Walker Percy was a Southern writer and philosopher and one of the most influential American writers of the 20th century.
In Percy’s “Life in the South” essay he describes at great length his belief that bourbon should be “knocked back neat.”
“The joy of bourbon drinking is not the pharmacological effect of the C2H5OH on the cortex but rather the instant of the whiskey being knocked back and the little explosion of Kentucky U.S.A. sunshine in the cavity of the nasopharynx and the hot bosky bite of Tennessee summertime—aesthetic considerations to which the effect of the alcohol is, if not dispensable, at least secondary.”
Percy goes on to tell the story of drinking gin fizzes with a Bellevue nurse he met in the Boo Snooker bar of the New Yorker Hotel in 1941. He didn’t realize gin fizzes were made with raw egg whites, to which he is allergic.
Needless to say the night didn’t end the way he had intended and it led him to conclude that: “Anybody who monkeys around with gin and egg white deserves what he gets. I should have stuck with bourbon and have from that day to this.”
Prior to the financial crisis, trading in free capital markets was akin to knocking back bourbon neat. It was a more pure experience when fundamentals mattered and technicals were more reliable.
Since 2008, it's been a steady diet of gin fizzes as Bernanke then Yellen and other central bankers monkey around and imprison the very markets that were once free to move where they saw fit. The markets reaction to last week’s FOMC statement and Yellen presser is proof positive that we are living in a gin fizz world.
The markets were confused over what Fed Chair Yellen actually said.
She basically emphasized that the Fed's actions will be data dependent, meaning that she will be reacting and not “pro-acting”.
If you don’t know what I mean by confused, lets take a look at how several key markets reacted. The S&P 500 gained 1.77% last week, hit a new all-time high and is quickly closing in on the beautiful round number of 2000. Wall Street loves its round numbers.
The US Dollar also loved what came out of Jackson Hole, gaining 1.11% last week. That kind of gain is huge for a currency. It was the largest one week gain for the dollar in 9 months.
US equities had a huge week, led by housing stocks (ITB) and retail stocks (XRT). Housing stocks were up over 4.5% last week. Have you seen US housing data recently? I can assure you that the data is not strong like bull. Housing starts, peaked last November. Mortgage Applciations have exhibited no sustained growth in over a year. New home sales have been declining for three straight months and have yet to come close to last year’s numbers during 2014. But a monster move in housing stocks makes sense?
Retail stocks were up over 4% last week. Does this make sense given where the US consumer is currently? Personal Income growth has been flatlining for 2 straight years. The personal saving rate peaked in December of 2012 and has been declining ever since. There has been a mild pick up in savings over the last couple of months but we still aren’t back to the savings level of last August. The year over year growth rate in US retail sales peaked in June 2011 and has been in a downtrend of lower lows and lower highs ever since.
Over this same 3-year period, the US Retail sector ETF (XRT) is up 69%. Let me repeat that: In a time period where retail sales have been falling, an ETF that tracks retail stocks is up 69%.
Now that we’ve examined just a couple of the ways that US equities continue to be detached from reality, lets continue our look at how key markets responded to Jackson Hole.
If we’ve learned nothing over the last couple of years, we’ve learned that Fed meetings cause a lot of movement in the US yield complex and the Treasury market. Last week, yields on 10-year Treasuries gained 5.8 basis points or 2.5% and long dated Treasuries (TLT) lost 36 basis points.
Investment grade corporate bonds (LQD) declined a whopping 5 basis points. These weekly price moves are pretty “ho hum” for these markets given what’s at stake. So, US equities screamed higher and the fixed income markets couldn’t be bothered.
It should be pointed out that even with last week’s returns, US Treasuries (TLT) have nearly doubled the S&P 500 (SPY)’s return so far this year, returning over 16%. What does that tell you about growth expectations in the US?
I should point out that while the S&P is hitting new all-time highs, TLT still remains 6% below its all-time high from July 2012.
How did emerging markets react to Yellen’s perspective on Fed policy going forward? I mean, all we heard back in December and January was how the Fed’s tapering and the end of QE was the end of emerging markets as we knew them.
Emerging markets (EEM) also had a ho-hum response to last week’s headlines gaining just 54 basis points. That said, the death horn that was being blown for this group early in the year was a bit premature, as EEM has returned 7.9% so far this year, very nearly equaling the return of the S&P 500 at 8.8%.
The big difference to point out is that, like TLT, EEM is still off its all time high by 9%, where as the SPY just clocked a new all-time high last Friday.
This is how financial markets imprisoned to Fed statements behave.
Each week, I use this commentary to focus you on the aspects of last week’s news and market action that I believe to be the most critical; and I eliminate everything else. Last week is a perfect example of why I have a job and this commentary exists. There is a lot of noise in the markets each week which have absolutely no impact on trading decisions. That said, trading the markets as the Fed determines the time-line and magnitude of its first rate hike will be tricky.
One way to avoid getting trapped in bad trades is to avoid certain markets all together. You’ll notice in the Focus Markets section of the report this week that I have moved to a NEUTRAL bias in 4 out of the 8 markets.
A NETURAL bias is indicative of a market where the fundamentals and the technicals are not aligned, and as such, the market should be avoided all together. We are only going to attempt to trade markets where the risk to reward is skewed in our favor and I have a strong conviction over the intermediate term direction of that market.
I will admit that the gin fizz element of today’s markets makes forecasting of a market’s direction challenging to say the least. And those are the times to move to a NEUTRAL bias and move to cash as well.
I much prefer to drink my bourbon neat and I would certainly prefer to trade free markets. However, as I said last week, it’s important that you ALWAYS “Trade the market you have, not the one you want.”
I prefer bourbon, but gin fizzes are here to stay. Luckily I’m not allergic to raw eggs.