Today’s topics: a review of the financial markets over the past week.
…what a day yesterday was…a real head scratcher…Q1 GDP revised up but in line with expectations but that didn’t stop the talking heads from treating it like the second coming…you fill in of whom. After opening with a nervous tone the stock market ground it’s way higher till at one point it was up 130 points but then whittled the gains back down and steeled for 52 at the close. Volume was better at 1.22B shares starting out the well then fading later on but while the highest of the past five sessions the average has been just 1.17 days, well below the fairly typical 1.5B average of the past six months and even the puny 1.29B since March 24 that TB keeps harping on…bring on the doldrums…they are already here!
Bonds have been in freefall…even as the dollar rallies! The economic data has been mixed lately but if you sift through the numbers there is nothing to suggest a reason…other than the removal of ‘fear’ from the markets which TB contends has been replaced once again by complacency! The 1 month T-Bill which got down to well below 1% briefly is now at 2.02%, slightly above the Fed Funds target and even above the 3 month T-Bill (1.89%). We have had a terrible rout in bonds over the past four sessions, and if inflation is truly a concern, why have TIPS been the worst performer…sure they were over priced but at a 2.1% real rate of return they looks pretty good again…but never stand in front of a moving train. Over the past week the yield curve from 3 months out to 5 years has steepened and then while still rising has flattened out to 10’s and 30’s. The 2 year note at 2.65% is cheaper by 22bp’s; 5 yr, 3.40% cheaper by 26; 10 yr 3.40% cheaper by 21; 30 yr 4.73% cheaper by 17bp’s; 30 yr TIP 2.08%, cheaper by 23…all this in just three trading days. That is a loss of 1-5/8 on the 10 year; 2-1/8 on the 30 year; and 5-3/4 points on the 30 yr TIP!!! Surely, a correction will come soon…but having taken out the supports although on five occasions since late February we have mounted significant rallies.
The main focus is or should be on the dollar…it is bouncing and for the first time since the selloff from Mid May is back above the 40 day moving average…73.05 vs 72.54…considering the record low of 70.70 on 3/17/08 that is little consolation but merits close watching. What is happening? Is it merely a result of the yen carry trade?…borrowing cheaply in yen, selling the yen and buying the dollar…looks to be the case as it is the Yen that is suffering the most of the major currencies…although you wouldn’t know that by their stock market, the Nikkei which has been the strongest over the past few sessions, and in fact up 22.6% since the March 14 low…cheaper Japanese goods? S&P 500 in contrast, is up just half that from the March 17 low.
As for commodities, there has indeed been speculation…but also investing in the form of ETF’s and commodity index funds which have seen enormous growth, mainly from pension funds…so let’s not blame the entire mess on hedge funds…or oil companies…or even OPEC. ETF’s and index funds have the result of amplifying both up and down moves in the market as they result in ‘piling on’: on the upside more money comes into them and has to be used to by commodities or commodities derivatives, but the converse is also true and even more significant. Yet in the April selloff Gold was able to support at $850…$857.80 is now the 200 day moving average, so both levels should be respected…go with the flow. As for Crude, which closed at $126.62…$120 is the 40 day, but it could fall to $111 and still be in the long term uptrend. There are your markers.
Stocks have had the easy gains…if you want to call them that…would you want to go long on the last day of the month after a bounce like we have just witnessed? Furthermore, some of the biggest gains have been in sectors that have been hammered severely. Note the tech rally yesterday…sans Semi’s!
Auction rate securities update: If you are in awe of PIMCO and Bill Gross, you obviously do not own the auction rate preferred’s issued by their various closed end bond funds. Whereas Nuveen and some others have attempted to mitigate the problem of the two classes of investors one (bond funds) interested in higher returns accomplished thru leverage, and the other just wanting the liquidity they were promised. Now they are demanding it. According to Bloomberg, David Chandler, a retired commodities trader and lawyer…a perfect combination these days, no?…add in a quant and we would have a trifecta…a triple crown…like Big Brown has the chance of achieving next week…horse was even brought to the NYSE yesterday! Wait…where were we…oh yeah, PIMCO. Chandler, who bought several hundred thousand of PIMCO preferred’s has gotten tired of contacting the company who is, by the way, the only one of the five major issuers who hasn’t initiated a buyback. While TB is disgusted at PIMCO’s lack of action, he is more so with the SEC who could have taken everyone off the hook by demanding that they buyback the securities…harm to bond fund holders?…pullease…they have reaped enormous returns thru leverage and all they would be doing is leveling the playing field…so now PIMCO, along with major dealers of ARS is facing a lawsuit…unless justice is truly blind the answer is obvious…but the law being the law, how it turns out is debatable.
Other fallout from ARS is money market funds. The only form of ARS that is money fund eligible is VRDO which has a hard put to a third party. With more institutional investors flocking to this form due to a lack of liquidity in the others, rates on these are less than 2% and in some cases less than 1%. Yesterday, TB was looking at Schwab money market funds. Taxable is yielding 2.20-2.40% while tax exempt is yielding 2.20-2.75%…TAXABLE EQUIVALENT! In other words, you may as well invest int the taxable which has sweep attached and daily liquidity! Tax exempt bond yields have loosened up a bit in the front end with about 2.70% in 2011-12…but the supply is still far exceeded by demand. That is why TB is more than happy to forego liquidity for yields of 3.5-4.5% on 7 and 35 day auction resets backed by municipal bonds…these are gradually be refunded or restructured so that by the end of the summer they will likely be a relic…by the way, about 1 in 3 are not ‘failed auctions’ meaning that they have some form of liquidity at least. The question will be what to do when that game is over?
TB was a contributing author to Frank Fabozzi’s The Handbook of Municipal Bonds, a 1332 page tome. TB was referred by a friend and was flattered to be included with authors who are well-known in the industry, some legends from his early days in investment. He mentions this not to boast, but to make a comment. Last summer, when the book was being compiled, there were no problems foreseen on auction rate securities or municipal bond insurers…none! TB read all the pertinent chapters and could find no indications of cracks in the system…amazing how two instruments that have been in use for decades can suddenly turn from gold to dross…but then, we are in a fast moving financial community. A Bloomberg story today is on Joseph Fichera who was the first to publicly see problems in ARS…but he was more than 20 years too early…had TB heeded that advice he would have given up a lot of returns! Article is by Mike Quint and a good read.
It seems to TB that we are at a significant crisis in the financial system that far too little has been written about it: the US has had a Uniiform Commercial Code for decades, that has mitigated the differences between varying laws in the states…but now mortgage law, including the ramifications on tax law, securities law, and other forms of contracts are being tested…and hopefully the stupidity of not having a usury law…imagine charging 25% interest when borrowing costs to lenders are so law…and they wonder why they are seeing rising defaults…even as their ‘best customers’ get zero interest for a year! Auto leasing and lending might even come under review…the only thing harder to do than get an auto lease these days is to get out of one! Due to all those big SUV’s and zero interest loans, half or more of all auto loans are upside down…and how about if your car is stolen…or totaled…now you not only have to pay more than insurance will reimburse you but you have no vehicle! So people are foregoing making home loans first…takes 9 months or so do get you…auto loans second…do they really want to repossess that worthless hunk of steel?…and finally credit cards…after they have maxxed out buying gas and food for their families. Sure glad this isn’t a depression…or even a recession…it’s just depressing!
TB would urge you all to consider that above circumstances and realize that in thin markets, fundamentals or even technicals can be deceiving and costly.
TB doesn’t expect much action today but one never knows…he didn’t expect much yesterday either and is still scratching his head. IF he was to make a bet, despite the weak technicals, he would be inclined to favor bonds over stocks and commodities.
Hope you have a fun weekend…are we having fun yet?
TB
Trader Bill thinks it is clear to anyone reading these missives that they are merely commentaries…as he sees it…and do not necessarily reflect the views of anyone other than his own. Information is gathered from sources he has found reliable, but no guarantees of accuracy are implied. These are merely observations of events in the marketplace offering in an attempt to offer a non-mainstream viewpoint. Hope you find it useful.
Copyright TBD Capital LLC May 30, 2008
