Thursday, June 18, 2009
the fedex earnings report was, as ed harrison points out, a colossal disappointment for anyone who wants to think there's a nascent booming recovery afoot. there's been plenty of data to question the "green shoots" meme, a term i think soon enough to be consigned to the dustbin of history. but not much of it has been as high in profile as a 10% revenue miss from the world's bellwether courier and shipper. the fedex number changes that.
still, further economic recovery is not a necessary precondition for a further massive rally if the conditions of the marketplace are right. stock index technical weakness from overbought levels beginning in may put me short the S&P earlier this month, and that condition has begun resolving itself over the last few days. the question is whether equities will continue to correct, reflecting a slower but continuing economic contraction -- or even anticipating further deterioration.
acknowledging that money doesn't move into or out of a secondary market, this has more to do with the balance sheet capacity and financing costs of large market participants which allow them to leverage into equities versus the flow of primary supply (or contraction thereof through buybacks). on this, two points:
the sharp rise in treasury yields has more than offset spread tightening in long-maturity corporate debt instruments. i suspect this is a problem for industrial finance more than bank borrowing, which is mostly pegged to LIBOR or fed funds. threats to LIBOR exist, but none have yet materialized. so while -- as noted yesterday by hugh hendry -- rising yields could choke off economic recovery by raising the cost of finance for industry and households, the effect on equity balance sheet financing is questionable.
but it has been noted that banks and other equity market participants are broadly deleveraging, as reliance on systemic wholesale funding -- a product of a massive current account deficit, once intermediated privately, now only possible with the intermediation of the fed -- is gradually unwound. this is i think a major longer-term negative for equities.
the question of primary supply is something else again. pragmatic capitalist with a potentially important outlook update from trimtabs, ned davis and the venerable richard russell.
Prior to May, according to TrimTabs Investment Research, the highest level of share issuance in a given month was $38 billion. May blew that record out of the water, with a monthly total of $64 billion.
Furthermore, that blistering pace has continued during the first two weeks of June, according to TrimTabs.
How bad an omen is this corporate eagerness to offer its shares to the investing public? Looking back through recent history, TrimTabs found that there have been just 12 months since 1998 in which total new corporate offerings totaled at least $30 billion. The average return for the S&P 500 index over the 90 days following those months was a loss of 4%.
Dissecting the data further, TrimTabs next focused on those months in which not only did total corporate issuance exceed $30 billion, but also those in which total corporate share purchases were less. The S&P 500’s average 90-day return following those months was a loss of 7%.
This more-narrowly-defined subset applies to today, unfortunately. According to TrimTabs, corporate new offerings since the beginning of May have been nearly five times greater than corporate purchases.
The recent surge in the supply of shares has also caught the attention of Ned Davis, the eponymous head of Ned Davis Research. He has found through his research that it is optimal not to focus on monthly totals but instead on a rolling 13-week window. On this basis, according to Davis, recent corporate issuance has been exceeded historically only by two other occasions — early 2000 and early 2008.
Those were “not great times to buy stocks,” Davis notes dryly.
Davis also draws an even more ominous parallel to the recent corporate rush to sell stock: “This high level of [recent] supply is one of the key characteristics of the monster rally in November 1929 - April 1930.”
From April 1930 through the low in July 1932, of course, the Dow Jones Industrial Average fell by 86%.
For the record, I should point out that Davis, despite these ominous portents, remains cautiously bullish for the short-term, since many of his other indicators suggest that this rally has further to run.
But TrimTabs is quite bearish, recommending that clients be 50% short U.S. equities. “Stock prices are going to fall hard,” they predict.
the rally of the last twelve weeks was often disparaged as a government-orchestrated short-squeeze and pump operation that would get the banks into a position where they could plausibly issue equity to improve their capital position (and wean them off government funding). this they have in fact done, regardless of how you view that characterization. and the titanic flood of equity supply into a market where corporate buybacks are more or less dead means that primary supply has grown significantly over the last six weeks.
in an environment of generally deleveraging market participants, including those participants who underwrote those massive equity floats and may still be placing shares, one has to imagine that -- regardless of rates -- on net the pressure will be on stocks to price to meet the systemic balance sheet capacity to hold them. this is less a function of the cash assets in the system than the liability-side funding of the system. though declines in equity prices may not proceed via a straight line -- in fact, they almost certainly won't -- the funding structure of equity holders, including banks, insurers and hedge funds, remains under pressure.
UPDATE: via zero hedge -- CNBC interviews charles biderman of trimtabs.