Dead cat bounce or does the equity market have what it takes to reverse that negative bear market stigma? As we highlighted over the last few weekly notes, we suspected the equity markets would bounce. However now, we feel that the euphoria has hit some technical levels that should put to test the veracity of this rally. We like to take a longer-term approach in times like this as everyone is all goosed up about the rebound, because fundamentally nothing has really changed. In fact, one can argue where fundamentals are concerned, the backdrop continues to weaken, global instability continues to gain, and the US government furlough seems to be foolishly overlooked.
As we noted in last weeks letter, the equity markets looked locked and loaded to test their crucial supports and they did just that. The SP500 tested the 2550 level and the Nasdaq the all-important 6495 level, both markets saw minor follow through. All eyes are dependent upon what the FED does on Wednesday as the markets still see around a 68% chance of another 25bp hike. We read in the WSJ on Monday an Op-ed from Stan Drunkenmiller and Kevin Warsh and it can be summed up via this quote, “the central bank should pause its double-barreled blitz of higher interest rates and tighter liquidity.” As much as we respect the both of them, we disagree whole heartedly.
Last week we touched upon the importance of the Federal Reserve and their waffling in regards to staying consistent with their rate hiking plans. The FED is supposed to be independent of political influence but it seems that POTUS and his constant remarks have taken their toll as Powell seems to be tight roping his options right now.
This last week was full of reports of wide spread over valuations across the gamut of both global equity markets as well as global bond markets, especially Europe. Now we aren’t talking about some bobble headed main stream media types, we are talking about titans, the likes of Ray Dalio, Stan Drunkenmiller, Jeff Gundlach all relaying the same theme, “well above historical norms.” We even read a great piece on the PEG ratio from Fasanara Capital, which stated that the PEG, which is a statistical measure of how expensive a stock is relative to its ability to generate earnings, is well above 1999 highs and probably rightfully so given the plethora of cheap financing from zero rates, unprecedented HY rates and of course continued tax breaks. All that said, the pressure from the rhetoric from the guys we just mentioned should begin to mount, as they most certainly have an agenda attached to such warnings.
The FOMC decided to raise rates another 25bp to a high mark range of 2.25%. We applaud the continued move; however, we feel that we could be doing more and doing it faster. Holding interest rates or real rates still negative, some 10 years after the 2008 crisis is deeply concerning. All too often people focus on the Fed Funds rate, but the real rate, the FF less inflation, is still negative. Rates are still very accommodative...although the FED left that word out of the statement today. Watching Powell is like watching your Accounting professor discuss reconciling the balance sheet on a late spring afternoon. He and the FED continue to use words like transitory, gradual and appropriate, a decade into a recovery and we are still using these words. The dot plots are all calling for continued hikes peaking around 3.25/3.65%. We view this as highly opportunistic and we do not think the global economy nor the domestic economy will be able to absorb such a short rate given the sheer size of global debt growth. For those that haven’t seen, we often use our own “dot plot” picture: