From PEI by James Smith
Of course its unlikely that Greenspan will repeat his now infamous
expression
about the mkts becoming "irrationally exuberant"....but then again, he
doesn't have
to. This market is hanging on by its fingernails. Anything Greenspan
says will
most undoubtedly be construed by the mkts to mean whatever fears are
uppermost in
the minds of traders...which currently is a big 50 bps move in March
(rather than
a more modest 25 bps).
Again, a break below 1369 (S&P Mar) will suggest that a Free Fall is
underway,
but only a weekly close below 1352.00 will confirm a slide to 1303
(first mthly supt).
We cannot rule out a test of 1147.00 before the current correction has
run its
course. If a free fall is more likely, its still worth noting that a
daily close above 1428.50 will
put the bulls back in the driver's seat. (Caveat Venditor: New Highs
on the S&P
into March signals a blowoff to 1880 or higher into May, with a more
severe two year
correction to follow).
DOLLAR/YEN: If DLR/YEN is looking stronger again today, like it wants
to
make a fast move higher towards JY 116.15, maybe its because of the
perception that US rates can only continue higher while Japanese rates
will do
basically nothing--this can only put downward pressure on the yen. It
all comes down
to perceptions on which economy is likely to continue growing the
strongest.
Sure there's still some small risk to the USD of repatriation if US
stocks slide, but that
is becoming less a factor than the relative strength of US vs JPN
economy.
JAPANESE GOVERNMENT BONDS
Many people take the view that if the Japanese economy is re-entering a
recession, that JGBs should stay up in the nether-world of
unrealistically low
returns of 1.5--2.0% yields on a 10 year bond. They call this a
"flight-to-quality"???
To me it stretches the imagination too far to suggest that risk-averse
Japanese
investors will move from a falling Nikkei stock market into the riskiest
bond market
on the planet. JGBs might rally slightly on a short-term basis, but
they we do not see
New Highs on JGBs. The real move in JGBs will be DOWN! A doubling
of
JGB yields from 1.6 to 3.2% (or higher) seems entirely reasonable.
Why?
At some point (soon!) Japanese investors will realize that the Post
Office, in which
trillions of dollars of Japnese savings are held in longterm deposits,
is technically
insolvent.
Yes Virginia, , governments do default on occasion. Even though the
Post Office
accounts are backed by the full faith of the Japanese govt, I'm not sure
what that's
worth, nor do I believe that anyone else knows either. Japanese State
and Local
debt is expected to reach 6.1 Trillion dollars by next year! Yes, I
said dollars
not yen. The ability for Japan to pay back all this debt is seriously
in question.
And even when govts that are in trouble don't default on their debt,
they resort to
the next best solution--debasing their currency!
Since many of the Post Office savings accounts come up for renewal this
year,
its my view that the majority of these accounts will not be renewed.
Japanese people
are not irresistably attracted to risky markets like the S&P, let
alone the Nasdaq,
but they might be enticed by higher short-term rates in the US.
To put this in clearer perspective, the Japanese investor can renew
his account
at the Post Office and get 0.28% on a longterm savings account that has
huge penalties
for early withdrawal....or he can invest it short-term in a US money
market fund and
get close to 6% with no longterm penalties for early withdrawal to worry
about.....and
he would be investing in a currency that is likely to appreciate
strongly over the
next few years. Gee, its a tough call isn't it? "Saaah! So desu
neh! Muzukashi."
Maybe the trigger will be a further downgrading of Japanese debt by
Moody's or S&P,
or maybe it will be something that Greenspan had for breakfast....an egg
McMuffin that
resists all attempts at digestion. Who knows?
All I know is that higher longterm rates in the US (along with the
widening differential
between US and Japanese rates) will eventually cause JGBs to fall off
a cliff. The spread between US rates and Japnese rates is like a
rubber-band being
stretched to its extreme limits. At some point, its going to
snap...probably soon!
When JGBs crash, the Nikkei goes in the tank for another two years (into
2001) and,
like the coming Tokyo earthquake, the after-shocks of this event will be
felt around
the world.
A stock market correction can cause a recession, but only a bond market
crash
can cause a depression. Japan is at real risk of sinking into not just
a recession, but
a full-fledged depression. As Japan's problems deepen, they will be
forced to print
money on a scale that no one is currently thinking about.
Have you figured it out yet? Can you see how this relates to
commodities?
......a very real risk is that as things get real dicey in Japan,
Greenspan may be tempted to
NOT raise rates as much as is warranted by the surging US economy and
the return
of inflation. He probably won't lower rates, but he may not raise them
if Japan is in dire
straits. If so, smart money would take heed of the inflation risk in
owning US bonds by either selling their bonds outright and/or hedging
that risk by buying into commodities. Smart Money might also buy even
more US stocks, but as already noted, a further rally from current
levels,
could easily lead to a bubble into May.
Does the 1997 Asian Currency Crisis jar your memory? A Japanese Bond
Market Collapse
could easily become a replay for the Asian Currency Crisis.
If it weren't for the Asian Currency Crisis and the LongTerm Capital
Trillion Dollar Ponzi
scheme that followed a year later, short-term rates would never have
stayed so low.....
the stock market would not have rallied so strongly....and what to do
with the Surplus
would not be a topic for political debate.
The real risk is that no matter what Greenspan does, inflation is
coming back.
Funding 30% of US debt 1 year or less and funding 70% of US debt 5 years
or less was
a risky gamble that paid off in the early years of the administration,
not because the
administration was particularly clever, but because the net effect of
the 1997 Asian
Currency Crisis and the LongTerm Capital Ponzi Scheme Fiasco, was to
keep short-term rates lower than justified by real growth in the US
economy. Try to convince me that the administration knew in advance
that the 97 Asian Currency crisis was coming, and that they further
realized that it would be smarter for them to fund our debt mostly on
the short-end of the curve to take advantage of artificially lower
short-term rates.
Does this mean there would be no commodity bull mkt if the
administration had not manipulated
the yield curve?
NO. The commodity bull market would still come even if the
adminstration had showed more
wisdom in funding our debt mostly on the long end of the curve rather
than the short-end,
but it would not have the same amplitude. Funding your debt mostly with
30 year bonds means
you don't have to come to the market so often to serive that debt.
When you fund most of the debt short-term, you not only pay more (with
rising short-term rates), but it can easily become a vicious cycle.
Once inflationary expectations take hold, no one will want to own bonds,
even if their yield ratchets dramatically higher.
Stocks can only go higher so long as perceptions of a greater return in
the stock market outweigh the guaranteed return in bonds. This can
often lead to a bubble. I don't think the S&P is at bubble levels right
now, the Nasdaq may be another story.
Do you really want to know how high commodites are going in the next few
years? Trust me, you don't want to know. People who complain about
high heating oil bills and higher prices at the pump now, will look back
wistfully at how cheap curent prices seem a few years from now.
The only thing that might alter the timing of a bull mkt in commodities
would be a manic move higher by the S&P into May. New Highs on the S&P
after February would confirm a blowoff rally to 1880 (mar) or higher
into the month of May, after which a serious two year correction in the
US stock market would emerge. It is important to note that a serious
two year correction in US stocks would not eliminate a longerterm bull
market in commodities, it would only delay it temporarily.
The first effects of a serious correction in stocks would be to lesson
demand for commodities,
but the more lasting effect would be to jolt people out of their current
complacent attitude towards
risk in the financial markets. More people would seek to hedge
themselves in tangible assets
like commodities.
But what if stocks continue down here in February?
A correction in stocks accelerating here in February into a May or
September Low would be healthier for the stock market. It would allow
stocks to recover and make Major New Highs going into November 2002.
Of course, commodities would also rally strongly into November 2002. |
