Wednesday, February 10, 2010

Confused? So Are The Markets

Confused? So Are The Markets

By Bill Fleckenstein | 10 February 2010

Unusually strong crosscurrents are creating chaos in markets all over. We need to step back to sort out what's happening with stocks, bonds, currencies and gold. Spending a week away with no TV or newspapers and only limited Internet access, as I did recently, gave me lots of time to think about the present investing environment, where there is mass confusion in all markets. Unusually strong crosscurrents make it difficult to ferret out what participants are thinking or anticipating.

However, I'll take a stab at it by reviewing various markets— stocks, bonds, currencies and gold— and considering whether my expectations need to be adjusted. First, though, a look at the innards of those crosscurrents. Despite the market destruction of 2008, there is still much speculative money chasing any and all markets. Thus the "noise-to-signal" ratio might be quite high for an extended period. Which is to say not that all market action should be ignored but that it might need to be taken with a little less seriousness, especially in the shorter term.

In fact, the noise-to-signal ratio might be much higher than in the past. An immense amount of money follows momentum-oriented strategies. Although momentum feels good when it's at your back, a quick change in direction can cause you a fair amount of grief. I'm not sure as to the ramifications, but I'm just going to factor that concept into my thinking a bit more.

Another crosscurrent has developed because of the massive money printing worldwide in combination with the near collapse of the global financial system. Along with an already 'noisy' market, what we see is an environment hospitable to silly ideas that pass for fads, such as the notion of all markets being driven by "risk on" or "risk off" decisions. Now for a look at the markets individually.

The Stock Market

The fact that it's been laboring and unable to make progress on good news is something I've been discussing since October. My feeling then that the market might be rangy, at best, was more or less what has transpired, with that inability to rally leading to the recent slide. This decline "tracks" the script. (If only I hadn't been stopped out of my Standard & Poor's 500 Index ($INX) short.)

What I do find surprising is that so many stocks that you might have wanted to own were smashed just as hard as, if not harder than, stocks you might have wanted to be short. To pick my favorite example of both, among a list of others: In the past two weeks, Research In Motion (RIMM) has actually behaved quite well while Microsoft (MSFT) was pounded after a legitimately sensational earnings report. Bottom line: For months now, it's been very difficult to make money on the long side of the market. (Microsoft publishes MSN Money.)

Stock Market Forecasts

As for the multitrillion-dollar questions— where will this decline end, and what will come next?— I don't have good answers. I suspect that after this "correction" has passed, we could easily see a failing rally instead of new highs, but it's difficult to hold a big opinion. Part of the reason stocks have thrown a temper tantrum is that the Fed, for the moment, is talking the talk of ending quantitative easing.

If and when that changes (toward more QE), which I expect it probably will, who knows what the market might do. Stocks are not cheap, especially given all the problems we face, but if the Federal Reserve turns on the spigots again, stocks could benefit. I believe that, for now, the wise thing to do is to watch the decline and see how the sorting-out process proceeds.

At some point, there might be an opportunity to trade high-quality companies such as Microsoft and a handful of other tech stocks from the long side. And perhaps, down the road, some shorts will set up. I still believe this year might be one in which stock pickers on the long side or the short side will do well as we see a market of stocks instead of a stock market, although thus far that is not what has transpired.

The Bond Market

It has done a bit better recently, helped by the strength in the dollar, and, perversely, it seems that an end to quantitative easing has the bond market thinking that interest rates might decline rather than rise[!?!] Without the buyer of last resort— namely, the Fed— scooping up more paper and in fact trying to ditch some of the paper it has, I find it absolutely staggering to think that rates could actually decline.

And if rates start to rise, that will put more pressure on housing and other sectors, as well as on the economy. So we should expect that the Fed will fight rising rates pretty much tooth and nail until the unemployment rate gets to a level that will cause Congress not to beat it with a big stick on a regular basis. Having said that, I continue to find bonds to be an uninteresting short, simply because it seems there continues to be far too much confidence in the Fed to do all the right things (an impossible task).

I think the bond market will be a better short once the dollar turns weak again and people begin to recognize that the Fed is completely trapped. (Politically, the Fed can't allow rates to rise right now, yet it wants to end quantitative easing.)

The Currency Market

That line of thought leads to the U.S. dollar, an area where the recent rally has caught me by surprise. What has precipitated this appears to be all the angst about the creditworthiness of Greece, Portugal, Ireland, etc. The reason there's friction in Europe is that it has rules, and the European Central Bank is trying to get the weaker countries to obey those rules.

See How Currencies Stack Up Today

In the end, I think that's a good thing, as it speaks to a stronger currency, not a weaker one. However, that angst seems to be the catalyst for a weak euro and a strong dollar generically. I've had no dog in the hunt of the euro, but I have with the Canadian dollar, which has held up better than most currencies, declining only a few percentage points off its high.

The Gold Market

Thus far it seems gold has held up quite well, especially two weeks ago, when commodities, stocks and many foreign currencies were smashed. Gold played a bit of catch-up, with a nearly 5% decline Thursday, but I still think it is the best currency available. To sum up: It looks like folks have been trying to make the big deflation trade— that is, buying bonds, buying the dollar, selling stocks, selling commodities. About the only thing I'm absolutely certain of is that deflation is not going to be an outcome this country experiences over the next couple of years, as long as the Fed still has a printing press.

That might be wrong, but it's the one view I hold just as strongly as I ever have. Hopefully this road-map update on various markets will help folks sort through the chaos.

At the time of publication, Bill Fleckenstein did not own or control shares of any company mentioned in this column .

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