Friday, July 29, 2011

Week in review 7.29.11

Thank you congress for that ugly, ugly week. 

The S&P 500 lost 3.92% as the all important debt ceiling deadline hung like a dagger over the head of the global economy.  All things considered though, 3.92% may not actually be too bad in relation to the gravity of the situation.  Between the relatively tepid decline in stocks, marginal increase in the VIX (to 25) and decline in treasury yields, securities prices don't seem to really believe that the government is going to default, or more importantly that a default would do too much harm to the economy.  

Still, Washington's lack of understanding of all things practical never ceases to amaze.  Even to a person who is in favor of a balanced budget amendment, it is stunning that congress would choose to take an ideological stand against the backdrop of a ticking-clock deadline.  Where were these principled politicians the last dozen times the ceiling was raised?  Why can't sensible policy be crafted in the absence of crisis, when time would allow for a thoughtful discussion of the future?  Why does the country have to be pushed to the brink of insolvency and beyond for politicians to take notice?

How lamentable that our politicians are only motivated to act with their backs against a wall.  Worse yet, is how once motivated Washington appears incompetent.  The US government should not be even close to the position that it is in today, 4 days from a "technical" default.  Set aside the fact that a compromise should have been made weeks ago, true leaders would have taken a stand years ago.  But now the stakes are too high, and the time for ideologues has passed.  Washington first must raise the arbitrary debt ceiling and then worry about how it's never going to come close to breaking it again.  Both do not need to be done at the same time, but both need to be done.

It's so difficult to give these politicians the benefit of the doubt, but even despite the theatrics, the rational observer must acknowledge that the most likely scenario continues to be that a deal will be struck.  This would obviously have positive implications for securities prices, which is probably why stocks ended the day off of their lows.  Even Washington isn't crazy enough to put political gamesmanship over the welfare of the US citizenry.  Let's hope.

Friday, July 8, 2011

Week in review 7.8.11

Considering the frequency of these posts, maybe it would be more apt to label this “month in review” rather than week in review.  I hope to be a little more consistent in my market commentary from here on out, but intentions and reality can often diverge.

Since my last post, the market has rallied 5.73%.  Without patting myself on the back too much, it seems that mid June was indeed a lot closer to the end than the beginning of the selloff.  Since then the pendulum has swung rather quickly (and with little reason) from fear towards greed.

Many would probably argue that we rallied because a bandage was applied to Greece or Japan is coming back on line, but I think the real reason is simply that stocks got too cheap.  “Consensus” is still expecting the S&P 500 to earn $100 for the current year, which means that at 1260, we were trading at 12.6x earnings.  Assuming the 30 year bond is priced correctly (it isn’t, but just to entertain) equities were trading at nearly a 400 bps spread to treasuries on a forward earnings yield basis.  That seems too high to me.

We’ve rallied a lot, but unlike my view in my last point, I think we’re closer to the beginning of this move than the end.  To be sure, we’ve gotten pretty overbought in the last couple weeks, but this week and particularly today were a nice breather for a bullish market.  Barring a total flub by congress on the debt ceiling (which I don’t think will happen) it looks to me like we’re entering the third leg of the economic cycle in which disbelief turns to belief turns eventually to euphoria.  Spare capacity though ample now should begin to tighten from here and CPI inflation likely will begin to pick up as the year moves on.  On a day where unemployment rose to 9.2% it’s tough to see this happening, but that’s typical.  Clarity tends to come with hindsight.