Trader’s Narrative

In today’s highly charged political environment, apparently everything and anything is game for the machinations of partisan political hacks. Even the US dollar has been pulled into this. So much so that it is generally believed and accepted that the US dollar is kaput, done for, worthless. And that the blame resides on the shoulders of Obama and his young administration.

But what if we step back from the raging and weeping talking heads on TV and instead of opinions, we just look at the facts?

Here is a chart of the US dollar for the past quarter century:

Reagan’s presidency presided over a boom and bust in the dollar - with the bust being the winning side. Trickle down didn’t really work but the deficit ballooned as tax cuts to the wealthy reduced government revenues. In 1989, the Republicans continued control of the White House with H. W. Bush’s presidency. While his administration managed to avoid a similar feat, the US dollar fell to new lows during the first half of his term.

The US dollar regained 50% of its value during Clinton’s presidency. You could argue that it was due to the balanced budgets and the elimination of the federal deficit. Or that it was due to the increase in the tax burden on the wealthy. There was even talk of reducing the federal debt. All that ended with the advent of the W. Bush administration.

Budget deficits and the US debt ballooned due to massive spending increases as well as tax cuts for the wealthy. The result was another major decline in the US dollar. Almost at the end of Bush’s second term the US dollar fell to multi-decade lows but recovered slightly as the last days of his administration drew to a close.

And that brings us to the present day with President Obama. He inherited an economy which almost overnight went into free fall. While I don’t agree personally with the measures taken to buttress the US economy, it bears noting that the US dollar is still above its recent W. Bush low. Also, as a contrarian, it is difficult to ignore the incredibly bearish view on the dollar right now.

So talk of a US dollar crash is either prophetic (if it becomes true) or Chicken Little-ish (if it doesn’t). And while 25 years or so is too small to make judgements on which, the Republicans or Democrats, are the better custodians of the US dollar, it is reminiscent of the counter-intuitive result of looking at the returns of the stock market under different political banners.

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The US financial system was resuscitated by the largess of the taxpayer. Without any real quid pro quo, transparency nor discussion, they were made whole. Their losses made public while their profits were guaranteed to remain private (as the recent obscene bonuses attest).

So now that the US economy is still on the ropes, fighting for its very survival and in dire need of a liquidity transfusion of its own via the credit markets, where are the banks?

Surely they are pumping the lifeblood they received from the US treasury and the Fed back into large and small businesses that are the engines of growth to allow the economy the same recovery they enjoyed. Right? right? Well, no. In fact, if you assumed that you couldn’t be more wrong.

As you can see from the chart above, bank lending in the US has contracted to an unprecedented degree. You may notice that a contraction of some shape or form happens each time we have a recession (the dark bars). And you would be right. But we are not taking a random walk down Wall Street these days. These are extraordinary times, which required extraordinary measures - whether rightly or wrongly.

So what are the banks doing with all the cash they received from the hard working American Joe and Jane Sixpack?

Hoarding it like a miser:

So we have banks flush with cash, not lending to those who need it and deserve it, but rather sitting on the cash or in Goldman’s case, using it to generate billions of dollars in profit which then is promptly cut in half to be paid as bonuses.

As David Rosenberg of the Toronto boutique firm, Gluskin Sheff posits, this may be why the US government bond market is so subdued:

The banks are deploying the cash in the government bond market, buying a net
$27 billion in the latest week and $130 billion in the past 18 weeks. Meanwhile, cash reserves keep piling up and just reached an all-time high of $1.2 trillion — enough to finance the entire U.S. fiscal deficit. This is a nice back-of-the-door mechanism for how the Fed is monetizing the government’s endless need for money: bolster reserves at the big commercial banks and have these banks buy the bonds that Uncle Sam sells in order to raise the capital needed to fund all the government’s fiscal stimulus measures.

Here is a very long term chart of the US 30 year bond yield:

The Chinese have a saying: ‘May you live in interesting times.‘ All I dare hope is that things don’t get any more interesting than this.

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This morning the Labor Department issued its report on employment conditions for September. The consensus estimate among analysts was -170,000 but the data came in at -263,000. This was worse than last month’s 216,000 job losses and even worse than most pessimistic estimates.

Here’s a long term chart of the nonfarm payroll data going back to the 1960’s:

TrimTabs had the lowest estimate at -358,000. They based this on the continuing decline in income and employment taxes withheld from paychecks. As well the TrimTabs Online Job Postings Index continues to be flat.

The weakness in the economy is reflected in the real-time Aruoba-Diebold-Scotti business conditions index which we looked at yesterday. The most recent data shows an adjustment downwards, taking the ADS index to -0.927 (from around -0.20).

The trend is once again down, which implies a contracting economy. This wouldn’t be a big deal had the ADS first spiked above zero as it has many times before recovering from a negative economic shock. But we didn’t see that this time as the ADS was barely able to return to zero before falling back into the negative.

Back in April, when this rally was young, we looked at something called the Anxious Index - a sub-index of the The Survey of Professional Forecasters which has had an uncanny ability to not only find the start of recessions but also to foretell their end.

Its most recent data (3rd Quarter of 2009) shows that it has collapsed from 74.78% to under 24%. This means that if the great recession isn’t over, it soon will be. At least according to the entrails of this specific econometric indicator. While we’re on the topic of econometric data, let’s take a look at another index hosted by the Philadelphia Fed.

Its full name is [deep breath] the Aruoba-Diebold-Scotti Business Conditions Index. The ADS index was the brain child of 3 economists - hence the tongue twister of a name - and it aims to measure economic activity. But unlike most metrics which are either lagging or leading indicator, it aims to track economic activity in real time. You can get detailed information about it here.

Here is a long term chart showing all the data for the ADS index from when it began being aggregated in March 1960 to now:

We just went through the deepest correction since the mid 1970’s. Looking at the chart, I also noticed that very rarely we see spikes when economic activity screeches to a halt, before rebounding sharply back to normal. The average value of the ADS is zero. Any number below it represents a contracting economy, and positive numbers indicate a falling unemployment and positive growth. So I became curious. What if we isolated just the 6 or so lowest readings and compare how the S&P 500 behaved during those periods. You can see the charts below.
Continue reading ‘The Aruoba-Diebold-Scotti Index & The S&P 500′

Last week I presented a historical study of what happens when the S&P 500 is this far away from its 200 day moving average. If you missed it, click the link to check it out in full.

According to the study, when the stock market has trended enough to set off this indicator, it has trouble continuing its heady ways in the months that follow. The average 6 month return is -5%.

If you look at the data carefully, it becomes apparent that certain date ranges contain a lot of repeated instances where the S&P 500 index is 20% or more above its long term moving average. We’ve just traversed one of these periods from September 16th to the 22nd. Between those dates there were 5 consecutive days were the S&P 500 was at this threshold (or very very close).

The last time this occurred was at the end of July 1997. But the best example was of tenacity in this indicator was in late 1982, just as the great generational super bull market was launched. Although the expected consequence of such an overbought condition is for the market to hit a wall, or at least to pause, during the start of the great bull market, this was not the case. While it continuously flashed red, the stock market continued to climb higher and higher, acting very out of character.

So the question is whether what we are seeing is a repeat of that atypical market action. In other words, do bull market rules apply?

Although there is no way for me or anyone else to prove it definitively one way or another, I highly doubt that what we are witnessing is the dawn of another rare secular bull market based on one variable: valuation.

I mentioned a lot of ratios, statistics and data before but putting all those numbers aside, here is a simple chart which sums up the strange voyage we have taken, from fully priced perfection to panic induced forced liquidation and back again:

That doesn’t look like a great launch pad for the next generational bull market. Heck, even bonds are priced for perfection. At best, we are going through a cyclical bull market - otherwise known as a bear market rally.