Page 1 of 3 CREDIT BUBBLE BULLETIN Hard facts ignored
Commentary and weekly watch by Doug Noland
Stock prices traditionally lead economic recoveries. Securities markets tend to
react swiftly to loosened monetary conditions, while it takes some time for
loose credit to work its way through to the bowels of the real economy. Highly
speculative markets react haphazardly, sloshing liquidity out and about.
As is commonly understood, employment conditions are a somewhat lagging
economic indicator. Most analysts have been content to read nothing of
significance from ongoing poor jobs and housing data. Overwhelmingly, the bulls
rely on faith - and history - that surging stock prices are discounting the
usual "V" rebound.
Data this week should have those of the bullish persuasion on
edge. July retail sales were much weaker-than-expected (down 0.1% against
expectations of a rise of 0.8%). Retail sales excluding auto sales were down
0.6% for the month (down 8.1% year on year), the largest drop since March's
1.1% fall. Looking back, there was no mystery surrounding first-quarter
consumer weakness. But even after a dramatic stock market recovery, July's
Department store sales were down a dismal 1.6% for the month (down 9.6% y-o-y).
Even Wal-Mart management commented that their customers were "selective" and
remained keenly focused on value.
Last week's preliminary report on August University of Michigan Consumer
Confidence was also a big disappointment. The consensus called for this
confidence reading to jump three points to 69. The actual report came in down
to 63 - the lowest level since those dark days of March. Readings on both
"Economic Conditions" and "Economic Outlook" dropped to five-month lows.
RealtyTrac reported that US foreclosures jumped to a record 360,149 in July.
This was up almost 7% from June and 32% higher than the year ago level. And
there's no relief in sight. American Bankruptcy Institute data had 126,000
Americans filing for bankruptcy in July, up 34% from a year earlier. It is now
expected that 1.4 million will file for bankruptcy this year.
Meanwhile, the economic optimists took comfort from the week's readings on
non-farm productivity, wholesale inventories, industrial production, and
capacity utilization. Positive data out of Europe and Asia also seemed to
confirm that some type of global economic recovery has taken hold.
From my perspective, the week's data confirm important aspects of credit bubble
analysis. First, ongoing headwinds will restrain rebounds in US housing markets
and household consumption - for an extended period. Second, the overall US
consumption-based economy will lag those of most of our more
manufacturing-oriented trading partners. In short, we are witnessing anything
but typical reflation dynamics, and those expecting a typical US recovery will
be disappointed. Our economy remains overly exposed to US consumption, while
having insufficient manufacturing capacity (and resources) of the type to
benefit significantly from heightened global demand.
Returning to the stock market, I see nothing typical going on there either.
With the Morgan Stanley Retail Index and the Morgan Stanley Cyclical Index up
56% and 49%, respectively, the marketplace apparently has no issue with the
recovery. I suspect these gains have been inflated by short covering. Indeed,
market dynamics likely explain much of the divergence between ongoing weak
underlying economic fundamentals and robust stock prices (especially in the
consumer arena).
Unusually large bearish hedges and bets had been placed against the
(consumer-driven) US economy. Unprecedented fiscal and monetary policy crisis
response stabilized the credit system, setting in motion a self-reinforcing
unwind of "bearish" positions. In the past, such a reflationary dynamic would
have seen stock prices for the most part accurately discount the future
direction of economic activity.
Stated differently, the reversal of bearish positions (and resulting short
"squeeze") would traditionally have (reflating) stock prices portending
recovery and a return to the previous trajectory of economic performance. In
general, a rejuvenated credit system - and the resulting recovery of financial
flows - would ensure that the "bear" case was proved wrong.
This time may be different. I would not be surprised if the confluence of
unusually large bearish positions, unprecedented policy response, and a
resulting major "squeeze" created a backdrop where the stock market was turned
into a rather poor foreteller of future prospects. From my vantage point, I
certainly don't believe stock prices today generally provide an accurate
reflection of underlying company fundamentals. And from an economic
perspective, I suspect the stock market is missing some key underlying dynamics
that will shape future economic performance.
In particular, equities seem to be discounting a return to business as usual
when it comes to the US economy. Retail and the "consumer discretionary"
sectors have been among this year's stellar performers. And, yes, this does fly
in the face of my analysis of new economic realities and a permanently
downsized role for household consumption in the US economy.
At this point, I view this as an anomaly at least partially explained by the
hastened reversal of bearish positions. But I also recognize that massive
fiscal and monetary stimuluses have been implemented with the policy goal of
sustaining the existing economic structure. The market has been content to play
this dynamic, expecting policymaker success.
As I attempted to explain last week, I view the impairment of the stock market
discounting mechanism as a key facet of monetary disorder. The reversal of
bearish plays not only created huge buying power throughout the markets, it
decisively reversed "the greed and fear" factor. Notwithstanding the
end-of-week sell-off, the bulls are greedy and the bears are on the run. And
the more that inflated stock prices entice shorting, the more games that can be
played to "squeeze" the timid bears.
The end result is a highly speculative stock market increasingly detached from
reality and vulnerable to wild swings in sentiment. Yet I don't expect the
emerging global reflation this time to disprove the US bearish thesis, although
it will no doubt be a wild market ride.
The bond market was happy with last week's developments. The Federal Reserve
confirmed it will be especially unhurried in raising rates and ending
quantitative easing. Weak US economic data were seen as confirming the bullish
bond view. To be sure, low market yields at home and abroad are imperative for
global reflation to gain a head of steam. And I would argue that
(over-liquefied) bond markets are subject to their own pricing anomalies.
In contrast to stocks, bonds have been fixated on US economic vulnerabilities
and the Fed, while content to downplay reflation risks. Last week's data
doesn't have me second-guessing the thesis of bond market vulnerability to
global reflation dynamics. For bonds as well, the backdrop is set for a wild,
speculative market ride.
WEEKLY WATCH
For the week, the S&P500 dipped 0.6% (up 11.2% y-t-d), and the Dow declined
0.5% (up 6.2% y-t-d). The Banks added 0.8% (up 3.4%), while the Broker/Dealers
declined 2.0% (up 41.7%). The Morgan Stanley Cyclicals fell 1.6% (up 49.4%),
and the Transports declined 1.2% (up 4.8%). The Morgan Stanley Consumer index
slipped 0.2% (up 8.2%), while the Utilities added 0.2% (down 1.3%). The S&P
400 Mid-Caps gave back 1.4% (up 20.0%), and the small cap Russell 2000 declined
1.5% (up 12.9%). The Nasdaq100 (up 33.0%) and the Morgan Stanley High Tech (up
45.8%) indices both declined 0.4%. The Semiconductors fell 1.3% (up 38.9%), and
the InteractiveWeek Internet index declined 0.6% (up 51.3%). The Biotechs
slipped 0.2% (up 32.7%). With Bullion down $6.50, the HUI gold index dropped
2.4% (up 18.2%).
One-month Treasury bill rates ended the week at 9 bps, and three-month bills
closed at 18 bps. Two-year government yields sank 24 bps to 0.96%. Five-year
T-note yields plunged 32 bps to 2.46%. Ten-year yields fell 29 bps to 3.57%.
Long bond yields were down 18 bps at 4.42%. Benchmark Fannie MBS yields dropped
30 bps to 4.50%. The spread between 10-year Treasuries and benchmark MBS
narrowed one to 93. Agency 10-yr debt spreads increased 4 to 9 bps. The implied
yield on December eurodollar futures sank 19.5 bps to 0.605%. The 2-year dollar
swap spread declined 5.25 to 40 bps; the 10-year dollar swap spread declined
10.25 to 22 bps; and the 30-year swap spread declined 11 to negative 15.5 bps.
Corporate bond spreads were mixed. An index of investment grade bond spreads
widened 5 bps to 171, while an index of junk spreads narrowed 29 to 720 bps.
Investment grade issuers included GE Capital $1.5bn, Praxair $600 million,
Howard Hughes Medical $600 million, Blackstone $600 million, Dominion Resources
$500 million, Hyatt Hotels $500 million, Discovery Communications $500 million,
Southeast Supply $375 million, Ralcorp $300 million, Raymond James $300
million, Cleveland Electric $300 million, Buckeye Partners $275 million,
Snap-On $250 million, Federal Realty Trust $150 million, and Brown University
$100 million.
Junk bond fund inflows were strong again at $570 million (from AMG). The long
list of junk issuers included Sprint Nextel $1.3bn, Dish $1.0bn, Case New
Holland $1.0bn, NII Capital $800 million, Berry Petroleum $450 million,
American Casino $375 million, Brunswick $350 million, Mediacom $350 million,
Prologis $350 million, Ball Corp $325 million, Penn National Gaming $325
million, Apria Healthcare $318 million, Clean Harbors $300 million, Quicksilver
$300 million, Hornbeck Offshore Services $250 million, Sirius XM Radio $250
million, CPM Holdings $200 million, Graphic Packaging $180 million, Olin Corp
$150 million, and Alliance One $100 million.
I saw no convert issues.
International dollar debt issuers included Nationwide Building Society $4.0bn,
Credit Suisse $2.0bn, Robo Bank $1.5bn, Deutsche Bank $1.0bn, Petrotrin $850
million, Finance for Danish Industry $1.0bn, Grupo Petrotemex $200 million and
Lloyds Bank $150 million.
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