Research & Insights

Posts published in August 2011

Midweek Market Comment: It's Ben Week Again!

August 24, 2011

By Katrina Lamb, CFA

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We humans are generally in the habit of marking off the annual calendar by milestone events that help give some structure to the otherwise random passage of time. At this time of year back-to-school vibes are in the air. But before we get to Labor Day there is another Big Important Date fast approaching. That’s “Ben Week”, and it’s this week, when Fed chairman Bernanke heads out west to give a speech at a central bank conference organized by the Kansas City Fed. Against a backdrop of soaring peaks and skies of deep azure Ben Bernanke will say something about the present state of things – we don’t know what that something will be, but it will likely move markets in one fashion or another, perhaps decisively, perhaps locking in a sustainable directional trend that so far has been largely absent in 2011, or then again perhaps not. The actual “event” of Ben Week will last for maybe 30 minutes or so, this Friday, August 26. Between now and then, in marketland it’s all Ben Week prognostications and divinations. Quid facies o Bernanke magne?

It was just a year ago that the Fed chair used the same picturesque opportunity to announce the launch of QE2. Right on cue risk asset markets embarked on a fall rally that powered through the tricks or treats of October and the cheery festoonery of Christmastime portfolio window dressing right into 2011. And then…something right out of the movie “Groundhog Day” as a burgeoning spring rally ran into the headwinds of a European debt crisis and weaker-than-expected macroeconomic indicators. Markets turned south, volatility spiked and now, one year to the day later, all eyes are again on the Fed. Listen carefully and you may hear that same refrain of “I Got You Babe” that dragged Bill Murray out of his sleep over and over again on that never-ending February morning.

But that may be where the déjà vu ends. Markets are already trading up strongly ahead of Friday, but given the extent to which they have been beaten down over the past several weeks it is not altogether surprising to see a swell of bargain-hunting taking a position ahead of the announcement. The thinking is fairly sound: if Bernanke does take bold action in the form of some kind of QE3 that expands the Fed’s balance sheet again or something of equal import, then shares are likely to rise dramatically from today’s low levels. On the other hand, if he merely makes mildly encouraging utterances about how the “Fed stands ready” then one may see a bit of selling but the downside would be limited. Along this line of thinking it would be not unusual to see solid buying continue over the remainder of the week.

The larger question is whether even a bold QE3 program would produce the kind of sustained market effect it did last year. After all, one could argue that QE2 did little other than to prop up asset prices for awhile. Unemployment hasn’t budged, consumer confidence remains low, the housing market is stuck and manufacturing indicators have turned down. Corporate profits are strong but the effects of that strength have yet to be felt much in the US economy. Sure, a Fed asset buying program could juice up prices for a few days, but eventually there has to be some connection between asset price growth and real economics. Right? Anyone? Bueller?

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Special Market Comment: Relatives and Absolutes

August 8, 2011

By Katrina Lamb, CFA

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A great deal has been said over the last three days about the S&P downgrade of US government debt. Much of this chatter has been wearily familiar as the usual actors who reside in Versailles-on-the-Potomac  recite from the predictable scripts of blame and false sanctimony. Let’s get straight to the point: how is the world different today, and how is it not different?

How it’s not different: The US has not ceased to be a safe haven. Look at the evidence – stock markets are plunging while, true to form, yields on US Treasuries are lower than they were last week. Remember – yields fall when prices rise. In fact the 10-year Treasury is right now flirting with a yield of 2.3%, which is a low of historical magnitude. The plain fact is that there is a global glut of savings that has to park itself somewhere. US corporate balance sheets are swelled with over $1 trillion in cash, and at any given time a good chunk of that cash will be invested in some mix of US government debt, downgrade or not.

How it’s partially different: There are other assets performing the safe haven role along with Treasuries: gold is up $40 today, and both the Swiss franc and the Japanese yen have resisted concerted policymakers’ efforts to keep the exchange rate down. As we noted in a recent column (Safe Haven Economics 3.0) the notion of safe haven asset itself is changing with the times. Relatively speaking there is no natural successor to US government debt as the go-to risk free asset. Rather than the idea of one “risk free asset” we should start thinking along the lines of “low risk basket” as a valuation benchmark.

Which brings us to how it is different: The absolute level of risk is higher now. Whether one agrees or disagrees with S&P’s decision (and fans of the rating agency appear to be few and far between) it is meaningful in a long-term sense that the bellwether asset of the last sixty years of global economic history is no longer triple-A. Not because the US can’t pay its bills – it can, simply by printing more money as Alan Greenspan himself blurted out on one of the Sunday talk shows – but because the pillars of the global economy – the US, Western Europe and Japan – are not as solid as they once were.

With the downgrade behind us attention will once again shift back to Europe. “Italy and Spain are the new Bear and Lehman” goes one pessimistic point of view. Actually they are not, for a number of reasons. Italy is not bankrupt – in fact it has a very high rate of domestic savings and its national fiscal budget is in primary surplus (i.e. before including interest obligations). Spain’s debt-to-GDP ratio is just over 60%, a far cry from the 140% ratio of Greece. In 2008 we were looking at the very real possibility that the banking system itself would simply stop working – payroll systems would stop direct depositing wages into checking accounts and ATMs would run out of cash. We are not looking at that specter – not today at any rate. There is a crisis of confidence in European bond markets, and that has long-term implications for the EU and the viability of the Euro. But what we expect to be more likely in the short term is ongoing volatility with a number of variables that could send markets higher or lower on any given day. Trying to guess which variables will show up on which day would be a fool’s errand indeed.

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