Investors continue to race to put cash to work. Across virtually every market segment, asset values continued to increase. This is great. Or is it? Do the markets reflect a recovering economy or merely excess liquidity? Do the markets foresee a recovery in employment, housing, and personal consumption? The wizards in Washington, in true political fashion, are declaring victory in terms of rescuing the economy. Is that premature? Let’s read the market’s tea leaves for September’s month-to-date returns…
DJIA: 9605, +1.1%
Nasdaq: 2081, +3.6%
S&P 500: 1043, +2.2%
MSCI Emerging Mkt Index: 894, 4.9%
DJ Global ex U.S.: 193.8, +4.4%
Commentary: Clearly, the real action is overseas. The U.S. markets are merely riding the coattails of the emerging markets and other developed international markets. Is the rally overseas sustainable? Are these markets forecasting a global economic recovery? Why hasn’t the Baltic Dry Index rebounded?
2yr Treasury: .91%, a decline of 7 basis points (1 basis point is .01%) Remember, lower rates implies higher bond prices.
10yr Treasury: 3.35%, a decline of 6 basis points
COY (High Yield ETF): 6.35, +4.9%
FMY (Mortgage ETF): 17.52, .69%
ITE (Government ETF): 57.85, .12%
NXR (Municipal ETF): 14.07, 0.0%
Commentary: The fact that U.S. Treasury rates continued to decline this week even in the face of $70 billion of 3yr, 10yr, and 30yr issuance indicates to me:
- investors view the U.S. economy as weak
- investors do not see inflation on the horizon. In fact, could the market be fearful of disinflation if not outright deflation? I am starting to think so. If that is the case, can we have disinflation domestically in the context of a global economic rebound? The cross currents and price action between the bond markets and equity markets presents a real conundrum. The eye popping returns within the high yield space are highly correlated with those in the emerging market space. I would caution people before adding exposure in those segments.
$/Yen: 90.65 vs 93.11 at August month end
Euro/Dollar: 1.4582 vs 1.4338 at August month end
U.S. Dollar Index: 76.72 vs 78.14
Commentary: The decline in the value of the U.S. greenback by approximately 2% reminds me of the overused Wall Street phrase, ’squeal like a pig…’
The fact is Big Ben Bernanke is not only funding the domestic economy with the Fed Funds rate at 0-.25%, he is also funding the spike in a number of markets around the world. How so? Investors around the world have entered and, given this week’s price action, continue to enter into the ‘positive carry‘ trade in which they borrow U.S. dollars to purchase higher risk assets.
This ‘positive carry’ trade was fed by the Japanese yen throughout the ’90s given the exceptionally low rates in that country.
Make no mistake, though, this ‘positive carry’ trade is nothing more than implementing leverage. Do not confuse leverage with brains when a market is rising because as I said the other day, leverage is death when that bull becomes a bear. As I think of market developments, I am convinced that this ultimate unwind of leverage trades currently being implemented is Jeff Gundlach’s reasoning for being bullish on the dollar. How will this work? Investors will look to exit their risk based investments (emerging market stocks and the like) and buy back the dollars which they have borrowed. In the process, the dollar may rally significantly. The timing of this unwind is the critical question.
Oil: $69.12/barrel vs $69.93 at August month end
Gold: $1007.6/oz. vs $952.4 at August month end
DJ-UBS Commodity Index: 123.792 vs 125.73 at month end
Commentary: How can we experience a global economic recovery without further improvement in commodity prices? The move in gold is a safe harbor trade against the weak dollar. Please see my comments above regarding the Baltic Dry Index.
While there are a few indications of economic improvement, overall I view the disconnect between the markets and the economy to remain significant. I am more in the camp that market returns are more reflective of ‘fast’ or ‘hot’ money chasing further price appreciation with an eye to exit. This price action can and will force participants into the casino, but please be aware ‘the road to hell is paved with positive carry.’