Monday, December 8, 2008
I've been highlighting signs of improvement in the underlying fundamentals for several weeks now, and the equity market seems to be catching on, finally. Short-maturity swap spreads peaked in early October, and have since fallen significantly. The implied volatility of equity options peaked in late October and again on November 20th, and has since fallen. The low in the S&P 500 to date was November 21st, and the equity market is now up over 20% from that low. There are no clear signs of a bottom, of course, but the evidence is slowly accumulating.
The newspaper headlines cite Obama's nominees for cabinet posts, his apparent willingness to forget about tax hikes, and his ambitious infrastructure proposals as probable causes for the rally, but who's to say it's not just a market that is finally figuring out how to cure itself? Hedge funds have undoubtedly completed the bulk of their deleveraging by now, and anyone who feared further losses in his or her portfolio must surely have read the calamitous headlines over the past several weeks and rushed to liquidate their holdings. Whatever the reason for the recent rebound, it's nevertheless true that prices had fallen to levels that were consistent with economic destruction exceeding the depths of the Great Depression; and as long as the reality proves to be less dire than the end of civilization as we know it, prices have to rise.
If indeed we have seen the bottom, and I think we have, nerves will still be on edge. Those who sought the shelter of cash (and there are plenty who have, since the value of cash and cash-like instruments stands today at an all-time high) will now suffer the embarassment of cash, as they compare their paltry returns going forward with double-digit gains on competing investments. Those who wished they had sought the shelter of cash will now see every rally as a second and third chance at salvation. Those who suspect they may have underestimated the economy's ability to right itself (e.g., the Fed) will fear the consequences of their actions. And those who suspect that now is the time to get back into the market will wait for selloffs, only to find their fears returning as prices drop. In short, the market is going to be climbing terrifying walls of worry for a long time to come.
Posted by Scott Grannis at 8:08 AM