"Will Macro Fears Impair Stock Performance?"

Sydney M. Williams

Thought of the Day

“Will Macro Fears Impair Stock Performance?”

August 3, 2010

As investors we find ourselves in an odd and uncomfortable period. (Of course, truth be told, we always view our current condition as unique and challenging, as it is inherent to investing.) The macro situation is sketchy at best. The near-collapse of the financial system and the ensuing recession spooked investors. Nobody knows the consequences of the health care bill, nor what the impact of financial regulation will be. The consumer – 70% of GDP – appears to be sensibly increasing his savings, but at the detriment to growth. Fannie Mae and Freddie Mac continue to swill dollars like hogs that have been starved for a week. There are a few states and some municipalities that seem close to bankruptcy. Debt and entitlement obligations are swamping our government and the Federal Reserve is determined to exercise every tool, including ‘helicoptering’ dollars to creditors in China, Japan and beyond.

Stock investors are decidedly nervous and yesterday’s rally did little to alleviate worries. Adding to equity investor’s concerns have been the proliferation of Index Funds, ETFs and algorithmic trading platforms which have caused an increase in the correlation of stocks, rendering stock picking less productive. As a result, macro calls have risen in importance, which is unfortunate because they are often wrong.

Nevertheless these same conditions, which have proved painful to equity investors, have been viewed positively when viewed through the prism of bond investors. Bonds have put in a stellar performance year to date. The yield on the Ten-Year has declined 41%, while that of the Two-Year has fallen 43%. Corporates have also done well with yields dropping 11% for Investment Grade and 13% for High Yield. In contrast, the S&P 500 is up less than one percent. Bond underwritings in July (excluding all agency and government backed paper) rose 76.5% from May with $66.6 billion in deals. In contrast, equity underwritings declined 19% in July versus May to $8.73 billion.

Measures of nervousness – gold, the Dollar and the TED spread – are moderately elevated versus year end, but off their highs, suggesting confidence in spite of macro fears, is returning. Gold is up 8% on the year, but down 6% from its high in mid June. The Dollar Index is up 3.4% for the year, but down 8.8% since its high in early June. The TED spread is 29 basis points versus 14 basis points at year end; however it is down from 36 basis points at the end of May and, importantly, lower than it was before we felt the full force of the credit collapse in the summer of 2007.

In markets, uncertainty breeds opportunity and certainty generates risk. Over the past three years nervousness upended certitude – and properly so. We came close, in the fall of 2008, to annihilation. This concern has been captured by a skulk of Cassandras – commentators, strategists and economists – airing their views on the internet, via CNBC and Bloomberg and even, for dinosaurs like me, in newspapers.

Anecdotally, it appears to me that the rise of these pundits has been accompanied by a decline in the number of analysts pitching a specific stock. In the late 1990s the opposite was true. Economists and others calling for sanity were but wisps in the wind. Who wanted to hear from a practitioner of the dismal science when you might get the goods on a stock which might double in six months?

We all know what happened in 2000-2002 and I would suggest that too much time spent on macro concepts may be akin, to distort an old saying, of missing the trees for the forest.