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Strategies & Market Trends : The Epic American Credit and Bond Bubble Laboratory
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To: kris b who wrote (75902)12/17/2006 10:27:51 PM
From: jimmg  Read Replies (3) of 110194
 
kris, here's my take on what the Fed's strategy is at this point.

1. They realize that the vast middle class is key to consumer spending and holding the economy together.

2. They feel the consumer spending benefits of the housing bubble is wearing off and they are trying to offset the impact of that through higher stock prices. They need higher stock prices in advance of actual weakening of consumer spending because they can't let psychology dip into retrenchment. They need continued high propensity to spend and take risk.

3. Getting money into the hands of the average consumer is done by raining money onto the economy via the stock market. It's the old "Tricklenomics" from the Reagan days. If you rain enough money down on the rich, the crumbs will fall to everyone below. Since they need quite a bit of crumbs to fall to offset the housing bubble, they need quite a large stock market ramp which we see today.

4. This becomes self-fulfilling after awhile. The stock market wealth is offsetting the housing bubble burst and everyone thinks we have a soft landing with stabilized housing and consumer spending. If we truly have a soft landing, the stock market can then can expand p/e's under the assumption that a profits recession will either not occur or be very minor.

5. This will all continue indefinitely in my opinion until the markets see concrete evidence that something is wrong. That could mean resurgent commodity prices causing inflation fears and a big bond market backup. It could also be corporate spreads widening and eventually shutting off the high yield spigot and consequently the lbo activity. Before we see corporate spreads widening we will need to see soft consumer spending and more companies starting to miss estimates such as Black & Decker last week.

6. The problem is that every sign of weakness triggers a bond rally and heightened stock market speculation. This is why I think the Fed needs to be boxed in by heightened inflationary concerns before we see the stock market seriously weaken. If the dollar holds up and commodity prices remain stable, this gives the Fed a free ride to facilitate money and credit growth.

So, I guess I'm at the point where I'm most closely focused on commodity prices, the dollar and long term interest rates. Perceived economic weakness followed by lower interest rates, tight credit spreads, stable commodities and a slowly eroding dollar is a bullish combination for the stock market. The Fed wants a lower dollar. That much is clear. They just don't want a dollar panic. They want a long, slow continual slide lower.

Unfortunately, the Fed is getting what it wants so far. I think it all blows up eventually but it's very difficult to estimate how and when. I remember last spring it was surging commodity prices that got Bernanke to start mumbling into Maria's ear. I think that's what it's going to take to derail this apparent goldilocks economy.
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