SMELLS LIKE DESPERATION
by Marc Faber
For the last few months, we have argued that U.S. economic growth was more likely to disappoint on the downside than surprise on the upside. We therefore recommended initiating
trading positions in long-term U.S. government bonds, which
were at the time oversold and almost totally out of favor.
We also felt that, contrary to expectations, a weakening
U.S. economy was likely to strengthen the dollar, as the foreign exchange market would begin to discount trade and current account deficits, which were likely to be less ominous than was widely expected. Our view was largely based on the sharp deceleration in the growth of U.S. monetary aggregates.
The 12-month rate of growth in M2 is, at 3.6% year over
year, at the lowest level since 1995. As a result of the decline in the rate of growth of money supply, "excess money," as defined by the growth in money supply in excess of nominal GDP, has also plunged over the last 18 months
The impact of decelerating money supply growth is not only leading to disappointing economic growth figures, but usually also precedes a poor, or at least indifferent, environment for equities. As our friend Gerard Minack of ABN AMRO explains, "When there is too much money around, it
often works its way into asset prices - which is why high levels of excess money growth usually lead to strong equity
markets. Conversely, when excess money shrinks, it usually bodes ill for stocks."
On the other hand, for as long as money supply growth
continues to be muted and, ideally, decelerates, the U.S. dollar has further recovery potential. And while I admit that I cannot see anything particularly positive about the U.S. dollar, I feel that the euro has, for now, even worse fundamentals and could, as a result, break down against the
dollar.
With regard to bonds, we continue to be reluctant holders
of U.S. dollar bonds. Bonds are no longer oversold the way
they were two months ago, but should the economic news
continue to deteriorate, as we expect, a further
simultaneous advance with the U.S. dollar seems likely. The
deceleration in money supply growth, negative real personal
income gains, uninspiring employment gains and the end of
the impact of the tax cuts are all bringing about a deteriorating consumer environment, which is evident from a
slowdown in the growth of retail sales and now also, for
the first time, some deteriorating trends in the housing market.
In addition, weakness in consumer durable stocks, such as General Motors, and the ultimate discretionary spending beneficiaries, such as Coca-Cola and Starbucks, as well as the recent collapse in the shares of Krispy Kreme certainly
don't augur well for consumers' staying power or for the
entire stock market! In fact, what I find most remarkable
about the most recent weakness in consumption is that this weakness coincided with another upside explosion in consumer loans. To me this smells like desperation!
Given these unattractive fundamentals, I would use any
strength in equities as a selling opportunity. Still, I am
also reluctant to be overly negative about equities and to
sell them short too aggressively. I am concerned that
parties interested in a Bush election victory, as well as
the momentum players, might have another attempt to push
stock prices higher, which in the present low-volume environment might succeed - at least for a short while.
Turning to commodities, we note that some prices have come
off rather abruptly. Soybeans are a good example of what happens when the Chinese suddenly step aside from their normal buying pattern. Of our recommended breakfast commodities, sugar and coffee have recently entered a correction phase. (Coffee, however, seems to have again stabilized and is likely to resume its bull market.) In the
meantime, it looks as if orange juice has made a major low
and we would use any weakness to add to positions.
We still remain confident that oil prices will rise in the
long run, as demand is likely to continue to increase,
while supplies will level off or decline. However, prices
may have temporarily overshot, and some caution is in
order. Oil shares have not confirmed the most recent
strength in oil prices, and this negative divergence should
raise some concerns about the potential for immediate
further price gains.
In general, I see limited opportunities for large capital
gains with low risks. For me, being at best just an average
investor, there are far too many insiders and smart people operating in the financial markets. In this environment, it
is difficult to take advantage of any inefficiency without exposing oneself to undue risks.
As most of my readers will know, every year, I visit
numerous financial institutions and attend quite a few conferences. As a contrarian, I am always interested in the
most frequently and least frequently asked questions.
During the last three years, I have never been at any conference or company presentation at which a question was raised about Africa! I was recently in South Africa and was
actually surprised by how well the transition from
apartheid to black majority had worked. And I was quite interested to hear about the numerous positive developments
on this largely overlooked continent, which will be one of
the prime beneficiaries of rising commodity prices and of
trade with China.
Regards,
Marc Faber, for The Daily Reckoning |
