When Price itself becomes the Biggest Variable

Normally, in economics, we try to argue for a particular price for an object based on supply-demand. But that is true only under normal cicumstances. In some situations though, price itself is the variable that impacts future prices. This is what people are doing when they are looking at charts and doing "momentum" investing.

And this is what might now happen in US housing. If home prices fall by 9% (at least the prices of new homes for sale has fallen by that in the report released yesterday, exisiting home sale price declines are much lower), why would anyone who has little equity in the home pay the full mortgage, whether employed or not? This would increase foreclosures, bring more houses on the market, further depress housing prices and accentuate the downward movement. I am sure Fed will be forced to intervene even more heavily than it already has (though I dont know when they will intervene). Though what they can do to move the 10yr bond (which determines mortgage rates) is open to speculation. Remember Fed controls the 3 month rate. The 10 yr rate is determined in the market, and with dollar depreciating on rate cuts, whether foreign investors will continue to invest in 10yr treasury bonds as Fed cuts more is an open question.

For stocks, momentum is often the best play. Look at Reliance in the last 2 months here in India. As Mr Steve Edney of Citadel had told me all those years ago, there are just two factors determing stock prices - earnings revisions and price momentum. But momentum cuts both ways, just like leverage.

So whats my portfolio now. 100% equities. I bought VWO heavily the day Fed cut rates by 50bp, which was 10 days ago. There is momentum in emerging markets. Dollar is weakening and commodities are going up which will benefit emerging markets. Plus 4th qtr is upon us - the best qtr for stock indices. The only risk is that next month is October - the deadliest month for markets (Oct 1929, Oct 1987, Oct 1998). It might be deadly this time if Fed doesnt cut. In India I bought ICICI, and it is already up 10%. Long live Momentum.