Correction: A previous version of this article incorrectly mentioned a 15 bp move in the 5 year and a 50 bp move in the 10 year note in response to the China news yesterday. The actual move was roughly 11 bps on both instruments. We apologize for any confusion and wanted to make our readers aware.
Editor's Note: Professor Fleckenstein provides his commentary for educational purposes and his insights are not intended as investment advice.
You can find his always insightful vibe on his daily Rap.
A New Basket Made in China
Before we roll into the financial news, it should be noted that the bombings in London yesterday had only a fleeting impact on prices. Thankfully, this time, there were no fatalities. Turning to the really big news, China finally stepped up to the plate and abandoned its dollar peg for a basket of currencies. It's also going to let the yuan appreciate 2.1% versus the dollar in that basket. I'm sure barrels of ink will be spilled about this event, as there has been so much speculation up to this point about what it would mean.
As far as my opinion goes, I believe the way to think about this is as follows: Change has occurred. It's not bullish for the dollar or for Treasuries. But just how bearish it is and how long it takes to have any real impact remains to be seen.
One fact that will determine how much this moves markets in the next several months is what the percentages are of the different currencies in the basket, and how fast the Chinese "fill out the basket." Informed sources that I talked to seem to think that the dollar will be about half the basket, and the euro and yen each may be about 15%, with other currencies mixed in as well (This is not a fact, just an educated guess.)
But I think anything that steals a bid from the dollar is not bullish for financial assets, given that we spew out a couple extra billion dollars daily, via the trade deficit, that someone needs to buy. However, anything that helps to steal a bid from the dollar ought to be bullish for gold.
This move by the Chinese will be mimicked, to some degree, by the rest of Asia, whose countries have been the ones supporting the dollar and our Treasuries. Since they will need to buy fewer dollars, they'll need to buy fewer Treasuries.
Ramifications for Red-Hot Housing?
That's where it starts to matter to us here in America. If rates trend higher over time -- which they will, all things being equal (though they never are) -- that will definitely impact the housing market negatively. And, since the housing market, in the form of the ATM, is the economy, it will matter to the economy and, by extension, the stock market.
But the key is, over time. We just don't know how long all this will take to play out. Of course, market participants can come to conclusions and accelerate the process, or decide it's a nonevent and, in the short term, thwart the process. In fact, the conclusion of the marketplace, in the short run, will probably be more important than whatever it is that the Chinese actually do, especially given the leveraged nature of bond-market speculation.
To my mind, we don't know more than we know. We don't know for sure what the composition of the basket is. We don't know how fast the Chinese will try to implement the changes. We don't know long it will take for the negative consequences to unfold. Therefore, the course of action is to just be alert for clues that this change is starting to matter.
Tech Termites Munch on Margins
Turning to corporate revelry, eBay (EBAY) won at beat the number. In the early going, the stock exploded for nearly 20%. It's interesting to note that although Yahoo couldn't take Google (GOOG)down, eBay was able to take it up -- just going to show that even in today's undertow in tech, momentum players were willing to bet on Google, since it's been so strong. The rest of the tech tape, though, was lower, thanks to the theme I was discussing Wednesday, i.e. margin pressure. That looks like it may be the theme for earnings season as far as tech stocks go.
Margin pressure is a result of pricing pressure, which is a function of either too much capacity or not enough demand, or both. Lam Research (LRCX) stumbled, in the form of its guidance, and that stock was down about 10%, undercutting some of the equipment stocks. But I think the big shocker was the margin pressure/saturation issues emanating from Nokia (NOK), as that stock was down about 12% in the early going. So, after Wednesday's party, today there was a hangover in technology. What Mr. Market gave us, he tooketh away yesterday.
Spoiled Pastrami on Ryland
As for the housing ATM, that arena saw problems yesterday. Ryland's (RYL) numbers were not quite what folks had hoped for, and that stock was down, before today's bond-market drubbing. All the homebuilders were weaker on the combination of those two negative items. With financials (thanks to the decline in the bond market) also joining tech and housing in the red-ink column, it was pretty much an across-the-board slide yesterday, though the damage was about equal to Wednesday's gains.
However, I think it's worth noting that over the past two days, AMD is now only off about 1%, net-net, in the same space of time that Intel is down about 5%. I take that as a sign that some of my long-held views concerning these companies are actually being embraced by others.
Returning to Google, my belief is that the stock could be the key to the tape. I felt if it could rally on its numbers today, and if it has coattails that drag other stocks up, maybe the rally will continue and we will get the blowoff I was musing about yesterday. If, however, Google cannot rally, my guess is, it will take the tech tape with it to the downside, and that may mean that the best has been seen. Therefore, today may be the day that tells us a lot about what happens next.
Roiled by the Renminbi
Away from stocks, the yuan revaluation drove the yen and British pound a couple percent higher. The euro, though, was back to its beleaguered ways. It initially tried to rally about 0.5%, but surrendered those gains in almost no time and turned red, before finally closing up fractionally. The precious metals were firm, and metals stocks were rather strong all day yesterday.
Commodities generically were not so lucky. Conventional wisdom suggesting that they would be bought across the board if China revalued the yuan got tossed on its ear, as most major commodities were lower yesterday. Whether that's meaningful or just noise, I don't know, because lots of head fakes are sometimes seen around an anticipated event, even if the yuan's revaluation was only vaguely anticipated.
I think the market we want to focus on (and as I have described, is the linchpin in how the yuan affects everything in America) is the fixed-income market. As I said earlier, this is a market we'll need to keep our eye on.
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