Priced in or not Priced in?
Guest post by Peter Tchir.
Not Priced In
This is one of the most memorable clips in recent years on CNBC. The Tepper “Balls to the Walls” take on QE2. It was short, simple, and spot-on. He nailed it.
What was interesting at the time was that his belief in how good QE2 would be wasn’t universally shared. Many, myself included, questioned what further reduction of rates would do. I doubted the theory that the money would drive financial assets higher.
I thought the problems were too big for something as simple as treasury buying to “fix”. Then for the next 6 months it seemed, we watched stocks go higher and “POMO” days because the bane of existence to anyone caught short the market. It wasn’t the impact of lower rates, it was flooding the system with money, and the impact on the dollar.
Even when QE2 was announced, the market didn’t react much, because the market didn’t believe QE2 would have much of an impact, so it “wasn’t priced in”.
That cannot be said anymore….
Many doubt that another round of QE will do much, if anything for the economy, but almost no one is willing to say they don’t think it will do much for risk assets. Even operation twist seemed to help risk assets (though I believe that was actually LTRO, not OT, but hard to determine). So now everyone “knows” that QE is good for risk assets because low rates, fresh money, and weak currency, push stocks higher. That has become a widely held belief.
That is the major difference between September 2010 and September 2012. Back then, not everyone believed stocks would go up with QE, now everyone believes that. So, if and when we get QE, do NOT expect a sustained rally last time. There is no one left fighting the Fed on QE. Stocks will likely go up on the announcement, but positioning already reflects it.
It will be hard to fight money being pushed into the market, but many have already anticipated it, and even during the more surprising QE2, there were periods of weakness. Oh, and the ultimate sell-off when QE ended, which is also likely to be front-run more aggressively this time around.
Not Priced In
Now back to Europe. In spite of the recent strength of stocks, not much is priced in. The Italian stock market has clawed its way back to about unchanged on the year. It is back at 15,200 and well off the lows of 12,360 in late July. That is what everyone talks about. How much “good news” is priced in. Well, this same market was at 17,130 just in March. How much “bad news” was priced in to get us to 12,360?
Why is the consensus belief that July was right and today is wrong? Let alone March prices which almost no one seems to remember. Was the world that good back in March? Actually, maybe it was. Maybe we let ourselves become overly pessimistic about the situation and it is the July price that is an aberration?
I do not think it will take much on the part of the ECB to spark a renewed rally in Spain and Italy. It is good that I don’t think it will take much, since I don’t think we will get much out of the ECB.
My most likely scenario remains an announcement that the market views as underwhelming, where we see some selling pressure, only to turn around as the reality is that the ECB has pushed the can far enough, and then we can start seeing signs of “brotes verdes”. Will the economies be fixed? No way.
But that isn’t necessary, all that is needed is signs that the economy may have bottomed and fear and greed will take over. Pent up demand to replace things that wear out can cause some activity in the underlying economy. Some EIB projects may finally get initiated. A couple business owners who have been holding off making improvements may decide this is enough.
We could see improvement. It will be improvement from the prior month, not from the same time last year, but that is all it takes, especially when the market has been this beaten down.
I’m not sure if this is like the October 2007 rally which didn’t last long, the post Bear Stearns is saved rally in 2008, which also didn’t last long, or the March 2009 rally, which, was dramatic, and in some ways still intact. I don’t know, but I believe that the market isn’t giving enough consideration to potential ECB activity, and it is underestimating what that little activity can do.
During the same interview, I thought this little segment, where Tepper asks Kernan about CNBC viewership is particularly interesting. The answer seems to be that the only thing that correlates with viewership is volumes.
So the financial media joins market makers, floor traders, and hedge funds as those hurt by low volumes. There are a lot of people in London today hoping that it is just our holiday that is keeping volumes low, but I personally am far from convinced that volumes spike back up.
It would be hard for volumes not to increase this week and next, but it feels that there is far more going on here than just a summer slowdown. That scares me, though not as much of the prospect that someone will decide that 60 in 60 was too intellectual for the investing audience and decide that 600 in 6 is a better approach to getting individual investors back to the markets and convincing them it isn’t just a game.
My strategy at this point, at its core, is to bet on re-coupling. Look for Europe to improve, and the U.S. to get worse. To the extent the markets like a Romney win, there is a decent chance we get some weakness as it would be hard for Democrats not to get an uptick during their convention, but really, it still comes down to Draghi and the ECB this week.