August 13th 2009
"...we'll be back this way again." Hank William Sr.
May 23 2008 was an important watershed date last year in addition to the September bankruptcy of Lehman Brothers. While the Lehman Brothers fall has been pretty highly documented, both at the time and in retrospect, May 23 had more stealth. The only reasonably widely followed fundamental indicator that we have found giving a signal of difficulty at the time was the TED spread beginning to widen more substantially. As you may have noticed in the last post, we included a brief description of what the TED spread is. Today we will expand that definition in order to illustrate why it may have been an indicator of termoil in the bank credit world at that time.
It is stated that the TED spread supposedly measures credit difficulties arising in the international banking systems the differential between rates charged by LIBOR member banks for a given time frame increases relative to the US Treasury rates for the same time frame as expressed by the relevant futures. In other words, if international banks feel a need to charge more for loans they make relative to the US Treasury rate for the same maturity; it is assumed that they are doing so because of a rise in perceived risk in the economy. One such rise in the TED spread began around May 23, 2008.
We use turning points from the Economic Confidence Model (popularized by Princeton Economics Institute) as one of our guidelines for finding points in time that may bring interesting activity in the markets. That model had turned down around February 25, 2007; conveniently the TED spread does not move in straight lines. We are speaking more of significant changes in the near-term trend.
Continuing the trend noted above, the TED spread began to narrow around the next upturn in the model, roughly March 23, 2008. Two months later (May 23, 2008) without an observable change in direction by the model, the TED spread began to widen again more considerably. In fact, by mid-October, 2008 the spread had widened to a five year high. From that point to February, 2009, there was a general decline in the spread, followed by a short move wider into March 9, 2009. Since then the general trend has been narrower up to the present date.
It seems reasonable to attempt to correlate the moves of the TED spread with those of the stock market. It is our opinion that the TED spread has some coincident negative correlation with the stock market in recent years. That is a widening TED spread seems to indicate a falling market, and vice versa. We do not mean to imply a direct cause and effect relationship, rather that they both may share sensitivity to the same outside forces. Either way, a significant widening of the spread should probably serve as an alert to stock investors. We follow it regularly now.
At times like this when some measures might imply that some of the stock indices are somewhat overbought, we tend to pay even more attention to indicators that may not be directly equity related, but have shown effects on equities. We also pay more attention to weekly charts of both indices and individual stocks. It is important to make use of all sources when considering making decisions. We also use stochastics and Bollinger bands as additional aids along Ibbotson data and data provided by other sources when it comes to tactical asset allocation decisions.
Thursday, August 13, 2009
Sunday, August 9, 2009
"A dollar is a dollar; a dime is a dime, I'd sing another chorus, but I haven't got the time."
The title above is from Eddie Hodges circa 1960, and is meant to highlight the theme we see currently in the financial world. By necessity, these comments will be brief.
A bit of history to set the stage:
1895-96 Following the 1893 Depression, the gold supply of the US Treasury dips to perilously low levels. J.P. Morgan arranges a gold loan of over $50 million to save the day, and then does it again the following year when more is required.
1934 FDR and Congress tell the American people to turn in all that clunky gold money they have been carrying around making holes in their pockets, that has a value of $20/oz and receive $35 in nice crisp paper money, effectively devaluing the dollar by a significant amount.
1971 Richard Nixon stops the exchange of gold for paper dollars to foreign sovereign states, effectively placing the US on a floating rate currency standard.
2008 World-wide credit crisis and other financial disruptions and the attendant responses thereto lead to the beginnings of questions as to the ability of the US dollar retaining its reserve currency status.
Those of you with a mathematical bent have already determined that the dates above are approximately 37 years apart. Those of you with an historical bent will note that the happenings described are all related to monetary difficulties of a substantial nature. Empirically, then, one might conjecture that there could be a monetary crisis cycle of some sort occurring roughly every 37 years. Historically, there have been other symptoms that have accompanied these monetary moments of the past.
Poor Eddie Hodges had it all wrong. At times like these,a dollar isn't always a dollar, in purchasing power term, at least. One hesitates to insult the dime under the circumstances, although it is somewhat fitting that FDR's visage appears on that coin.
If one had been watching the exchange rate of the US dollar (hereafter referred to as THE dollar) versus a basket of the other major currencies during the recent times, one might have noticed a tendency for the US stock markets to move contra-trend versus the dollar. (e.g., buck up - market down)
We believe this activity would seem to confirm the possibility that a monetary crisis is still passing through, and may continue to have effects on a number of financial entities. A statement attributed to Mark Twain, among others, may be appropriate here - "History doesn't repeat, but it does echo." If history is echoing closely with the past, there are a number of asset classes which will have peroids of out-performance in the future. As usual, timing and judgement will determine who will be among the "quick or the dead," to use a movie promo line.
This experience has taught us that we need to watch the so-called TED spread (the price difference between three-month futures contracts for US Treasuries and three-month contracts for Eurodollars having identical expiration months), which signals credit problems, among other things.
Thinking outside the bun, as Taco Bell suggests, still gets you bitten. Only avoiding mealtime altogether keeps you safe. But, a fellow still has to eat, so the idea is to drop in when the rush is over, collect bargains those leaving just left behind and sell them to the next rush coming in. Repeat as needed. Doing that consistently takes study to stay ahead of the crowd, courage to act against the popular flow, and the knowledge that, when dealing with crowds, every once in a while, your foot will be stepped on.
In closing then, don't touch that dial; things are just about to get interesting. You have a great seat. In the words of a favorite cliche's
"As you wander on through life, brother,
Whatever be your goal,
Keep your eye upon the donut,
And not upon the hole."
A bit of history to set the stage:
1895-96 Following the 1893 Depression, the gold supply of the US Treasury dips to perilously low levels. J.P. Morgan arranges a gold loan of over $50 million to save the day, and then does it again the following year when more is required.
1934 FDR and Congress tell the American people to turn in all that clunky gold money they have been carrying around making holes in their pockets, that has a value of $20/oz and receive $35 in nice crisp paper money, effectively devaluing the dollar by a significant amount.
1971 Richard Nixon stops the exchange of gold for paper dollars to foreign sovereign states, effectively placing the US on a floating rate currency standard.
2008 World-wide credit crisis and other financial disruptions and the attendant responses thereto lead to the beginnings of questions as to the ability of the US dollar retaining its reserve currency status.
Those of you with a mathematical bent have already determined that the dates above are approximately 37 years apart. Those of you with an historical bent will note that the happenings described are all related to monetary difficulties of a substantial nature. Empirically, then, one might conjecture that there could be a monetary crisis cycle of some sort occurring roughly every 37 years. Historically, there have been other symptoms that have accompanied these monetary moments of the past.
Poor Eddie Hodges had it all wrong. At times like these,a dollar isn't always a dollar, in purchasing power term, at least. One hesitates to insult the dime under the circumstances, although it is somewhat fitting that FDR's visage appears on that coin.
If one had been watching the exchange rate of the US dollar (hereafter referred to as THE dollar) versus a basket of the other major currencies during the recent times, one might have noticed a tendency for the US stock markets to move contra-trend versus the dollar. (e.g., buck up - market down)
We believe this activity would seem to confirm the possibility that a monetary crisis is still passing through, and may continue to have effects on a number of financial entities. A statement attributed to Mark Twain, among others, may be appropriate here - "History doesn't repeat, but it does echo." If history is echoing closely with the past, there are a number of asset classes which will have peroids of out-performance in the future. As usual, timing and judgement will determine who will be among the "quick or the dead," to use a movie promo line.
This experience has taught us that we need to watch the so-called TED spread (the price difference between three-month futures contracts for US Treasuries and three-month contracts for Eurodollars having identical expiration months), which signals credit problems, among other things.
Thinking outside the bun, as Taco Bell suggests, still gets you bitten. Only avoiding mealtime altogether keeps you safe. But, a fellow still has to eat, so the idea is to drop in when the rush is over, collect bargains those leaving just left behind and sell them to the next rush coming in. Repeat as needed. Doing that consistently takes study to stay ahead of the crowd, courage to act against the popular flow, and the knowledge that, when dealing with crowds, every once in a while, your foot will be stepped on.
In closing then, don't touch that dial; things are just about to get interesting. You have a great seat. In the words of a favorite cliche's
"As you wander on through life, brother,
Whatever be your goal,
Keep your eye upon the donut,
And not upon the hole."
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