What to Look For on the Road Ahead

The madness of markets of late reminds me of the fun house mirrors that make us look too fat, skinny, short or tall.  In the case of financial markets, prices can make us look too rich, or for most of us lately, too poor.  For those of us who refrain from wanton speculation, and are simply “long-term” investors, looking at a portfolio during times like these, or even bubble times, can distort our view of what we own and what we are “worth”.  Nonetheless, these time force investigation and introspection into our holdings and our investment strategies, and that is at least healthy.

With anxiety levels moderating, and technical selling being reversed by technical buying, “normalcy” might try to rear its ugly head over the next few weeks, if volatility crawls back into its cave.  The wild swings of recent days force a reminder of that fortune-cookie expression that things are not as bad or as good at they seem, but simply remain as they are.

Let’s hope that fundamental data such as earnings and government reports can once again find a way to drive markets, as opposed to steroid induced fear and greed (the mental image I have are the zombies from I Am Legend).  If this can actually happen, then here are some thoughts of what might actually move markets once the hangover wears off.   Below are some general market trends and movers to be cognisant of over the next few months.

Q3:: Earnings (non-financial): Non financial earnings are likely to have slowed, but may be perceived as better than market sentiment, due mostly to the fact that they are representative of the July, August and September period.  (Think of how many more iPhones you’ve seen lately)

Q3:: Earnings (financial): Likely to surprise here to the upside due mostly to modest gains in the ABX during the Q3 period.  (The ABX indicies measure the risks of owning bonds backed by residential mortgages)  See my post regarding mark-to-market and the “clarity” provided by FASB.  As it stands, the ABX will likely remain a near term pricing mechanism for many troubled assets.  The uptick in the index during the Q3 period will have a double effect: 1. it will improve the capital bases of financial firms, lifting sentiment on shares, and 2. it will lift spirits that a bottom has passed.  This will likely create some false signals putting out some of the other fear fires burning, but not necessarily representative of a cyclical turnaround.

The ABX indices measure the risks of owning bonds backed by residential mortgages

ABX-HE-AAA 07-1 (AAA Tranche of loans made prior to the first half of 2007)

Q3:: Government Data: Government data will continue to move towards slower or negative growth, however, there may be a few surprises here, surprises to the upside will be a matter of trusting the government, surprises to the downside will be a realization of the current (or pending) recession.  I’d continue to expect jobs data will underreport the damage due to the birth-death lag, and I’d expect the CPI to moderate fairly dramatically given the roughly 50% drop in oil prices during the quarter.  Both of these signals may fuel a prolonged bear rally through part of Q4.

These, among others will be reflections of how things really “are”.  While there will be lot of data and signals to look for over the next few months, not withstanding the TARP, and regardless of where the fundamentals lead us, let’s hope we can return to normalcy.

On those days when the mirror is distorted at least be reminded that it might just be the mirror and not you.

Markit ABX.HE Closing Prices
Markit Indices, Accessed October 15, 2008


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