Reflections of Friday

With a storm last evening, bringing with it some much needed rain, this post is a little late.

One of the things that I’m grateful for is having had the opportunity to be a market observer over the past 18 months or so. I’ve had pockets of having very little time to observe and longer periods, such as recently, that I’ve been able to watch more intently.

I do not know what is to come to pass over the next few weeks as the market grapples with the issues that have nibbled along the sidelines that are suddenly coming to the fore. I keep CNBC on, but it is in a room adjacent to my office. Though I have lots of beefs with CNBC, and I’ll not air them here, I do get some benefit even if it is to provide a counterpoint.

One thing I found of interest was their “Trillion Dollar” survey. All of them dismissed that there was a correction underfoot and believed that we were just undergoing a bull market correction. And I’m not dismissing their view….but it will be interesting to watch how this unfolds and be mindful of who says what so that later one can evaluate the quality of the guidance. I’m certainly not giving any guidance. Though, I still find Gary Kaltbaum one of the best commentators out there. Better yet, his show if FREE.

I believe that many investors have been lulled into a false sense of security through their diversified investments across the globe. I keep a list of ETF’s, and over the last couple of days, I think that every one of them has been in the red. Given that my internet access is kaput, I cannot provide fast facts, but I believe that EZA was down as much as 8% yesterday. This would have been on top of Thursday’s loss, which was likely in the 3-5% range.

I think that in general there is a distinction between diversifying country-specific risk v. global risk. The former you can diversify away; the latter is inescapable, so long as you are in equities. I believe that the dynamics (in so far as I can claim even but a rudimentary understanding) among the currency and debt markets—they are inextricably linked—have created a global risk environment that I do not believe the average investor appreciates.

It is the interplay of these dynamics of currency inequalities and risk complacency of the debt markets that have fueled the incredible rise of all of the world markets.

Now you have heard the same reasons as I have heard.

• There’s a global economic boom—Agreed, but if all of the central banks are curbing capital expansion by increasing interest rates, why do any consider that NOT to be a reining in of some of that expansion. There is a lag effect, and that lag eventually bites one in the arse.
• There’s a global liquidity boom—Agreed, but lenders have been complacent about risk. When that complacency is shattered then credit spreads (the difference between sovereign debt and other “stuff”) widen. When credit spreads widen, you lose liquidity. Since writing this on Word, my internet has come up and John Mauldin explains the “dry up” rather well. Do look for it.

And these reasons are REAL reasons, but after a while, real reasons start to lose their connection to reality. Martin Goldberg has the most terrific post on Financial Sense on Line for Thursday, July 26, 2007(Financialsenseonline.com). I hope that you will check it out. He speaks specifically about the discounting of information by the market. It really resonated with me, as the effectiveness of the market’s discounting of information has been a rubric to me. Here’s a quote

Discounting Mechanism? Not Near Market Tops!

A bull market “climbs a wall of worry,” and such is the case with this bull market. However, there is equal wisdom in the saying, “the stock market is a discounting mechanism that discounts the future.” It is this saying that suggests we are close to a market top. Why? Because today’s stock market not only doesn’t discount the future, but it barely discounts the present. This is evident by the amount of significant moves that are occurring the day of quarterly earnings announcements. Tuesday’s Amazon.com quarterly results are especially reflective of a market that not only doesn’t discount the future, but barely discounts the present. It was up over 20% on Wednesday’s trading. Similarly, one of the most visible and scrutinized companies in the word, Apple Corp., was up about 10% in after hours trading based on its after hours quarterly earning report.

A more accurate view of the stock market as a discounting mechanism is that at market bottoms, the market is extremely forward looking as it begins to move higher. The discounting window moves to shorter and shorter term time frames as the bull market ages, until finally at the top, very little if any of the future is discounted. The recent behavior of these large and visible companies to trade instantly and significantly higher based on what is announced the day of quarterly earnings, is a sign of a market that is not discounting far into the future if it is discounting the future at all.