CROSSCURRENTS:
Financial assets held by individuals, private pension funds and state
and local government retirement funds have clearly exceeded the
threshold of a mania. Equities for this group as a percentage of
financial assets are now 60%, the highest in history, exceeding the
prior high of 55% at the secular peak in 1968. At the same time, cash
as a percentage of financial assets has fallen to a record low of just
under 20%, well below prior lows recorded in the entire decade of the
'60s at more than 30%. The excessions of past records offer compelling
evidence of a secular, rather than cyclical peak. Even the theory of a
new paradigm cannot explain why exposures have changed to such a
radical degree. Although the notion that stocks should receive a lower
risk premium would on the surface, account for a larger exposure to
stocks, it is clear that this is not the explanation we seek. Risk is
now sought on all levels as shown by the enormous increases in credit
card debt, home equity lines of credit, corporate borrowings and the
trade deficit. We can only surmise that the long lived secular bull
market created a sense of confidence and invulnerability via the
largest issues and the indexes. As in Japan during the late 1980's,
there is the sense that the market is larger than any guess or attempt
we might make at fair valuations, thus Microsoft at one point was
enabled to trade at 5.8% of our entire gross domestic product. The
entire process of valuation seems to have been replaced with fanciful
notions having no basis in stock market history. Household equity
holdings have now reached nearly 170% as a percentage of disposable
income, compared to less than 60% in 1990. Even in Japan in 1990,
household equity holdings were only 60% of disposable income. We have
more than pushed the envelope. The rationale for valuations at this
stage can be summed up in three words; acceptance of risk. It is
exceedingly difficult for us to imagine how the acceptance of risk
might expand from current levels. Unfortunately, as history has shown
on numerous occasions, the acceptance of risk on equivalent or even
lesser scales has always led to a secular downturn and huge price
losses. Although the process may take a long time as it did in the
U.S. from 1968-1982 and in Japan over the last decade, in our view,
the process is ensured by the massive increase in exposure to risk.
Simply put, cycles rule the economy and human psychology. At this
juncture, we can expect an eventual huge change in psychology from
exposure to risk to an avoidance of risk. Logic dictates that such a
move can only be accompanied by much lower stock prices than now.
decisionpoint.com
AND
THE ONE INFLATION INDEX THAT REALLY HAS THE FEDERAL RESERVE WORRIED
By JOHN CRUDELE
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DO you know how much the price of burlap has risen recently? How about polyester? If you are investing in the stock market, you'll be closely watching this morning's goverment release of the producer inflation figures for September. The experts are anticipating that the Producer Price Index will jump 0.5 percent for the month, the same as the previous month.
That's dangerously high inflation in itself.
But all Wall Street really cares about are expectations.
So if the jump is more than expected - let's say even 0.6 percent - then you can expect a miserable day for both stocks and bonds. If 0.5 percent or less, trading today will be tolerable.
But here is the kicker.
Even if the PPI isn't disappointing, and even if next week's consumer inflation numbers are in line with expectations, interest rates and the stock market will still be under intense pressure in the weeks ahead. Here's a little secret that all you PPI and CPI junkies need to know. The Federal Reserve cares more - a lot more - about the price of burlap, polyester, plywood and zinc than anything the government comes up with. In fact, there are 17 commodities in particular that the Federal Reserve keeps track of.
First I have to give you a little history.
There's a guy named Geoff Moore who used to be Alan Greenspan's economics professor at NYU when the now-Fed chairman was going for his post-graduate degree a million years ago. The two remain tight to this day and Greenspan - word has it - listens carefully to what Moore says.
Even if you don't have sources on this, you'd know the Greenspan-Moore connection from something the Fed chairman said in 1994. Speaking to Congress in February, 1994, Greenspan said "Anything Geoff Moore does, I follow very closely."
So, back to burlap. Few people know it but Moore created an index of 17 commodity prices including the ones listed above. It's called the Journal of Commerce Industrial Materials Price Index. Moore, who now runs the Economic Cycle Research Institute in New York, bills the index as a leading indicator of inflation.
The idea is simple. If the price of materials like cotton , steel, aluminum and lead (some of the other 17 items in the index) are rising, the price of finished goods made from those materials will also rise sometime in the future. Moore thinks this is a neat little way to tell whether consumers and companies will be paying more for finished goods in the future.
The index includes the price of oil, but does not include gold and silver. Precious metals can be controlled by speculators and, therefore, aren't a true test of inflation.
So how's the Journal of Commerce Industrial Materials Price Index doing? It was rising at a 9.98 percent annual rate in late September, right before the Fed held interest rates steady but said that the next move would probably be up.
Say it out loud - nearly double-digit inflation. And the index has been climbing for most of this year. Oil is a lot to blame. But then again, the cost of oil affects everything.
"That index has been moving up aggressively. That's near it's all-time high," says Lakshman Achuthan, managing director of the Moore's Economic Cycle Research outfit.
"Commodity prices are clearly on the rise," Achuthan says. "When they all move up together like this, it's an indication of something happening in the economic world."
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