That was Kevin Bacon's character's line from Animal House just before he was stampeded by the crowd into a two-dimensional figure. It was also the general point this blog was trying to make during the market's nadir in August. Certainly the equity market has taken it to heart. If you had been out of touch for the last three months and looked at the current level of the stock averages, you would think that the market just went into the summer doldrums and was just now beginning to emerge. Technicians will tell you that the stock market is a leading indicator of economic performance. Based on that, we can expect a sharp economic downturn, followed by an almost as sharp economic boom. It seems hard to believe that the housing market in general is going to turn around quickly, given the nature of the market (the transaction costs and time involved are radically different) and the amount of excesses that need to be worked out, although some depressed local markets, Florida for example, could be helped by the weak dollar bringing in foreign buyers. Likewise, the fixed income markets sustained significant damage in the recent turmoil. Banks are starting to disclose the effects of the past three months, taking their lumps and hoping that liquidity flows back in. Like in the housing market, it is hard to believe that appropriate valuations now exist for all these credit and structured products that no one had a clue on a month ago (the only real appropriate valuation is what someone is willing to pay for x or y, not what some model says it is worth). It will take some time for the bond crowd build up their appetite for risk again.
The bottom line is that in this instance, hindsight will be 20/20. If the economy goes into a general (one not limited to housing and related sectors) recession, then the bond guys were right. If not, then the equity guys were right. As a life-long bond guy, I'm inclined to believe the equity guys. The events that occurred in the bond markets over the past few months were strange, to say the least, pushed forward by a blind ignorance of credit risk and the resulting liquidity risk, and aided by the absence of key players during the usual summer slowdown.
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3 comments:
I believe the bond guys, at least initially. History shows that following an ease, the bond guys have it right and that the ease-driven equity rally soon looses steam. Eventually the equity geeks will be right, but so is a broken clock.
It may seem surprising that I would hold historical precedence up as evidence since I am so very critical of those who look for historical patterns to predict the future because they often to not consider the context of what was happening at the time. However, by using recent history (2001) and a Fed Chairman with similar views as Mr. Bernanke (Alan Greenspan), the market contexts are similar enough to make a comparison. The equity market rebounded following the Fed ease of 2001, but by the summer, teh equity markets were sputtering. The 9/11 attacks was the final nail in the coffin. Similar Greenspan eases were followed by an initial boom as a result of market euphoria. Just like when one's team wins the world Series, the initial euphoria is eplacd with the feeling that all glory is fleeting.
i'm helping my son study for a Latin exam tomorrow. Let's say "Sic transit gloria" instead. Go Phillies!
Wouldn't that be "Ite Phillies!?"
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