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Strategies & Market Trends : MDA - Market Direction Analysis -- Ignore unavailable to you. Want to Upgrade?

To: pater tenebrarum who wrote (46805)	4/16/2000 11:10:00 PM
From: Casaubon	Read Replies (1) \| Respond to of 99985

. there will be a great wailing and gnashing of teeth when the Euro turns... HB, why do these hedge funds always find themselves on the wrong side of the trend change? Do they not make enough to make up for it during the trend? I really don't get this.

To: pater tenebrarum who wrote (46805)	4/17/2000 9:34:00 AM
From: Crimson Ghost	Read Replies (1) \| Respond to of 99985

Fed Must Not Flinch: From Morgan Stanley today Global: Getting Traction Stephen Roach (New York) Painful as it feels for the investor community, the April swoon in the US stock market is just what the Fed ordered. In my view, it says little about any serious flaws in the economic landscape. Instead, it has more to do with the excesses of asset valuation. The key question: What comes next -- for the Fed, the financial markets, and the US economy? The US economy remains in great shape. The problem is that it is not in the perfect shape that the broad consensus of investors had come to believe. I have been of the view for some time that the flaws lie mainly in a long simmering build-up of imbalances that pose a legitimate threat to inflation, financial markets, and the sustainability of the current economic expansion long (see "Facing Imbalances" US Investment Perspectives, January 15, 2000). Three imbalances have worried me the most in this regard -- the stock market, the current account, and the labor market. While these imbalances hardly point to the imminent demise of America?s long lived economic expansion, it is now clear that the authorities can no longer afford to leave them unchecked. The uptrend in core inflation indicates why. Most importantly, it is not a one-month story driven by the March CPI. It is a development that has now been under way for seven months. Excluding food, energy, and tobacco -- the volatile items that are typically stripped out of headline inflation -- the core CPI has gone from 1.5% in August 1999 to 2.2% in March 2000. Not only are the lows of inflation behind us, but expectations of future inflation are also in motion; the most credible gauge of inflationary expectations -- that of the University of Michigan -- is now flashing a prognosis of 3.2% inflation over the next year, well above the sub-2.5% lows that were evident last year. And there?s probably more to come. After all, it has taken 5.5% annualized productivity growth to hold labor cost pressures in check over the past six months. As wage inflation now accelerates -- and that?s certainly the verdict in early 2000 -- what are the odds that the productivity offset can hold at anything close to its recent pace? The same question can be posed regarding the prognosis of a strong dollar in the face of America?s gaping external imbalance. The Fed really has no choice in this climate. The days of monetary accommodation must now come to a close. With the inflation cycle having turned, the central bank needs to act very differently than it has in recent years. In the face of an explosive acceleration in aggregate demand growth -- with real personal consumption expenditures surging by more than 6.5% over the past two quarters -- the Fed has no choice other than to focus on venting the pressures that lie at root of the US economy?s mounting imbalances. That means inflation-adjusted short-term interest rates will have to rise high enough to bring the growth of domestic demand back down to earth. That could spell a surprisingly large policy adjustment -- an outcome that the Fed has assiduously avoided in recent years. Indeed, the real federal funds rate has remained near the lows that were set in the depths of the financial crisis in late 1998. The five monetary tightenings of the past nine months have been largely offset by the updrift in headline inflation. Yet now as energy prices recede, the emerging acceleration of core inflation is coming out in the open -- keeping real-short term interest rates far too low for a white-hot US economy. In my view, that underscores the imperatives of a multi-stage Fed tightening -- with an urgency last seen in 1994. Yet the financial markets are now presuming that Alan Greenspan is about to flinch. Prior to the recent sell-off in the equity market, the yield curve had been pricing in as much as 75 bps of additional rate hikes over the next 5-6 months. Now, the curve has taken out all but one of those moves, assuming that the central bank would be reluctant to go much beyond the 25 bp rate hike widely expected on May 16. Peter Canelo, the most bullish of our US equity strategists, is quite clear in how he feels the market would respond to such a Fed scenario: If the market actually believes the monetary tightening cycle is one rate hike away from being over, equities would then go straight up, ushering in yet another dip-buying frenzy that would keep the excesses of the wealth effect and aggregate demand growth very much intact. Perceptions of the so-called Greenspan put -- a Fed that falls victim to a classic moral hazard dilemma -- would be alive and well under such circumstances. And years of hard-won credibility would be squandered. Just like that. Market spasms notwithstanding, the Fed cannot afford to flinch. To take wealth-induced excesses out of aggregate demand, a stock market correction must be sustained. In that critical regard, I continue to believe that duration matters more than severity in judging the impacts of the recent fall in equity prices. If the market comes roaring back in the next few weeks, little will have been accomplished from the standpoint of macro demand management. As Greenspan indicated with great clarity last February, the outcome that works best from his standpoint would be for appreciation in the broader market averages to move down into closer alignment with the 6% to 7% pace of domestic income generation. Yes, the Nasdaq has now plunged 34% in the past four weeks (with three-fourths of that coming last week), but it still remains 24% above last October?s low. At the same time, the all-inclusive Wilshire 5000 -- the more relevant metric for the Fed -- is now running 3% above its year-earlier readings; while that?s down from the 16% comparison that prevailed as recently as a week ago, it depicts a US stock market that only now is just moving into the range that might begin to rein in the excesses of the wealth effect. That, of course, presumes that the equity market holds in its current vicinity for at least six months. In the end, there?s a lot to learn from the April shakeout in the US stock market. For the once high flying Nasdaq, the lessons are more about valuation than fundamentals; indeed, the secular case for B2B-based technology demand has become all the more encouraging in recent months. For the Fed, discipline and resolve are all the more critical, especially as the markets now conjure up hopes of a Greenspan-led rescue mission. For the economy, it?s all about the restoration of balance -- the stuff of a sustainable expansion. The good news is that the Fed seems determined to seize the moment and address long simmering imbalances. The bad news would come if the central bank flinched. No one ever said that getting traction would be easy or painless.