Archive for March, 2007

The Market – Tortilla Inflation

In case you haven’t heard, there are suddenly a lot of angry Mexicans these days.  I am not referring to the forced expulsion of illegal immigrants from this country, many of whom experienced disclocation from their families here in the States.  (Yes, they are illegal, and yes, it is a problem, but we probably could be a bit more humane with our illegal immigrant policy).  Nope, this instead is due to the price of their most basic food product, the tortilla, shooting through the roof.  TheStreet.com writes on 3/26/07, “In Mexico, manufacturers have already started to feel the pain of the [food] inflation, with political consequences.  In January, Mexico’s President Felipe Calderon was forced to impose a price cap on tortillas of 35 cents a pound, after thousands stormed Mexico City’s Central Square in protest of the massive rise in recent prices of tortillas.  Tortillas are a staple in the diets of most Mexicans and a key component of the Mexican economy.  The price cap, which is 40% more than the price for tortillas only three months ago, is still generating political tension in the country.  The hike in tortilla prices is believed to be a result of the demand for corn ethanol, generated by President Bush’s recommendations for a fourfold increase in the use of the substance in his new “cleaner energy” initiative.””  Some may laugh at this thought, but let’s be sure to remind them of all the American’s who complained bitterly because their cigarette prices were hiked substantially in an effort to quantify and pay for the effect of smoking on the public health system.  And as far as I know, humans don’t need cigarettes to survive.  Furthermore, increasing food prices due to an emerging third world middle class and the surge in demand from ethanol production will also hurt American’s wallets.  Rising food costs is not simply a third world issue. 

So in another classic foreign policy blunder becoming so endemic of this Administration, we are now exporting poverty to the lower classes of the third world.  And we are doing so in an almost blind hope that our investment in ethanol will add a net positive energy balance to our economy, instead of spending the billions in spending and subsidies on other alternative energy technologies.  But… this is what the decrepit US auto industry wanted, this is what US oil companies wanted, and unfortunately in our country, more often than not, the corporations, and not consumers, have the government’s ear first.  So let’s give the third world another reason to hate us by making it more difficult to pay for basic daily meals.  And don’t be surprised if you hear Chavez start expounding about how the great American evil empire is now trying to starve Latin American countries.  We just can’t seem to stop giving ourselves a black eye.

Add comment March 28th, 2007

The Market – March 21, 2007, Day of Disbelief

Today’s market action goes beyond belief and expected reality.  The two percent increase across all indices simply because of the deletion of the words “additional firming” without a thoughtful analysis of the meaning behind the Fed’s statement, screams ignorance as the bulls and bargain hunters shoot first and think second.  The Fed changed its typical language, dropping the focus on further rate hikes. The new language reads: “Future policy adjustments will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.” The old language reads: “The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.”

Perhaps the Fed doesn’t know what they are doing (unlikely), but let’s consider the change in the Fed policy statement relative to the data since the last meeting.  In the face of increasing inflationary pressures, further signs of economic deterioration, and housing malaise, the Fed decided to remove their “additional firming” position.  If the Fed is develping a more dovish stance, as the market seemed to believe today, then this Fed may not be very smart.  But I don’t think the Fed’s intention today was to suggest that it is more dovish (much to the market’s chagrin).  Rather, I think the Fed’s intention was to show that its concern is no longer simply about inflationary pressures, but now includes increasing concerns over the potential for macroeconomic systemic shock risks (such as subprime fallout, continued housing malaise, potential manufacturing sector recession, etc.) and a weaker than expected economy.  The Fed is basically saying, “we do not believe inflation is the only risk anymore, as such we are removing the ‘additional firming’ position and replacing it with ‘we will do whatever is necessary to help this economy if it weakens more than expected, or suffers a sudden systemic shock, or inflationary pressures increase.”

I have to wonder if during this frenzied bullish up-move today, did no one step back and think ‘hm, the Fed really talked a lot today about increasing inflationary pressures… maybe they aren’t trying to suggest they have a dovish position.”  The Fed even said, “Recent readings on core inflation have been somewhat elevated.” That’s opposed to January’s statement, which read: “Readings on core inflation have improved modestly in recent months, and inflation pressures seem likely to moderate over time.”  Today’s Fed was not a dovish Fed; it was a Fed proactively positioning itself for a quick response to the three economic risks noted above.  Remember, we are dealing with Helicopter Ben, whom likes to remind the market of the Fed’s multiple tools available to sustain stable economic growth.  Hopefully the market will come to its senses, and all of the fast money that greedily poured into the market today will somehow grow a brain and consider that the Fed may be more concerned about the economy than it would like to let on.

Add comment March 22nd, 2007

The Market – A Speculation Induced Sell-off

Though the market has had quite a fall, I don’t think we have even seen a general selling panic and that suggests this recent fall simply reflects the closing of leveraged speculative positions. A tremendous amount of carry-trade speculation may have been built into this market! There is potentially another 40% carry trade speculation built into the Yen, which gained in value from around 121 to 116.7 this week (not to mention Swiss Franc) if you assume the Yen should more likely be priced around 112 given the underlying fundamentals of the Japanese economy. That is a lot of potential liquidity hitting the markets over the next few weeks. Throwing some numbers out there, if speculative carry-trade closing represented 80% of this markets fall, or around 3.5% for the week, more unwinding could represent around a 2.8% fall.

Why do I suggest that speculative unwinding represented so much of this market’s fall? Various commentary talks about how most institutions and average American investors still seem to be holding to their portfolios and “according to a new MSN-Zogby poll, just 5% of Americans said they see a decline like this week’s as an opportunity to buy, and only 1% said the slumping stock market causes them to sell. Thirty-four percent said they either don’t own stocks or are unsure how to react to a downturn.” CNBC writes, “most strategists on Wall Street haven’t made any moves in their portfolios, however, as they believe it is still too early to determine which moves to make, CNBC reported: “Now that the correction is on us, people are trying to decide what to do,” said Jordon Kimmel, a market strategist at National Securities.”

So will this market continue to have an unwinding of leveraged speculative positions? The risks that could force a carry-trade unwinding and closure of speculative market positions include increasing Yen value, fall-out in the sub-prime and thus CDO market causing capital requirements to clean up that mess, a few blow-ups in highly leveraged hedge funds, a broader fall in the market led by the average American investor and institutions not partaking in the carry-trade, and also a blow up in an emerging market like Russia or India. Jim Jubak of MSN Money writes, “India is very dependent on global cash flows. Unlike China, India runs a trade deficit and only showed a total capital account surplus in fiscal 2006 because of that $12.5 billion from overseas investors in stocks, foreign direct investment of $6 billion in 2006 and rising corporate borrowing on international capital markets (about $6 billion in fiscal 2005). India was relatively untouched by the Asian financial crisis of 1997, but it is much more vulnerable to changes in external cash flows today.”

The defining aspect of this market run-up and recent fall was the liquidity explosion driven by cheap credit that took the positive market reaction to a ‘goldilocks’ economy and drove it even higher both here and in emerging markets. Unfortunately, it is extremely difficult to measure how much liquidity in the system is currently priced into the market, as well as the leveraged risk structure of that liquidity. We are able to measure, with some broad assumptions, some of that liquidity risk exposure through the fall of the Yen and Swiss franc and the corresponding fall in the market. Yet overall, too many people know too little about the amount of risk built into current liquidity levels, especially with regard to the derivatives market and CDOs.

A key aspect of this recent market fall is that it didn’t really involve the average American investor and institutions not partaking in the carry-trade. Whether this is dangerous complacency or simply confidence is an important question. Most of the market commentary I read suggests that because the economy is fine, this market should regain its footing and start trending up again. But should we rely on an altar of unbridled confidence when so many bearish tipping points exist? And could seemingly insignificant events, such as the trading scandal, though not in any way a fundamentals changing event, add a smell of rot to this market and increase investor skepticism?

Over the next few weeks, it is going to be very important to watch the effect of the speculative positions on the mentality of the base market support and hope (unless you have a bearish position) that none of the tipping factors described above lead to further speculative unwinding and a bearish domino effect on the broader market support. For instance, the fact that gold fell so much and is now at $644 while silver is at $12.90 is quite interesting. It suggests real concern that China is slowing down. I think it also suggests an unwinding of speculative positions. As mentioned above, the fact that most investors, including the average American investor and institutions not participating in the carry-trade, have not felt the need to reposition their portfolios, ie, buy gold or silver as a defensive hedge, suggests that the fall in these two metals was speculative position closing. I think if these metals start rising in value, and the Yen or Swiss franc do not fall in value suggesting a carry-trade re-strengthening, then consider that a bearish sign that the broader market is buying gold and silver as a hedge against further market deterioration.

On a technical basis, the Nasdaq is suddenly very close to its 50 day weekly moving average around 2,300, only about 70 points or 3% away from Friday’s close! The Dow is also quickly approaching is 50 day weekly support around 11,750. That is about 360 below Friday’s close or 3%, and that could feasibly be reached as Dow lost 533 this last week alone. If either index blows through those supports, we could see some real downside with selling pressure from broad market investors.

Add comment March 3rd, 2007


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