IT’S ALL ABOUT LIQUIDITY!
Is the real economy rebounding or is this just a liquidity/stimulus driven rebound? David Rosenberg has an opinion:
IT’S ALL ABOUT LIQUIDITY, ROSENBERG!
This is what we are hearing. The fundamentals take a back seat because there is so much liquidity to be put to work, and it all must go into equities. This reminds us of all the liquidity talk during the bubble peak of late 2007. The reality is that the mountain of money is no higher or lower than it was when the market was plumbing the depths through 2008 — money market mutual funds back then were $3.5 trillion and guess what? Today they are $3.5 trillion. Go figure.
So you see, liquidity is a catch-all term when nobody can really explain why the market is going up. This rally is based on a lot of hope that we are going to see a V-shaped economic recovery in the U.S. The S&P 500 is priced for 4% real GDP growth. We don’t see it. Try 2%, which is what the investment-grade corporate bond market is priced for. If we get 4% GDP growth then the equity market is fully priced, but that sort of economic expansion would take Baa spreads of U.S. Treasuries down another 100bps to 200bps, if historical relationships were to hold. But if we see 2%, then at least you will clip your coupon in the fixed-income market. The S&P 500, which at one point would have licked its chops over such a possible outcome (back when it was priced for -2.5% growth last March), would now see 2% growth as a disappointment and would correct down towards 850, again, based on our models.
I would argue that it’s all about psychology. As the global economy began to fall off a cliff last summer and fall investors began to worry. When we saw some of our most prominent financial institutions vulnerable investors panicked and sold everything. Now, we’re seeing the return of rational thinking and cooler heads. The government has certainly helped to steady the markets, but what has really returned to the market is some semblance of confidence. What the government needs to start worrying about now is whether they are letting that confidence get a bit ahead of the real underlying fundamentals of the economy.
Source: Gluskin Sheff
Surely, the rational and cool heads were buying in March and April. Certainly, if the world was in balance and stock market trading was dominated more by those prone to the odd bit of meditation, rhythmic chanting and sitting in the lotus position, I wouldn’t expect gold to be above 1000 and the yen to be below 91 to the dollar. This comment is not intended to be a criticism though TPC….you do a good job of providing a sense of context for these markets.
TPC,
I understand fully that “its all about psychology”, but my question then is what explains the psychology.
From the latest Black Swan:
“Buying bonds domestically and using the currency internationally as rocket fuel to boost
other asset markets in the hopes of reviving demand based on asset wealth effect i.e.
implicit weak dollar policy, could be the game Uncle Sam and his advisory staff are
playing.”
http://www.blackswantrading.com/files/articles/ab80bcff14abfcce37160920667723fbbsccc091109.pdf
Perhaps the argument supporting liquidity is this: high frequency/program/quant trading keeps the market liquid. This is all that keeps the stock markets greased. There simply aren’t the buyers moving in to do it, thus the low volume.
A declining dollar fuels risk trading, at the same time that (as addressed by Black Swan), the price of Treasury bonds moves up, contrary to more recent past, where flight to safety supported the dollar. The Fed has the best of both worlds.
Seems government stimulus, Fed actions, and primary dealer trading IS the economy, now.
Chrispy, I bought stocks for the first time in 2009 on March 8th (http://pragcap.com/how-are-we-doing), the day before the market bottomed. I have turned more cautious of late, which is my attempt at playing the contrarian role of these psychological swings….
I fully understand that psychology and market movements are not correlated. If anything, they are inversely correlated. Fear maximizes at the lows and euphoria peaks at tops.
TPC, I was not questioning your knowledge of markets and how they work – that is very apparent. Merely, adding that there remain signs of stress, despite the apparent increased level of calm. As an OEX option veteran of the 87 crash and having run an index derivatives desk in Japan from ’88 – ’93 I am certainly fully aware of the psychology of the markets at extremes. Indeed, while overall option modelling has correctly been much maligned, the measurement of implied volatity has provided an effective guage of panic for the two occasions I mention above, the ’97 crisis and the November low of last year. The relevant index options in each event reached implieds of 60% and then blew out to 80+. 60% implies panic and the resultant blow out to the high 80s is the result of forced margn calls…and that is when the extreme prices are reflected in equities. So, for me, my own main purchases were based around November of last year…and the March low was a retest – bear in mind that I invest across a variety of indices. Much of that position has subsequently been sold, mainly as I simply do not recognise current conditions and find it extremely hard to get a handle on what the true contrarian position is here. I do hold a small amount of PM stocks, but that’s largely due to following Bill Fleckenstein, who I’ve known since that stint in Japan.
Will dip buyers/HAL9000 come in and spike it higher high at close with good Michigan index? Perhaps bears will get a small relief if this typical behavior changes. I was surprised it did not surpass 1,060 earlier today to get more buyers. Perhaps it will Monday as White House will have more announcements then.
Dip buyers/HAL9000 changed their mind in the last minute and gave the bears a small relief, interesting. Sounded like USD the reserve currency also the carry currency, did not sound right.
I’ve never fully understood how liquidity is translated into the rally. It’s like a black box for me. But I do agree with the idea of psychology. For me, most of players in the market now are speculators (experienced, I might add) who are a bit more confident (and also cautious) than last year. And who knows, they probably got out way before those retail investors last year. And that explains why we have a rally but with light volume. Now the smart money is back. Some of it figures to ride the wave and some wants to wait till it tanks.
This might be a bad analogy but I can’t help to say it. It feels like one of those action movies. The bad and the good both have the ability to destroy each other but they want to keep the status quo. Whoever misfires first will bring on the bloodshed. Any significant down or up movement will result in the bull or bear getting the upper hand.