The Situation:
Some quick brief notes before markets open. I will be busy all day apartment hunting so won't be attached to a Bloomberg. Hopefully when I get settled I will find one at the graduate center at Lincoln Center, or I will have to use the on in the Bronx.
Either way, we have seen corrections in currency markets the day before the unemployment report on the pound with the continued use of Quantitative easing. And the Euro reacted strongly dropping 200 pips or so within the first 20 minutes of the US jobs reports being announced. Other major pairs were on pulled back on a limited scale. The big day is on tuesday! unfortunately I will still be house hunting... (the life of a student... terrible timing in such historical events)
Ive been talking to Sauros and Pat about Central Banking market driven theories. The mechanism that which is feeding the equity rally is not quite clear. Though it is clear the relationship of Monetary Policy, risk aversion and economic reports are what are fundamentally driving currency price behavior in this low interest rate environment. This in turn is moving dollar denominated commodities especially oil. Though the biggest " ? " is what the heck is driving equities.
We combed over a number of scenarios and its not quite clear; whatever the case maybe, one can play a correlative strategy despite not having a clear view on fundamentals.
Some people suggest that inflation is what is driving the equity rally since march. I dispute this claim as bond performance was the best performing asset class these past few months. It is only recently that we are seeing improved capital flows to equities that are on par or performing better than bonds; depending on region.
So if bonds are doing very well it can't be clearly a inflation driven environment...
HOWEVER!
I thought of a possible explanation. All of 2008 we are seeing risk aversion increasing and lots of people holding money on the sidelines. We also are getting a huge pent up money supply from the member banks who got all the fed injections and bail out monies. The increase of bonds can be explained by one type of player in the markets. These players are the ones who are still some what risk averse but are looking for relatively safe assets that will give a higher safe return than more volatile securities such as commodities or arguably equities. So this leaves the possibility of inflation fears, but however some players are simply more risk averse focused.
The second type of player can be the ones who are buying into the inflation story (similar notions as played out by the ECB), and including the others are all the huge corporations who are favored clients of the big banks that can still get corporate loans. This is confirmed as many huge banks saw increases in the loaning/credit markets in the first and second quarter. In this sense all the money the Fed has been injecting has to go somewhere. This money is possibly going to the big multi national corporate banks. Consumer loaning is still down, consumption is down, retail is down, and personal savings is up. (these players are driving the equities rally; be it artificial or sentiment driven).
So in a sense this is all a one sided earnings driven story. Pat also pointed out a very good point, if member banks are not significantly loaning to their multi-national corporate clients, the recent arguably "good" earnings are due to purely cost cutting and don't reflect true growth. This may be the case since we saw many companies with surprise earnings, but with lagging sales and revenues.
So its hard to believe that there is literally no domestic demand, as demand would have to be a huge part of what is driving these equities. We discussed that one possible solution of the demand problem was being met from abroad. Essentially huge players in emerging markets are what is making up for what local demand is lacking in (possibly capital flows form abroad). Big players like china has seen ballooning and questionably bubbly equity markets and huge expansions in loans (though to an extent still justifiable when looking at loan to deposit ratios).
So that would be completing the story of what is going on...
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Summary:
So what does this all mean. Central banking is key! Tuesday when the FOMC meets will be a great indication of where markets will be heading.
Short term we see the S&P500 going higher, but will it sustain this levels? not likely. I put a possible price target of 1100 on the S&P500, though Pat is calling 1050 before a possible trend change. We are all in consensus though that the markets ill need a significant correction to reach those levels. Already oil and currencies have corrected significantly, while the S&P500 has only see around 1% corrections which does not warrant further sustainable levels.
Oil we are still short term bull.
For currencies the Pound and EURO has corrected signficantly and arguably now is the right time to be buying in the markets if one is a bull. Though I opt to be conservative and wait for Tuesdays news to get a better view of trend developments. Overall though I expect continued dollar weakness (if this is the case implications for the EURO zone can be grave if they truly stop QE policies).
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I apologize for the scattered thoughts; we making huge strides in incorporation which is taking most of our time these days. hopefully things will clear up once we make that hurdle.
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