Great
manias in financial and tangible assets have been methodical in their
euphoric climax and consequent contractions. With six now recorded since the
first one in 1720, it has been fascinating to watch this one track its way through
the typical post-bubble path-- now to twenty months after the stock market
peak when global credit markets would start another phase of distress.
The signal for the
beginning of the contraction has been the reversal in the yield curve. Typically,
the boom can run for 12 to 16 months against an inverted curve, as the demand
for margin by speculators drives short-rates up faster than long-rates. While
rising interest rates seem to worry Wall Street strategists, history records
that troubles begin when the curve reverses to steepening and short-dated
market rates of interest start a steep decline. It has been prudent to
recognize that this along with declining Treasury bill rates is one of the
warnings about the end of a speculative frenzy and its inevitable collapse.
This time around,
the curve inverted in early 2006, and the 16 months counted out to June,
2007, which we frequently discussed. Included was the seasonal tendency of
credit spreads narrowing into to May, and then if the party has been wild enough
-- reversing to disaster. By mid June, the curve and spreads had changed
enough to conclude that the greatest train wreck in the history of credit had
begun, making banks and financials a "Widows and Orphans Short."
The next step in the
path was that as credit became more stringent through the summer of 2008, our
conclusions were that a typical fall crash was possible and considered the
1929 and 1873 examples would provide reliable guidance. This worked out
rather well, setting up the possibility of a dramatic revival in animated
spirits to around April-May. On the equivalent move in 1930, Barron's wrote
that it would be "difficult to quench the fires of enthusiasm." This
spring the equivalent move in commodities, corporate bonds and stocks ran
into early June--close enough--when a number of our indicators registered
excessive speculation. Also the run against the dollar became overdone.
Where the fall crash
and its rebound have been the main events, the next one is determined by the
twenty-month count following the 1929 and 1873 bubbles. Credit markets then
took a turn for the worse.
June is the fateful
month and one key signal would be another reversal in the yield curve- -this
time to flattening, which could be soon followed by spread widening.
When steepening
started in 2007 standard research applauded it as banks usually make better
spreads, but we noted that steepening at the end of mania signals financial
distress. Our concern about the reversal to flattening in June is that it
indicates the resumption of illiquidity. And the reversal in the curve last
week was a "heads up" on a market change that could hit
inappropriately positioned traders. It will also change orthodoxy about the
"benefits" of steepening.
On timing and credit
market change that is global in nature, most bank stocks in most countries
are again vulnerable. Over the past two years market forces have assigned the
always specious notion of a national economy that can be managed to the dust
heap of history.
Technical Comment
Since it was
developed in 1997, our proprietary Bank Trading Guide has provided a number
of reliable "sells', that usually lead the high by a few weeks. An
outstanding one was when LTCM collapsed. It does not provide "buys'.
Our last entry into
banks and financials was in mid February on the plunge in the BKX (US bank
index) to 19.5 and then in early March when the index had plunged to 18. Quite
simply, the sector was devastated and we were looking for good time out in
April-May. The rally was a quick double to 43 in early May when the advice
was to begin lightening up, with more aggressive selling reserved until our
Guide gave the signal.
More recently, we
have noted that it has become more volatile, which is usually preliminary to
an important reversal.
Ross has updated the
Guide and added to it, and the charts follow.
When the Bank
Trading Guide becomes overbought along with independent market readings there
has a tendency create a high in the BKX within the next ten days and then
decline by 10% to 17% during the following three to five weeks. We have
entered the period of anticipated weakness.
Sell Signal
|
Max offside
|
Max Potential
|
Trading Days
|
11/20/1989
|
1.577
|
1.70
|
-8%
|
1.41
|
10%
|
48
|
3/30/1993
|
27.94
|
29.66
|
-6%
|
24.70
|
12%
|
47
|
4/3/1995
|
28.42
|
29.59
|
-4%
|
28.42
|
0%
|
0
|
10/6/1997
|
75.96
|
76.57
|
-1%
|
66.27
|
13%
|
16
|
4/5/2004
|
100.68
|
100.68
|
0%
|
90.62
|
10%
|
24
|
2/25/2008
|
88.35
|
88.72
|
0%
|
73.22
|
17%
|
13
|
Signal
|
Potential for this
move
|
5/28/2009
|
36.72
|
33.05
|
10%
|
|
30.48
|
17%
|
|
|
|
|
BKX
There are six
occurrences since 1986 (the '89 example is Citicorp).
Bob Hoye
Institutional
Advisors
Read
all the other essays written by Bob Hoye
The opinions in this report are
solely those of the author. The information herein was obtained from various sources;
however we do not guarantee its accuracy or completeness. This research
report is prepared for general circulation and is circulated for general
information only. It does not have regard to the specific investment
objectives, financial situation and the particular needs of any specific
person who may receive this report. Investors should seek financial advice
regarding the appropriateness of investing in any securities or investment
strategies discussed or recommended in this report and should understand that
statements regarding future prospects may not be realized. Investors should
note that income from such securities, if any, may fluctuate and that each
securitys price or value may rise or fall. Accordingly, investors may receive
back less than originally invested. Past performance is not necessarily a
guide to future performance.
Neither the information nor any
opinion expressed constitutes an offer to buy or sell any securities or
options or futures contracts. Foreign currency rates of exchange may
adversely affect the value, price or income of any security or related
investment mentioned in this report. In addition, investors in securities
such as ADRs, whose values are influenced by the currency of the underlying
security, effectively assume currency risk.
Moreover, from time to time, members
of the Institutional Advisors team may be long or short positions discussed
in our publications.
Copyright © 2003-2008 Bob Hoye
|