Note: Professor Fleckenstein provides his commentary for educational purposes - his insights are not intended as investment advice. You can find his daily comments at www.fleckensteincapital.com
Mr. Bond Market & Fannie: A Pair in Pain
On Friday, we learned that the PPI, ex food and energy, was up 0.8%, vs. expectations of 0.2%. Regular readers know that I pay no attention to the CPI and PPI for two reasons: (a) I don't consider them to be accurate gauges of inflation, and (b) it's clear that the inflation rate in this country is materially higher than stated, so I see nothing that these statistics add. That said, the higher-than-expected print in the PPI roiled the bond market.
What's Discombobulating Bonds?
Now, is that because the bond market was just waiting to tip over (witness the island reversal on the TLT chart), and this was the piece of news that did it (in which case, inflation concerns will become the topic du jour for a while)? Or was this just noise? Obviously, the answer to that question is not immediately knowable. But I think it's worth pointing out that oftentimes in markets, a move is percolating beneath the surface, and an event comes along that sets it off. So, whether this could finally be the start of a serious break in the bond market, or a sign that inflation concerns are ratcheting up, I don't know. But it will be important to follow those developments closely to see if that's the case.
If folks decide that we have an inflation problem, and they realize that interest rates are actually lower than the inflation rate for most of the yield curve, it will then become clear that the Fed is really trapped, and that the Fed will have to respond to inflation pressures, rather than trying to promote GDP growth. If that process gets a head of steam, it ought to be a sufficient catalyst to completely unbuckle the stock market.
The Fed has been behind the curve on inflation for so long, it's almost impossible for me to believe that people are actually waking up to this problem, but perhaps that is what Friday's move in the bond market signaled. I have made no secret of my biases regarding inflation pressures in this country, as my motto on the masthead of the site says it all: "In a social democracy with a fiat currency, all roads lead to inflation."
Fannie Drops a Size
In addition, Fannie Mae (FNM) and Freddie Mac (FRE)were under a fair amount of pressure, with FNM breaking through $60 and trading down to $58, its lowest price in five years, before closing $58.90. Perhaps turmoil in the fixed-income market has at last seriously up-ended the innards of the world's largest leveraged bond fund. Or perhaps there are new revelations forthcoming about what Fannie did in the past to make the number, or some combination of the two.
There is also the possibility that when Easy Al Thursday noted it might be a good idea that Fannie and Freddie shrink their portfolios, folks put two and two together and realized it wasn't good for their "business model." Of course, just to show that he didn't understand what his suggestion might lead to, he said: "At this stage, the risk is, as best I can judge, virtually negligible." Then again, he is the man who said the housing market couldn't be a bubble because people had to live somewhere and houses weren't easily fungible like stocks. But we've covered that before.
In any case, with yields going up and cracks appearing in the financing of the housing ATM (via the aforementioned problems at Fannie, Freddie, and some subprime lenders), that would be a powerful one-two punch for undermining what has allowed American consumers to live beyond their means for so long.
Scoping Out a Shift in Psychology
I cannot stress how important these developments are in the bond market and at Fannie Mae, assuming that what we are seeing is not just noise. It's fun and satisfying to make predictions when you get them right, but real money is more often made by reacting to the recognition of a change in the psychology of the marketplace.
To repeat, it's too early to say that psychology has changed, vis-a-vis either the bond market or Fannie Mae / the housing ATM. But potential developments along that line should be front and center on folks' radar screen, because if the bond market decides that the Fed is behind the curve, or Fannie Mae is in serious trouble, it's game over for the stock market, the real-estate market, and the economy. That is a big deal.
Indices Untouched by a Tempest
Having said all that, my conclusion was certainly not shared by most stock jockeys Friday. Even with the long end of the bond market down a point, and Fannie (and Freddie) down 3%, the major indices were unaffected. Tech stocks were firm and housing stocks were modestly weak.
Finance stocks also leaked a bit, though they were not anywhere near as heavy as they ought to have been, if it turns out that Fannie Mae, or the bond market, is in serious trouble. In summary, at the corner of Broad and Wall, all was deemed well, despite these potentially disconcerting developments.
Away from stocks, the dollar was all over the place: first rallying on the worsening news about inflation, and then sinking later on. By day's end, the dollar had closed pretty flat. The metals behaved similarly, though inversely, to the dollar. Perversely, at first, they sank on the inflation news, then thought better of it and rallied, before silver closed up 0.5% and gold closed flat. Fixed income itself was heavy all along the curve, with the 10-year note down half a point by day's end. Oil was up a couple percent.
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