6.5% Rallies Only Occur in Bear Markets

Repeat after me: 6.5% rallies only occur in bear markets....6.5% rallies only occur in bear markets....

Yesterday's equity love-fest was just the latest iteration in what has become a seemingly endless sequence of bum-clenching drops followed by spine-tingling rallies. Obviously, the net impact has been to drag stock prices lower...but man, what a ride!

Goldman's sales desk put out a remarkable stat yesterday that warrants passing on (even if Macro Man is too lazy this morning to personally verify it). Apparently, between 1950 and 2000, there were exactly seven days in which the S&P 500 had an intraday range of 5% or more. Since the beginning of October 2008, there have been 22. Yowsah!

CORRECTION: Looks like Macro Man needs to get his eyes checked. Apparently it's 27 occasions of greater than 5% intraday ranges from 1950-99, and 7 from 2000-06. So with only 22 occasions over the last seven weeks.....it's been a snoozer!

In any event, yesterday's rally took the SPX back to the friendly environs of Team 850's erstwhile bid zone. Having been prior support, it could well turn into a bit of a resistance zone, though the lure of trying to breach the downtrend line of the last few weeks' price action may prove irresistible to futures jockeys and other momentum-driven "investors."

Unfortunately for the risk-asset love-fest thesis, the wheels already appear to be coming off. The Japanese seemed happy enough to take advantage of yesterday's rally to slot yen crosses; AUD/JPY trading down 4% from the NY close doesn't exactly engender a warm feeling for holding equities, even for a short-term punt.

One "pro-risk" market where Macro Man is broadly constructive is in Brazil, specifically the fixed-income market. The instrument of choice for offshore punters such as your author is the DI curve, which is essentially an exchange-traded swap curve. The DIs are still pricing in higher rates over the next year, despite the global slowdown and strong disinflationary impulse of lower commodity prices- many of which Brazil exports. Wholesale price inflation is beginning to edge lower, even as the currency pass-through has pushed expectations a bit higher.

While it's been a bumpy ride for Macro Man's favoured point on the curve, the Jan 10's, he has managed to retain exposure via options. And with other high-yielding CBs (Turkey, Hungary, India, Indonesia) cutting rates, he expects that it's only a matter of time before Bacen follows suit. To him, receiving in this exposure offers much better fundamental value and risk-reward than trying to catch the falling knife in stocks in the early stages of a bone-crushing recession.

Finally, Macro Man would be remiss in not mentioning yesterday's pre-budget report in the UK. It is hard for someone who's never lived in Britain to understand the attention paid to budgets; what in the US is a dreary, drawn-out affair is transformed into a carnival-style spectacle here in the UK.

The sights and sounds of rival parties hooting and hissing at the speeches of front-benchers, with the florid Speaker of the House (who appeared to come straight from the pages of a Dickens novel) vainly shouting "order! order!" is not to be missed.

Beyond the spectacle, however, lies the substance....most of which left Macro Man scratching his head. The notion that a modest drop in VAT will stimulate the economy is well-nigh preposterous, as is the insistence of the government that hiking national insurance payments isn't an income tax. The rise in the top rate of income tax was predictable, as indeed was the delay of said tax hike until after the next election.

Most puzzling of all were the economic projections of the Chancellor, Alistair Darling, which anticipate a short, relatively mild recession before a resumption of growth in late 2009 and into 2010. When he claimed that trend growth in the UK was 2.75%, Macro Man just about lost it.

Mr. Darling seemed happy with his forecasting ability, however; so happy, in fact, that a little-known provision of the pre-budget report provides for a merger of the UK Treasury and the Met Office. Henceforth, it will be Mr. Darling who forecasts the weather. Macro Man was pleased to see that the next month is predicted to be 25 deg (77 deg F) and sunny.

Unfortunately for Mr. Darling, forecasting is a tricky business. The remainder of his time in office (both economically and meteorologically) is likely to be very rainy indeed.

Comments

[bricki:]

I do have to admit that broadcasts of the British Parliament are always entertaining and received well over here. The US equivalents are way too boring. It is interesting that our friends in Canada seem to have followed the British model of decorum (i.e. none).

One bit that I am wondering about however - if 6.5% rallies only occur in bear markets, what about the converse? Do 6.5% panics only occur in bull markets? Nobody seems to write about this, but it would be an interesting thing to consider. I've always thought that overall markets tend to go down faster than they go up.

2008 Nov 25 09:47 AM

[John Pseudonym:]

The new bubble is bonds.

What a predicament we are in...

If the economy turns for the better, the bond market will collapse. Interest rates will jump and the value of the dollar will sink.

Oil and commodities will spike too...

Everything is just so bad...stick with cash for now.

2008 Nov 25 10:30 AM

[Brad Ferris:]

Bonds are definitely looking "hot" right now, but what's the alternative for many risk-adverse investors? They've gotten slammed in the equity markets and have run with their losses in hand into the bond markets. What will hurt them the most is that if that bubble deflates then they have more losses & inflation to deal with.

2008 Nov 25 11:01 AM

[Crank Monkey:]

Bonds aren't all alike. High yield bonds suffer from default risk, while higher rated bonds are subject the risk of increasing interest rates. If deflation is the order of the day, then junk bonds could crater. Conversely, if inflation ensues then higher rates could make higher rated bonds falter. Unless you can guess what the economic environment will be like, it's hard to say where bonds will wind up.

2008 Nov 25 01:29 PM

[Steve in TN:]

I am shorting the long-Treasury bond and am long U.S. corporate bonds. Treasury bonds are the most overbought investment in the world currently.

2008 Nov 25 03:51 PM

[Kunst:]

I agree. It's time for TBT (double-short 30-year treasuries). Likewise UDN (short US $). Both have nowhere to go but up.

The overall market trend is still down. This has been a fun few days. I cashed out UYG for a 45% gain in 6 days -- nice, but I'm not greedy. It's starting to look like time to dust off the ultrashorts again.

2008 Nov 26 09:29 PM