May 15, 2003
Rally Takes on a Life of its Own

Over the weekend the May Blue Chip survey of economists pointed out what everyone already knew: growth is not going to be as strong as expected in the coming months.  Similarly, yesterday’s awful April retail sales report confirmed what everyone already knew: the post-Iraq rebound in consumer spending has not yet materialized. Suffice it to say, when the stock markets capsize this will confirm what some bears already think they know: the current rally represents little more than a bear market rally. 

Despite yesterdays weaker than expected retail sales report, the markets managed to post only modest losses. Moreover, despite two down days in a row, the markets are still up on the week. Short covering is likely responsible for some of the recent market gains.  However, it is more likely that the markets are benefiting from fund managers chasing S&P performance for fear of losing their jobs, and/or inflows into equities. To be sure, whereas last year was the first year for equity outflows since 1988, this year is shaping up to be the first year of money market outflows since 1993.  And after 8-months of equity outflows in a row, some money market capital has been landing in equities since March.

Liquidity considerations aside, there can be little doubt that the current rally has spooked bears.  Quite frankly, yesterday’s action – tiny equity losses in the face of bad economic news and a run on bonds – is not really definable, except to say that people are bullish on stocks, and bruised shorts are not eager to attack…

As for yesterday’s run on bonds - which helped push the yield on the 10-year to its lowest level since 1958 (3.52%) – it was not based upon a rush to the ‘safe haven’ of bonds.  Rather, and ever since the Fed warned of the possibility of deflation, the action in Treasuries has been bullish because each economic report is being received with the word ‘deflation’ in mind.  Given that Greenspan and company are considering unconventional ways to attack deflation, Treasury buyers appear to be doing the Fed’s bidding. To note: if the Treasury market is so terrified of deflation what is the stock market thinking? (the disconnect between stocks and bonds this week has been remarkable)

Also yesterday, Treasury Undersecretary Peter Fisher took his name out of the running for the head New York Fed job. Many have speculated that this development helped prompt a rush to the 30-year Treasuries.  Mr. Fisher is responsible for originally stopping 30-year issuance.

A deluge of economic reports are due out today and tomorrow. As well, tomorrow is options expiration. Stock market strength begets stock market strength, at least until equity investors realize, as bond investors have surmised,  that the over half million jobs that have been lost in the last three months are not soon coming back...

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