The End-of-Year Downshift Is Beginning

By: Michael Ashton | Mon, Dec 10, 2012
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With the last major central bank meeting of the year (the Federal Reserve's) due on Wednesday, and few important pieces of data ahead aside from Friday's CPI, markets seem to be starting the inevitable downshift into the end-of-year holidays. Admittedly, it is somewhat hard to tell. It looks like aggregate equity volume in 2012 will be down a stunning 28% or so from 2011 (see chart below, source Bloomberg). This continues a recent trend, but accelerates it as well.

aggregate equity volume in 2012 will be down a stunning 28%

I've discussed in these articles in the past the possible causes of this seemingly-secular decline. I believe that there are at least two causes. One is not particularly worrisome; there was probably already a trend in place for volume to move off of organized exchanges to "dark pools" and the like. But the recent drop in volumes seems more likely to be caused by recent events, and judging from anecdotal evidence I've seen - namely, that market-makers are reducing the scale of their operations across almost all products because of the regulatory difficulties of maintaining those operations - a big part of the recent decline is likely to be attributable to the gradual implementation of Dodd-Frank and the Volcker Rule. This is something less than shocking. What hasn't yet happened, but I suspect may, is that asset prices themselves decline if liquidity is meaningfully impacted by declining volumes. For any given asset, the fair price is a direct function of liquidity (as well as many other things, of course), which is why there is such a thing as a 'liquidity discount' enshrined even in tax law. The decline in liquidity itself is probably non-linear (since market-makers will be less aggressive as they perceive other market-makers being less aggressive), and therefore the decline in asset values is likely non-linear as well.

Not to mention being totally unpredictable as to timing, I might add. But there is something to the old rule of technical analysis rule that markets can go down on big volume, but they can't typically go up for an extended period on low volume.

Global political events haven't yet left town for the holidays. Italian Prime Minister Mario Monti announced on Saturday that he plans to resign after former Prime Minister Berlusconi withdrew his support. 10-year Italian yields jumped 30bps to 4.81%, but remain considerably below the levels associated with any serious concern about Italy (see chart, source Bloomberg).

10-year Italian yields jumped 30bps

Across the Ionian Sea, Greece extended the original deadline for its debt buyback by two days, signaling that it hasn't reached its target. According to reports, the government has received tenders for €26bln (in face amount) versus its target of €30bln. However, the important number is the difference between the face amount of the debt offered compared to the price paid by the government. That number needs to get to €20bln, and there is no way to know if the government is close. If they have overpaid relative to the 33 cents on the dollar they were expecting to pay, and have spent, say, €10bln to get those €26bln in tenders, then they're not really all that close. If they have spent €7bln, then they're very close and I would guess close enough. I'm not sure we know.

In the U.S., no apparent progress has been made on the fiscal cliff.

But here's a little story that caught my eye. "NYC Base Subway Fare May Rise to $2.50, Board Members Say." I only point it out because the 11% hike in base fares seems out-of-place with a weak economy...if, that is, you think that economic growth causes inflation. Personally, I don't believe in that old, discredited notion, but some people do.

Looking forward over the balance of the month, I don't expect that wDoe will see a Santa Claus rally in equities. Although we got such a rally in 2010 (+6.5% in the S&P 500), and smaller ones in 2009 (+2.8%) and 2011 (+0.9%), there seems to me to be too much uncertainty for investors to make significant bets into the end of the year. The outcome in December is likely to be decided by a coin flip - if the fiscal cliff is resolved, then equity markets will rally (and that rally probably should be sold, since the underlying fundamentals are still very poor); if the fiscal cliff is not resolved, stocks will slide into the end of the year (and that selloff is probably worth buying, if it's deep enough, since there's a reasonable chance that the issues are resolved after both sides realize the other side isn't going to blink). I'm not sure that's a market I want to have a strong commitment to right now, in either direction.

 


 

Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA
E-Piphany

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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