|The Stock Market, The Sopranos, and My Crazy Dream About the US Fed|
By Joe Digiammo
JUL 02, 2013 11:32 AM
With the death of James Gandolfini in the news, my troubled subconscious mind merged two of its preoccupations. Up for some dream analysis?
I know this has been a long and exhausting journey for most people lately. At least, I know it has been for me. But it seems that every day, I’m learning more and more as we, as investors, try to navigate our way through the minefields created by the launch of QE and its tapering.
I’m also learning that I may need a vacation. I have never let markets or work consume me, but I had a very strange dream the other night. They say dreams emanate from our primal mind and not our conscious mind. As I put this dream into context -- for me, at least -- it tied up what has transpired across markets last week through this week.
Just one month ago, the S&P 500 (INDEXSP:.INX) was sitting at a new all-time high of 1686 and the 10-year US Treasury was at 1.91%. Abe and Bernanke were keeping markets humming along with their drugs and Draghi was puttering behind on his 8-horsepower "Rupp" pull-start minibike. Corporations had meandered through earnings season with 70%+ beating the bottom line, much less beating the top line, but many were locking in record low rates on long-term debt, changing capital structure, raising dividends, declaring buybacks, and making shareholders happier than all those people in the GEICO commercials. China was slowing, albeit from 8% GDP growth to 7.5%; Moreover, things in Syria -- and the Middle East by extension -- had continued to worsen. But the US was going to be energy independent in five years.Some market pros were declaring a secular bull market as the Dow Jones Industrial Average (INDEXDJX:.DJI) again reached a new all-time high, confirmed by a new all-time high in the Dow Jones Transportation Average (INDEXDJX:DJT). The quality of jobs were not great in April, but the private sector added 176,000 jobs, a "sweet spot," a Nirvana scenario. Decent, but not good enough to stop the party (stimulus). Housing continued to crank in step with record low interest rates and market pros were finally saying not only should we not adhere to the ole' axiom "Sell in May and go away," but we may in fact embrace "Buy in May and stay."
Then, on May 22, Big Ben said "could" (In the context of the taper). Imagine the party ripping, the beat thumping, and all of a sudden, a big scratch on the turn table as the music stops. The S&P closed last Friday at 1592, 4.6% off of the all-time high, confirming a break of the vaunted long-term uptrend line at 1618 dating back to November 2012. All of a sudden, the 10-year US Treasury went out at 2.52%, up from a yield of 1.63% on May 1. Perhaps even more stunning was the fact that US Treasures simply could not find any liquid buyers and/or a bid as Dodd-"Beans and Frank" has ironically changed the risk profile at the seven large dealers as their balance sheets have been reduced by some 90%. Conflicting articles emerged last Friday from Fed puppets. One said the Fed "was not surprised by the market's reactions," while the other, by the Wall Street Journal’s Jon Hilsenrath, claimed that investors were "misreading" the dove signals of what Bernanke said on Wednesday. Then, it seemed people suddenly realized that more than 19,000 people have died in Syria, and Vlad Putin is trying to recreate Rocky IV and the Cold War while stealing Robert Kraft's Super Bowl ring.
Suddenly Barron's -- which had bulls charging through 15,000, and then possibly 17,000, a month or two ago -- was sporting a cover two weekends ago that alluded to eerie empty cities and bridges to nowhere popping up in China, and it read like a Stephen King novel. Barron’s also spoke of monstrous train stations that do not have the passengers to support them and referenced a mall in China that's bigger than the Mall of America but is 95% vacant.
All of a sudden, China is finished if the "great migration" from the countryside to the "new" cities constructed with state-sponsored money does not come to fruition. The trickle-down effects are being felt everywhere from cement to steel to gold teeth and pinkie rings. Debt to GDP in China has suddenly grown in proportions (from 130% in 2007 to 210% as of last quarter) that rival M.C. Hammer, Mike Tyson, and Japan in the late '80s, sending all three into a spiral. Now there's a cash crunch prompting the People's Bank of China (PBoC) to inject cash for the first time since February 7, bringing overnight repo rates from 13% to 8% to 4+%. Nothing like having central bank reserves of CNY 19 trillion, right? Housing in the US is again on the brink, even in the face of existing homes for May (85% of the housing market) surprising on the upside two weeks ago at 5.18 million versus an estimate of 4.96 million. Prices are +12% year over year. Mortgages going from a low in December of 3.4% for a 30-year fixed to 4%+ last week is going to completely choke off investment despite Bernanke contending that housing may be the one bright spot in the economy -- plus, rates are still near 40-year lows. Moreover, Bernanke even pondered in his post-FOMC press conference on June 19 that more Americans are starting to believe in housing (again) as their number one investment
Just this week Lennar Corporation (NYSE:LEN) said, “Against the backdrop of recent investor concerns over mortgage rate increases, we believe that our second-quarter results... continue to point toward a solid housing recovery." Demand in all of the company's markets is ahead of supply, and higher interest rates have had little impact on sales or prices. This statement came after Lennar posted stellar quarterly earnings, with the obvious highlight being new home sales were up 27% year over year.
Now, you cannot own an emerging market currency and so you need to unwind and buy US dollars, but this only serves to continue pummeling emerging assets and driving the dollar to levels at which the US will never be able to compete. I had thought last summer was the end. Remember when Greece, which is in the crosshairs again, and Italy were going to sink the world? Everyone wondered if there was going to be more QE. Would Germany save the EU?
Having been in the markets for more than 19 years, it's safe to say that I have seen this before. When we begin to hit turbulence, all the sins of markets past percolate. China will become Japan, but because the world is even more globalized now, it will be worse. The EU is “again” going away. The currency unwinds are conjuring up images of Long-Term Capital Management. Forget that over time, stocks have returned 12% all in. So rates go to 5%? I say, "So what?!" Do you remember someone in your family telling you about their first mortgage at 18%? How about all that cash that corporations like Apple Inc. (NASDAQ:AAPL), Cisco Systems, Inc. (NASDAQ:CSCO), and Microsoft Corporation (NASDAQ:MSFT) are sitting on? One can presume that in a rising rate environment, these companies can now earn more interest on that cash with some yield and a little growth potential. Maybe if you were overweight the utilities or telecom sectors, you would want to pare back and get long on some growth/income stocks, along with maybe a bit more small/mid-cap exposure to offset a rising dollar. We can make money if rates continue to rise.
Insurers, in theory, can more easily offer attractive annuity products and earn more on their investment pools in a period of rising rates. Banks, in theory, can make money doing what they are supposed to do — lend — with a steeper yield curve. Yes, there are duration considerations, and to be fair, I have seen investors migrating from money center banks like JPMorgan Chase & Co. (NYSE:JPM) and Citigroup Inc (NYSE:C) to regional bank plays where there is less delta in terms of a markdown to their bond and MBS portfolios. (Note the recent relative strength of the KRE/SPY ratio versus the relative strength of the XLF/SPY ratio.)
Moreover, PIMCO's legendary portfolio manager Mark Kiesel said in Barron's recently, "When you have a company whose fundamentals are improving, those bonds can rise even when interest rates are rising." We, as retail investors, can obviously focus on higher yields and ladder our portfolio to buy the higher-yielding bonds at the back end once our shorter term bonds mature (in a rising rate scenario). This is exactly what the Fed is doing. Our markets have been operating under unprecedented policy conditions and, not to be trite, wasted investors are simply trying to adjust. Unfortunately, you cannot just have a Gatorade and take a few Advil.
Late last week, markets stabilized again. China has put a Band-Aid on the credit crunch by injecting cash. European credit has tightened back up a bit with Spain and Italy included. In the US, we have seen Nirvana-type economic data that is not too good but not too bad, a signal that the Fed may in fact continue QE longer than its forecasts indicate. The most salient example of this would have to be the most recent GDP data, which came in at 1.8% versus a survey of 2.4%. Again, not too good, but not a recession. The world is most likely not coming to an end. US Treasuries have stabilized, and what’s good for bonds generally has been good for stocks of late. For instance, since June 19, the price (not yield) on 10-year US Treasury, has been roughly more highly correlated to the price action in regards to the S&P 500. However, in trading, there’s an axiom that goes, “The trend is your friend.” Again, I want to reiterate that I humbly believe that the bulls will have to reclaim the vaunted uptrend line at 1625 on the S&P and confirm that level again with at least two closes above to sustain this week’s rally in equities. But when I try to figure out why we have started to stabilize again and why credit spreads have begun to tighten again, I cannot help but think that the primary factor in this week’s price action can be traced back to “Fed speak.” In this context, I can segue to my dream.
I want to share this dream with you because it encompassed Ben Bernanke and the Fed being in The Sopranos, Episode #87, “The Reunion.” I preface this by saying that I’m a huge James Gandolfini fan and so, by extension, I was a huge Sopranos fan. So I presume that this dream was also a result of James Gandolfini’s passing.
It started with Ben Bernanke concluding his press conference on June 19, scurrying backstage and leaning on a table with sweat dripping down his brow. He was visibly shaken. He then eschewed the advances of the press behind closed doors, grabbed Hilsenrath by the arm, and whisked him to an old Ford plumbing truck waiting in the rear of the building. At the wheel was Minnesota Fed President Narayana Kocherlakota, a dove with a capital D.
Bernanke turned to Kocherlakota, and just said, “Start driving.” After a few minutes of awkward silence, he then said, “I really screwed [expletive] up.” Kocherlakota retorted, “I could not agree more.” All the while, Hilsenrath was in the back of the plumbing truck, chained to its side. I could only hear the din of his mumbles and kicks coming from the back. Bernanke indignantly banged on the backside of the cabin and yelled, “Shut up, Jon! I cannot think!”
Kocherlakota continued, “What were you thinking, Ben? I mean, what were you thinking? We need to realize our [the Fed] forecasts have a track record like that of Washington and social programs. This market right now -- and the world, for that matter -- are so pumped up on our juice. We’re not ready for this!” Bernanke said, “I know, I know... but it has to end sometime. On some level, damn it, we need to distance ourselves from inflating asset prices. But, on a personal level, I’m more worried about our friends in New Jersey. You know, ‘them.’” Kocherlakota said, “Why, what did you tell ‘them'? I had thought you were out of that loop.” Bernanke responded, “I told them to get long the back end of the curve. My verbiage was intended to take some air and excess liquidity out of certain aspects of the market, but investors will sit back and say that at the end of the day, they will have the best of both worlds. If things are not so good, we will keep buying. If things get better, we will taper. Hilsy [addressing Jon Hilsenrath, still in the back of the truck], shut up! I will tell you when you can speak!”
Kocherlakota gripped the wheel really tightly and continued, “Ben, what are you saying?” Bernanke replied, “I told you. I told the head of what may be the most powerful crime family on Earth, a guy who does not know the difference between a bond or a stock, to load up on longer dated US Treasuries.” Kocherlakota let out a gasp and simply said, “Oh boy.” Bernanke then instructed him to pull into a roadside Motel 8, on the outskirts of Washington, DC. Then Bernanke and Kocherlakota led Hilsenrath into a dingy, dimly lit room, pulled out a bottle of Teacher’s Scotch (my father-in-law drinks that), and locked the door. My dream then circled to the famed Bada Bing in New Jersey. Tony Soprano lumbered into the back room that constituted his office. Already waiting for him and seated at the table were Silvio, Paulie ,and a visibly shaken Janet Yellen. Tony got right to the point as only he can. He turned to Yellen and said, “Where is he [referring to Bernanke]?” Janet said, “I do not know exactly. I have not spoken with him yet today.” Tony retorted, “Well, let me tell you something. I want you to pick up your pretty little phone and get that [expletive] on right now!”
At that point, Janet fumbled for her phone. Silvio was nervously tapping his fingers, his head pointed down with that one-of-a-kind countenance, replete with the frown and glare. Paulie then turned to Tony and said, “You know, T., money aside, we could have some fun with this.” Tony snarled, “Oh yeah, Paulie, how’s that?” Paulie replied, “Bigger things could come of this. You know, I’ve been doing some reading on this stuff. This 'Fed Speak' is really controlling things. It’s perfect for us. It controls the markets. The way I see it, we can double down and then just have these academics, like our pretty little friend here, just start talking the way we want them to.” Tony was now enraged and said, “You know what, Paulie, you should be thinking about the construction contract up for grabs in Newark and our waste management issues in Orange. What you’re going to do is help Miss Yellen here locate this Bernanke guy and set this straight. One thing I do know -- aren't you supposed to get your investment back eventually in a bond? Well, you and Sil are going to get my money back with a little juice for the house!”
My vivid subconscious mind then circled back to the dingy Motel 8. Bernanke and Kocherlakota were seated slumped over at a tiny table with two glasses tipped over. All the while, Hilsenrath was still struggling in the corner trying to speak, but he was quickly realizing his efforts at that moment were in vain. Suddenly, there was a harsh knock -- more like pounding -- on the door. Bernanke raised his foggy head and signaled to Kocherlakota to check it out. Kocherlakota took a peep, then looked back at Bernanke and said, “We have some visitors. It’s ‘them.’” Bernanke made a feeble hand gesture, exasperated, and said, “Let them in."
Paulie and Silvio entered the motel room, introduced themselves, and politely asked if they could sit down. Silvio then turned to Bernanke and said, “You know why we’re here?" He replied, “I have an idea." Silvio then said, “Tony is obviously not happy; none of us are. We may not know much about this ‘money policy’ [expletive], but one thing we do know is that we’re down a lot of money today.” Paulie then jumped in capriciously, saying, “From what I understand, these markets are pumped up on your words and all the investors out there are like the junkies we deal with, buying and selling on your every move. Is that right?”
Bernanke tried to take off his academic hat and relate in the vernacular. “It’s a bit more complicated than that," he began. "You see, this economy is still in a pretty bad way. We saved it with no damn help from Washington. They’re part of this, too, you know.” Silvio then interrupted and said, “This, you know, economic stuff is way over my head. Let’s cut to the chase. You screwed up, Mr. Bernanke, and my boss is not happy! So this is simple: You’re going to give us back the money we invested in these instruments. And on top of that, you’re going to pay us 12% for our time.”
There was again an awkward moment of silence until Bernanke finally replied, “I do not have that kind of money, at least not on me. You guys have to realize that this is much bigger than you!” He then turned to Kocherlakota and said, “ But there’s another way out of this. Get me Fisher [Dallas Fed President] and Dudley [NY Fed President] on the phone. Tell them, ‘Broken arrow.' Tell them to ‘release the hounds.’ I need them. We need them. I cannot retract myself.” Kocherlakota replied, “Okay, let me dial them up. They will have the perfect opportunity next week and markets will not expect them to defend QE.”
After this, I woke up. My mind went blank. I then realized I had to pack for the Cape and be at the office by 6:30 a.m. I just thought this dream really summed up where we have been and what’s transpired, namely in regards to “Fed speak,” and it also pays homage to the passing of James Gandolfini.
No positions in stocks mentioned.