Monday, January 11, 2010

Equity rally update

I'm updating these charts because they have been very impressive for a long time and bear watching very closely. Implied volatility in equity options continues to trend down, helping equity prices to trend up, something I have been noting since late 2008. The recent strength in the dollar (note that the red line in the second chart moves inversely to dollar strength) has not derailed the rise in equities, contrary to the very popular view that the equity rally is just part of a larger "carry trade" that only works if the Fed keeps rates low and the dollar declines.

This rally is built on solid economic fundamentals, in short. But I see so many analysts arguing that this is all a house of cards that is set to collapse for any number of reasons (e.g., huge commercial real estate vacancies, a second wave of home mortgage defaults, an inflating credit bubble, the winding down of fiscal stimulus, rising tax rates, soaring Treasury yields, etc.) So many people are worrying these days about all the things the might go wrong, yet so few people seem to worry about all the things that might go right. This is how major bull markets always work: the market climbs a wall of worry, and ignores the fundamental drivers of the recovery.


Unknown said...

is zero percent fed funds what we find with solid economic growth?

Unknown said...

not buying your read

Benjamin Cole said...

The two latest posts are excellent.

As a financial reporter, I have reported through several cycles since the late 1970s.

In one regard, recessions and booms are the same: Near the top of every boom, the pundits tell you why this time things are forever changed for the better, the boom, and the "California real estate will never depreciate as there are barriers to entry" sentiments come to mind.

At the bottom of every recession, the "Things will never be the same again" tune goes the other way, with oil, demographics, debt etc cited.

This last recession was a doozy--I have never seen economic data plummet like that, the way itdi in late 2008.

Cargo at LA and Long Beach ports off nearly 40 percent. I nearly lost my bowels. Of course, while doing the pottypants is the best time to buy.

The negative sentiments from the ugly recession are still with us.

My guess is that the recovery continues, building up steam for years.

Any sort of fiscal responsibility from the feds, and we have a long-term boom.

Scott Grannis said...

michael: The Fed first gave us zero FFs because they (correctly) realized that they needed a massive increase in money supply to match the massive increase in money demand that resulted from the Lehman panic; this was necessary to avoid deflation, and it succeeded awhile ago in averting this major threat to the economy. Since then they have felt (incorrectly) the need to continue with zero rates because they (incorrectly) worry about lingering deflation and they feel a tremendous need to ensure the economy grows. They are well on their way to overstaying their welcome at zero interest rates. The market feels the same concerns about deflation and the supposedly fragile economy. I don't buy it. I think we will see the Fed forced to move rates up higher and faster and sooner than everyone currently expects, because the economy is on much firmer ground, I think, than most observers give it credit for.

Scott Grannis said...

Benjamin: thanks, and you're very right--if any good comes out of the current fiscal catastrophe that is unfolding it could be extremely positive. I think the political winds have shifted enough to make that a real possibility. The country is getting an appreciation for fiscal responsibility like it hasn't had for a very long time, thanks to the 1-2 combination of reckless spending from Bush and now Obama.

Jay Norman Davis said...

A little off point:
I have heard someone saying a bubble and melt down in China. If this comes about I wonder if China might have to sell off their US Bonds. Also what are your thoughts about India and if positive do you have any idea about what possibly be a way to go about it. Your thoughts abot these issues.

As always, Thank you,

Benjamin Cole said...


People think because I criticize the R-Party and ag and defense spending, I must be a liberal loonie. No way.

I am a loonie, but against chronic federal deficit spending. I know the D-Party is feckless as well.

Imagine the shot of confidence that would run through markets if we could have assurance that deficit spending was coming under control.

I hope Scott is right--The Tea Party will ride to the rescue. Meanwhile, think Asia.

brodero said...

Sir John Templeton said " Bull Markets grow on skepticism"

He also said they mature on optimism....we are still in the skepticism stage....

septizoniom said...

if we all know that bull markets grow on skepticism can they grown on skepticism? is this the "third order" keynes old maid insight?

brodero said...

If you don't like aphorisms how about NIPA corporate after tax
post 1170 on January 29th and because a 1 to 1 ratio to the S&P 500 is cheap.AND 1170 would be the quarterly average....we are going to break 1200 this quarter.