There is no doubt that Santa Claus arrived on Wall Street this year! With the S&P 500 and the NASDAQ Composite up 14 of the last 17 trading days, the Santa Claus rally posted a return of over 6% on both indices. Not a bad return from the bearded one. But who really is Santa Claus? Is he the historical figure that we all heard about? Or is the bearded one a new Santa, one bringing billions of dollars of cash to Wall Street firms daily, from the Federal Reserve Bank?
Yes ladies and gentlemen, the new Santa is none other than Ben Bernanke. He does have the beard and he did spend the end of this year bringing gifts of large amounts of cash to the once beleaguered Wall Street banks, but after that the similarities stop. I’ve never seen him photographed in a red suit and I’m pretty sure he arrives to work in a car with no reindeer or a sleigh in sight.
Now the Fed through their QE2 program is going to continue to flood Wall Street with billions of dollars through the spring, but will the rally continue? That remains to be seen. Complacency among investors is at almost unprecedented levels. The extreme bullishness is pervasive. It’s as if investors believe that nothing could go wrong. However, it is at times like these that the majority almost always is mistaken and the market does the most damage to highest number of participants.
So where are the warning signs? Oh they are out there and it is in the form of rising interest rates. The bond vigilantes may cause Fed Chair Bernanke some headaches. Recall that the Fed is trying to buy bonds with the intent of keeping interest rates low. They want low interest rates to attempt to stimulate the housing market and to keep corporate lending rates down to motivate businesses to borrow and expand, in an effort to create jobs.
The Fed also wanted to stimulate the stock market to recreate a wealth effect for investors and retirement plans. The success the Fed is having so far with stocks is causing bond holders to rethink their strategy of avoiding stocks and holding safer Treasuries. Rising stock prices are starting to influence droves of investors to sell their bond positions, which are driving bond prices lower and conversely resulting in higher interest rates. How far and how fast rates go up remains to be seen, but printing more money to the tune of hundreds of billions of dollars historically would be considered inflationary. And inflation is bad for bonds as it also drives interest rates higher.
This new conundrum of higher interest rates with an economy struggling to stand its own is not good and will have to come to terms probably sooner rather than later. When? Perhaps next week or maybe money managers will do what they can to sustain the market one more week and wait until after the first of the year. One thing is clear Santa had his rally. The Wall Street gang is celebrating right now. While it is good to enjoy the season and the recent rally, there are some dark clouds on the horizon and to ignore them would be unwise.
Happy Holidays to all and best wishes for a healthy, happy, and prosperous new year.
Thursday, December 23, 2010
Friday, December 10, 2010
According to Plan?
This week the NASDAQ Composite and the Small Cap Russell 2000 Index closed at levels not achieved since January 2008. The S&P 500 is flirting with prices that were held back in September of 2008. The stock market is responding according to the QE2 plan laid out by Fed Chair Ben Bernanke a couple of months ago.
However the bond market is responding inverse to the Bernanke plan as yields are rising across the board, driving bond prices lower. This week Treasuries experienced the second largest two day selloff in the last 50 years. Is this a sign that the bond vigilantes are out, disgusted that the national debt continues to escalate at a mind boggling pace? Or could it be that investors, who over the last year piled into bonds, are now open to taking on more risk in the stock market. This will remain a critical discussion going forward and will determine how well the Bernanke plan succeeds.
If interest rates rise at an orderly pace and the economy continues to show strength, the stock market could retest the all time highs over the next 12 to 18 months. However, if inflation starts to accelerate, it could spell trouble for both the stock and bond markets, as well as the economy. Already there are signs that higher mortgage rates are slowing the pace of the loan refinance market. Could the fledgling housing recovery fall into a double dip should mortgage rates continue to rise? The Fed is attempting to thread the needle when it comes to the inflation / deflation conundrum.
For the moment the markets are breaking out to new multi year highs. The Fed’s game plan to purchase bonds from the primary broker dealers to the tune of tens of billions of dollars per week seems to be producing the desired outcome where some of the proceeds are migrating over to the stock market. Corporate earnings, which had declined over 92% from its 2007 peak to the 2009 trough (which brought inflation-adjusted earnings to near Great Depression lows), have recovered significantly. S&P 500 earnings have surged up over 900% and are now above the levels attained at the peak of the dot-com era. In fact, earnings have only been higher than current levels for a two plus year period of time that occurred at the tail end of the credit bubble.
While earnings are above those achieved at the dot com peak, it must be noted that S&P prices are not. On December 31, 1998, the S&P closed the year out at 1,229. We were at those levels yesterday, some 12 years later. Does that mean that stocks are undervalued? Not by historical standards. The market is fairly valued today and was overvalued back in the late 1990’s.
Investor Intelligence readings display a high level of optimism: 56.2% Bulls with Bears at 21.3%. Bullish sentiment has not been this high since the end of 2007, while the bull/bear spread is approaching levels seen in April of this year just before the flash crash. Sentiment is a secondary indicator but it should not be ignored. The VIX also shows complacency among investors.
There are other outside factors that could have an effect on the market in a meaningful way in either direction. The markets have priced in the extension of the Bush tax cuts. A failure to get this done before the Congressional Holiday recess could be detrimental. Hot spots geopolitically like Korea can change the temperature on markets rather quickly. China may have inflation issues and at some point next year global debt problems will once again take center stage.
So far the Fed has managed the stock market according to plan. Participants are hopeful that this will continue. Most money managers are hoping for a Santa Claus rally or at the very least a sideways market through the end of the year to protect their bonuses. We are in the favorable season for stocks. The third year of a Presidents term has had an uncanny tendency to produce superior returns. Hopefully the stars stay aligned and the markets climb back to all time highs. Small cap stocks and the NASDAQ are the market leaders, with mid cap stocks not far behind.
* Pacific Financial Planners maintains positions in the following: ACAS, AINV, BG, DRYS, EEM, GLD, IWM, KOL, MDY, PCL, PDP, PIE, SGG, SWHC, XLF, WTNY
However the bond market is responding inverse to the Bernanke plan as yields are rising across the board, driving bond prices lower. This week Treasuries experienced the second largest two day selloff in the last 50 years. Is this a sign that the bond vigilantes are out, disgusted that the national debt continues to escalate at a mind boggling pace? Or could it be that investors, who over the last year piled into bonds, are now open to taking on more risk in the stock market. This will remain a critical discussion going forward and will determine how well the Bernanke plan succeeds.
If interest rates rise at an orderly pace and the economy continues to show strength, the stock market could retest the all time highs over the next 12 to 18 months. However, if inflation starts to accelerate, it could spell trouble for both the stock and bond markets, as well as the economy. Already there are signs that higher mortgage rates are slowing the pace of the loan refinance market. Could the fledgling housing recovery fall into a double dip should mortgage rates continue to rise? The Fed is attempting to thread the needle when it comes to the inflation / deflation conundrum.
For the moment the markets are breaking out to new multi year highs. The Fed’s game plan to purchase bonds from the primary broker dealers to the tune of tens of billions of dollars per week seems to be producing the desired outcome where some of the proceeds are migrating over to the stock market. Corporate earnings, which had declined over 92% from its 2007 peak to the 2009 trough (which brought inflation-adjusted earnings to near Great Depression lows), have recovered significantly. S&P 500 earnings have surged up over 900% and are now above the levels attained at the peak of the dot-com era. In fact, earnings have only been higher than current levels for a two plus year period of time that occurred at the tail end of the credit bubble.
While earnings are above those achieved at the dot com peak, it must be noted that S&P prices are not. On December 31, 1998, the S&P closed the year out at 1,229. We were at those levels yesterday, some 12 years later. Does that mean that stocks are undervalued? Not by historical standards. The market is fairly valued today and was overvalued back in the late 1990’s.
Investor Intelligence readings display a high level of optimism: 56.2% Bulls with Bears at 21.3%. Bullish sentiment has not been this high since the end of 2007, while the bull/bear spread is approaching levels seen in April of this year just before the flash crash. Sentiment is a secondary indicator but it should not be ignored. The VIX also shows complacency among investors.
There are other outside factors that could have an effect on the market in a meaningful way in either direction. The markets have priced in the extension of the Bush tax cuts. A failure to get this done before the Congressional Holiday recess could be detrimental. Hot spots geopolitically like Korea can change the temperature on markets rather quickly. China may have inflation issues and at some point next year global debt problems will once again take center stage.
So far the Fed has managed the stock market according to plan. Participants are hopeful that this will continue. Most money managers are hoping for a Santa Claus rally or at the very least a sideways market through the end of the year to protect their bonuses. We are in the favorable season for stocks. The third year of a Presidents term has had an uncanny tendency to produce superior returns. Hopefully the stars stay aligned and the markets climb back to all time highs. Small cap stocks and the NASDAQ are the market leaders, with mid cap stocks not far behind.
* Pacific Financial Planners maintains positions in the following: ACAS, AINV, BG, DRYS, EEM, GLD, IWM, KOL, MDY, PCL, PDP, PIE, SGG, SWHC, XLF, WTNY
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