WHY IS THE MARKET ADVANCING?

The summer of 2012 has defied expectations.

On August 21, the S&P 500 hit a 4-year high. It climbed 3% in the first three weeks of the month following a 1.26% July gain. Across the past four weeks, the index’s total return has been just under 4%.^1,2,3   

 

Unexpected? You might say so. You can’t predict how the market will behave. This summer, stocks are managing to advance despite lingering threats.

                                    

Shouldn’t Wall Street be more pessimistic? After all, the “fiscal cliff” is drawing closer, the risk of a crack in the eurozone hasn’t exactly faded, and the European Central Bank and the Federal Reserve have not yet boldly responded to disappointing economic signals. Did Wall Street just collectively dismiss all of this in recent weeks?

  

Few saw this rally coming. The prevailing opinion – at least in spring – was that stocks would limp along through the summer, possibly retreating in reaction to news from Europe and subpar U.S. indicators. That was essentially the story in 2010 and 2011. In 2010, the S&P saw an April-May selloff and didn’t recover until that November. In 2011, a May-June selloff preceded a disastrous July; it took until February 2012 for stocks to get back to where they had been ten months earlier.⁴

   

This year, the S&P hit a peak in April and a valley in June – and just two months later, it returned to its YTD high.⁴

 

What factors are buoying the market? ECB President Mario Draghi’s (vague) pledge to do whatever is necessary to support the euro has certainly calmed some nerves. Investors continue to anticipate that the Fed will ease in the near term. The real estate sector appears to be healing, even as other economic indicators show sluggishness.

 

Some analysts think that the market simply wants to move higher - bullish sentiment has prevailed, even with all this uncertainty. In fact, a few analysts wonder if this summer’s advance mirrors a longstanding pattern.

 

Will history repeat? While it is far too early to answer “yes” to that question, it is interesting to note some past tendencies of “mature” bull markets. According to research from Bespoke Investment Group, we are now in the ninth longest and ninth strongest bull market since 1928 (nearly 1,300 days old with 110% appreciation).⁴ 

 

Mature bull markets witness corrections. In June, we more or less saw one – the S&P dropped 9.9% from its April high, actually 10.9% on an intraday basis. According to Bespoke, this was the twentieth bull market correction in the past 84 years. In the 19 previous corrections, the S&P took an average of 98 days to fully rebound from its low. This year, only 81 days were required.⁴

 

So what happened once the S&P recaptured its highs after these corrections? The index rose during the following month in 84% of these instances, with the average gain in those 30 days being 2.1%. Stretch that window of time out to three months, and data shows the index advancing 65% of the time with an average gain of 1.3%. Six months after such a rebound, the S&P was higher 84% of the time with the average advance at 5.5%.⁴

 

This data suggests that once a bull market is entrenched, a correction doesn’t shake the confidence of investors. There is still the perception of an upside.

 

A steepening VIX curve may be cause for concern. The CBOE VIX (the so-called “fear index” indicating expected volatility) fell below 14 in mid-August. This month, the VIX futures curve has shown a steepness not seen in several years, with VIX futures prices for October above 20 and in the vicinity of 25 for January. Some analysts wonder if complacency is about to give way to greater anxiety, since the VIX has shown longer-term volatility at a higher premium than short-term volatility.⁵ 

 

Yesterday’s statistics don’t equal tomorrow’s reality; nobody knows what the market will do this fall and winter. What we do know is that this summer, stocks have nicely exceeded expectations.

   

Citations.

1 – www.cnbc.com/id/48737245/ [8/21/12]

2 - www.bloomberg.com/markets/stocks/ [7/31/12]       

3 - news.morningstar.com/index/indexReturn.html [8/22/12]

4 - www.cnbc.com/id/48740766 [8/21/12]        

5 - www.cnbc.com/id/48692307 [8/16/12]

Sincerely,

William T. Morrissey and Tammy Prouty

Sound Financial Planning Inc.wtmorrissey@soundfinancialplanning.net

Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO PETER MONTOYA.

LYING ABOUT LIBOR

You may have been scratching your head at the ongoing (so-called) "Libor Scandal." What, exactly, did those banks do that was so awful? One answer is: they lowered your interest rates on everything from credit card debt to student loans.

Come again?

"Libor" is an acronym that stands for "London Interbank Offered Rate," which is calculated each day by the British Banker's Association in London. Every morning, representatives of the BBA ask large banks to estimate the rate at which they believe other banks would lend them money over various time periods--ranging from overnight to 12 months. The BBA collects all the estimates, throws out the highest and lowest figures, averages the remaining numbers and publishes the result every day at 11:30 AM London time--denominated in ten currencies, including the U.S. dollar.

Libor is then used by lenders around the world to reset their rates for a variety of variable-rate loans. When their teaser rates run out, many U.S. adjustable-rate mortgages (ARMs) are priced at somewhere between 1.5% to 3% over the one-year Libor rate. Some of the credit cards in your wallet or purse charge, on all unpaid balances, 20% (or more) above whatever the Libor figure happens to be. Commercial and student loans are routinely set and adjusted based on Libor figures.

Rigging this important interest rate benchmark was shockingly easy. The scandal, which has already caused Barclays PLC CEO Robert Diamond, Jr. to resign in disgrace, came about when regulators discovered that bank executives made a habit of lying about these numbers to the BBA representatives--and even discussed their phony numbers with executives at rival banks in email messages. As a result, since 2008, large and sometimes questionably-solvent banks have been estimating that they are far more creditworthy than they knew they actually were. By submitting low estimates of their borrowing costs, they artificially and systematically drove down the published Libor rate.

A total of 17 large financial institutions, including five companies with significant brokerage and sales operations in the U.S. (UBS, Citigroup, Credit Suisse, Bank of America and JP Morgan), plus Barclays Bank and Germany's Deutsche Bank, are under investigation by regulators in the U.S. and Europe. Barclays has already paid $340 million in fines.

As it turns out, even a cursory check of the rates that banks were actually borrowing on the credit swap market would have turned up the discrepancies. After the scandal broke, Fortune magazine pulled up these figures, and reported that Citigroup might have been the most persistent offender in the group. The magazine compared each bank's Libor submissions with other measures of their borrowing costs, looking for the biggest gaps (and, therefore, the biggest lies). Citibank's differential consistently led the pack.

Rigging Libor gave brokerage traders a crafty advantage over their customers. At Barclays, traders made big bets on derivatives whose value depended on Libor; knowing how those rates would incrementally shift up or down was remarkably lucrative--at the expense, of course, of investors who didn't have this advantage.

What are the implications of all this for the average Joe on the street? If your mortgage happens to be an adjustable-rate loan tied to the Libor index, brace yourself. Your rates may have been artificially low since 2008, and could jump as the BBA starts to get more realistic estimates. The aforementioned student loans and interest on credit cards could also bump up a bit.

Beyond that, you can thank the deceptive brokerage firms and banks for lowering interest rates and saving you a few dollars, even if you know that you were the last thing on their minds when they whispered deflated estimates into the phone.

But perhaps the biggest takeaway is that we have once again discovered that some of our largest financial institutions have gotten in the comfortable habit of lying. Indeed, in an op-ed piece in London's daily The Telegraph, an insider from one of Britain's biggest lenders, speaking for his colleagues around the world, said that this manipulation and deception--telling quasi-regulatory bodies that the bank could borrow at 2% when in reality the right number was more like 5-6%--was a routine part of doing business.

Nt only was the deception an open secret, the large banks themselves, he said, would refuse to lend to their customers based on the phony Libor rates they were providing. Why? Because they knew the numbers were phony.

Sources:

http://www.institutionalinvestor.com/Article/3063818/What-the-Libor-Scandal-Really-Means.html?LS=EMS688545

http://www.huffingtonpost.com/2012/07/11/libor-rate-scandal_n_1664737.html?utm_hp_ref=libor-scandal#slide=1212057

http://www.independent.com/news/2012/aug/04/libor-global-interest-rate-benchmark/

http://www.huffingtonpost.com/mark-gongloff/libor-scandal-citigroup_b_1689853.html

http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/9368430/Libor-scandal-How-I-manipulated-the-bank-borrowing-rate.html

Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.

LEADING INDICATOR - HIDDEN OPTIMISM

The stock market caught everybody off-guard last Friday; the S&P 500 index climbed 1.90% on news that the U.S. economy created 163,000 new jobs in July--about 60% more than economists were expecting. But this was the fourth consecutive week of gains, and there is no clear explanation for those other positive trading weeks in the economic numbers. Newspaper columnists and cable pundits have told us that investors were expecting the Federal Reserve Board to do something to stimulate the economy. But what, exactly, can the Fed do now that interest rates are at rock bottom? Buy more Treasury bonds when rates are already near the lowest in the world? Lend to banks at even cheaper rates than they do now?

Others have said that investors are feeling optimistic that the Eurozone debt crisis is easing. The good news there, oddly enough, came when Spanish prime minister Mariano Rajoy, on Thursday, hinted in a press conference that he might be willing to request a full-fledged bailout. He didn't actually come out and make the request, but only said that he would "do whatever is in the best interest of the Spanish people." This reassured investors who had been worried that the Spanish government would resist asking for help even as its two-year government bond rates topped 7%.

Looking deeper into Europe's ongoing credit mess, The Economist magazine reports that the only real solution is economic growth. Then the magazine offered a remarkable statistic. Since 1975, the countries now using the Euro currency have given birth to exactly one company that currently ranks among the world's 500 biggest: Spain's Inditex. (By way of contrast, the U.S. state of California alone has created 26.) The magazine tells us that Europe is going to have to change the way it does business before we can expect to see an end to the present crisis.

So where did this (admittedly guarded) optimism come from? The interesting thing here is that inexplicable rises in the stock market are not uncommon, and many times they are one of the first indications of a yet-unseen recovery in the economy. Economists divide the numbers they watch into two categories: "leading" and "trailing" indicators. The leading indicators hint at the future; that is, they change before the economy as a whole changes. Trailing indicators confirm the trend.

The Conference Board lists ten leading indicators--and one of them happens to be the Standard & Poor's stock index. It seems to work--although not perfectly--in predicting when the U.S. will fall into, or pull out, of a recession or experience better economic growth.

The chart below shows the index in good and poor economic times; the gray shaded years represent U.S. recessions. Notice that the markets have tended to drop before the recession hits, and that they tend to start recovering before the U.S. has emerged from the gray zone. (The 2001 recession is an exception, but the market did start to recover before the end of the recession had been declared and confirmed.)

How does this work? The best explanation seems to be that our economy's insiders--that is, corporate CEOs and top executives--are able to look at their own operations and notice improvements in sales, revenues or efficiency that economists cannot yet measure. Astute investors who have a network of friends and other sources deep in the economic system will get the same information, and both groups will start quietly buying into the market at what they regard as bargain prices. The market will start to go up without any apparent reason to outsiders--until the recovery is finally confirmed by those trailing economic indicators, at which point everybody else crowds in and we experience a bull market.

Of course, it works the other way as well. Toward the end of the bull, those same insiders sense that the current prices are too high for what they see in their own operations. They start to lighten up their stock holdings, shifting more weight to the sell side of the ledger, and stock prices inexplicably start trending downward.

The point is that most of us never know why the markets suddenly become more optimistic, as they have over the past four weeks. This is something that economists freely admit. Instead, they watch and listen to what the investors are whispering through their trades. The other point is that what you normally hear on the cable financial programs is exactly the opposite of what you've just read. The next time you hear a well-dressed pundit telling you that the economy has done this, and therefore he expects stocks to do that, remember that the whole dynamic actually works the other way around.

Sources:

http://www.marketwatch.com/story/europe-holds-key-to-fifth-week-of-us-stock-gains-2012-08-04
http://www.mohavedailynews.com/articles/2012/08/05/news/business/doc501e256935df2987942161.txt
http://www.economist.com/node/21559614
http://en.wikipedia.org/wiki/Economic_indicator

Sincerely,
William T. Morrissey and Tammy Prouty
Sound Financial Planning Inc.
wtmorrissey@soundfinancialplanning.net
Primary Office
425 Commercial Street, Suite 203
Mount Vernon, WA 98273
Phone: (360) 336-6527
Secondary Office
650 Mullis St., Suite 101
Friday Harbor, WA 98250
(360) 378-3022

PLEASE READ THIS WARNING: All e-mail sent to or from this address will be received or otherwise recorded by the Sound Financial Planning, Inc. corporate e-mail system and is subject to archival, monitoring and/or review, by and/or disclosure to, someone other than the recipient. This message is intended only for the use of the person(s) ("intended recipient") to whom it is addressed. It may contain information that is privileged and confidential. If you are not the intended recipient, please contact the sender as soon as possible and delete the message without reading it or making a copy. Any dissemination, distribution, copying, or other use of this message or any of its content by any person other than the intended recipient is strictly prohibited. Sound Financial Planning, Inc. has taken precautions to screen this message for viruses, but we cannot guarantee that it is virus free nor are we responsible for any damage that may be caused by this message. Sound Financial Planning, Inc. only transacts business in states where it is properly registered or notice filed, or excluded or exempted from registration requirements. Follow-up and individualized responses that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, will not be made absent compliance with state investment adviser and investment adviser representative registration requirements, or an applicable exemption or exclusion. This information should not be construed as investment advice. All information is believed to be from reliable sources; however, we make no representation as to its completeness or accuracy. WE WOULD LIKE TO CREDIT THIS ARTICLE'S CONTENT TO BOB VERES.