Market Talk

As with many others, I’m keenly interested in what happens when the Fed’s QE2 program ends. Will there be a QE3? Will the markets crash without the Fed in there proffering support? Will anyone even notice what the Fed does if Charlie Sheen keeps talking?

One thing I’m wondering is this, and I don’t have a good answer for it although I’m asking around: let’s say the Fed decides not to do another round of asset purchases. It’s still sitting on more than $2 trillion of securities. Let’s say the Fed decides to hold them to maturity, something that been talked about. If that’s the case, sans a bond-selling program that would effectively drain some of the liquidity it put out there, the Fed can sit on its zero-percent interest rates and bloated balance sheet and still have interest rates that are negative on an inflation adjusted basis.

In other words, they don’t need to do a QE3 to still be very loose with their policies. There are issues of timing and reinvesting maturing debt on the balance sheet, but in general I think the Fed can keep monetary policy wide open without undertaking another big program.

It seems reasonable to me to see it that way, but I don’t have a PhD in economics. Actually, I don’t have a PhD in anything, but that’s another story. Gluskin Sheff’s David Rosenberg has contemplated a world without QE3, and comes to the conclusion that it’ll look a lot like the world without QE2, an era that lasted from approximately April to August 2010.

WHAT HAPPENS IF THERE IS NO QE3?

We are now being asked this constantly and the follow-up is “who picks up the slack if the Fed stops its bond-buying program”?

The answer(s) is hardly complicated since we have a template for this in 2010. It is a very simple guidepost.

Last year, from April 23rd through to August 27th, the Fed allowed its balance sheet to shrink from $1.207 trillion to $1.057 trillion for a 12% contraction as QE1 drew to a close. Go back a year to the Federal Open Market Committee minutes and you will see a Federal Reserve consumed with forecasts of sustainable growth and exit strategy plans. A sizeable equity correction coupled with double-dip fears were nowhere to be found.

Now over that interval …

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I’m not a pessimist. But I get pretty cranky when my car dies in the driveway, my son gets sick, when the person on the bus behind is gabbing on their cellphone, when the financial system drops an atom bomb on the economy that we’re still dealing with, when the central bank plays God with the markets, when companies wrap themselves in the flag and then ship jobs to China, when politicians from both parties wrap themselves up in the flag and then take millions of dollars from the companies shipping jobs overseas, and then rewrite the rules to favor the companies shipping jobs overseas, when…

Well, you get the picture. I consider myself an optimist. But I am also a realist, and I have to tell you, right now, realistically, everything stinks.

Okay, you got me; not every single thing in the world stinks, and like the New York Knicks, everything that stinks can get better. It may take a major upheaval, a revolution or exiling Justin Bieber to Inner Mongolia to make it better, but it will get better.

Now, if you’re a player, a real player, a Koch brother or Jamie Dimon, then everything’s great. But, for the rest of us, here’s just a partial list of everything that today stinks. Tell me if I left anything out.

The economy stinks. We are not creating anywhere near enough jobs, which means we’ve got millions of people stuck on unemployment, and millions more who are employed but are seeing their wages and benefits undercut by the lack of demand. We have a completely shot-through housing market. The list is endless. We will be lucky, and I mean David-Tyree-catching-the-ball-against-his-helmet lucky, to avoid another global banking crisis.

Stocks stink. I don’t want to hear about bull rallies. The market is largely controlled by computers programmed by pros who can suck all the value out  of a stock 200 times over before you even get near it. The average investor does not stand a chance, not a chance, of getting real value out of the stock market.

Bonds stink. The Federal Reserve has been driving down interest rates in the interest of driving investors further out along the risk curve, into, say, stocks (and commodities.) Where you’ll get crushed by the quants and bots. That’s not even factoring in default risk. I’d go so far as to say that today, there is not a single safe investment for the average person. Not one.

The Republicans stink. Poppy Bush had it right when he blasted “voodoo economics,” but nobody in the party listened, we had 30 years of “supply-side economics” that led directly to an all-time economic crisis. Republicans stink.

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US stocks jump alongside stocks in Europe after an auction of Portuguese bonds is deemed a “success.” Yes, Portugal managed to sell a bunch of bonds. But the yields are on the verge of beyond the nation’s ability to handle. Some success.

John said it best, calling it the Portuguese Pretense. You don’t think these guys need a bailout? Think again.

DJIA rises 83 to 11755, S&P 500 gains 11 to 1286, Nasdaq Comp rises 21 to 2737. Euro rises sharply. For the Dow and S&P, it’s the highest close since August 2008. For the Nasdaq, it’s the highest close since November 2007 (March 2000, here we come!)

Here in the States, USDA’s crop report leads to one conclusion: your food bill’s going up. No surprises in latest beige book; economic growth is moderate, job growth is weak.

Early mood is positive for US stocks, as Portugal’s bond sales are deemed a success.

Not a surprise, since central banks around the globe have every interest in making sure the auction went well. Euro has come off earlier highs, recently at $1.297; stocks in London post modest gains, while advances in Paris and Frankfurt are stronger.

Activity in Europe and its debt theatrics have steered US stocks so far this week, but focus should begin to shift more toward 4Q earnings as the flow of reports begins to pick up. Intel reports tomorrow, JPMorgan Friday. December import prices due at 8:30 a.m.; Fed’s latest Beige Book out at 2:00 p.m. ET.

S&P futures up 7.20; 10-yr note lower, yield at 3.39%.

Let’s talk Treasury auctions (the seven-year auction consequently went well,) stock gains and retail sales in the wake of Snowmageddon.

We’ve been among the crowd pointing to the bond sell-off as a potential sign of something bigger. David Kotok of Cumberland Advisors is also among that crowd. But whereas our concern has been the bond vigilantes lashing out against Washington profligacy, his main point is that the rise in bond yields isn’t solely a U.S. happening.

It isn’t necessarily being driven by inflation either, he notes. But what is sure is that investors are moving out of sovereign debt and exhibiting a herd mentality and going into stocks and commodities. I’m not sure exactly where that puts us; seems stocks and commodities were having something of a run before the recent bond sell-off. Still, the idea the there’s a global move out of bonds is important.

Via The Big Picture:

First and foremost, let’s be clear. This bond market riot is a global phenomenon. US-centric observers are blaming the rise of the benchmark ten-year Treasury note yield on an inflation-risk scare or on Fed money printing with QE2 (quantitative easing round 2) or on expanded deficits because of the tax-cut extensions. These observers are missing the boat.

This is global. Look at this chart (http://www.cumber.com/content/special/G4.pdf) on Cumberland’s website in the Special Reports section. The title is “Charts for Bond Herd Commentary.” In chart one we have rebased the yields of the four key global currency benchmark ten-year notes. We start at the low yield day of October 12. Since then the upward movement in yields has been correlated worldwide. We pick the four big denominations of debt, the yen, pound, dollar, and euro. Together they define the overwhelming majority of world capital markets.

This correlated movement suggests that the selling is coming from a reallocation of assets in large indexed global funds. They are moving monies out of the highest-grade sovereign debt bonds and into other sectors. We have now confirmed this with several large portfolios. We infer from our anecdotal evidence that there are many others doing the same thing. Their reasons for acting may be different but their actions constitute a herd mentality in this sector of high-grade sovereign debt.

US stocks slip modestly, as the dollar rises on a weakening euro, and despite a Treasurys market that continues to sell off. The disquiet on the continent the past few days proves hard to shake off.

DJIA eases 19 to 11458, S&P 500 loses 6 to 1235, Nasdaq Comp falls 11 to 2617.

Stocks were stronger earlier, after what was generally regarded as good US data. But equities were again beholden to happenings in forex market; once the euro started to lose strength, on those old sovereign-debt fears, stocks couldn’t help but follow.

Treasurys sell off again, 10-year yield hits highest point since early May. While almost nobody seems very fazed by the massive giveaway the Senate passed today, it’s worth considering the bond market’s reaction. David Rosenberg over at Gluskin Sheff gets to the heart of the trust thing:

The question will be how much trust people can put into a government that is run by an executive branch that pledged to fight hard for redressing the country’s income polarization, but just did the exact opposite; and a Congress that was voted in to curb the fiscal excesses and to get the nation’s financial house in order — and yet these lame-duckers will very likely feel the pressure from the “leadership” to pretend that “pay go” never existed. Leave it to the creditors to finance these “stimulative” measures, which amazingly include tapping into the Social Security fund so as to stimulate consumer expenditures. What a way to run a country — thrift, saving and prudent are clearly dirty words in the Encyclopedia Americana. It is disconcerting that the Democrats now opt for the tax cuts they reviled in 2008 and that the GOP leadership right now doesn’t mind running up the fiscal tab even more. What exactly do these guys stand for except more “stimulus”?

The bond market delivered a message this week, not that anybody wanted to hear it. Liam Halligan in the Telegraph heard it, though:

Some say that growing signs of a US economic recovery are positive for stocks, which means money is being diverted out of Treasuries, so lowering their price, which pushes up yields. That’s wishful thinking. Sovereign borrowing costs have just surged in the US – and therefore elsewhere – because a politically-wounded President Obama caved-in and extended the Bush-era tax cuts, combining them with a $120bn payroll tax holiday.

Lower taxes, and the certainty of lower taxes, may bolster business investment and growth. That’s the logic employed by those painting last week’s global yield spike in a positive light. Government borrowing costs rose in America and elsewhere, they say, as a re-bounding US economy is now drawing investors’ cash away from sovereign bonds and towards more productive uses.

The reality is, though, that the market is increasingly alarmed at the rate of increase of the US government’s already massive liabilities. America’s government debt is set to expand by a jaw-dropping 42pc over the next few years, reaching $19.6 trillion by 2015 according to Treasury Department estimates presented (amid very little fanfare) to Congress back in June. Since then, government spending has risen even more. So US debt service costs, like those of many other Western nations, are expanding rapidly in terms of both the volumes of sovereign instruments outstanding, and the yields on each bond.

Could the Irish opposition parties actually vote down the budget?

I’m not asking rhetorically. I don’t know the answer to that question. Even if they do pass the budget, what happens after the January elections? Even if the election isn’t some kind of debacle that throws the entire nation into turmoil, how is it going to handle its crushing debt-load over the long run? Those are not rhetorical questions. They weren’t to Fitch, which downgraded the Emerald Isle by three notches. From the Journal story:

“The scale and pace of the deterioration of public finances, continuing contingent fiscal and macro-financial risks emanating from the banking sector, combined with the highly uncertain economic outlook and loss of market access, means that Ireland’s sovereign credit profile is no longer consistent with a high investment grade rating,” the report said.

The Irish government of course doesn’t see it like Fitch. But I’m not sure how much their word is worth anymore. Regardless, the overarching issue here is that the European mess is far from over, even once we get past the “headline risk” over the next few months.

So, yes, there are still big risks over in Euroland. But what about the picture here at home? Are the bond vigilantes, who’ve been so quiet during this time of government excess, finally waking up? Boy, that’ll make some story for 2011, won’t it?

Those aren’t rhetorical questions, either.

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