Limited Investing Opportunities In Range Bound Trading

Time flies when we are having fun… we are now into the 13th week of a stock market rally that started in March. The embers of the stock market rally has not flickered out entirely but there are signs of investors taking some profits off the table.

In the short term, stocks may still rise. Blue chips have retreated slightly but are generally holding up while rotation plays have seen penny stocks enjoying a new lease of life. Some of the penny stocks have dubious fundamentals but this indicates investors’ appetite for quick gambles before getting up from their seats in the casino.

I have constantly stressed on a major stock market correction because I am not convinced that global economies will experience a V-shaped recovery. Yes, the worst may be behind us, as vouched by Paul Krugman.

He said: “I will not be surprised to see world trade stabilize, world industrial production stabilize and start to grow two months from now. I would not be surprised to see flat to positive GDP growth in the United States in the second half of the year.”

Before we get carried away, he tempered his optimism with another remark: “In some sense we may be past the worst but there is a big difference between stabilizing and actually making up the lost ground.” That implies we may not see full employment nor optimal production and consumption any time soon.

The harsh reality remains that employment, retail sales and auto sales are dismal. Non farm payrolls shows the smallest decline since October 2008 but the unemployment rate was worse than anticipated. Consumer spending, which powers two-thirds of the U.S. economy, dipped while consumer borrowing in April fell by twice as much as analysts had expected.

For the time being, bears have not asserted their full presence and range bound trading will be the order of the day. In the event of any drastic correction, the stock market has a tendency to fall slowly and then all at once. However, it is impossible to predict the timing of this reversal or what event will percipitate the downfall.

It could come from the energy sector which has been leading the market rally. Despite Goldman Sachs forecast of $85 price levels by year-end, actual demand in energy has not spiked tremendously. Hence, when the music stops for this fund-driven commodities run, things can get ugly like the collapse of oil trader Semgroup last year.

Or the tremors may emanate again from the financial sector. It has yet to discharge the first batch of toxic assets from the subprime crisis (saved only by the abolition of mark to market accounting) but could already be gearing up for the next lot of toxic waste from commerical loans, defaults of prime borrowers (people with sound credit and conservative, fixed rate mortages) who now comprise the largest share of new foreclosures in the 1st quarter, credit card delinquencies, and the possible unravelling of the $640 trillion OTC derivatives market.

Rising interest rates, Treasury bond yields and the demise of the US dollar are also factors which can cause irrational behavior in Mr Market. And, not to discount the highly unlikely but nevertheless possible mother of all crisis, a bailout of the US Treasury which has been heaped with the irresponsiblity of the financial sector. Its troubes could dwarf the collective collapse of AIG, Lehman Brothers and General Motors.

The US dollar is a sign of investors’ confidence in the US economy. While America still retains its status as being the most economically competitive country in the world, investors are growing jittery about the size of US deficits – ballooned further by stimulus and bailouts. At some point, not even America’s innovation, political stability or military superiority can prop the dollar’s value.

Ben Bernanke was astute enough to note that US cannot “borrow indefinitely” but he did not have a ready solution. Since “quantitative easing” (money printing) became fashionable in the Federal Reserve’s diction, Ben Bernanke had enjoyed a few early victories.

Initially, the monetization of debt (snapping up U.S. Treasury bonds which foreign creditors did not purchase) was successful in boosting Treasury bond prices and containing interest rates on medium and long-term U.S. bonds.

However, the buying spree could not prevent T-bonds from returning to its equilibrium – plunging prices and surging interest rates. The Fed has also poured half a trillion dollars to purchase mortgage-backed securities but mortgage prices are not on the mend and rates have still surged.

Success is limited because the Fed must print money to buy T-bonds. But the more dollars printed, the greater the inflationary pressure which prompt bond holders to ask for higher rates since they will be paid back in cheaper dollars.

Clearly, the T-bonds market could do without the Fed intervention as it results only in more investor selling. The corrresponding increase in interest rates could undermine stimulus packages and threaten nascent recovery in the housing market. Creating artificial demand is self-defeating and the US has little choice but to cajole, entice, threaten the Chinese or international investors to buy its T-bonds.

However, even if there is no love lost for the US dollar, until another reserve currency has been established, its current weakness has ramifications for the wider economy – commodity prices are being driven up which worsen the panic over inflation. People are worried about their declining cash value and buying assets which they don’t need.

We have to remember that amid green shoots and a “satisfactory” bank stress test, part of the current stock market rally was sparked by a fear of inflation. That is not a good thing. I mean, just look at the Zimbabwee stock market. The key Zimbabwe Industrials Index trekked up nearly 600% and 12,000% in twelve months.

You will have easily trumped Warren Buffett’s achievements but when you cash out your stocks in Zimbabwe currency, you realise all the capital gain is illusory. Zimbabwe economy is crumbling which shows clearly that stock market advances driven by inflation fears does nothing for the economy in terms of creating jobs, production or private investments.

I will rather see the stock market consolidating than to rise because market participants have no choice but to jump in because the US is frantically printing money to pay its debts while debasing its taxpayers’ and other nations’ savings.

The Federal Reserve is toeing a very fine line in maintaining a Goldilocks environment (not too cold and not too hot). It has to constantly tweak its monetary policy to adjust to new circumstances and making mistakes are increasingly costly. And the worry is that the weapons in its arsenal are dwindling.

In the current range bound trading climate, there are very few value investments available. Price-earnings are not attractive and there is little inclination to add on to positions unless second quarter results bring more cheer. This time though, investors will be looking for solid results instead of semi-bad news.

At the moment, a whole gamut of emotions (indecision, uncertainty, volatility, anxiety) run wild in the stock market. Any forays must be made on a short term basis. While I have taken some profits off the table and awaiting the next opportunity to enter the stock market, I am still holding on to substantial portions of my long term stocks which offer solid dividends.

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