American model - a myth or a reality?
"Orphan" liquidity is not ignorant but it needs shelter
I have great respect for the big Kahuna thread and I've heard about it from Mohan and others, unfortunately, never visited it, but what I read from them on our thread, I find their arguments to be quite logical and cogent. I think SI is lucky to home bulls and bears in perfect harmony and I see no problem if bears with some backhand swipes make money in a bull trend, likewise, I would do that if a bear market ushers. As I always maintain, `bear' and `bull' is not a permanent state; one has to keep the right equilibrium of perception. As far as I know, from what I've tried to learn about the word "Kahuna," in Hawaiian local dialect it means a "big wave;" surfers wait to ride that big wave, if my understanding is correct.
To be honest, it is not my intention to engage in a contentious debate with people on the other side of the market spectrum, but undue importance of "money flow" in analysis I don't believe is the single factor which can be a determinant for the direction of the entire market. For me it has always been a secondary and not a primary tool; it is an effect, not a cause. Yes, money flow is an important element, but money flow alone could not be able to predict the course of the market back in end of July. So the first change of sentiment was only after bond yields headed south soon after NAPM numbers showed strong purchasers prices in August. However, money flow in the market, prior to the NAPM numbers, did not show any clear indication of an impending drop. But my predictions two weeks before that were based on fundamental trends of bonds and economic indicators which all showed me that Alan Greenspan's positive spin on the economy would not be substantiated by numbers in August and September. There had to be a dichotomy in numbers. Greenspan spoke about non-inflationary environment and growing profits, but I was pretty sure that the non-inflationary part of his speech was right and the market rallied on it. But the market did not understand that strong corporate earnings would not come on the back of a weak economy. One of my posts in those days referred to my concerns on the weak economic numbers and I came up and wrote that for a strong DOW we need strong economic numbers.
This very precarious balance which needs to be maintained between strong economic numbers, low unemployment and low inflation is the job that Greenspan has fine-tuned very nicely so far, but it does create a lot of volatility because any strong number is interpreted as an inflationary red-flag and that starts an uncertainty which continues until PPI or CPI confirms that that is not the case. It was for this reason that I was not drawn into the rally post-September NAPM numbers where I saw that there was a 0.2 increase in the purchasers prices. I have always highlighted the fact that NAPM employment cost index and journal of inflation are forward indicators, and CPI and PPI are lagging indicators of inflation, but CPI and PPI are the two numbers which manifest and should confirm the rises in purchasers prices and employment cost index. If these two numbers are not confirming the indication of purchasers prices and employment cost index, I would think it is safe to assume that we have a strong economy without inflation and the so-called Phillip curve relationship is finally breaking down, that is, lower employment eventually results into higher inflation.
The very point I am trying to make is that the fundamental conditions are not changing. Yardini's money flow argument is a sound one but it fails to provide enough evidence based on which one can predict a direction. How can you determine the direction of the market with a single element? Marshallian K, for me, is a more sophisticated and better indicator. Directions of the market are determined by X number of factors. Present stratospheric levels are more prone to macro-economic events which are going to hit the market than a factor like 'money flow' alone.
Imagine yourself as a fund manager managing say $10 billion. Where will you invest your money? If you see, in the last 7 years, these beautiful stories about Latin America, Mexico, Asia, and then Japan, all have turned sour; only one story remains sweet and that is DOW's. If we take lessons from history, the major bear markets are preceded by banking crises. Presently in US, banks are making absolute great earnings with very little risky exposure. Look at Japan, for example, for the last few years the bear market continues. Look at what problems they have, does US have the same? Can you compare Japan to the US? No. US had savings and loans crisis expected to cost taxpayers $625 billion. Treasury was able to resolve it at half that cost on timely basis. Japanese banking problems are gruesome. Since the last seven years, they haven't even started addressing the core of the problem! All these banking problems find their roots in speculative bank lendings on real estate deals. Is there asset inflation in the US? No. Properties being sold at 1% yield translating into 100 times the rentals is unheard of in the US but it was happening in Tokyo before the problem started and spiral of debt mushroomed. Most of the banks lent money, in recent Asian crisis, on long-term capital and real estate projects at minimal returns and proceeds of these silly loans were ploughed back in the market taking NIKKEI up beyond 30000 without any effort to stir up domestic demand. Lack of any bad news on banking front and US's strong domestic demand are very positive elements for the market. I wish the Japanese would take a cue from this and use some of their accumulated wealth and raise their quality of living. Across the Atlantic and the Pacific, this is the debate - is the American model a myth or a reality?
We now come to trade surplus. I am a student of Paul Krugman and, for me, it has never been a very positive point for a country to run a great trade surplus. Even now Japan is running a huge trade surplus, but look at its economy, it is in shambles. US with a trade deficit has been working on the basic economic concept of "core competence." As a nation, they decided that they produced jets better than anyone else or geared up their research on technology and software instead of consumer-based, labor-intensive industries. This is the miracle of "new economy" and "niche competence." So, what happened? Nike and Adidas are manufacturing shoes and other products in sweatshops of Bangladesh, China and Pakistan and that translates effectively importing price stability and countering the wage pressures. Japanese, on the contrary, never even encouraged domestic demand and despite great trade surpluses and foreign exchange deposits have been unable to ignite the most important component of economic growth, i.e., people's willingness to spend. So, all those Japanese savings sit in banks, literally earning 0.5% which basically makes it a non-performing asset like gold. One of the benefits of paper currency is that it can be invested. THAT is what I mean by "orphan" capital, Japanese inability to utilize their earnings in their own land; they have $300 billion in US Treasury, but where else can they put that kind of money? Its not that its foolish, but US is the only safe haven and that is true for US equities also.
For me, I have many views; for the last 2/3 years, the market has performed so far the way many bulls thought it would and if someone does not want to agree, I would respect the opponent's opinion but will not change mine.
Iqbal Latif |
