Friday, May 23, 2008

Markets and oil

A few snippets from this recent post express my own consternation:
What makes markets so intriguing today is that equities seem largely immune to a combination of $120+ oil, softening housing markets and a likely collapse in western consumer spending. Arguing that several trillion currently either sheltering in money market funds or rapidly accumulating thanks to petrodollar wealth in sovereign wealth funds will ride in to support stock markets (a.k.a. greater fool theory) only logically goes so far in the face of such sizeable challenges. But some confusing short-term resilience on the part of stock markets does not invalidate the need for caution, it rather reinforces the need for patience ...

In the face of almost insurmountable doubts (over likely economic slowdown, the impact on consumer confidence of softening residential property prices, the robustness of Asian fundamentals in the face of the ongoing commodity rally, the impact of $130+ oil, and the health of government bond markets given growing doubts over the under-reporting of inflationary pressures) it makes absolute sense to assume ongoing and substantial macro uncertainties. That argues, in turn, for nuanced and highly selective exposure to equity market risk, to capital preservation strategies in bond market terms, and to a healthy degree of ‘absolute return’ (quality hedge fund) as opposed to long-only market positioning, not to mention further asset diversification. Markets may not yet be flashing red, but there seem to be more than usually strong headwinds about.
I think that pretty much sums it up -- the market does not make much sense right now in the face of what's happening in the real world. Stocks seem like they're on prozac. I would have only a couple of comments on this post.

First, I haven't quoted it, but that article mentions a Citibank analyst who has overlaid the charts of various bubbles (Japan 89, Nasdaq 2000, Saudi Arabia 2006, Shanghai 2007) with the current prices for commodities. I agree that it is difficult to value commodities and so difficult to know how much of their current valuation is speculative. I also agree that financial markets should be the subject of ethological study -- capitalism is a fascinating animal behavior pattern. But you've got to be kidding me if you think you can convince me that something is a speculative bubble merely by overlaying its chart on that of other speculative bubbles. This is supposed to be the grand new "science" of behavioral finance? Give this chart overlay stuff a rest. It's about as useful as technical analysis, or reading entrails generally is.

Second, my own experience investigating funds that bill themselves as "absolute return" is that their not. Maybe funds like this really do exist, but I think they are few and far between, and not the ones that everybody normally gets excited about because by remaining "market neutral" they get lost in the dustbin of under-performance during the good times. Now that times are tough, suggesting that investors take these guys out and dust them off is a bit ingenuous -- they've already been driven out of business by all the performance chasing redemptions during the good years. So if you don't already have some money allocated to this type of thing, I'm not sure I would rush to do it now.

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