The author mentions interest rates. It was very strange and ominous to watch the stock market make a new all time high today while long-term Treasuries were getting monkey hammered. Add t-bonds to the list of canaries in the coal mine. More importantly, that sort of raising of the cost of capital reverberates across the entire economy and financial markets as financial models re-price everything (lower) in real time. Therefore stocks can only ignore the 800 pound elephant in the room for so long. No surprise real estate (REITs) were hammered today, no doubt due to interest rates.
The Beatings Will Continue Until Morale Improves
As I wrote recently, t-bonds are selling off due to asset allocation into stocks, fear of Fed 'tapering', and recent improvement in macro-data. This sell-off will continue until it causes a "risk off" event, and then as we have seen this movie several times before, the wheels will come off the stock market bus, yet again...
The Heat is On - 30 Year Interest Rates are Rising
2) The Dollar
Another key factor in this equation is the dollar. As long as it remains low, then the carry trades funded by the Fed are all good. However, on the back of the recently strong macro data, the dollar was up big today against all other major currencies. This is another self-destructing scenario. A strong dollar puts pressure on foreign profit translation and it also makes imports more favourable than exports. Even more importantly, a strong dollar would set-up a vicious cycle in which dollars lent abroad would be forced to flow back to the U.S. further driving up the dollar. This would ultimately lead to a massive unwinding of the carry trades and end the artificial leveraged support for European periphery bond markets. This repatriation of "hot money" would be fast and violent and cause major dislocations across world financial markets. The fact that interest rates are rising makes the scenario much more likely to occur now, since the cost of carry is rising on two fronts - both from a currency perspective and from a borrowing perspective.
3) Stock market volume
As I have pointed out several times, the Fed-sponsored, HFT driven ramp to new highs was based upon and dependent upon ever-dwindling stock market volumes. It's much easier to manipulate thinly traded markets than heavily traded markets. So, we should fully expect that an inevitable pickup in downside volume will cause some very interesting pricing scenarios indeed. Suffice to say these current nose bleed stock market levels have in no way been tested by determined sellers.
I fully suspect that we will see a combination of higher long-term interest rates, stronger dollar and heavier volume at the same time. Then the Fed's latest ephemeral bubble will be put to the same test as the last two, only I suggest somewhat more spectacularly...
