I received this "informal note" from the Chief Economist of a mid-size, well known firm (it went out to institutional clients last week). Note that it is based purely on Fundamentals and Valuation — not quant, sentiment or technicals:
"Despite the negative mood hanging over the equity markets, it’s important to take a step back and look at the fundamentals. It seems to be that equities (and the bond market for that matter) have priced in a recession and isn’t likely to be forthcoming."
I emailed back asking these 3 questions:
1) The Dow is w/i 5% of its 5 year, 1 year and 1 month highs – how much of a recession is be priced in?
2) How likely — or unlikely — do you think a recession is?
3) What do the fundamentals have to do with anything?
The kicker came in the final recommendation: short the 10-year against a long position in the S&P 500.
Give the guy credit for having giant cohones to go against the grain — but its not a trade I would be willing to make right now — at least not based on market internals, sentiment or cyclical concerns.
Who knows, he may ultimately be proven correct, but I find valuation/fundamentals to be extremely difficult to use for timing purposes . . .
~~~
For today, let’s see how markets react to Amazon and GM . . .
What am I missing? What’s the gain on that trade (i.e. shorting the 10-year against going long the S&P 500)? I’m no expert but something doesn’t sound right to me in that idea.
If the FED is “driving” the economy by looking in the rear view mirror (indicators are incomplete, outdated, and way too slow for todays .com speeds..IMO), then the market seems to be trading on PAST earnings expecting future returns…isn’t there a saying like “past performance does not guarantee future returns”? The volatility is what is worrisome…I liken it to the speed wobble you get when going wayyyy too fast and it doesn’t matter whether your climbing or dropping…20+ years of trying to out-do ourselves…that’s alot of “wobble” to correct.
WTF?
I’ve got one more question for him. Show me the closed out positions of your trades over this bull cycle since you are giving trading advice. It’s easy to sit on high and pontificate your edicts to the minions. It’s quite another thing to feel the emotions associated with plowing thousands to millions to tens of millions of dollars when you initiate a trade……..and your professional or personal financial future relies on it.
I bet his cohones aren’t quite as big as he’d like you to believe. He probably has all of his personal wealth in an index fund and has no trading background
My own theory is that the Fed will keep rising until the “conundrum” is resolved. Since the conundrum was that long-term rates were not going up, each successive rate hike means the long-term yield has farther to go.
If you share that point of view, the shorting of the 10-year seems like a good idea. I’m just not so sure about the long the S&P end of the trade.
Are you guys picking on Cody again?
“1) The Dow is w/i 5% of its 5 year, 1 year and 1 month highs – how much of a recession is be priced in?”
I suspect the guy is looking at it from the perspective of late 1990s valuations, which were far higher than the historical mean. To me, pricing a recession in would be dropping the current market P/E down to 12-13 or lower. We aren’t seeing that, so although there are more institutional folks talking about a downturn in profits, they don’t seem to be acting on it.
I did see a bear on CNBC yesterday talking doom around noontime. Which was shocking. Isn’t that a sign of the apocalypse?
GM is breaking out on my point and figure chart, Barry. Right now.
GM reports a multi-billion dollar loss and the stock takes off. Go figure.
Amazon, on the other hand, is no mystery.
NSC misses. UPS warns of slowing. AMZN blows up. BA sets sights lower for 2006 but keeps hope alive for 2007 (a few order cancellations next year could scotch that). Homies confirming the bleak picture in real estate.
Don’t worry! Be happy!
Big increase in revenue — ostensibly signs of Waggoners turnaround iworking
Lousy tech stocks. If they weren’t stinking up the joint I dunno if we’d be doing so bad. But Wall Street and CNBC and the like are still fixated on them.
Any chance you guys could get fixated on COP, SLB, ECA . . . ?
«but I find valuation/fundamentals to be extremely difficult to use for timing purposes . . .»
I guess you were thinking of Keynes and his two arguments that stock prices are driven by twice removed perception, and that such perception can stay ”wrong” for longer than a trader can stay solvent :-).
Brian,
Energies have been looking more and more toppy since January. It’s like the market is suspecting that energy demand will be falling. That is consistent with expectations of an economic slowdown.
Buy-and-holders in energy stocks, particularly E&P’s, have been on a roller coaster ride for a year. Lots of thrills but the ride has taken them back to where they started on companies like ECA and COP, even the driller “king” HAL.
Most drillers like BHI, RIG and SLB have done better, but those stocks are still better to trade than to sit on.
You like the GM action? Then you’ll love this one…Consol Energy (CNX – an appalachian coal and natural gas company) annouces yesterday that their coal bed methane reserves are about triple what they previously thought and that they will be expanding production and reserves could be higher still after they survey some additional land holdings. Meanwhile nat gas is trading at a historically low spread to crude and power plants are seeing record high usage this week due to heat waves in the west. News hits the wire today. Stock takes off right?
Nuh uh. Gaps down 2% and keeps going south to the tune of 5+%. It’s a relatively thinly traded (~ 3M/d), lowish float issue compared to say BTU, and it made the 10:30 turn to claw back about half the drop, but still….
«My own theory is that the Fed will keep rising until the “conundrum” is resolved. Since the conundrum was that long-term rates were not going up, each successive rate hike means the long-term yield has farther to go.»
Sure, but that is one of two (actually three) possibilities:
* Bernanke proves that he is tough on inflation and kills the economy to prevent expectations of inflation.
* Bernanke proves that he cares about federal and personal debt and lets inflation rip for a while to evaporate its real value.
* Bernanke proves that he is Houdini’s secret grandson and manages to cool down expectations of inflation while letting a bit of inflation chisel away at the real value of the debt overhang.
I personally think that the 3rd ”everything goes well” case is unlikely, as ”fine tuning” has a bad history.
Then whether Bernanke will choose to kill the economy to kill inflation or save debtors with inflation is the biggest question of the day.
Given the very different outcomes I think that long term trading is mad until it is clear which way things are going, because this is a purely political decision, and could go either way.
My personal impression is that first he will try to ”fine tune”, but a bit too tightly, and when hundreds of thousands of mortgagees and the Secretary of the Treasury converge on Washington with pitchforks, inflation will be let loose to solve the debt overhang problem.
Yeah, COP has been in a trading range for a year. Granted it’s doing ok today. (On this news, I expected it down $2 or $3 or so).
“The nation’s third-largest oil company earned $5.18 billion, or $3.09 per share, compared with $3.14 billion, or $2.21 per share, in the second quarter of 2005. Results far surpassed Wall Street expectations, as analysts surveyed by Thomson Financial anticipated earnings of $2.81 per share.”
Meanwhile WS fixates on tech stocks with their magical penny that they sometimes beat the street with.
I know, “last good quarter”. Is energy as tied in to the US cycle with the whole China/India thing going on now? We’ll see I guess.
AP, NG options expire today, inventories tomorrow, hang-on it could be a bit bumpy.
I track PGH, PDS and PWI, of which PWI is more weighted to NG. It has been a bit more volatile lately compared to oil.
The NG/oil spread has got to close and I don’t think oil is falling to NG! I’ll be curious to see what happens to NG inventories tomorrow.
Call me old fashioned… But that trade is the equivalent of buying camels and selling armadillos. What’s the objective… ? I don’t like either side of the trade…. Everything that I see leads me to the short side of S&Ps and long Gold… The party is over…!
Bernanke does not seem to me to be a Paul Volcker kind of tough guy. He seems more to be a pander to the powerful kind of guy, like Alioto. So, if you trust the powerful to do the right thing, we’ll be fine.
for future reference, it’s spelled “cojones”. The j is pronounced like an h in Spanish. An h in Spanish is silent.
adeu,
Mateu
deja vu all over again…
AMZN 2006: “We’re investing now to make money for the future… Our underperforming profit doesn’t matter…”
AMZN 2000-2001: “Our lack of profit doesn’t matter… It’s more important to invest heavily to solidify market share and grow the entire segment…”
(paraphrased…)
somebody please shake Jeff Bezos and tell him that profits matter… he obviosuly didn’t learn that in 2000-2001…
But they don’t matter, to Jeff Bezos that is. See how much stock he has sold at higher prices? He’s set.
“For today, let’s see how markets react to Amazon and GM . . .”
At this point, the market is so screwey it almost seems like if 499 of the S&P 500 were to miss and guide lower, they’d each get the obligatory 10% haircut – and then all the money would rotate into the one remaining stock.
Blissex,
Have you considered that (with financial globalization, the rise of non-bank banks, the importance of Government Sponsored Enterprises as credit money creators, etc) the Fed has become progressively less able to do what most still believe it can.
Back in 2001, Larry Lindsey commented that we had arrived at “nuclear credit fission”, which really seems to capture.
Perhaps the Fed is effectively weaker even as it remains nominally strong and – in an attempt to overcome the contradiction – must raise the funds rate substantially higher than would have been required.
Or if not must depend on the semi-coordinated actions of other major central banks. Coordination that becomes less so as the world economy slows and international competition heats up.
Is the reasoning that energy demand decreases with economic slowdowns still applicable in a global market?
Or does this reasoning only apply to a domestic recession?
Are emerging markets really going to slow to the point where the total global consumption of energy is actually going to drop?
Somehow I don’t see consumption dropping in a slowdown.
Regardless, if the perception is that consumption will drop during a slowdown, this perception will drive the initial trading period once the slowdown occurs. I’m asking about this because once the initial perception-based trading period takes place, the fundamentals will assert themselves later in the cycle and the scarcity of the resources will actually dictate the price.
Yields have peaked. Time to buy TLT.
«must raise the funds rate substantially higher than would have been required.»
Ah sure, globalization has reduced the domestic impact of monetary policy; when the FOMC set rate to 1% that triggered a boom and inflation in China and India rather than in the USA…
But Bernanke and the FOMC still command expectations to a large extent. If they aim for recession, recession will happen, and if they aim for inflation, inflation will happen. Probably as you say at a much higher cost than in decades past.
«Bernanke does not seem to me to be a Paul Volcker kind of tough guy. He seems more to be a pander to the powerful kind of guy, like Alioto. So, if you trust the powerful to do the right thing, we’ll be fine.»
Ah, but while the middle class are clearly by now the inflation party (being heavily indebted), which way do the upper classes lean? Towards recession, to protect the value of their cash and financial holdings, or towards inflation, to protect the value of their stocks and real assets?
My impression is that the upper classes prefer recession, but eventually the middle classes will stampede and inflation will happen. Especially as the USA treasury is as indebted as any middle class family, or more.
But whether inflation or recession happens, that depends mostly on politics. Consider the impact of high or even higher oil prices: inflationary or recessionary depending on how the authorities react to the shock.
«deja vu all over again…
AMZN 2006: “We’re investing now to make money for the future… Our underperforming profit doesn’t matter…”
AMZN 2000-2001: “Our lack of profit doesn’t matter… It’s more important to invest heavily to solidify market share and grow the entire segment…”»
Ah sure! :-) A bond analyst during the dot.com boom said that Amazon was essentially just a low margin catalog retailer, and it was not even sure that they could service their debt.
It always amazed me that a bunch of jolly and generous fellows have given a rather nice chap like Bezos a few billion dollars to create from scratch yet another low margin catalog retailer, just because he talks well and added “.com” to the name of the retailer.
But then on a smaller scale I have seen an animation sw start-up (about as sure a loser as a catalog retailer IMNHO) where other generous fellows have given $4m funding to a student so he can pay himself a large salary on his first job (CEO of course) and repeat the «We’re investing now to make money for the future» mantra for a few years.
Nice jobs if you can get them :-).
My 2 cents:
# Technical analysis:
more on psychological pattern.
i.e. The resistance tells us that there are traders who still have stock at that price, so when the price hits that resistance, many of those traders would sell their stocks, and the stock will go right back down
# Fundamental analysis:
more on ‘what if’.
i.e. What if the employment rate is high?
What if the oil price is below $20.
What if the company is merged with company B, and so on.
I am a technical analysis person and would be happy to see other fundamental and technical persons’ performs their technics at http://www.wikinancial.com. So, no more debates on this issue.
This kind of debate has been going on for years and those people are hiding their performances.
See you there