Market Commentary

In my view the odds of a substantial move in the markets
June 29, 2010

 In my view the odds of a substantial move in the markets is rising each day, a view based upon the observation that the 50 day, 100 day and 200 day moving averages are virtually the same.  The operative question is in which direction?

I think higher for several simplistic reasons.  First, all know the major negatives.  Barring a new externality, I think the major negatives are fully discounted.  Second, a stronger than expected BLS employment report that might be released on Friday.  Expectations of a strong labor report are virtually nonexistent, conversely from last month’s view.  Third are earnings.  I think profits will again exceed most forecasts.  I am not aware of any high profile warnings perhaps the result of strong productivity gains, the result of the lack of hiring.

Is this view Pollyannaish?  Several months ago I wrote mortgage bond yields have the potential to decline if treasury rates also dropped.  This outlook was far from consensus given the conventional view that government purchases were artificially keeping mortgage rates low.  Once this support is gone, yields would spike regardless of treasury yields given lack of demand.

As all know mortgage rates today are around 60 year lows because of the massive amount of liquidity in the financial system.  The giant bond manager PIMCO suggested yesterday Freddie Mac and Fannie Mae should sell its $5 trillion portfolio into this strength. 

As penned last week cash comprises a record 11% of the S & P 500 balance sheets.  Excess bank reserves are around $1.1 trillion vs. the historical average of $1-$2 billion.  By casual observation every time I walked past the TV yesterday the headlines were suggesting a second dip recession is all but inevitable.

As written many times, a double dip recession is an extremely rare event occurring only once since WWII, a recession engineered by the Federal Reserve to squelch inflationary pressures. I ask are these second dip fears rational given the massive amount of cash at hand, 0% short term interest rates and 50% of the stimulus still yet to be spent?

All are extremely nervous because of the unexpected events of fall 2008/winter 2009.  The scars are very shallow. 

The hallmark of this crisis is not that change occurs but rather the velocity of change.  My introductory sentence to today’s comments is that the 50, 100 and 200 day moving average are virtually the same suggesting a substantial move could occur, dovetailing with the velocity of change theme.

Perhaps the above outlook is not as outlandish as it may appear.

Commenting briefly about yesterday’s action, all markets were relatively quiet, perhaps waiting for Friday’s data.

Last night the foreign markets were down. London was down 2.28%, Paris down 2.91% and Frankfurt down 2.35%.  Japan was down 1.27%and Hang Sang down 2.31%.

The Dow should open moderately lower.  There are questions about China’s growth rate, civil unrest centered upon European austerity measures and general fear the recovery is dead predicated upon historical low yield on treasuries.  For the record I believe these low yields are a function of too much liquidity in the financial system chasing one vehicle.  In other words I think the odds are around 50% the next bubble market is the UST.  The 10-year is up 9/32 to yield 2.99%.