A Case for the Bear
A contrarian is most successful at making money when the market is at the top (extreme bullishness) or at the bottom (extreme bearishness).
When I was reading this article last week, what really caught my eyes was that tiny chart on the right-hand side labeled “Reason to Worry: Adjustable-rate Mortgages as a percentage of all mortgages.”
Putting on my contrarian cap, I say to myself, this can be a decent sentiment measuring tool. For example, when more borrowers are fearless of the future (there is nothing to fear; the world is all good and is going to be better), more choose the adjustable-rate mortgages. Conversely, when more borrowers are not certain of what the future holds ahead (fear and uncertainty), more go for the 30yr fix mortgages.
The chart showed three spikes of 30+ % of mortgages are adjustable-rate since 1990: one in mid 94, one in early 00, and the current one is now. We all know what happened in 2000. But in 1994, DJIA dropped 12% from March to May; Nasdaq dropped 14% within 3 weeks around the same time, and 10% drop for S&P100.
What happened in 1994? It was the year of the bloody bond crash. At the time, there was little sign of inflation, the economy was growing, and the U.S. had a record deficit. Sounds familiar? In February, the Fed unexpectedly raised interest by 25 basis points to 3.25%, the first of four hikes in four months, which caused the bond market to pinic due to the overly leveraged "carry trades." Deja-vu?
The only difference this time is Greenie issued an early warning in May allowing the bond market to cover their “carry trades.” We will know how much this advance notice helped, as the story unfolds later in June when the Fed starts raising interest rates.
Thursday, June 03, 2004
An unconventional, out of the herd reading of the financial markets.
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