is still low, jobless claims are not at worrisome levels and both durable goods and new home sales were up; 3) recent problems appear more psychological than fundamental, and the relative calm over the past few days is giving me some confidence.

I don’t want to leave your guys an impression of complacency now. You all know my arguments from my previous diaries. Some ppl already argued that if housing is leading the economy into recession, we would expect GDP and employment data to be materially worse by now...... I still have the same answer:”in this volatile market, we need some patience.” That said, I'm not convinced there isn't more pain to come, particularly in subprime related names. But I think for many of HG names, the worst is behind us. For now I would still maintain short position. However, stable market liquidity is the largest risk to maintaining a short position, but I believe this risk is mitigated to an extent with the entire UST curve being so far through the current Fed Funds rate. 

Battle Between Bear and Bull (4Bs, junk bonds!)

As always, the battle between the bears and bulls remains intense. Bears believe that the recent equity rally is a “knee-jerk” reaction to the Fed’s decision last Friday The bulls fought back after the sharp rebound in stocks around the world. They say “do not fight the Fed” and deep-inside, they claim that the world economy is in good shape – or at least not as bad as what Mr. Market’s behavior has showed.

I don’t have a crystal ball to foresee everything, but I think that the path toward recovery could be slower than those that followed previous shakeouts, and the ride to higher prices will be lumpy ( Sound familiar to an old Chinese proverb!) Certainly, a good news for equity is that the Fed is going to loosen again. But in a large part, there are still many frightened investors and badly burned debt holders who are suffering from their losses.

Moreover, I do acknowledge that it will be foolish to bet against the central bank’s ability to deal with such a deflationary shock. History has showed that monetary reflation has always worked (here, 5.25% Fed funds = gunpowers). Indeed, from the ppl I met over the week, the investment community is still deeply skeptical about the CBs’ ability to quickly turn around the credit crunch. The reason is simple -- one cannot expect a drop in the Fed funds rate to immediately begin to fix the excesses in the housing sector. However, the great impact on Fed policy to the economy and financial stability cannot be underestimated as well.

 

Pert Up your Ears?

At the end of the day, I think all the arguments come to a judgment call -- whether the subprime crisis is dragging the US economy and world growth or if it is a financial crisis that can be cured by the prompt and adequate central bank moves.

The past week’s market reaction to the Fed’s decision has been somewhat confusing -- equity world seems to be stabilizing vs. credit market is still largely caught up. These confusing and contradictory market moves suggest that overall conditions are still very uncertain and the next move could be explosive in either direction in the coming weeks.

I remember a comment to former Head of Federal Reserve, Alan Greenspan – “when he is delivering his speeches or testimonies in the US Congress, every trader becomes quiet and their ears pert up. Since the new Fed chairman, Bernanke, will speak on “housing and monetary policy” on next Friday, August 31, why don’t both bulls or bears pert up their years again. 

Long Yen Gets Squeezed

Finally, don’t forget the carry trade, which is one of the substantially leveraged risk- hunting strategies and has resulted in a lot volatilities. The long Yen position seemed to be squeezed due to the fact of very strong US durable goods data, better than expected homesales and dovish ECB comments (that should be supportive for the euro as it supports equities) proved short-lived.

In the other hand, the USD is still a anti-cyclical currency and has been held up by intensifying risk aversion and spreading fears for a global economic slump. By the same coin, renewed weakness in the dollar is expected when risk aversion subsides and the Fed begins to reflate. But, the expected drop in the USD should be measured and gradual because the market has already discounted the news of Fed rate cuts and the softer outlook for the US economy.

Have a good weekend, my friends