Diary of a Financier

SPX 2008 Analogue Rears Its Head (& Shoulders)

In Capital Markets, Economics on Tue 2 Aug 2011 at 23:09
  • Judging by market valuations, a GDP slowdown has been discounted.
  • Spending & consumption trends will deteriorate as unemployment benefits continue to roll off, but the incremental rise in jobs cuts should cease in time for an inventory restock this fall.
  • The air is reminiscent of Lehman, and today’s SPX close at 1254 is the same as the eve of Lehman.
  • SPX Head & Shoulders neckline was an attractor, important to see if 1253 support holds.
  • The 2008 v 2011 analogue is completely aligned, and I do expect a shakeout to force a few bankruptcies/distressed acquisitions, since prolonged easing always begets imprudent risk.
  • Hence, fiscal policy is the best repair–particularly for innovation. But, budgetary & spending constraints leave policymakers with only monetary options, so the Fed will undertake a QE3-lite/hyper-HAMP program.

I’ve got to record some thoughts, because today has been a search for answers among many questions. My last specific comment on the broad market was as follows:

8/1/11 I will now await the arrival of S&P 500 (SPX) at 1425. We’ll all now turn our attention to the saga in Europe; soon the Emerging world too. No buying the SPX yet, because technicals need to reverse and prove to me that the H&S 1255 neckline is no longer an attractor.

That 1255 neckline (specifically 1253) was indeed an attractor, not to mention it’s also today’s closing print. I’m glad I waited around. Glad I was short Italy (EWI). Glad I’m long the US Dollar (UUP), MBS (MBB), and 10-year Treasuries (TLH). I’m glad I’m only 23% long equities (including EWJ)–although equities are where I’ve taken my licks. I hadn’t the chance to accumulate a big enough position in Gold (GLD), because I’m just too uncomfortable taking a big stake in a security that’s going parabolic through overbought trading bands. At least I have some exposure to the precious metal. I probably should have also sold some of my big gainers, like Natural Gas (UNG), which I knew was pulling back, but I’m treating it as a secular opportunity.

Enough of that reflective stuff; let me discuss what’s coming.

Even though the Street hasn’t downgraded consensus outlooks, market prices are fully reflecting the expectation of a slowdown to <2% GDP henceforth. A lot of investors are mining for that conviction, but valuations speak louder than pundits. (SPX TTM PE= 14.37; SPX 2011E PE= 12.87.) We've seen continued weakness in macro data, much of which was telegraphed by all the business owners grabbing headlines with the "I can't hire until Washington figures out its politics" meme. I consider the spending & consumption data most concerning, because droves of Americans' unemployment benefits have now expired. The trend will worsen as more individuals roll off. In addition, Congress’ debt ceiling/spending cut resolution gives no more clarity about the political atmosphere for small business hiring. All are bleak for 3q2011, but corporate America’s magic formula suggests we weather this quarter’s layoffs to reach next quarter’s inventory builds.

“This is a replay,” I heard someone in the office grumble today. I know what he meant, because the volatility, the macro data, the slight earnings misses cum selloffs are reminiscent of 2008. By the way, broad indices in the US closed tonight back down at levels from September 15, 2008, the day Lehman collapsed. Consider that bankruptcy and the market swoon around it. Consider the annihilation of all the leverage; of all the equity (homeprices, securities & assets); of all the fiat (currency in circulation & electronic dollars). Then consider the government liquidity that was supposed to displace it all. After trillions in TARP/TALF/HAMP/QEs/etc., SPX back at the 1254 level from the eve of Lehman eerily & symbolically reminds us that it wasn’t enough. Deflation is a mighty force.

This all gives the SPX 2008 v 2011 Head & Shoulders analogue new gravity. Remember my observation:

6/30/11Like 2008, today’s market has set up a bearish Head & Shoulders. Using the 2008 analogue as a guide, SPX should plunge into a correction before reaching the classical pattern’s second shoulder around 1345. However, I do not fully subscribe to analogues, especially when the indicators for weekly/monthly charts don’t match. Today’s market doesn’t look as exhausted as 2008′s in their longer-term fractals.

Today, the indicators from all fractals have fallen into place as if I were asking for it. SPX 2011 now perfectly resembles 2008 on all accounts:

SPY daily (2008 v 2011)

SPY weekly (2008 v 2011)

SPY monthly (2008 v 2011)

I’m amazed that this crisis is in its fourth full year. I do not expect a “double dip” into a new recession, but I do think the market will shakeout. (Wait to see if 1253 support holds on the SPX.) I think there’s some pretenders who are hanging by their umbilical cords, and they need to be snipped. Within that context, I had a meeting with a floating rate bank loan PM this morning. I wrestled two critical admissions from him:

  1. Banks are approaching his team with big blocks of new loans for sale. Whether due to Dodd/Frank or rampant issuance, the banks are offering the paper at unusual discounts.
  2. Many of the low credit quality bank loan debtors are paying down their floating rate debt and converting to fixed rates due to ZIRP.

These notes are hattips to my warning against prolonged periods of monetary easing:

Historically, when the Fed unnaturally halts or reverses tightening cycles despite continued SPX/GDP strength, the 10-year cascades lower, risk runs amok, and recession rears… gratuitous periods of easing–the prolonged Anti-Inertial Fed Funds Rate Interventions–eroded the risk premium component of interest rates… Without the incorporation of this risk expense to borrowers, the economy accelerates in overstimulation.

Throughout the American 30-year disinflationary regime (“The Great Moderation”), policymakers opted for the easy solution to economic problems: lower interest rates. That’s a lot easier than convening a Congressional committee or a White House cabinet to brainstorm. Monetary Policy implements at the snap of the Fed’s fingers. Better yet, it’s a broad stroke that leaves resource allocation to the market mechanism, whereas Fiscal Policy requires far more effort, far more originality, thinking, analyzing, deliberating.

The market mechanism can work, but maybe the problem was that Fiscal & Monetary Policy pile onto the same side of trades here in America. They both manipulated housing for one reason or another. They both excited the Tech Bubble, then they both colluded to paper-over America’s structural issues from 2002-present. (Not a good harbinger for the education bubble. I plan on digging into some vintage ABS info before this weekend. I’ll see what the health of student loans is.) I have no problem with government agencies supporting the private sector, but far too often they turbocharge the fastest rollercoasters in the amusement park, which leads to dangerous derailments. I’d rather see fledgling industries get the juice.

Regardless, structural issues are still the problem du jour. They’re like a schoolboy’s volcano at the science fair, the more baking soda deployed, the greater the mess when it blows. Fiscal solutions are still the answer. Unfortunately, the federal government exhausted its resources already by churning an American economy void of secular, organic innovation. (I can’t help but think of housing, GSEs Fannie Mae & Freddie Mac, and mortgage interest tax deductions.) Government spending would yield greater growth from investment in innovation. Particularly given America’s demographic headwinds, real GDP growth will struggle to exceed 2007’s high in fixed-dollar terms. The system remains fiscally leveraged–albeit deleveraging–from the household to the private sector to the public. That makes it hard for anyone to capitalize on historically cheap lending (i.e. ZIRP monetary policy). The point is, the government should have stimulated innovation in 2002 via fiscal means, not monetary.

If there’s a specific matter to address, address it specifically. I favor the alternative/renewable energy hoss because it conquers so many of our national crises all at once. Unfortunately, the US government is already overextended beyond budgetary/spending limits, so it cannot undertake such measures. It’s left to the Fed instead. That’s why I expect the Fed to do what it can with its Fisher-Price toolkit. I expect the Fed to pursue QE3-lite, a housing-focused program like an airtight, hyper-HAMP.

I understand the predicament, so instead of uselessly complaining about the mistakes of yesteryear, I’m trying to figure out how our country gets out of this.

–Romeo

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  1. re: Employment Benefits… Calculated Risk noted this afternoon:

    NELP’s new analysis shows that in 2011, six states cut the maximum number of weeks that jobless workers can receive unemployment insurance to less than 26 weeks—a threshold that had served as a standard for all 50 states for more than half a century, until this year. Michigan, Missouri, and South Carolina cut their available weeks down to 20; Arkansas and Illinois cut down to 25; and Florida cut to between 12 and 23 weeks, depending on the state’s unemployment rate. Double-digit unemployment in Michigan, South Carolina, and Florida did not discourage lawmakers there from making the cuts.

    … Indiana changed the formula it uses to calculate weekly benefit amounts so that the average unemployment check will drop from $283 to $220 a week.

    Throughout the recession, states with inadequate unemployment insurance trust fund reserves have relied on loans from the federal government to pay state unemployment insurance benefits. This September, states will begin paying interest on these loans, and starting in 2012, the federal government will raise taxes on employers in borrowing states until loans are paid in full, as required by the law.
    http://www.calculatedriskblog.com/2011/08/states-cutting-unemployment-insurance.html?utm_source=feedburner&utm_medium=twitter&utm_campaign=Feed%3A+CalculatedRisk+%28Calculated+Risk%29&utm_content=Twitter

  2. […] didn’t rear any growth from the lowest lows of the Great Recession, to wit I have also noted Real GDP having not exceeded its 2007 high-water-mark… SPX/Gold- S&P 500 priced in Gold. […]

  3. […] (GLD) severely, and I thought GLD was grinding up in overbought territory.  (I already had an open GLD long, but I hadn’t been able to build a big enough stake before the price rallied […]

  4. […] (GLD) severely, and I thought GLD was grinding up in overbought territory.  (I already had an open GLD long, but I hadn’t been able to build a big enough stake before the price rallied […]

  5. […] decoupling? My hunch suggests the answer is not so binary: America has regressed into a “shakeout,” which I foretold this […]

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