Just a little charting. Here is the a junk bond index SHIAX plotted together with S&P500 (click to enlarge):
As you can see all previous tops and bottoms of SHIAX and S&P500 are exactly coincident, except the last 6 weeks.
Maybe this pattern is accidental? Ok, lets look at the 10 year chart:
All the same pattern for the last 10 years, except this time.
So, this time is finally different? Yes, I think so. The stock market is finally separated from the reality
July 14, 2007 at 3:16 pm
interesting, not sure what it means beside your comments, maybe you could expand your idea for citizens like myself.
thanks for posting,
July 14, 2007 at 4:43 pm
Simple.
Both junk bond index and S&P index are essentially measuring the same thing – the balance of fear and greed. Usually fear and greed in junk credit markets is exactly coincident with fear and greed on the stock market.
Not this time. Various credit markets, like junk bonds or MBS/CDO markets are experiencing panic, blood and fear. But stock market is doing just great, like those people don’t worry about anything.
Maybe someone spread liquid Prozac on NYSE floor?
July 14, 2007 at 8:01 pm
Oh that is too funny. It is to bad this is not out in the mainstream press so the masses can truly understand.
July 14, 2007 at 10:04 pm
>Not this time. Various credit markets, like junk bonds or MBS/CDO markets are experiencing panic, blood and fear. But stock market is doing just great, like those people don’t worry about anything.
I suspect that the street believes that fallout in the bond market (CDO’s) will force the fed to lower raises and attempt to cut off a crisis by flooding the market with liquidity. If they are right, than the stock market should do fine as inflation means higher earnings as they raise the prices on good and services. After, all it worked just great back in 2002, when the fed started to cut raises to historic lows. Why would this time be any different? When bad news hits the new wire about declining retail sales or bad news about housing, the market almost always jumps higher (on the believe the Fed will cut). Whenever good news comes out, retails sales are up or home sales, increasing number of new mortgages, the market falls on the belief that the fed will hold or raise rates. The market is fixed on future fed action. Everything else is irrelevant.
There is a good chance that Fed or Congress will bail out the subprime mess. After the first group of Subprime lender bankruptcies, Congress drafted a $168 Billion bait out fund. If the Fed or Congress starts bailing, shorting the market is probably a bad idea, as their would be no credit crunch, but a blow out in inflation. If their is a bailout, the market will believe that all loans are guarenteed and its impossible for anyone to lose money. This would kick off another wave of reckless investing.
Eventually the tide will turn, but I think actions by the Fed and Congress could delay “judgement day” by at least another two or three years.
We certainly live in “interesting times”, but I would settle for ordinary times in a heartbeat!
Best of Luck to everyone.
July 14, 2007 at 10:42 pm
>>> I suspect that the street believes that fallout in the bond market (CDO’s) will force the fed to lower raises and attempt to cut off a crisis by flooding the market with liquidity.
Could happen, agree. That will put oil at above $80, so I’m holding positions in oil and commodities to hedge that scenario.
>>> shorting the market is probably a bad idea
Oh yeah, NEVER EVER short the market. I short tons of stuff, mostly homebuilders, REITs and financials. But I would never short the whole market. I’m actually long tons of stuff, too.
July 15, 2007 at 8:36 pm
I don’t accept anonymous’ theory, as the collapse in 1998 shows correlation even as the Fed cut and LTCM was bailed out.
Also, regarding shorting the market. There’s no chance of the SPX getting bought out at a 60% premium, but that risk is there on any homebuilder, REIT, or lender right now. Even when the announced deals are pure BS and fall through, the pain of a short would be terrible, and many won’t hang on through it.
BTW, with consumer spending collapsing off a 0.7% GDP, it’s hard to see how this overvalued market could sustain any further rise.
July 15, 2007 at 9:28 pm
i agree with anon y mous – shorting individual names and shorting the broad market both have advantages and disadvantages.
one thing you fail to mention re: the broad market is that there’s never been a recession in the past 50 years during which the S&P500 *didn’t* fall by double digits. the average decline has been something like 25-30%. maybe this time it really will be different, as you say, but i doubt it.
July 15, 2007 at 10:14 pm
btw, i hope my last post didn’t come across the wrong way.. i actually always enjoy reading your blog.
July 15, 2007 at 11:31 pm
>>> never been a recession in the past 50 years during which the S&P500 *didn’t* fall by double digits. the average decline has been something like 25-30%
Yes, but you will never pick the exact top and exact bottom. Suppose you will make only 20% out of 30% market decline during 2 years. Besides, you will short too early and initially will lose some substantial amount, making your family unhappy about you.
My theory is that it’s much better to short bad stuff instead on the whole market and get long some good stuff to participate in the market rally if it happens.
July 15, 2007 at 11:34 pm
Suppose the rulers will decide to destroy the dollar in order to save housing and stock market. How to hedge against that possibility? I think by getting some oil.
July 16, 2007 at 1:45 pm
anon y mous Says:
>I don’t accept anonymous’ theory, as the collapse in 1998 shows correlation even as the Fed cut and LTCM was bailed out.
FYI: That was my post. I forgot to put my name when I posted. My apologies.
Can you elaborate why you disagree. If I recall, the blow out during the 1998 crisis stemmed from a crisis overseas in Asia and Russia. I don’t believe the failure of LTCM was the root cause. The US wasn’t significantly impacted as the US markets recovered very quickly and took off in 1999.
theroxylandr Says:
>I short tons of stuff, mostly homebuilders, REITs and financials. But I would never short the whole market. I’m actually long tons of stuff, too.
Your probably safe, but a major bailout of the subprime mess would signal to the market that all Mortgage related securities are protected by the US gov’t. This would imply to investors that there is zero risk (the no-lose scenario) and the sky is the limit. Lending would soar and so would inflation. Builders could make a rapid recovery as investors dump into hard assets to hedge against rabid inflation. FWIW, I am not suggesting this is a “sure thing”, but one of a many different potential outcomes. I don’t believe there is a “sure bet” these days. The only thing I am certian about is a very uncertian future.
theroxylandr Says:
>Suppose the rulers will decide to destroy the dollar in order to save housing and stock market. How to hedge against that possibility? I think by getting some oil.
Well this can be difficult. If the dollar crashes there is probably a good chance that pre-existing oil contracts would be scraped. I can’t imagine overseas exporters honoring contracts when the dollar crashes.
The only way you might be able to hold on is to purchase domestic gas or oil wells. Then again if US imports fall off a cliff because of the dollar or geopolitical events, the US gov’t would almost certainly nationalize domestic oil and gas companies and insititute fixed energy prices.
FWIW: I currently invest in short term treasuries to hedge against a black swan event. If the Fed and Congress begin a bailout I’ll move out of treasuries and into stocks that will take advantage of inflation. If the fed and Congress fail to act, then will probably fall into deflation (interest rates will soar and the markets will crash).
Since I am am in very short term bonds (1 and 3 month) I can quickly change gears. I see no reason to take one sided bets (shorting or going long) since I don’t think there is a soul alive that can predict the future. The best bet is to not lock yourself into investment that will get you clobbered if the market swings into the opposite direction than you have anticipated. Wait until something happens rather than try to outguess the market. Right now we are tetering on the edge, but its impossible to say whether it will fall to the left or to the right.
July 16, 2007 at 2:08 pm
“a major bailout of the subprime mess would signal to the market that all Mortgage related securities are protected by the US gov’t. This would imply to investors that there is zero risk (the no-lose scenario) and the sky is the limit. Lending would soar and so would inflation”
While I agree that a major bailout would send such a signal to investors, I don’t necessarily agree that lending would soar as a result (although inflation most certainly would soar.)
What you are basically saying is that as long as debt is made available cheap enough to anybody with a pulse, there will always be takers. This sounds logical, but probably isn’t the case. It seems to me that the RE bubble simply exhausted itself and now we are looking at several years of downside (falling prices, increasing foreclosures, etc.) regardless of how much easy money is made available. The reason for this is pure financial mania exhaustion and besides, who wants to own a depreciating asset? Also, with falling prices, there is a natural limit to the refinancing boom as well. Put another way: It certainly wasn’t lack of easy money or higher rates that caused the RE bubble to pop in the first place, there was plenty of easy money through 2005, 2006, and even today.
RE is toast for many, many years and there is nothing that can be done to reverse this trend, short of hyperinflation that extends to paychecks as well, which so far hasn’t happened in the slightest degree and I doubt this will ever happen as long as the global wage arbitrage exists.
I refer to Japan’s RE bust as an example of this sort of dynamic. Japan’s ZIRP policy, government-propped zombie banks, and ridiculously trashed currency never did “solve” the deflation problem – Japan simply came out of deflation 18 years later as part of the normal cycle.
July 18, 2007 at 5:35 pm
> refer to Japan’s RE bust as an example of this sort of dynamic. Japan’s ZIRP policy, government-propped zombie banks, and ridiculously trashed currency never did “solve” the deflation problem – Japan simply came out of deflation 18 years later as part of the normal cycle.
First off, Thanks for the comments. Let me explain why I believe we will not follow the same path as Japan.
1. Japan is a nation of savers. They export far more goods than they consume, and the average Japanese lives a modest lifestyle. This differs greatly from the culture of americans, which are far more inclined to consume, even to the point where they consume far more than they earn.
2. Back in 2002 and 2003 as the US tipped towards deflation, the Fed was able to flood the economy with excessive amounts of credit that has fueled a huge expansion in the money supply This created a housing bubble, another stock bubble and caused near double digit inflation for energy, housing, food, healthcare and education. The only reason why the core inflation rate hasn’t risen as fast is because Asia has subsidize its exports which has artifically capped inflation on imports. Pretty much all domestic goods and services, as well as imports from non-bretton woods II exporter rose
>It seems to me that the RE bubble simply exhausted itself and now we are looking at several years of downside (falling prices, increasing foreclosures, etc.)
If the fed bails out the Subprime mess, foreclosures would likely end or number of homes being foreclosed on would be substantially reduced. This would halt the slide in housing prices and eventually cause prices to start rising again, bring back home ATMs and residential construction.
I believe if the Fed and Congress acted in unison, their policies could easily overwelm and deflationationary pressures in the near term. Eventually such policies would undermine the economy and triggler the “mother of all deflationary” cycles. Unfortunately the public and our gov’t suffers from a severe case of short-term-itis.
The difference between Japan’s policies was never to undermine there long-term economy in its efforts to fight deflation. Its economy generated a strong trade surplus which prevented its currency from inflating significantly.
July 28, 2007 at 7:42 am
[...] under Investing , Finance , Money , Economics Two weeks ago I’ve published an article “This time is different”, where I warned that the stock market is totally irrational. I’ve pointed that historically [...]
August 5, 2007 at 10:34 pm
The boomers while offically starting in 1946 birthdates really become a significant number with the 1950 birthday’s. From 46 to 49 has population numbers very similiar to the war generation.
2005 then is when this group starts to turn 55 in fairly large numbers running up to 2012. 55 is significant because folks tend to reduce spending around this age which could and probably will the rate of consumer spending.
We are just now beginning to see a reduction in consumer spending while many are pointing to the general debt levels it also could be the beginning of a generational shift caused by boomers hitting the 55 age level in large numbers. They probably will begin taking SS benefits at age 62 rather then 66 which also will impact gov’t outlays. I read somewhere that up to 70% take early SS so I expect that trend to continue. That doesn’t mean they will retire but at least take whatever money is available.
August 11, 2008 at 10:22 pm
[...] Here you can see that the junk bonds market gave a very good signal of the coming crash, which I reported a week before it happened. [...]