Looking into the stock rally since September

From January to the end of August 2010, the US dollar rallied about 20% against a basket of world currencies. Over that same time frame stocks sagged and the S&P 500 lost just over 6% for the first 8 months of 2010. Then the rumour of QE2 sparked a sudden drop in the US dollar and an inverse jump in risk assets everywhere. As shown below in our favourite US dollar chart, the US dollar index is now approaching near-term support again around 76 and we will soon see if it is able to bounce again off this trend line. If it does, we should see the next correction phase for stocks and commodities which are now heavily over-bought.

In 6 short weeks, the S&P has spiked from a year to date loss of 6% to a gain of almost 6%. Impressive. But also troubling for those trying to invest capital carefully. As we have seen many times the past decade, price moves based on stimulus injections, price manipulation and currency jolts have always been like dynamite: volatile, time-limited and full of risk.
As we have mentioned many times the past 18 months, the stock rally since the spring of 2009 has been on alarmingly anaemic volume. Traditionally, less participants and less buying pressure leave markets more vulnerable to downside pressure when selling spikes. The flash crash in May was a vivid example of 'surprise' moves that can materialize in these markets. The more over-stretched, over-bought and over-valued prices become, and the more heightened the price risk to capital invested.
So knowing that these periods have a history of ending badly for investors, one cannot help but wonder who has been buying this rally over the past 6 weeks?
We know that retail investors have been selling stocks and stock mutual funds month after month since January 2009. Individual investors, like consumers, seem focused on building cash savings and relative safety. Not too enamoured with the stock market for some reason…hum…interesting. So it’s not the retail crowd. We also know it is not mutual funds doing the buying as they have not been receiving net inflows from investors and were already fully invested coming into September (they almost always are) with cash rates at a cycle low of 3.5%.
So who is buying? The answer seems to be pension funds–suffering from huge funding holes and still desperately trying to double or nothing rather than admit their 8% return goal has been missed for 10 years and is actually reckless; hedge funds most of whom lost money over the past 3 years and are now desperately trying to catch up; and proprietary trading desks at financial institutions who are losing revenue in most of their business areas this year and are aggressively trying to goose profits for year end bonuses. As David Rosenberg points out this morning from the Federal Reserve data, bank-wide trading assets are up $50 billion in just the past month. Could it be that the banks, who run the Fed, had an inside scoop that more QE was being contemplated in Q4 as a feel-good run up to the November mid-term elections?
If pensions, hedge funds and bank trading desks had a record of wisdom, or lasting profits their buying the past 6 weeks might be somewhat reassuring to those of us worried about preserving capital in these markets. Sadly that is not largely the case. The supposed “smart money” has become increasingly desperate the past couple of years. This leaves the rest of us to navigate our capital through a world of wild wagers being made by throngs of the financially deaf, dumb and blind.

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3 Responses to Looking into the stock rally since September

  1. Anonymous says:

    Interesting comment left on Ellen Roseman's latest blog post
    (http://www.ellenroseman.com/?p=1062)
    “MDB
    Oct 13 2010
    Hi Ellen, just read your article on the fees associates with investing.
    The commissions paid on the sale of mutual funds in Canada is not the issue at hand. The big problem is with the MER.
    Take it from someone with 30 years in the industry, Canadian simply are not capable (or refuse to believe) of grasping just how MERs work.
    This I can tell you from having sat across the table from not only my own clients, but also from potential clients, whom I was trying to win over.
    Just to set the record straight, a mutual fund investor loses 60-80% of their total lifetime return because of MERs.
    The MER, remember, does not include many other costs associated with the management of a fund. The biggest omission is the stock and bond trading fees.
    On a typical equity fund, the stock trading fees will take another 1-2% away from the investor.
    John Bogle, over at Vanguard, also makes a valid point with regard to the lost cost opportunity of money because of the fees associated with mutual fund investing.
    On a Canadian equity fund with an MER of 2%, you can add on another 3% premised on the aforementioned. So in total the investor is on the hook for 5% up front on Canadian equity funds and in the range of 6-7% on international funds.
    Let us not forget segregated funds, where the investor is losing in the range of 8-10% in fees.
    When you compare that to the fact that the NYSE has returned around 7% on average since inception, one can see the problem at hand.
    Now, back to my original point. I would pull out a prospectus and show the investor the MER and explain how it was applied.
    My clients would glaze over, not wanting to understand this issue. If everyone they knew invested in mutual funds, that made it okay with them.
    Some perceived that a regulated product sold by a licensed broker could do no harm.
    Others just had a complete lack of wanting to comprehend the dynamics of investing (this despite the hour and hours I spent with them, just like when they were in school, they chose to not pay attention).
    I could never understand how such an easy product feature was incomprehensible to investors.
    When it came to investors from other brokerages coming in, I truly believed that despite the prospectus in hand, they thought I was misleading them in order to discredit their advisor.
    They would look me in the eye and say that they were not charged the fee (MER). The only fee they would ever comment on was their annual RRSP trustee fee.
    Mutual funds, here we go, are a marketing ploy. They were designed from the ground up to meet the pre-existing mindset of a human being.
    Physiological studies of how an individual’s mind works when it comes to investing resulted in the birth of the mutual fund.
    Just look at the name, “mutual fund,” which implies that there is something warm, community based, generally accepted by the masses at work here.
    There is no such thing as a mutual fund, it is a stock portfolio, a bond portfolio, or some combination thereof.
    Individuals bought mutual funds because they didn’t want to directly own stocks. But in reality that is what they did. They bought a basket of stocks.
    Because the TSX is so thinly traded, the funds these individuals bought were only able to invest in a handful of companies, those with a large enough market cap to withstand their buying power.
    The act of buying 2 or 3 funds to diversify only resulted in a duplication of holdings.
    It is impossible over the long run for a mutual fund to outperform the return of the stock of the company that offers the fund for sale.
    Thus, if there is an investment opportunity at hand, it is in the ownership of mutual fund company stocks.
    What other business is allowed to levy massive fees to the owners of its products, regardless of performance, each and every quarter of the year?
    There is no tightening of the belt during times of recession, but only this massive block of consumer equity sitting being billed year after year after year.
    Other brokers would say, “I wonder how much money Michael Lee Chin makes every year.” I would open the AIC annual report and point to the management fees, which were in the hundreds of millions of dollars.
    Mike became a billionaire from the selling of mutual funds. He didn’t invest in mutual funds, he owned them.
    Warren Buffett has been quoted on many occasions showing his disdain for mutual funds. Yet many mutual fund salesman use him as an example of the buy and hold dogma out there today.
    Warren Buffett buys companies and only when the existing management team agrees to stay on board to run day to day operations. Up until the recent fire sale in the equity markets, he hadn’t bought a stock in over 20 years.
    In closing, may I state that mutual funds are a zero sum game for the investor for the reasons which I have stated and a number of which I haven’t.
    The only winner here is the salesman. Even if you have small book of business of $10 million, it will generate $100,000 per year in trailer fees.”

  2. Anonymous says:

    there's also some hope that earnings season will be strong. that's also giving some lift to this market.

  3. Anonymous says:

    you can sometimes see a temporary borrom in the US dollar when you see most newspapers in Canada running stories about parity with the US dollar. Yesterday was such a case. A bounce should be imminent

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