Jan 28, 2005

Has the Worm Turned?

Well the market managed to scrape through without taking out the morning lows. It was pretty touch and go but with the big Microsoft (MSFT) numbers after the bell tomorrow should have a positive bias. We will see. There were some negative reports out too but MSFT's size should win out.

I am sticking with my plan of remaining a spectator through Monday. I am taking the time to think about the bigger picture. The market has become very familiar with the key features of this rally: low interest rates, a weak dollar, strong oil, stock buybacks, and mergers. All these features are tied together and stem from the low interest rates. The Fed never misses an opportunity lately to refer to rates as accommodative and I would guess it will eventually change the market perception. With the flat yield curve I am a bit concerned that the process will uncoil very quickly.

Another prime candidate to shift the paradigm is the widening of corporate bond spreads. The process will be started by investor's shifting into short treasuries at some point and will probably end a year later with some marginal companies being cut off from debt markets. That process will probably effect emerging markets debt too. This process could still unfold even if the long end of the treasury curves stays where it is.

A third candidate for change is a reversal of the dollar trend. Maybe the Fed hikes manage to bring money to the U.S. or maybe economic prospects abroad start to look less attractive. I don't really see this happening though it seems to be a pretty popular view in the market right now. If China does revalue the Yuan I bet the market experiences a good of month of higher volatility while people figure out exactly what all the new trends will be.

The point of all this is that I get the feeling the macro forces are about to shift a bit and the interrelationships of the last couple of years are about to end. I don't mean this in a bad way that they all reverse direction but some will reverse and in a few cases the correlations will become inverse.

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