... two interesting columns ...
... from John Hussman ... Sunday August 18, 2002 : Hotline Update
Copyright 2002, John P. Hussman, Ph.D.
As of last week, the Market Climate remains characterized by unfavorable valuations and favorable trend uniformity. This keeps us in a modestly constructive position, with about 40% of our favored stocks unhedged and exposed to market fluctuations. That's about as much market exposure as I believe is prudent in view of valuations and economic conditions.
I've received a few comments wondering how trend uniformity could have turned favorable so quickly off the recent low. The reason, as I've noted many times, is that trend uniformity does not measure the extent or duration of a market advance (or decline, for that matter), but instead measures its quality. Without revealing anything proprietary, quality is essentially an issue of information content.
The information content of market action is found not in what the market does, but what it does that departs from what it ought to do. For example, suppose I give you a series of numbers, and ask you to calculate the average. If the average so far is 25, and the next number is 25 as well, there is no new information in that data. But if the next number is say, 30, your average changes, because the data is different from what you would have expected. In other words, information is contained in the forecast errors. This is why stocks move not on earnings reports but on earnings surprises. This is why I spend so much time talking about divergences within market action - credit spreads, a dollar action, market breadth, and so on.
When I talk about high-quality market action, I'm talking about market action that conveys a great deal of information. A couple of weeks ago, we got a favorable shift in trend uniformity, because even though market action was lousy, it was lousy in a very high-quality way.
The August 19th issue of Barron's has an excellent interview with Ned Davis. He has an interesting response to investors who have been waiting for a series of Lowry's-type "90% down-days" to signal a solid market bottom: "If you look at the up and down volume and what percentage of it is in advancing stocks and declining stocks, you'll find what we call a waterfall decline: two days or more in which 90% of volume is on the down side and two on the up side. The New York Stock Exchange data didn't show it, but our own database of the 1,500 largest companies showed we had two 9-to-1 down days and then two 9-to-1 up days. That is our definition of a selling climax. We've had record volumes and the market made new lows before turning up. Normally, you would get a new cyclical bull market out of that. This time, we'll see something more like last September, but it will not be a sustained rally."
Davis also notes substantial concerns about a debt bubble and the large U.S. current account deficit - both problems that I've emphasized for well over a year. Aside from a few good articles in the London Economist, the mainstream press continues to overlook the importance of these problems. It's good to see them surfacing in Barron's. Debt - both domestic and foreign, continues to be the greatest obstacle to sustained economic growth. And unfortunately, the only two ways to adjust to high debt levels are to pay it down (which requires a slowing of consumption and investment growth relative to income) or to default on it. Neither of these are conducive to robust economic growth. This is a classic case of the party being over, and still having to pay the piper.
In any event, favorable trend uniformity is a signal that investors, at least for a time, have a robust preference to take market risk. Regardless of valuations or underlying economic fundamentals, favorable trend uniformity indicates that market risk currently has at least modest speculative merit. A 40% exposure isn't aggressive, but it's constructive. And in view of current conditions, I believe that level of exposure is just about right.
http://hsgfx:reciprocal@www.hussman.com/hussman/members/updates/latest.htm
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from Morgan Stanley's Global Economic Forum, August 16, 2002
Currencies: Rising Risk of a Softening in the US' Strong USD Policy
Stephen L. Jen (London)
I believe that the risk of the US Treasury softening its strong USD policy further is rising. I do not believe that the Treasury will explicitly abandon the strong USD policy; that would be too dangerous for the bond market. However, another "re-definition" of this currency policy is a logical next step, in my view, in light of the fact that (1) the USD has failed to correct in broad index terms and (2) the Fed’s capacity to ease is diminishing. This prospective policy adjustment would be particularly relevant for USD/JPY.
There are three reasons why I believe there is a rising risk of a USD policy shift.
Reason 1. The USD index has barely adjusted
Our US economist Dick Berner still sees a further widening in the US C/A deficit close to US$600bln in 2003 (or about 5.5% of GDP). In my view, this is not something that can be financed at the current level of the USD. The need for a meaningful adjustment in the USD seems clear. However, despite the fact that the USD has already depreciated -- year to date by around 10% against the EUR and the JPY -- the USD index has weakened by less than 2% on the Fed’s broad TWI. As I argued in an earlier note ("USD Correction: All Pain, Little Gain," July 3, 2002), to really make a difference on the current account, the USD needs to weaken against the currencies of its main trade partners, i.e., the dollar needs to weaken on a broad trade-weighted basis. On the other hand, USD correction against major currencies such as the EUR and the JPY affects cross-border capital flows, not the goods market. The fact that the USD index has refused to correct suggests to me that the only way for the C/A deficit to be normalised may be through a sharp compression in domestic demand, which could mean a "double-dip." This is clearly not something many people would want to see. To reduce the risk of such an outcome, I believe a policy adjustment may be needed to induce a correction in the USD.
Reason 2. The monetary conditions have not eased
I view the inability of the USD index to correct as a problem not only for the external balance, but also for monetary policy. In terms of the monetary conditions (the combined interest and exchange rate effects), the inability of the USD index to correct effectively shifts the burden of easing to the Fed. A stubbornly strong USD not only keeps the overall monetary condition tighter than desirable in the US, but also eases pressure on the ECB to lower rates. In my view, given that the Fed is running low on ammunition, it makes sense for the Fed to ease only when it is absolutely necessary. Further, the double-dip scare, instability in Latin America, and the risk of a war further argue in favour of the Fed saving its bullets for later. Therefore, further easing in the monetary conditions must come from the USD.
Reason 3. The equity bubble has already been deflated
One big difference between three months ago and now is that the equity markets have deflated by about a quarter. Morgan Stanley’s equity strategists believe US equities are now under-valued. The US Treasury was previously not in a position to tinker with the strong USD policy for fear of pricking the equity bubble. But now that the equity bubble has already burst, this should reduce the fear of the Treasury triggering a discrete move in USD asset prices by announcing an adjustment in the USD policy.
O’Neill will be nowhere near Yankee Stadium
If there is a shift in policy, it would not be an explicit one, because the bond markets could be easily spooked. Having said this, this would not be the first time that the US Treasury under the Bush Administration has quietly modified/clarified the definition of the strong USD policy. On February 16, 2001, Treasury Secretary O’Neill clarified that the US does not have a strong USD policy per se, but that the USD was strong primarily reflecting strong economic fundamentals. Though he received much criticism from the press and market commentators at the time, my own reaction was that it was a brilliant move to "sneak" in an "exit strategy" on the strong USD policy. Under former Secretary Robert Rubin, the meaning of the strong USD policy was never explicitly defined. The market was led to presume that a strong USD was more like a policy "objective" than an endogenous economic variable that reflected other underlying variables in the real economy. With Secretary O’Neill’s definition, the Treasury would no longer be compelled to defend the USD (verbally or otherwise) if the USD corrected. What I have in mind now is a further step in the same direction.
Engineering such a shift in policy without triggering a run on USD assets will not be easy. One scenario is that the Treasury could stop reiterating the strong USD policy when the USD corrects, and make comments to the effect that the exchange rates should be determined by the market (as they did around the time of the G8 summit this year). Second, the US could pressure Japan’s Ministry of Finance (MoF) to stop or scale back JPY-weakening intervention. Third, Secretary O’Neill could comment that the USD is already very strong (as Secretary Rubin did). I don’t know how the Treasury can quietly bring about a policy shift. But I do believe it is something it needs to do.
USD/JPY is still the weak link
Japan may want a weak currency, but the US now needs one. In debating USD/JPY, the market, in my view, has been overly fixated on what Japan wants. In a global recession, every country could use a weak currency; Japan is no more special than other countries. If the US is leading the world into a second dip, how can we expect the US to tolerate JPY-weakening intervention by the country that is running the largest trade surplus against the US?
In addition, so far this year, the BOJ has not eased, the government has embarked on fiscal consolidation, no meaningful reform has been put in place, and Koizumi’s economic policy, seen from Washington, D.C., has been centred on a weak JPY. This may no longer be acceptable. The US position on JPY-weakening intervention has always been the following: (1) let the market decide whenever possible; (2) if the MoF has to intervene, the Treasury may "look the other way" if such intervention is matched by reform or stimulus. Since Japan has not met any of the latter conditions, my best guess is that the US will be less tolerant of the kind of heavy intervention that was conducted by the MoF during May and June of this year to support USD/JPY. With the pressures from the cumulative C/A surpluses building up in Japan, the pressures are mounting for USD/JPY to take a lurch lower. If 115 is penetrated, I believe the USD/JPY’s correction could be sharp.
Bottom line
I believe US policy makers are in a serious bind. The ability of the Fed to ease is constrained, and likely will be increasingly so. At the same time, the USD has been stubbornly strong, with the index having corrected by less than 2% year to date. I believe the US desperately needs easier monetary conditions, and the exchange rate could be the next policy instrument. While an outright adoption of a weak USD policy is still appears extremely unlikely, US policy makers adopting a softer definition of the strong USD policy is now a distinct risk, in my view.
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