I think it is more likely that the market will be higher by January 1st than lower. Even though the total return of the stock market has been very good this year, there continues to be a wall of worry the the credit and subprime mess, slowing U.S. economy and sky high oil and commodity prices will cause a sharp downturn in the market.
My understanding is that hedge funds have the highest short ratio that they've ever had. A lot of protection has also been purchased in the form of defensive put options. In addition, due to a lot of caution resulting from the sharp downturn in February and again in August, many market managers have underperformed the market. There are just a lot of people that have "hung back" this year.
Why is all of this important? Because it means that there is a lot of money that is available to come into the market on the long side. Money managers that have underperformed are going to have to chase performance going into the end of the year. They won't have any choice but to pile into the stocks that are still going up. People that have been overly cautious may very likely rush into the market as it continues to get away from them.
Trades that should be working, like shorting VMWare while being long EMC are not working, as VMWare just goes up and up. People that don't remember how rapid and brutal an emerging market correction can be are pouring money into China, further inflating the bubble. All of this leads me to believe that themes that have been working will continue to work in the race to the end of the year. And you know what? Bubbles can continue to inflate for a long time before the inevitable implosion comes.
Oil sure looks toppy. I have lightened up on some of my energy positions believing that there could be a correction sooner rather than later. Refiners and integrated oil companies have not done as well lately due to the very narrow cracking spreads. The crack spread should widen as we get further into winter helping the refiners' margins.
I've heard some prognosticators suggest that financials are in position for a strong move up since they have been so beaten up. But I think there are so many other good ideas that are continuing to work why should I take a chance on Citigroup and the risk that a few more billion of bad SIV's crawl out from under its balance sheet?
The economy had slowed but there hope of a soft landing and reacceleration. The just released 3rd quarter's GDP number showed growth of 3.9% - the strongest performance in 4 years. Employment remains strong. Real wages are growing. Disposable income in real terms has increase 4.7% in the past year. Inflation is in check.
The Dollar continues to fall but American exports are surging and imports are falling, significantly reducing the current account deficit. The housing downturn took a bite out of last quarter's GDP number but the increase in exports put back in almost exactly the same amount.
The Federal Reserve just cut the overnight lending rate by 25 basis points as an insurance policy. The Fed may cut another 25 basis points in December but we are getting closer to neutral.
Assuming I'm right I can certainly see a significant downturn early in 2008 due to tax gain selling after a big 2007. Hopefully I will be one of them.
Disclosure: at the time of this posting the author was long VLO, EMC, DVN, LFC, CHL and short POT, XOM, USO.
1 comment:
The economy had slowed but there hope of a soft landing and reacceleration. The just released 3rd quarter's GDP number showed growth of 3.9% - the strongest performance in 4 years. Employment remains strong. Real wages are growing. Disposable income in real terms has increase 4.7% in the past year. Inflation is in check. – I am seeing government and fed stats being published that are extremely shady, I see them more as reactionary stats to allow the Fed and the government to do as they wish rather than leading indicators telling them what to do. One example were the negative employment numbers that came in negative in September that paved the way for an aggressive drop on 9/18. These numbers were then revised upward in October once the drop was in place.
Regarding inflation, I see Austrian economics as more logical to my engineering brain, and Austrian economics looks at the source of inflation (money supply) and not the symptoms such as consumer price indexes. 18 of the top 20 economies have money supply increasing greater than 10% per year. I may be missing something but this money needs to end up somewhere and equities seem to be a great place to park them and is causing asset inflation now that real estate is off limits. I believe inflation to be around 8-10% in the US. Using this more accurate measure, I see GDP already negative and in a recession. Middle Class is screwed, basically anyone not in equities is screwed.
This is completely in-line with your year end forecasts though as this money printing, leveraged accounts, yen carry trade, sovereign wealth funds liquidity is getting into the BRICs, Energy, Gold, Metals, Minerals and basically anything that can’t be printed.
I see the stats as the story the gov’t and the Fed is trying to write to hide what’s really going on behind the scenes. I am completely bullish as well though.
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