What Efficient Market?
My reaction to last week’s equities bull roar registered somewhere between “bemusement” and “stunned.” After Moody’s and S&P both stated that they had “no estimate” for the amount of housing market turmoil which would precipitate a downgrading of AA and AAA debt (the main source of backing in CDOs), I woke up this morning to rumors of a $160 billion merger between Vodafone and Verizon (which was quashed), a sweetened $98 billion bid for ABN Amro, a $2.1 billion merger between IHOP and Applebee’s, and Blackstone’s $1.6 billion acquisition of a knee and ankle brace company to its private-equity empire.
While private equity does offer many advantages over a public listing, it is not clear to me how Blackstone can efficiently manage dozens of major companies with some $100 billion in revenues and over 600,000 employees. Apparently, Blackstone’s original investors have come to a similar conclusion: the firm’s share price has plummeted from a post-IPO peak of $37 per share to under $30/share.
Even more puzzling than the white-hot merger mania was the 300-point gain on Thursday and Friday, which was predicated on higher-than-average retail sales (along with more mergers). Drilling down into the retail sales, however, the overwhelming majority of the unexpected gains came from higher food prices. Concurrently, oil surpassed $76/barrel, sending ExxonMobil’s valuation rocketing above $500 billion. If food and energy price inflation can deliver that much increased market capitalization, sooner or later the Fed will be obliged to consider raw inflation, rather than its currently too-convenient “inflation ex-inflation,” core CPI-based metrics.
Oil has slipped slightly from its high yesterday (currently around $74/bl). Again, the high price of oil is attributable to high risk premia much more than a massive imbalance between supply and demand. Expect the risk premium of oil to subside somewhat as American-Iranian negotiations over Iraq progress; the price tag of continuing the Iraq war has become increasingly prohibitive for both the United States and Iran.
Sell Sell Sell Commodities!!
The ruble, Canadian dollar, and other oil-driven currencies will lose some luster as the price of oil falls back down to earth, sooner or later. (Much more so the ruble, however). The subprime turmoil which has driven American consumer demand beyond anyone’s expectations appears to have struck the previously invincible asset-backed (“ABX”) AA and AAA bond markets yesterday afternoon (both of which hemorrhaged approximately 5 percent of their value, according to manager Barry Ritholtz).
While we think the overall subprime exposure has been exaggerated – hedge funds stand to gain much of what Bear Stearns, Bank of America and the other banks will lose – it should still precipitate a global scaling back of liquidity, which will be reflected in higher bond yields.
Asian equities stand to lose the most from a liquidity retrenchment. Stay away from China, which is about where Japan was in 1990, and Japan, which would be a train wreck regardless of the wider liquidity situation, and will be for a while yet.
Because the current equities rally is, to everything we can see, irrational, we don’t pretend to know for how much longer the rally will endure. All we can say is that it won’t, beyond a one- to three-quarters timeframe.
While we are hardly bullish on the dollar, we do not see justification for the doomsday predictions that have become all the rage among the finance commentariat. We are dollar-neutral, even mildly dollar-bullish, as a function of what we see as an overheated commodities market (a major cause for the US trade deficit).
The Bottom Line
USD: After two weeks of continuously falling against most currencies, the USD might begin to look ideal for buyers. With very important U.S economic data being release this week, look for big moves throughout the week. However, trading the USD will be extremely complicated with a massive inflow of fundamental data; traders should look to purely news trade and avoid swing trading.
EURO: The EURO will remain strong throughout the week with the psychological level of 1.40 within sight. With more possible weak US data, the EUR/USD pair should continue its current uptrend. More importantly, the ZEW index should show significant growth after last month’s weak figure.
Pound: In terms of growth, the pound has exceeded all expectations and is currently trading at its all time high against the dollar. With very little strong US economic data being released over the next week, the pound should remain strong – in the near term.
NZD: A trend reversal may not be coming up anytime soon, with extremely high RSI levels and very little positive economic data being released for the USD, look for the NZD to break .80 (psychological level) over the next week. Consequently, with the release of a fairly high CPI, traders have already begun to speculate another rate hike in the near future.
AUD: Expect the AUD/USD to follow the NZD/USD pair closely.
CAD: This week might finally end the current trend for the USD/CAD pair. With Crude Oil expected to decrease over the next week, look for the CAD to take a sharp turn down. Fundamentally, with extremely weak inflationary indicators being released and a projected fall in the oil risk premium, expect a fall in the CAD.
Overall Outlook for the Week:
USD: Mildly bullish
EURO: Bullish
CAD: Bearish
NZD: Very Bullish
YEN: Neutral to mildly bearish
--Alex Forshaw & Sumant Yerramilly,
http://www.bestwaytoinvest.com
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