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Friday, November 7, 2008

The Pschizophrenic Markets II

The employment data for October was announced this morning and the news was bad, really bad. The economy lost 240,000 jobs in October. This number is not only bad on its face, however it was worse than the 200,000 in expected losses. Furthermore, the unemployment rate jumped to 6.5%.

With all of this bad news, one would expect the markets to react in kind. Yet, we have seen the exact reverse across the board. So far, the Dow is up almost 200 points. The Treasuries, on the other hand, have responded worse. If the markets were responding to economic news with any logic, we should have seen the exact opposite response across the board. It's possible we are seeing the effect of buying ( or selling) on expectation and the reverse on news.

It's also possible that the markets have stopped responding to economic data at all. What we have seen in the markets over the last couple weeks is something even more troubling than the bear market that has taken hold. What we have seen are equity and debt markets foresaking logical response altogether. Yesterday, the European Central Banks cut their short term rates sharply. Yet, the debt markets responded with a collective yawn. The movement in LIBOR, the Treasuries, as well as the German Treasuries was rather mild. The European Central Banks cut their short term rate by a full percent and a half. This should have moved short term rates down significantly and should have moved long term rates up. (the central bank rate is a short term rate and that's why short term rates should have gone down, it is also long term inflationary and that's why long term rates should have gone up) Yet, we saw almost no movement.

Today, we have worse than expected economic news. This should have pushed stocks down. Bad economic news is also deflationary which should have pushed long term interest rates down. Instead, we saw the exact opposite on both, so far. In fact, I wouldn't be the bit surprised if all these numbers are transformed prior to the end of the day.

At this point, I am convinced that all markets, debt and equity, are being pushed not by market forces, investors, and long term players, but rather they are being manipulated by speculators. Speculators dismiss economic news because it is irrelevant to their agenda. Speculators have no long term plans for the market. All their movements are for hours and days at the most. Rather, they respond to trends in the market movement. The only thing that can explain ten percent movements daily in the Dow is that speculators are moving this market for their own short term benefit. Many of these folks are likely the same folks that pushed up oil over the summer, and many are also likely trading from overseas.

What this means for the indefinite future is that first and foremost there will be a total lack of predictability. It not only means that it will be difficult to predict the future movement of the market, but furthermore, it will be just as difficult to predict how the market will respond to already announced news. That's why I continue to only recommend a volatility play.

Unlike most others, I don't believe that anything should be done to or about these speculators. Speculation is an unfortunate part of any market, however trying to regulate speculation is a dicey proposition. Many of the scourge investments like short selling were created to give investors a reason to stay in bear markets. They were created to give investors an investment vehicle if they believed the market was bearish. Take away this tool, and these investors won't as easily return when the market is bullish. Just because someone is investing with absolutely no scruples doesn't mean it makes any sense to try and regulate them.

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