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3 CREDIT BUBBLE
BULLETIN A
new bull market Commentary and
weekly watch by Doug Noland
I am compelled
in this bulletin to respond to a vicious rumor
that I've turned bullish. I cannot refute that the
market backdrop is constructive for global risk
asset inflation. Risk aversion has dissipated, and
risk embracement and rank speculation have
returned with a vengeance. Bulls and speculators
alike have been emboldened, yet again.
Bears have been pummeled into submission.
Those that buy global risk assets on the premise
that policymakers will backstop markets assuredly
exclaim, "I told you so!" My analytical framework
has always included the possibility for a climax
"blow-off top" scenario that would doom the
historic "global government
finance bubble." I guess
I'm as bullish as Ludwig von Mises must have been
when he coined the phrase "crack-up boom".
Market ebullience has evoked chatter of
the emergence of a new bull market. From my
perspective, there is little new here. The current
environment remains consistent with market trading
dynamics that saw major stock indices more than
double in price from March 2009 lows. It was an
historic rally incited by the unprecedented global
fiscal and monetary response to the '08 crisis.
More recently, it has been a powerful rally
incited by an abrupt policy-induced market
about-face - one chiefly fueled by the reversal of
hedges and short positions. It's evolved into one
heck of a short squeeze.
I've lived
through a number of abrupt policy-induced rallies
going back to 1991. These "bull market" advances
tended to last a couple years or so, building
momentum until speculative excess finally sowed
the seeds of their own demise. Bond market - and
certainly mortgage-backed securities/mortgage
derivatives - excesses in 1992-'93 ensured the
1994 fixed-income rout.
The 1995 Mexican
bailout ushered in catastrophic speculative
excesses in the emerging markets, especially among
the "Asian Tigers", as well as in Russia,
Argentina and elsewhere. The 1998 Long-Term
Capital Management bailout incited "blow-off"
technology bubble excess. The post-tech bubble
policy bailout stoked much greater systemic
excess; the global policy response to '08 even
more so. Greek bailout I ...
Now it's the
December introduction of the European Central Bank
(ECB) Long-Term Refinancing Operations (LTRO)
coupled with concerted global central bank
liquidity operations and assurances. Finally,
analysts trumpet, the type of policy resolve
necessary for European debt crisis resolution.
It's justifiable that market players today
contemplate the possibility that policymakers have
created a backdrop conducive for yet another
couple of years of market exuberance.
There may be little new in the market
backdrop, yet we must recognize that the policy
backdrop has changed profoundly though, perhaps,
subtly.
The nature of policy responses has
evolved and escalated; measures have become
overwhelming, preemptive and essentially
unbounded. The early '90s policy measures (largely
rate cuts) were in response to large-scale bank
and savings and loan failures. Other policy
responses followed huge debt defaults, banking and
credit system failures, and widespread financial
turmoil. The "Lehman moment" quickly elicited the
policy bazooka.
These days, global central
bankers are determined to resort to the big guns
before there is so much as a failure of a
significant financial institution. If market
expectations are met later this month with the
second round of the ECB's LTRO facility, the ECB
will have provided well over a trillion euro
(US$1.3 trillion) of additional liquidity prior to
the failure of a single major European bank. It
has become systemic "too big to fail" - and the
markets are keenly aware of policy ramifications.
And I'll tell you where the analysis has
turned most tricky. In the past, these
policy-induced market reversals emerged from a
period of acute market illiquidity and associated
systemic stress. A major loosening of financial
conditions would unfold following a problematic
period of risk aversion, tightened credit and
associated economic weakness. Corporate profits
would be faltering and confidence in US equities
and risk assets would be strained. The US credit
system would be fragile. This time is different.
It is worth noting that the worsening of
European debt strains in 2011 actually engendered
an important loosening of credit conditions in the
US. Treasury and agency debt markets, the
commanding source of system credit expansion,
experienced a near buyers' panic. Markets always
fear the unknown. Suddenly, collapsing Treasury
yields and talk by the Federal Reserve of a third
round of quantitative easing ensured that any
fledgling momentum for Washington fiscal restraint
was nipped in the bud.
As such, the bulls
were assured of ongoing massive fiscal support for
spending, corporate profits and economic
expansion, without worry that economic momentum
might have the Fed looking to shrink its balance
sheet and tiptoe away from near-zero rates.
We are now into the fourth year of
previously unimaginable stimulus. Considering zero
rates, massive Federal Reserve monetization and
unconscionable deficit spending, economic
performance has been abysmal. There has been ample
confirmation - economically and financially - to
the secular bear thesis. This fragility has
virtually guaranteed ongoing fiscal and monetary
largess. At the same time, the backdrop should
engender sufficient economic momentum to support
bullish sentiment. Today's ultra-loose financial
conditions - especially in government and mortgage
finance - should equate to decent gross domestic
product (GDP) growth, seemingly solid corporate
profits and, even, more than a faint pulse in
housing. And this could suffice as support for the
bull thesis.
Of course, the stronger the
markets, the more positive the news flow and
analysis - which can support a self-reinforcing
boost in overall confidence.
But don't
count me bullish. I see no holes in the analysis
that this remains an ongoing slow train wreck -
the unfolding worst-case-scenario. The European
financial and economic crisis will not be resolved
anytime soon (think post-bubble Japan). Greece is
an unmitigated disaster and, throughout Europe,
economic structure now (in a post-credit boom
backdrop) matters.
I don't see how such
dissimilar economic structures (and social and
political systems), say between Italy and Germany,
are consistent with a common currency. LTRO only
buys time. China is, as well, an accident in the
making.
Here at home, Treasury debt
issuance is unsustainable. An incredible amount of
finance is being mispriced, over-issued and
misallocated. It may equate to GDP growth, but it
won't amount to sustainable robust and balanced
economic performance. Indeed, we should by now be
familiar with the dynamic where the more prolonged
the bubble the greater the distortions and
maladjustment to our already maligned economic
structure. And surely the last thing our system
needs at this point is another bout of
destabilizing speculative excess in our stock and
risk markets. It's a dangerous phase.
Yet
these types of policy-induced market runs become
the devil's playground for precarious bubble
excess. With the bears out of the way, stock
prices become easily detached from underlying
fundamentals. Markets become dislocated - and
speculation runs roughshod. Markets will tend to
climb walls of worry - and derivatives will tend
to leverage market buying power. And a marketplace
dominated by trend-following and performance
chasing trading dynamics forces everyone in. It
convinces most to disregard risk. Hedging is
abandoned, and everyone gets comfortably
positioned on the same side of the boat.
I
look at the global backdrop and see all the
makings for a major, major market top. It's just
impossible to know how far away - both in time and
price - we are from such an outcome. I don't
envisage a new bull market - but instead see the
same type of manic marketplace that brought us the
2010 "flash crash" and the 2011 10-day market
shellacking.
WEEKLY WATCH The
S&P500 rose 1.4% (up 8.2% y-t-d), and the Dow
advanced 1.2% (up 6.0%). The Morgan Stanley
Cyclicals added 1.2% (up 16.1%), while the
Transports slipped 0.3% (up 4.4%). The Morgan
Stanley Consumer index rose 1.6% (up 4.2%), and
the Utilities gained 0.3% (down 3.3%). The Banks
were 2.4% higher (up 15.8%), and the
Broker/Dealers were up 2.6% (up 18.0%). The
broader market plugged right along. The S&P
400 Mid-Caps rose 2.1% (up 12.0%), and the small
cap Russell 2000 gained 1.9% (up 11.8%). The
Nasdaq100 was up 1.4% (up 13.5%), and the Morgan
Stanley High Tech index jumped 1.9% (up 16.7%).
The Semiconductors rose 2.8% (up 18.5%). The
InteractiveWeek Internet index increased 1.0% (up
12.2%). The Biotechs were about unchanged (up
24.3%). With bullion little changed, the HUI gold
index slipped 0.6% (up 4.4%).
One-month
Treasury bill rates ended the week at 3 bps and
three-month bills closed at 8 bps. Two-year
government yields increased 2 bps to 0.29%.
Five-year T-note yields ended the week up 4 bps to
0.84%. Ten-year yields increased one basis point
to 2.00%. Long bond yields ended up a basis point
to 3.14%. Benchmark Fannie MBS yields jumped 8 bps
to 2.87%. The spread between 10-year Treasury
yields and benchmark MBS yields widened 7 bps to
87 bps. The implied yield on December 2012
eurodollar futures rose 4 bps to 0.57%. The
two-year dollar swap spread increased 1.25 to 28.5
bps. The 10-year dollar swap spread was little
changed at 8 bps. Corporate bond spreads ended the
week little changed. An index of investment grade
bond risk was about unchanged at 99 bps. An index
of junk bond risk declined 3 bps to 571 bps.
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