Strange Bedfellows

Strange times make for strange bedfellows, a fact which has been amply demonstrated by the financial crisis of the past fifteen months. Didja ever think you’d live to see the broad-based nationalization of the banking system in many Western, notionally-capitalist economies-including those governed by ostensible free marketeers?

The trend has continued apace this week. Consider the juxtaposition of the following pair of headlines, each of which is factually true:

1) “US Consumer confidence registers lowest-ever reading” and “Stocks rally more than 10%”, each of which occurred yesterday;

2) “Over-leveraged emerging economies face crisis” and “IMF to lend up to five times its asset base to ease crisis”. Uhhhhhh……OK. So the answer to a problem sourced in leverage is for a multilateral institution with a proud history of failure to lever itself up? Good luck with that. (As an aside, apparently the IMF has sought to re-mortgage its Washington, DC headquarters to increase its capital base. Unfortunately, they don’t qualify for a jumbo mortgage and so couldn’t obtain a loan.)

So what are we to make of yesterday’s newsflow? The consumer confidence data was execrable no matter which way you slice it, notching up the worst reading in the nearly 40-year history of the Conference Board survey. Ominously, Macro Man’s pet indicator the “jobs hard to get” component surged above the high of the early-Noughties recession, heralding more job losses to come.

And yet markets rallied…..err…because they decided to. Now, it is true that there is a negative correlation between the consumer survey and forward returns on equities, suggesting that it is indeed always darkest before the dawn. Yet the absolute value of the correlation is quite small, certainly not enough to justify a ten percent rally immediately after the print.

However, there is a lot of talk about month-end pension fund rebalancing flows out of bonds and into equities. Given the scale of the monthly moves, there is probably something to that talk. Certainly both legs worked yesterday (though not, it must be said, on Monday.) Macro Man had a plan to scale into a small equity long to take advantage of this expected flow; while he managed to execute a truly miniscule clip on Monday and Tuesday, he lad little interest in chasing yesterday’s uber-rally.

And let’s not forget; 10% rallies are not normal, and they don’t occur in bull markets. Yesterday’s price action managed to crack the list of all time best days on the Dow, which Macro Man published earlier in the month. The updated chart (which calculates lognormal rather than arithmetic daily returns) is below; this month now features two of the best and worst 15 Dow days of the past 80 years.

Not even the crash and Great Depression saw that kind of concentrated price action. Then again, we’re living in a world where a German automaker briefly becomes the world’s biggest company even as the global economy heads into a bone-crushing recession. Strange bedfellows, indeed.

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