Good evening,
The days of seemingly long ago beckon as I type what used to be the once-a-month update in a relatively mild market.
Since I have WWII on my mind, General Patton comes barreling to the forefront. I have to admit I am looking forward to the day I can say outrageous things and quell the raised eyebrow because of a few gray hairs. After the war, Patton continued on his previous colorful and what we would call politically incorrect rampage. In a meeting with Hugh McColl earlier this year, who is also known for outrageous comments, he made several about illegal immigration, this from a man who had a bus station moved because it obstructed the view from his office in downtown Charlotte. I digress. After the war, Patton sidestepped removing every previous government official with a smudge of Nazism in his past and publicly contended communism as the next global threat. As a reward for forecasting the next 40 years of American experience, the Army stripped him of his Bavarian Command. He contemplated his resignation from the Army and on his way to go pheasant hunting with his chief of staff was in a car accident. As a result, he loss the use of his legs. Eleven days later, when apprised of the fact he would never ride a horse again, he went to sleep never to awaken again.
Yesterday the bulls were not asleep and quite rightly built on their momentum from the previous two trading days. An infrastructure frenzy abounded, Art Cashin of UBS shared a great comment of Dennis Gartman’s – “…“things that if dropped on your foot will hurt” were suddenly en vogue. You would have thought America was about to be turned into one huge parking lot by July 4th.” The market seemingly likes what the President-Elect has proposed from an infrastructure standpoint. In his emerging pragmatic style, he clearly stated that in infrastructure dollars he’s looking to grant, will be allocated where the most return will be felt for taxpayers. Democracy loves an egalitarian prospect and capitalism will support it as long as it’s profitable.
The technicals were important yesterday and today. We broke through the floor of 895 in the S&P but didn’t have any panic selling at the end of the day which is heartening for the future. Tomorrow watch the three year Treasury Auction. Anticipate the sales to go okay until the dollar starts to weaken. Too much is being put on Retail Sales which I believe is putting too much stock in the rearview mirror.
Merrill’s network of research sent this gem to me last week: Paul Leming’s work showed that in the 14,284 trading days since January 1, 1950, there were 68 days that had moves of 4% or more. Further, 28 of those 68 (41%) have occurred in the last three months. Since I received that we’ve had two more 4% days. Now it’s 30 out of 70 (43%). The volatility remains historic and gut wrenching. Jim Cramer shouted-out this afternoon on CNBC that the uptick rule would NOT solve any volatility, the Mad Hatter has joined the tea party again. We contend that 1/3 of the volatility would go away if the SEC reinstated the uptick rule to short sales and naked calls.
Lastly, communism is re-emerging as a possible contender for space in the global outlook again. The Financial Times had a great editorial today noting that the Russian Ruble is once again approaching the shaky ground of 1998. Couple this with the fact that Russia actually loses money when oil falls below $55 a barrel and there’s some unsettled activity there. China also reported significant and sudden drops in exports. As the policy makers meet this week they may have more than economic growth in their rice bowls. The Guangdong province, notably one of the largest manufacturing provinces, had riots last month as a result of layoffs. Zhang Ping, the nation’s top planner, warned of massive unemployment and social unrest. Why do I bring this up ?! Stay domestic, while we have our own anomalies at hand, our politics are much more transparent and baked in to the market.
The rally has a lot of technicals in its favor ! Price movement has been steady not hyperactive. Keep you eye on volume. And, when the Big 3 finish their bargaining the market will respond accordingly.
Stay away from cascade information and adaptive decision making, this is the time for independent thoughts and solid, proven practices. Avoid the irresistible pull of irrational behavior.
http://researcharchive.worldnet.ml.com/GetDoc.aspx?id=10793183&type=Pdf
Sources: Art Cashin-UBS, The Financial Times, ML- Research, and CNBC. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of December 9, 2008, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Merrill Lynch to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. A portion of the income may be taxable. Some investors may be subject to the Alternative Minimum Tax (AMT). You cannot invest directly in an index. Discuss your investment needs with your financial professional before investing.
Tuesday, December 9, 2008
Reconstruction 12/08
Good afternoon,
Today in history, we declared War on the Japanese and entered WWII one day after the sinking of the Flower of the Pacific Fleet. Please let me salute all of our past Veterans and current Service men and women and their families.
The bulls didn’t drop any nuclear bombs on Friday but they gave it the good college try. David Carradine turns 72 today. While my only exposure to him is the character Bill in the movies Kill Bill Vol 1 and 2, I find the repertoire of his work stunningly vast. Any actor that can go from French movies, to “Dr. Quinn, Medicine Woman” and land in a Quentin Tarrantino movie has range….Or a good agent.
From last Thursday it’s been clear the market has range. I think much of Thursday’s sell off was a last minute unwillingness to be in the market in the face of the expected large number drop in Non-Farm payrolls. Friday, however, despite the media’s “woe is us” message, traders were focused on the meek movement in unemployment. It was inconsistent with the payroll pitch into oblivion. Through Friday the S/P500 held the bears at bay. Not falling below 815 proved to be the stalwart defense the bulls needed. By the afternoon, buyers rushed in to get their possible last minute sales and moved the market higher and higher. While the volume was strong, I wouldn’t put all my eggs in one basket yet.
In my spare time, I did a quick study for 2 years between the information reported in the left hand column of the WSJ and the DJIA performance. The trend that emerged was this. When the economy is getting ready to start turning around it does so in the midst of some very bad news. Friday and the next 10 trading days or so could prove to be important. On Friday we close up which is critical because of the bad news that prevailed. For anyone counting, we’re at three pieces of good news in the last two weeks.
Global Range – don’t be shy about paying attention to what’s happening around the globe. It’s important to how to invest at home. On the front page of the NY Times there was an article expressly insinuating that the Pakistani ISI has been protecting the group allegedly responsible for the attacks in Mumbai. Pakistan was looking to India for a loan prior to the attacks. Predatory lending will take on a whole new definition if these allegations prove to be true. Should the Pakistani government, already on shaky ground, run out of money, considerable unrest will ensue.
Looking a little farther east to China, Premier Hu has cautiously addressed that economic stress could jeopardize the Communist Party’s grip on power. There is some information leaking out that the Army has already been deployed to the provinces to keep civil order. The Atlantic quotes Gao Xiqing, President of the China Investment Corporation, who manages $200B of the $2T of China’s foreign investments, has indicated an effort towards not aggravating the dollar by pulling out of the Treasuries market. Whether unrest at home and with the government would change this attitude remains to be seen.
Since today’s theme is range let’s move from gloom and doom to some good historical data with which to put things in perspective. In Barron’s over the weekend, Barry Ritholtz noted that in the last 100 years the relative strength of the S/P500 has only fallen to its current level 5 times. Each time it fell it was followed by a significant rally. It didn’t ensure a bottom, but did ensure a rally.
Given the potential significance of the next ten days here are some of the support levels to watch -- Dow at 8118 and the S/P500 at 815. An upwards swing would have to break through an S/P 895 (which we have at this moment and I don’t think 3 min can undo that) and 920. Should that occur we’re looking at post Election Day highs. The credit markets could still pull us down for the month (a statistical anomaly in the history of the Dow). At the bottom of this email is some information from Nouriel Roubini for any diehard technicians.
Let’s make it through the weekend before we hang the stockings.
"A severe global recession will lead to deflationary pressures. Falling demand will lead to lower inflation as companies cut prices to reduce excess inventory. Slack in labour markets from rising unemployment will control labor costs and wage growth. Further slack in commodity markets as prices fall will lead to sharply lower inflation. Thus inflation in advanced economies will fall towards the 1 per cent level that leads to concerns about deflation.
"Deflation is dangerous as it leads to a liquidity trap, a deflation trap and a debt deflation trap: nominal policy rates cannot fall below zero and thus monetary policy becomes ineffective. We are already in this liquidity trap since the Fed funds target rate is still 1 per cent but the effective one is close to zero as the Federal Reserve has flooded the financial system with liquidity; and by early 2009 the target Fed funds rate will formally hit 0 per cent. Also, in deflation the fall in prices means the real cost of capital is high - despite policy rates close to zero - leading to further falls in consumption and investment. This fall in demand and prices leads to a vicious circle: incomes and jobs are cut, leading to further falls in demand and prices (a deflation trap); and the real value of nominal debts rises (a debt deflation trap) making debtors' problems more severe and leading to a rising risk of corporate and household defaults that will exacerbate credit losses of financial institutions." Nouriel Roubini – FT Wednesday Dec 3, 2008
As a result, the velocity of money and how it impacts economic growth should be watched with care.
Sources: Art Cashin-UBS, Barron’s, and “The Atlantic.” This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of December 8, 2008, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Merrill Lynch to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. A portion of the income may be taxable. Some investors may be subject to the Alternative Minimum Tax (AMT). You cannot invest directly in an index. Discuss your investment needs with your financial professional before investing.
Today in history, we declared War on the Japanese and entered WWII one day after the sinking of the Flower of the Pacific Fleet. Please let me salute all of our past Veterans and current Service men and women and their families.
The bulls didn’t drop any nuclear bombs on Friday but they gave it the good college try. David Carradine turns 72 today. While my only exposure to him is the character Bill in the movies Kill Bill Vol 1 and 2, I find the repertoire of his work stunningly vast. Any actor that can go from French movies, to “Dr. Quinn, Medicine Woman” and land in a Quentin Tarrantino movie has range….Or a good agent.
From last Thursday it’s been clear the market has range. I think much of Thursday’s sell off was a last minute unwillingness to be in the market in the face of the expected large number drop in Non-Farm payrolls. Friday, however, despite the media’s “woe is us” message, traders were focused on the meek movement in unemployment. It was inconsistent with the payroll pitch into oblivion. Through Friday the S/P500 held the bears at bay. Not falling below 815 proved to be the stalwart defense the bulls needed. By the afternoon, buyers rushed in to get their possible last minute sales and moved the market higher and higher. While the volume was strong, I wouldn’t put all my eggs in one basket yet.
In my spare time, I did a quick study for 2 years between the information reported in the left hand column of the WSJ and the DJIA performance. The trend that emerged was this. When the economy is getting ready to start turning around it does so in the midst of some very bad news. Friday and the next 10 trading days or so could prove to be important. On Friday we close up which is critical because of the bad news that prevailed. For anyone counting, we’re at three pieces of good news in the last two weeks.
Global Range – don’t be shy about paying attention to what’s happening around the globe. It’s important to how to invest at home. On the front page of the NY Times there was an article expressly insinuating that the Pakistani ISI has been protecting the group allegedly responsible for the attacks in Mumbai. Pakistan was looking to India for a loan prior to the attacks. Predatory lending will take on a whole new definition if these allegations prove to be true. Should the Pakistani government, already on shaky ground, run out of money, considerable unrest will ensue.
Looking a little farther east to China, Premier Hu has cautiously addressed that economic stress could jeopardize the Communist Party’s grip on power. There is some information leaking out that the Army has already been deployed to the provinces to keep civil order. The Atlantic quotes Gao Xiqing, President of the China Investment Corporation, who manages $200B of the $2T of China’s foreign investments, has indicated an effort towards not aggravating the dollar by pulling out of the Treasuries market. Whether unrest at home and with the government would change this attitude remains to be seen.
Since today’s theme is range let’s move from gloom and doom to some good historical data with which to put things in perspective. In Barron’s over the weekend, Barry Ritholtz noted that in the last 100 years the relative strength of the S/P500 has only fallen to its current level 5 times. Each time it fell it was followed by a significant rally. It didn’t ensure a bottom, but did ensure a rally.
Given the potential significance of the next ten days here are some of the support levels to watch -- Dow at 8118 and the S/P500 at 815. An upwards swing would have to break through an S/P 895 (which we have at this moment and I don’t think 3 min can undo that) and 920. Should that occur we’re looking at post Election Day highs. The credit markets could still pull us down for the month (a statistical anomaly in the history of the Dow). At the bottom of this email is some information from Nouriel Roubini for any diehard technicians.
Let’s make it through the weekend before we hang the stockings.
"A severe global recession will lead to deflationary pressures. Falling demand will lead to lower inflation as companies cut prices to reduce excess inventory. Slack in labour markets from rising unemployment will control labor costs and wage growth. Further slack in commodity markets as prices fall will lead to sharply lower inflation. Thus inflation in advanced economies will fall towards the 1 per cent level that leads to concerns about deflation.
"Deflation is dangerous as it leads to a liquidity trap, a deflation trap and a debt deflation trap: nominal policy rates cannot fall below zero and thus monetary policy becomes ineffective. We are already in this liquidity trap since the Fed funds target rate is still 1 per cent but the effective one is close to zero as the Federal Reserve has flooded the financial system with liquidity; and by early 2009 the target Fed funds rate will formally hit 0 per cent. Also, in deflation the fall in prices means the real cost of capital is high - despite policy rates close to zero - leading to further falls in consumption and investment. This fall in demand and prices leads to a vicious circle: incomes and jobs are cut, leading to further falls in demand and prices (a deflation trap); and the real value of nominal debts rises (a debt deflation trap) making debtors' problems more severe and leading to a rising risk of corporate and household defaults that will exacerbate credit losses of financial institutions." Nouriel Roubini – FT Wednesday Dec 3, 2008
As a result, the velocity of money and how it impacts economic growth should be watched with care.
Sources: Art Cashin-UBS, Barron’s, and “The Atlantic.” This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of December 8, 2008, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Merrill Lynch to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. A portion of the income may be taxable. Some investors may be subject to the Alternative Minimum Tax (AMT). You cannot invest directly in an index. Discuss your investment needs with your financial professional before investing.
Monday, December 1, 2008
Forecasts, TV and Little Red Riding Hood
Good afternoon,
I hope everyone’s Thanksgiving lived up to their expectations. If I seem weary, I’m still suffering from an over-indulgence of Tryptophan and training for a half marathon.
All forecasts are wrong, some are useful. What makes a forecast useful ? Does it forecast the right direction? Is it accurate in magnitude? It it’s timeframe relevant? What is its probability of success? And the icing on the cake is its accuracy from a trend record. I’ll take the first four always.
“Over the next ten to twelve years, we will see three recessions that will slowly move the average price-to-earnings ratio of stocks to historic lows. Rising oil and energy prices will be a main culprit of both the slowdown in the economy and an increase in inflation. Ever-increasing monetary inflation will, in fact, trigger a huge increase in all commodity prices, as well as a decline in bonds. Asset inflation will show up in the housing markets as home values continue to skyrocket. The dollar will continue to weaken against major foreign currencies. The current war will become increasingly unpopular, and the next administration will be forced to withdraw troops, under the guise of declaring victory. The American voting public will be split as never before, with major patterns in voting habits making a generational change. The newspapers will continue to write about how an Asian country will dominate the world economically in less than a few decades.
Following this period of malaise, there will be an amazing cycle of new technical innovation that will spark yet another major bull market. The new technologies will change the world in ways that simply cannot now be imagined and will lead to whole new industries, putting amazing new power and abilities into the hands of individuals and governments.” The Third Wave, Toffler
I bring this up because I believe investor success in the next 20-30 years will depend not only on how well information is processed but also how well an accelerated rate of change is managed. Think back the changes our grandparents have seen they went from the combustion engine and putting a man on the moon to talking to their grandkids via the voodoo magic of wireless. Are you ready for the change to come in the next 30-45 days? The “fear bubble” is close to being oversold. All of the variables to date — fiscal and monetary policy initiatives, the price of oil, lower government bond yields, political change in Washington and now quantitative easing by the Federal Reserve — seem to be working together to arrest the credit crisis, bolster economic activity and put a floor under deeply distressed stock prices. Confidence is the key. If confidence can be rebuilt, stock markets will perhaps anticipate a recovery. Although we are not making a case for it yet, a lot of the ingredients seem to be falling into place.
Our TV Nostalgia seems to be for the 60’s and 70’s yet our markets are harkening back to the extreme volatility levels of the 30’s. Andrew Mellon, appointed Treasury Secretary in 1921, gave us our current legacy of Treasury Secretaries. Our current history of frequent financial crises has put the spotlight on the Treasury Secretary as well. Today we have Mr. Paulson who seems to be always just behind the curve. I believe his talents lay in what was initially important to the current administration –tax policy, skeptical of government influence and China. He is less of a strategic thinker than a grand negotiator. The newest prospect the Obama Administration is dating seems to have broad appeal to Wall Street. Timothy Geithner is someone, who I believe won’t need on the job training. He spent a decade learning through the Asian financial meltdown and had the foresight to see some of the systemic risks in our current financial system. This bodes well for our future as a national economy.
Little Red Riding Hood and the Wolf have yet to meet. John Maudlin says it best “Sure, we had a credit crisis in August, but the Fed came to the rescue. Yes, the subprime market is nonexistent. And the housing market is in free-fall. But the economy is weathering the various crises quite well. Wasn't GDP at an almost inexplicably high 4.9% last quarter, when we were in the middle of the credit crisis? And Abu Dhabi injects $7.5 billion in capital into Citigroup, setting the market's mind at ease. All is well. So party on like it's 1999.
"However, I think when we look out the window from the lofty market heights, we see a few fire trucks starting to gather, and those sirens are telling us that more are on the way. There is smoke coming from the building. Attention must be paid."
I had been pounding the table for over a year to get out of the stock market. All of the signs of upheaval were there. And now many portfolios are down by 50%. And the fire of a credit crisis is blazing all around us. The firemen in the form of the Fed, the US Treasury, and central banks all over the world are trying to put it out.
And while the stock market may enjoy a serious rally over the next few months, we are not out of the woods. The fire is still raging and we are witnessing ever-more aggressive attempts to get the fire of the credit and housing crisis under control.
Yesterday the Treasury announced yet another huge $800 billion bailout, but this one has a different flavor. Much of the previous bailout money has come from the Treasury either borrowing money and buying assets (which does not create new dollars) or simply taking assets onto the national balance sheet, guaranteeing the debt. With this latest move, the Fed is going to buy $600 billion in mortgage bonds by monetizing, or creating, new dollars.
Normally this would set off more alarm bells, over worries about inflation. But these are not normal times. With the twin bubbles of the credit and housing crises still imploding, we are seeing a massive deleveraging and the disappearance of multiple trillions of dollars from consumers and businesses. And the bond market clearly expects more softening and maybe even deflation. The 10-year bond is below 3%. I wrote 10 years ago that we could see the 30-year US bond below 3% by the end of this decades-long cycle, which we began in the early '80s with Paul Volker.
As I wrote last April, the velocity of money (how fast a dollar moves through the economy) is slowing rather dramatically. It could fall another 10% and just get back to the average for the last 107 years. Given the growth in population, inflation, productivity, and other factors, the money supply will need to grow by 7% annually for the next several years to keep the economy at equilibrium. Remember, GDP (gross domestic product) is essentially the velocity of money times the supply of money. If the velocity slows down, the money supply needs to rise just to stay even.
The Fed is going to have some room to pump up the money supply without seeing inflation rise precipitously. I think this is the first of what will be several large injections, as they will keep it up until the economy begins to recover. They will especially do more if it looks like we could roll over into a deflationary environment next year.”
Conclusion – Little Red Riding Hood made it to Grandma’s not without some peril but nimble thinking and steadfast persistence.
Sources: The Third Wave, Toffler, Enter, Pursued by a Bear- James Suowiecki, John Maudlin, ML-PIA Proprietary Research. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of December 1, 2008, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Merrill Lynch to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. A portion of the income may be taxable. Some investors may be subject to the Alternative Minimum Tax (AMT). You cannot invest directly in an index. Discuss your investment needs with your financial professional before investing.
I hope everyone’s Thanksgiving lived up to their expectations. If I seem weary, I’m still suffering from an over-indulgence of Tryptophan and training for a half marathon.
All forecasts are wrong, some are useful. What makes a forecast useful ? Does it forecast the right direction? Is it accurate in magnitude? It it’s timeframe relevant? What is its probability of success? And the icing on the cake is its accuracy from a trend record. I’ll take the first four always.
“Over the next ten to twelve years, we will see three recessions that will slowly move the average price-to-earnings ratio of stocks to historic lows. Rising oil and energy prices will be a main culprit of both the slowdown in the economy and an increase in inflation. Ever-increasing monetary inflation will, in fact, trigger a huge increase in all commodity prices, as well as a decline in bonds. Asset inflation will show up in the housing markets as home values continue to skyrocket. The dollar will continue to weaken against major foreign currencies. The current war will become increasingly unpopular, and the next administration will be forced to withdraw troops, under the guise of declaring victory. The American voting public will be split as never before, with major patterns in voting habits making a generational change. The newspapers will continue to write about how an Asian country will dominate the world economically in less than a few decades.
Following this period of malaise, there will be an amazing cycle of new technical innovation that will spark yet another major bull market. The new technologies will change the world in ways that simply cannot now be imagined and will lead to whole new industries, putting amazing new power and abilities into the hands of individuals and governments.” The Third Wave, Toffler
I bring this up because I believe investor success in the next 20-30 years will depend not only on how well information is processed but also how well an accelerated rate of change is managed. Think back the changes our grandparents have seen they went from the combustion engine and putting a man on the moon to talking to their grandkids via the voodoo magic of wireless. Are you ready for the change to come in the next 30-45 days? The “fear bubble” is close to being oversold. All of the variables to date — fiscal and monetary policy initiatives, the price of oil, lower government bond yields, political change in Washington and now quantitative easing by the Federal Reserve — seem to be working together to arrest the credit crisis, bolster economic activity and put a floor under deeply distressed stock prices. Confidence is the key. If confidence can be rebuilt, stock markets will perhaps anticipate a recovery. Although we are not making a case for it yet, a lot of the ingredients seem to be falling into place.
Our TV Nostalgia seems to be for the 60’s and 70’s yet our markets are harkening back to the extreme volatility levels of the 30’s. Andrew Mellon, appointed Treasury Secretary in 1921, gave us our current legacy of Treasury Secretaries. Our current history of frequent financial crises has put the spotlight on the Treasury Secretary as well. Today we have Mr. Paulson who seems to be always just behind the curve. I believe his talents lay in what was initially important to the current administration –tax policy, skeptical of government influence and China. He is less of a strategic thinker than a grand negotiator. The newest prospect the Obama Administration is dating seems to have broad appeal to Wall Street. Timothy Geithner is someone, who I believe won’t need on the job training. He spent a decade learning through the Asian financial meltdown and had the foresight to see some of the systemic risks in our current financial system. This bodes well for our future as a national economy.
Little Red Riding Hood and the Wolf have yet to meet. John Maudlin says it best “Sure, we had a credit crisis in August, but the Fed came to the rescue. Yes, the subprime market is nonexistent. And the housing market is in free-fall. But the economy is weathering the various crises quite well. Wasn't GDP at an almost inexplicably high 4.9% last quarter, when we were in the middle of the credit crisis? And Abu Dhabi injects $7.5 billion in capital into Citigroup, setting the market's mind at ease. All is well. So party on like it's 1999.
"However, I think when we look out the window from the lofty market heights, we see a few fire trucks starting to gather, and those sirens are telling us that more are on the way. There is smoke coming from the building. Attention must be paid."
I had been pounding the table for over a year to get out of the stock market. All of the signs of upheaval were there. And now many portfolios are down by 50%. And the fire of a credit crisis is blazing all around us. The firemen in the form of the Fed, the US Treasury, and central banks all over the world are trying to put it out.
And while the stock market may enjoy a serious rally over the next few months, we are not out of the woods. The fire is still raging and we are witnessing ever-more aggressive attempts to get the fire of the credit and housing crisis under control.
Yesterday the Treasury announced yet another huge $800 billion bailout, but this one has a different flavor. Much of the previous bailout money has come from the Treasury either borrowing money and buying assets (which does not create new dollars) or simply taking assets onto the national balance sheet, guaranteeing the debt. With this latest move, the Fed is going to buy $600 billion in mortgage bonds by monetizing, or creating, new dollars.
Normally this would set off more alarm bells, over worries about inflation. But these are not normal times. With the twin bubbles of the credit and housing crises still imploding, we are seeing a massive deleveraging and the disappearance of multiple trillions of dollars from consumers and businesses. And the bond market clearly expects more softening and maybe even deflation. The 10-year bond is below 3%. I wrote 10 years ago that we could see the 30-year US bond below 3% by the end of this decades-long cycle, which we began in the early '80s with Paul Volker.
As I wrote last April, the velocity of money (how fast a dollar moves through the economy) is slowing rather dramatically. It could fall another 10% and just get back to the average for the last 107 years. Given the growth in population, inflation, productivity, and other factors, the money supply will need to grow by 7% annually for the next several years to keep the economy at equilibrium. Remember, GDP (gross domestic product) is essentially the velocity of money times the supply of money. If the velocity slows down, the money supply needs to rise just to stay even.
The Fed is going to have some room to pump up the money supply without seeing inflation rise precipitously. I think this is the first of what will be several large injections, as they will keep it up until the economy begins to recover. They will especially do more if it looks like we could roll over into a deflationary environment next year.”
Conclusion – Little Red Riding Hood made it to Grandma’s not without some peril but nimble thinking and steadfast persistence.
Sources: The Third Wave, Toffler, Enter, Pursued by a Bear- James Suowiecki, John Maudlin, ML-PIA Proprietary Research. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of December 1, 2008, and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and non-proprietary sources deemed by Merrill Lynch to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. Past performance is no guarantee of future results. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Investment involves risks. International investing involves additional risks, including risks related to foreign currency, limited liquidity, less government regulation and the possibility of substantial volatility due to adverse political, economic or other developments. The two main risks related to fixed income investing are interest rate risk and credit risk. Typically, when interest rates rise, there is a corresponding decline in the market value of bonds. Credit risk refers to the possibility that the issuer of the bond will not be able to make principal and interest payments. Index performance is shown for illustrative purposes only. There may be less information available on the financial condition of issuers of municipal securities than for public corporations. The market for municipal bonds may be less liquid than for taxable bonds. A portion of the income may be taxable. Some investors may be subject to the Alternative Minimum Tax (AMT). You cannot invest directly in an index. Discuss your investment needs with your financial professional before investing.
Subscribe to:
Posts (Atom)