Special Edition: What they are buying and what they are not
>> welcome to a special edition of television, i am brian sullivan in new york. we’ll spend the next hour talking to three market professionals in detail about their assessment of the current stock market and factors that will likely affect trading in coming months. we’ll learn what they’re buying and what they’re not buying and why. joining us in the school studio are patricia chadwick, founder and president of ravengate partners,% -art hogan and jeffries & company% -and gary shilling, president of a. gary shilling & company and columnist for “forbes.” patricia, starting with you, interesting year for the market because here it is nearly halfway through the year and the s&p is basically flat for the year, about half the stocks up and half of them down. you could say there’s a lot of nothing going on but it’s the opposite. there’s a lot going on. why are we where we are today?
>> because the average of what is going on ends up being average. i think the underlying economic news is extremely good. i think we have great productivity numbers helping spur the economy and now we’re seeing the unemployment numbers coming down and profits growing rapidly. that is very good news and you would think that would drive the market . on the other hand, there is iraq that is not irrelevant at all. we have the price of oil fairly high which people are concerned will make the economy roll over, a legitimate concern. we have interest rates rising. the fed may not have risen yet but interest rates are rising because the economy is strong and there are people who are nervous about inflation and then there’s the issue of terrorism, a backdrop in the environment that makes people concerned particularly in an election year.
>> art, you’re in the trenches every day. what do you hear from buyers and sellers out there? why are people buying and why are people reluctant to buy?
>> if you look at what’s happened over the last couple of weeks, and last week was a great example with a great week starting out from the git-go on monday, big up day and people probably realized we’re probably one or two percentage points away from worst-case scenario. if you take all of the worries we’ve addressed, many of them have been priced in. you can tangibly price in higher interest rates.
>> has the market priced in any interest rate hikes at this point?
>> i think the market has priced in 75 basis point of interest rate fed fund rates tightening in the next 12 months.
>> you think it’s built in already?
>> i do. if you look at what the market is adjusting to, and take that back 10 years and say what happened in 1994, we went from 3% to 6%, the market initially% -sold off on the dow 5% to 6% and% -rallied 2% by the end of the year. we’ve done the worst-case scenario, selling off in the nasdaq and dow. the s&p has held off nicely but as you mentioned we’re unchanged on the year. so i think we’ve priced in the interest rate scenario.
>> gary, you’re not convinced the fed may raise?
>> it’s already happened in the markets . the overarching consideration to me is the unwinding of the tremendous speculation that’s been built up because the fed in its efforts to try to save the economy when the stock market tanked by pushing interest rates so low has engendered a huge, huge opportunity in the carry trade. in other words, you borrow short, lend long. people have been in commodities. they have been in currencies, anything you can do with cheap money. what we have seen since april 2, when they―when the march employment numbers came out -- is just how big that speculation was because in unwinding it, huge, huge effects. commodity prices down, dollar up.
>> aren’t you making a case for stocks? because if people are unwinding some of these carry bond trades, if they’re winding commodity positions, won’t some of that money go into equities?
>> so far stocks have been relatively unaffected compared to bonds and commodities and currencies against the dollar. but the question is, this is a big speculative balloon and the air is let coming out of it very fast and how big is the rip out of which the air is leaving and is this going to be a soft landing or crash landing and are some of the participants, major financial institutions, going to get hurt? you look back at 1994, what art mentioned, who went up in smoke? kidder pea body in orange county and long-term capital% management.
>> you’re talking about a crash in the bond market .
>> you don’t know what will happen.
>> you never do.
>> you have huge hedge fund and other speculative money out there running markets and you also know that everybody’s on the same side of the same trade at the same time so when they unwind, when everybody is headed trying to jump out of that balloon in their parachutes, they all aren’t going to make it and what you don’t know is are there going to be major problems.
>> we don’t see speculation in the equity market . you don’t have huge market positions. you have a huge amount of cash on the sidelines and i do think that the equity market ultimately reflects the health of the economy and i don’t think you’re saying that the economy is unhealthy.
>> but you have two risks, one to the financial structure and that can be big. after all, you look what happened to asia in long-term capital management, that had ramifications for stocks.
>> and guess what happened in 1999, the stock market soared.
>> but the other thing you don’t know is how much damage will this do to the economy and housing is most vulnerable and last week seesaw existing home sales, an area where it’s sensitive to rising interest rates and you have huge leverage in terms of individuals.% their equity in real estate is%at all-time highs and net ownership is at all-time lows.
>> money is still coming on to the trading floor and people still want to buy stocks, do they not?
>> absolutely. and returning to gary’s point, there is concern there’s more% -leverage than there should be and that is an offshoot of being cheap money for a long period of time. but in 1994, we had a fed funds rate that went from 3% to 6% quickly. the fed is clearly not going to do that this time. they’ve already addressed the% fact that this will be measured. we’re not looking at 50 to 100 basis points at a time but perhaps a june 25-basis point move and this story is out there. we’ve known for the better part of a year that the fed had to tighten at some point. interest rates are as low as they have been in 58 years.
>> but art, the markets have already done most of what the fed is likely to do or maybe more than what the fed is likely to do. you look at the selloff further out in the curve, that’s tremendous. the fed doesn’t even need to move, the work has been done for it and maybe that’s because people are reacting to 1994.
>> how much of the bond market is necessarily fed pushed? bonds have been in a bull market for a long time and at some point everything will roll over, it may not be the fed.
>> there’s no reason that bonds shouldn’t have rallied and rates shouldn’t go lower than this but the point is everybody’s looking for inflation, looking for the fed to act. you have all the speculative money and when the fed flinches and changes the wording on the fomc statement ever so slightly, wham, everybody’s trying to get out of the gondola with the% -parachutes.
>> but they’ve changed the wording a few times recently and we haven’t had the big drop, we’ve had moves, but we haven’t had --
>> every other financial market you can name.
>> the fed has the message out there and the market has moved ahead. in terms of homeownership, anybody who wants can take their variable rate mortgage right now and convert it into a fixed rate mortgage, it will be higher than it was a year ago but they are locked in and rates can go up to 40% and they’ll be unimpacted on their mortgage and it’s good advice for individuals if they think rates will rise.
>> people are going exactly the other way, crowding into variable rate mortgages. washington mutual has billboards wherever they’re in markets say come in for an a.r.m., adjustable rate mortgage.
>> hold it there, gary. we’ll return to talk about the fed, the economy, housing rates, stock, bond, commodity markets , deflation, china and everything in between. that’s the whole show. we’ll be right back.
