It was silly season on Wall Street Friday. November's unemployment figure -- still a dismal 10% and subject to revision -- came in stunningly better than expected and the markets immediately soared to fresh 2009 highs. The Dow Jones Industrial Average ($INDU) alone shot up as much as 150 points in early trading.
And then, at about 11 a.m. Eastern, everybody decided to sell. "I don't know what happened," says David Wyss, chief economist at Standard & Poor's. "Some of it was probably just profit taking, but anybody who believes in rational markets hasn't looked at them very long."
On a Teeter-Totter
The Dow spiked, plunged and eventually finished with a wee gain. Welcome to the wacky world of equities, where good news is bad news and bad news is good news. It seems traders -- as fidgety as chipmunks but with shorter attention spans -- suddenly and collectively realized that an improving jobs picture could make their cheap-dollar-fueled bubbles blow up much sooner than expected.
Here's how: Stocks, gold and oil have all ballooned on the so-called reflation trade. That's where central banks and governments around the globe keep interests rates low (in the U.S.'s case, essentially at zero), while simultaneously flooding the world economy with stimulus spending. All that cheap liquidity has to flow somewhere, and it's been pouring into pretty much any asset class you can think of.
Magnifying this effect is that the weak dollar has become the vehicle of choice for the international carry trade. That's where traders borrow cheap currency (until recently, the yen for 16 years) to purchase higher-yielding assets such as stocks, bonds, oil, gold and commodities in general. Profit is made by pocketing the difference. As the dollar rises, borrowers of greenbacks find themselves in a short squeeze, which forces them to sell those higher-yielding assets in order to buy outright the dollars they've borrowed.
Dollar's Surprise Move
So if the economy is stabilizing faster than forecast -- as today's jobs report at first seemed to suggest -- the chipmunks figured the Fed will have to raise rates sooner than they expected. Why is that bad? Stocks and bonds drop on rate hikes even in the best of times. But in this case, it would hurt even more because a rising dollar will make all the assets it has reflated -- equities, debt, gold, oil, etc. -- fall even harder.
Which is exactly what the chipmunks did to these asset classes Friday. The dollar jumped and everything predicated on it being weak fell. Who saw that coming? Apparently no one. As Dennis Gartman, author of the well-regarded investment newsletter bearing his name, said Friday, punters who played the jobs report got what's coming to them.
"Anyone, anywhere who chooses to make material 'bets' in the world of trading/investing predicated upon the outcome of [the unemployment] report deserves the sound thrashing that he or she shall likely receive," Gartman told clients, noting that these reports are "notorious for revisions of 30% to 60%...in either direction!"
If there is some weirdly good news about Friday's market action, it's that at least the dollar/securities correlation remained intact, unlike the previous spooky session. On Thursday, small cap stocks, financials and oil fell even as the dollar sunk, too, notes Keith McCullough, CEO of ResearchEdge, a New Haven, Conn., strategy and research firm.
Rates Staying Put
"Dollar down equals stocks and commodities down?" McCullough wrote Friday. "Yes, this is new," the former hedge fund manager says. "It's called unwinding the reflation trade," says McCullough -- a situation that does not bode well for our bubbles.
Also adding to Friday's market mishegoss was that even though the employment report was a pleasant surprise when benchmarked against economists' and market expectations, "the overall labor market backdrop remains extremely fragile," wrote David Rosenberg, chief economist and strategist and Canada's Gluskin Sheff. In other words, at least some of the chipmunks took the time to actually digest the data -- and they didn't like what they ate.
But getting back to the idea that the Fed might hike rates anytime soon? Well, that's just goofy. "The Fed will need to see sustainable unemployment trends before they'll raise rates," says S&P's Wyss. "And then if the fragile recovery started to fall apart, they would just drop them again."
The bottom line for retail investors is that one day in the market (or in Friday's case, 90 minutes) does not make a trend. Every day is but a single data point -- and some points are noisier than others.
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