At These Levels

The 18-mile bike ride from my house to the office nearly killed me this morning. I managed to pull a muscle on my left arm so even typing on a computer keyboard requires some effort. Somehow, this seemed like a great idea this morning and now the 18 miles on the way back, not so great.

Last night the new issue of The Econtrarian came out. It has some great insights in the history of the Federal Reserve and the reality that the more things change, the more they stay the same. Regarding the outburst in inflation around World War I and the subsequent boom with the low inflation rate in 1920, The Econtrarian notes:

"Not only was the year-to-year variation in prices relatively small, the wholesale price level in the seven years ended 1929 grew at an annualized rate of change of only 0.3 percent. A prominent economist at the time, Irving Fisher, praised the Fed’s policy by saying that 'stabilization ushers in a new era for our economic life … adding much to the income of the nation.' This is the same Irving Fisher who on October 16, 1929 exclaimed: 'Stock prices have reached what looks like a permanently high plateau. I do not feel that there will soon, if ever, be a fifty or sixty point break below present levels … I expect to see the stock market a good deal higher than it is today within a few months.' Between October 1929 and June 1932, the monthly average of the S&P 500 stock market index fell by 83 percent. So much for prominent economists’ forecasts of stock market performance."

The whole report is here.

A different approach yields similar outlook.

I find it amazing that the stock market completely reversed yesterday's loss while Treasury yields took out yesterday's highs on a poor 5-year note auction. Those two events should be mutually exclusive.

And the bond situation is the same around the world. I don't know if it's the end-of-quarter window dressing or what, but it doesn't look sustainable. The market can be irrational longer that you can remain solvent; that much is true.

Yesterday's market reaction to the Bernanke "coming out" party speaks for itself. I'm inclined to wait until the end of the day before commenting too much on the action.

The take in yesterday's post "I Can't See Bernanke Here" indicating that the FOMC statement read as if Greenspan wrote it is resonating with the press, while the inflation concerns that I had in Global ViewPoints the past couple weeks are resonating with the Fed.

The Federal Reserve statement:

"The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 4-3/4 percent.

"The slowing of the growth of real GDP in the fourth quarter of 2005 seems largely to have reflected temporary or special factors. Economic growth has rebounded strongly in the current quarter but appears likely to moderate to a more sustainable pace. As yet, the run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation, ongoing productivity gains have helped to hold the growth of unit labor costs in check, and inflation expectations remain contained. Still, possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures.

"The Committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives." [emphasis added]

Looks like 5 percent at a minimum, but dare I say more? Stocks not liking it on a knee-jerk reaction.

CNBC is running with that "independent" research story about Biovail, but Jeff Matthews is so much more on the money here.

The Federal Reserve's statement will be picked over with the finest-tooth comb given the new author, Ben Bernanke. Greenspan used to write the previous FOMC statements, and I wonder if it will be the same here. The market has been "on hold" for more than a week around the 1,300 level on the S&P, and it should move violently after the statement.

As usual, the real move sometimes comes on the next day. Make no mistake, market participants are looking for the light at the end of the tunnel in that statement. They want to hear the Fed is almost done, but many also believe the Fed won't signal the end of the tightening cycle until it is actually over.

The program trading statistics are out, and the verdict is in (I talked about this on Thursday).

Program trading as percentage of total volume on the NYSE was 68.9 percent on the breakout week. Every 2 out of 3 trades were executed by a computer to get stocks and indexes on the on desired prices.

I have no idea how long this will continue, but my guess is not forever. The ratio can't go to 100 percent, as we'll all leave (the bulls and bears are in the same boat on this one) and the programs will take over.

The ratio went from 20 percent six years ago to regularly approaching 60 to 70 percent these days. When people wonder why the rallies and selloffs don't live up to expectations and prematurely die, it's because of programs continuously reverting to the mean, in my outsider have-no-evidence-other-than-anecdotal-to-prove-it view.

There are people who have worked hard on the proof, and given the fact that the company they work for runs several billion dollars, I wouldn't call their credibility into question right away.

Source: NYSE, Ivan Martchev

Not as velvet this time as last time.

I just received this e-mail from a long time reader:

"Regarding your real estate flipping story in today's issue of Global ViewPoints, here is another good one for you. In 2003 my wife and I were looking to purchase a Florida condominium not for investment but to use as a winter getaway. We didn't even want to rent it out. We inked a deal for a condo in Venice, FL in Nov. 2003 just as real estate there was beginning "take off". (I paid about $20,000 more that the initial price when the development was started in early 2004). It took 1 year to build, and we closed in Nov. 2004. By that time, the units just starting HAD DOUBLED IN PRICE! They were completed at the end of 2005 and into early 2006. Of 160 units in the complex, at least 32 are on the market right now and a few original units had sold previously. Most have not even had blinds put up or furniture placed in them. They just closed and put up the sign! This is taking place in Sarasota county where there is a 3 year "supply" of properties on the market and NO ONE is buying. Most of the flippers doing this are setting themselves up to be creamed because they got into the game way too late and had to wait 1 year to take ownership to boot. By that time the market had completely reversed! I'm not worried...I use my condo 10-12 weeks per year and enjoy the lack of crowds at the pool and the tennis courts! For me it's a long-term vacation home."

And how about this from Bloomberg.

 www.bloomberg.com

Clearly, new home sales used to be a very cyclical indicator (see above). I don't want to know how far they can fall, but I have a feeling I will find out.

I'm going to do something that I rarely do (that is called an exception). I'll give you some premium commentary I'm currently writing.

I have a regular lunch meeting, which tends to spiral out of control, at the local Palm restaurant. The words "pan-seared, cold in the middle" may not mean anything to you, but around the office a colleague has almost earned the "pan-seared" nickname for always ordering the same thing at The Palm! And he's been to The Palm long-enough to get enough "Palm dollars" to be cartooned on the wall (no joke here).

So off I go to pan-seared jokes and here's the premium commentary. Technically, no one is paying for the premium part yet, but that's the master plan:

"During the past week, the markets have done little, which makes the prior week's progress somewhat suspicious, as it came right before options expiration. The biggest dealers of options on Wall Street are also the ones who run the most powerful trading programs. And they can create a rally for no reason, including just to push indexes and stocks to the prices they desire come expiration time.

"I hate to sound conspiratorial (although I often do), but do you know that the program trading volume is 57 percent of total average volume? That ratio is regularly above 50 percent, and growing? In other words, more computers execute trades on the NYSE than people. Sometimes it feels like Don Quixote is battling the financial windmills of program traders and losing, I'm afraid to say. The ratio was running consistently below 20 percent in 1999, but in 2005 and 2006 it climbed to more than 50 percent. And it has been as high as 76.3 percent.

"I only mention this because few individual investors realize the size of the problem, with the caveat that a problem for some people is obviously an opportunity for others. Stocks can and do move for numerous other reasons than the fundamentals, but such are the rules of the game. You can't change them. If you don’t like the rules, don't play. If you are interested in seeing the main culprits, the last reported week is here in pdf format, with UBS Securities not only the largest program trader overall (see "total" column), but also, by far, the largest for its own account (see "principal" column).

www.stockcharts.com

"One of the results of program trading is the 'meandering' of the major indexes with little progress to either the upside of the downside. The S&P 500 hit 1,270 during Thanksgiving week and has made little progress since--up 4.4 percent year to date--even though there's been a slight upward bias. People become excited on every new high, but in reality the selloff that follows the marginal new high is larger than the magnitude of the new high advance. This will be over soon, as the market is coiling for a big move. The perennial question is which way?

"I mentioned in January that the market has made a major turn every March during the last five years. If it was vigorously selling off, it bottomed for a long period of time. If it was rallying, it made a top. March isn't over and the recent new high gives the crowd false comfort.

"Another reason for the new highs on the major averages was the bond market taking a breather from the substantial pressure it's been under. As detailed in this week's Global ViewPoints, the risks is that bond yields will rise further, which is likely to put pressure on stocks. Any move above 4.80 percent on the 10-year Treasury yield should be respected.

"Bond markets are under pressure worldwide. This is from a recent Credit Swisse daily commentary:

• The long-term trend is rising for 47 of the 49 global stock markets (= 96 percent = bullish). The medium-term trend is rising for 86 percent of all 49 markets. The short-term trend is bullish for 73 percent of the 49 markets.
• The S&P 500 index should hold above 1,295/1,290 or a correction is likely to have started. A break below 1,275 will signal a break of the wedge downwards. The trends in the 500 S&P Index constituent stocks are still long-term positive as 72 percent of all 500 stocks are rising, 67 percent are medium term rising and 66 percent are short-term rising.
• Bond price trends remain bearish as 78 percent (long term), 95 percent (medium term) and 92 percent (short term) of the 37 bond markets tracked are in a downtrend. [emphasis added]

"Clearly, the fact that bonds are selling off and stocks are rallying is a global phenomenon. I don't think it is sustainable, but, fighting windmills has never been a winning strategy, so one must respect the tape. "

The quotes below are from a much longer piece "Inside the China Debate" from Morgan Stanley's Chief Global Economist. I have rarely been more entertained while reading macroeconomic reports:

"The third message was the show-stopper, for my money. It came in response to a question I raised on the growing and worrisome risks to the US-China trade relationship -- a topic that I had just spoken on in the formal proceedings of the China Development Forum (see my 20 March 2006 Special Economic Study, “Globalization and Mistrust: The US-China Relationship at Risk”). The time was late, and we were all tired after two days of intense discussions. This was the last question of the meeting -- and the final word from the Chinese leadership at this year’s China Development Forum. The Premier was especially animated and intense in framing his response. “China views this relationship as very important,” he said, “and takes these risks very seriously.” He implied that efforts will be made to further expand Chinese imports from the US as well as deal with the all-important concerns over intellectual property rights. He was emphatic in re-emphasizing the limited role that foreign exchange policy could play in tempering the US saving shortfall and related trade imbalance -- in effect, implying no major change in the RMB exchange rate. At the end of his discourse, he leaned forward, looked me straight in the eye, and stated with great emphasis, “You can take this message back to the American people: It is unfair to make China a scapegoat for structural problems facing the US economy.

"The next morning, as luck would have it, I had the opportunity over breakfast to run Premier Wen’s comment by three US politicians who just happened to be in town -- Senators Schumer, Graham, and Coburn. As they put it, the liberal, the moderate, and the conservative, respectively, had come to China in a rare moment of solidarity to demonstrate both the breadth and depth of bipartisan political support to bring the US-China trade issue to a head once and for all. Schumer and Graham, of course, are co-sponsors of a bill (S. 295) that would impose 27.5% tariffs on all Chinese imports into the US unless there was an RMB currency revaluation of a like amount. They were steeped with confidence that this bill had overwhelming support in the Senate and most likely comparable support in the House. And since it played to the angst of middle-class US wage earners, they did not expect the first veto of a politically-weakened President Bush to be exercised on this issue.

"Chuck Schumer is a very smart and savvy man. He is using the bully pulpit of a prominent politician to put so much pressure on China that it will have no choice other than to give. Nor does he have much doubt that this approach will work. “This is exactly what I did in Japan in 1986,” he said -- apparently the last time he was in Asia [Did you feel the velvet punch?]. “It worked in Japan and it will work in China.

"While the senators claimed they were there to listen and learn, my guess is that this was a classic window-dressing sojourn. As I probed them on the issues, they had all the answers down pat -- their minds were made up. Schumer actually conceded the point on the structural macro linkage between the trade deficit and the national saving problem -- a first for a major China basher. This, of course, has been a major leg of my own macro stool for longer than I care to remember. “I agree with you,” he said, “America doesn’t save enough and we consume too much.” Fine to that point, but then he turned the logic inside out: “I care deeply about the loss of US manufacturing jobs to China. If I am successful in cutting our trade deficit with the Chinese, not only will those jobs come back home but I will have succeeded in boosting US saving and cutting excess consumption. My bill can do all that and more.” I am rarely speechless, but at that point, I started to choke on a huge bite of watermelon. “Let me get this straight,” I gasped, “tariffs will boost saving?” Too late -- he was already off to face the ever-present battery of cameras and microphones. "

The whole report is here.

I get really annoyed when I read this (such garbage appears regularly in the press), written by people who clearly don't know what they're talking about. To understand my rise in blood pressure, read this, written by people who do.

From Bloomberg:

"UPS Uses Political Clout to Press for Cuts in Pension Benefits

"March 20 (Bloomberg) -- For 15 years, United Parcel Service Inc. has spent more money on U.S. elections than any other company. Now UPS, which has gotten its way on everything from federal highway programs to expanded routes to China, is seeking a new return on its investment.

"The world's largest package-delivery service wants Congress to allow employers to cut pension benefits already promised to some workers in plans funded by multiple companies. Atlanta-based UPS says the plans can no longer afford to pay full benefits because so many companies that used to pay into the pool have gone out of business. As the number of contributors shrinks, remaining companies are obligated to fund the retirement plans."