Market Talk

There isn’t much that can derail the stock market these days. Jobs report stunk? It’s an outlier. Bond yields rising? It’s a sign of a recovery. Sovereign defaults in Europe? The ECB’ll mop it up. It’s been a good year to be a stock investor, and it’ll probably be a good year for the stock market next year, too.

That’s the general consensus. The Street’s bullish. The crew over at CNBC is in good spirits. Democrats and Republicans are spending like they have a blank check (they do.) Ben Bernanke’s “100% confident” he can control inflation, should it ever appear. Everything’s just peachy again, unless maybe you’re one of the 15 million unemployed Americans.

Or you’re Societe Generale’s Albert Edwards:

I’ve been doing this job long enough to recognise when the markets are entering a new phase of madness that leaves me scratching my head with bemusement. The notion that we are in a sustainable economic recovery is as ludicrous as it was in 2005-2007. But investors are back on the dance floor, waltzing their way towards the next, inevitable implosion – yet another they will no doubt claim in retrospect was totally unpredictable!

No doubt, the music is playing again, and people are dancing. That retail sales report came out this week, and everybody jumped all over it. But how many stopped to ask why? Why are people spending more money now, when unemployment is still “around” 10%, when wages aren’t growing, when companies still aren’t hiring. Why would people forget everything that happened in the past three years and start blowing money again? The answer, of course, is that they aren’t, as John explained yesterday. But subtleties like that aren’t part of the conversation right now.

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Equities are overvalued by a few different measure, like 30-50% overvalued, but the Fed doesn’t care. It just wants another bubble to fuel the wealth effect. Newswires’ Alen Mattich explains.

This is just a brilliant insight from Peter Boockvar of Miller Tabak, writing at The Big Picture. The bubble isn’t in gold, or bonds, or even stocks. No, sir. The bubble is in printing money.

If you have it, the Bank of Japan will buy it. The BoJ cut interest rates from .1% to a range of zero to .1% and announced a 5T yen fund to buy not just JGB’s but corporate debt, commercial paper, ETF’s and Japanese REIT’s. If you live in Japan and thought about selling stuff in the closet on EBAY, hawk it to the BoJ instead. Bernanke in the Q&A of a speech on Fiscal Sustainability last night responded to a question about QE and said “I do think that the additional purchases…have the ability to ease financial conditions.” Another round of QE seems inevitable with the size and pace being the only question. It’s no wonder that gold is rising to another record high. Gold is not in a bubble, money printing is. Emerging economies however are not happy with the rise in their currencies. Brazil doubled the tax on foreign purchases of fixed income and South Korea said banks who do FX trades will face audits.

We weren’t the only ones who seized on the comments yesterday from Brian Sack of the New York Fed. Gluskin Sheff’s David Rosenberg also realized just how telling they were.

The line in the speech that set us off was this: “Nevertheless, balance sheet policy can still lower longer-term borrowing costs for many households and businesses, and it adds to household wealth by keeping asset prices higher than they otherwise would be.” Perry Mason couldn’t have teased out a more incriminating statement. Rosenberg thought so, too. From his comments today:

I just love that one comment to the effect that QE “adds to household wealth by keeping asset prices higher than they otherwise would be.” When will these guys ever learn that maybe, just maybe, these Fed policies aimed at targeting asset prices at levels above their intrinsic values is probably not in the best interests of the nation? As our friend Marc Faber likes to say, the “Bernanke put” is cut from the same cloth as the fabled “Greenspan put” — only the strike price is different.

Imagine running a policy aimed at getting people to spend money based on an artificial level of asset values — what an admission. Then again, this is what the Fed has been all about since the LTCM bailout of 1998. We’re still not convinced after reading this sermon that this next “pull-another-rabbit-out-of-the-hat” experiment is going to end with very much success. There is something to be said about paying for our mistakes and to have the Fed try to rekindle an asset-based economy that has only ended up in generating a series of burst bubbles over the last 12 years, not to mention encourage a lifestyle of living beyond our means, is irresponsible at best, dangerous at worst.

For most of this year, while the stock market’s been flopping around like a fish, the bond market has been steadily rising, with bond yields steadily falling. It’s hard to say exactly how much of this is due to investors seeking the safety of bonds and how much is due to the Federal Reserve consciously keeping yields low. Suffice it to say that while investors have been dumping stocks, look at mutual fund flows, the sell-side on Wall Street, those “bulls” who somehow always are somewhere telling you now’s the best time to buy stocks, have been crying that bonds are in a bubble, and that bubble is bound to burst.

It’s quite amazing that this crowd, which didn’t see any bubble in stocks in 2000, which didn’t see any bubble in housing or stocks in 2007, somehow suddenly has crystal clarity on the subject. They don’t. They’ve just been in stocks for so long, they can’t conceive of a time when stocks wouldn’t be the best investment around.

I read the best rebuttal to this argument I’ve yet to see this morning (albeit David Rosenberg has also been banging this drum loudly and convincingly) from Capital Economics’ Julian Jessop. Pay particular attention to his first line, because that sums it up in a nutshell.

An asset bubble develops when prices move far out of line with anything that could reasonably be justified by fundamentals. That was the case with dot.com stocks in 2000 and many property markets since. However, the current low levels of bond yields (and even further falls) would be consistent with the prospect of a very long period of near-zero short-term interest rates, low or negative inflation, and lacklustre returns on riskier assets that increase demand for the safety of government bonds. After all, these factors have kept Japanese government bond (JGB) yields very low for many years – much lower than the levels currently seen in the US and Europe – despite the dire fiscal position in Japan.

Admittedly, structural factors have also played a key part in driving down JGB yields, including a large pool of captive domestic buyers. But similar factors may come increasingly into play in the US and Europe too, as changing regulatory requirements and additional QE prompt both private institutions and central banks  to hold more government bonds on their balance sheets.

The upshot is that we see no compelling reason why bond yields cannot fall further in the US and Europe from their current levels, without this amounting to a bubble.

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Well, it was good while it lasted.

It wasn’t anything about the eurobail, or the stock market. It didn’t have anything to do with the “flash crash,” or the audit of the Fed, or even Pizza Hut’s loopy pizza vote on Facebook. No, the most disturbing thing I read today was this, about the red giant, China:

HONG KONG (MarketWatch) — China’s economy is teetering on the edge of a major slowdown, though it’s not a shakeout in the property market that’s about to spark the distress, according to a noted China strategist.

David Roche, an economic and political analyst who manages the Hong Kong-based hedge fund Independent Strategy, says the world’s third-largest economy is now on the brink, faced with the inevitable reckoning that follows an extended bank-lending binge.

“We’ve got the beginnings of a credit-bubble collapse in China,” said Roche, predicting the economy will likely cool from its stellar double-digit growth rate to a 6% annual expansion as a result.

A credit-bubble collapse in China. Yeah, that’s just what we need right about now. We had a credit collapse in the U.S., we just avoided one, I think, in Europe, and now China’s on verge of one? That’s just perfect. Isn’t China the country that’s supposed to lead us all out of this mess? And I thought it was just the developed world that was going to implode in an orgy of debt.

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Don't be afraid to go against the herd.

Bubbles are a funny thing. People try to spot them as they’re developing, but the longer they linger before popping, the more complacent people get about them.

Look at the housing bubble, for instance. Folks knew the rapid growth in housing prices wasn’t sustainable. But as prices kept going up, people either became more complacent or truly believed they could get out at the right time.

The same sort of thing seems to be happening in gold, as an “almost universal agreement” seems to exist about the current gold bubble.

“Usually the markets have the courtesy of giving cover for bubbles,” says Rick Bookstaber, a senior policy adviser at the SEC. “But with gold, no one seems even to care about a justification.”

He notes a herd mentality is developing, with the likes of George Soros and John Paulson publicly pumping gold. Goldman Sachs also believes gold could go as high as $1,400 over the next year, Bookstaber adds. And Charles Morris of HSBC has said, “I absolutely believe it’s heading into a bubble, but that’s why you buy it. ”

Bookstaber goes on to describe how investors tend to follow the herd, even though time and again it’s been proven to be a “less than rational” business decision.

“Everyone seems to be happy in agreeing that this is a bubble, and we are all going to participate in this bubble in a rational, genteel way,” Bookstaber says. “Though we might want to ask who is leading this herd, because my bet is they will be stepping aside and cheering us over the cliff.”