Friday August 30, 2002 Market WrapUp
Bubblarious! Fed Denies Fault
According to the Fed, asset bubbles can’t be prevented. The reason is that raising interest rates to prevent a bubble from taking place would
wreck the economy. In the words of Mr. Greenspan, “No low-risk, low cost, incremental monetary tightening exists that can reliably deflate a
bubble.” In defending the Fed’s bubble policies in the last decade, the Fed chairman said, “It was far from obvious that bubbles, even if identified
early, could be preempted short of the central bank inducing a substantial contraction in economic activity, the very outcome we were seeking to
avoid.” The Fed, after studying policy options during the bubble, opted out of trying to manage the bubble. In Fed-speak, this is an admission that
the Fed, once it turns on the monetary spigot, has no way of controlling the outcome. In other words, it’s not their fault.
In essence, the Fed is now trying to distance itself from the bubbles that are created by its own policies. Those policies helped to create the
greatest stock market bubble in the nation’s history--a bubble that will go down in the history books as the greatest asset bubble in known
history--far worse than the last bubble created during the 1920’s. Even today after a substantial downturn in all the major indexes, the stock market
prices remain far more overvalued than the peak of the stock market bubble of the 1920’s.
One More Time: Excess Credit Creates Bubbles
From an economic point of view, it is important to reiterate
that all boom and bust cycles are a monetary phenomenon. It
is through the creation of excess credit that booms are given
birth. The extra money the Fed injects into the financial
system finds its way through the economy by misdirecting
production, which is responsible for the malinvestments left in
its wake. The Fed oversees the supply of money in an
economy by the credit creation it allows to take place. If the
economy is a bucket and the Fed controls the spigot,
controlling the flow of money out of that spigot, it is directly
responsible for the consequences. All boom and bust cycles in
the past can be directly attributed to monetary excesses
created by central banks or governments.
Today’s comments that the Fed can do nothing to stop
bubbles from taking place is simply not true and wishful
blame-shifting. Asset bubbles are the direct creation of Fed
policy which is always purposeful. To deny culpability implies
that central bank policies is without consequences, or even
worse, implies that they don’t know what they are doing. This is
frightening to think about when you consider that through its
latest round of rate cutting, the Fed has created another asset
bubble in real estate to take the place of the one that
preceded it in the stock market. By lowering interest rates to
the lowest levels since the 1960’s, the Fed, through its rate
polices and injections of credit in the banking system, has
created a mortgage bubble directly related to the current
bubble in real estate prices. Like the stock market bubble that
preceded it, the Fed takes pride in the fact that consumer
wealth has improved with rising real estate prices, and
therefore the tremendous mountain of new debt taken on by
households is not a problem. The mounting debt is compared
to rising asset prices and therefore justified.
I Just Don't Buy It
These were the same arguments made during the tech bubble
of the late 90’s. Rising stock prices and the wealth effect were
heralded as a positive contributor to strong economic growth, when in fact all that was done economically was excess money was channeled into
the financial instruments, such as stocks and mortgage backed securities. The rise in asset prices was simply another manifestation of inflation.
Instead of “things” or hard goods, the newly created money or credit went into financial instruments creating an asset bubble. Today that excess
money and credit is going into mortgages, real estate, and now things like raw materials. Let me summarize what the Fed Chairman was really
saying today
‘We can create new money and credit, but we
can’t control where it goes; therefore, we aren’t
directly responsible for the bubbles that are
created as a result of our policies.’
The Fed and government are now looking for a scapegoat. Corporate fraud, uncontrolled financial markets, personal greed, manias, and
malinvestments are nothing more than the visible manifestations of monetary creations by the Fed. The popular media and the financial press
are looking at corporate scandals as the blame for this year’s plunge in the financial markets. Last year it was blamed on 9/11, and the year before
it simply was not recognized. The prominent view back in 2000 was that the downturn in stocks was merely a corrective process in a continuing
bull market. It was only after the terrorist attacks of September 11th that analysts, anchors and economists were even willing to acknowledge that
we were in a recession or bear market.
Same-o, Same-o
Nothing has changed over the last few years. Each new leg down in this continuing bear market is explained by something other than what its root
cause is, which is a credit induced boom created by monetary policy. Until we are willing to accept and acknowledge this fact, we will never
come close to rectifying it. Instead, half measures and wrongful policies are now being implemented that point to the same mistakes of the
1930’s. The more we apply wrongful remedies, the worse it will get. What happens to this economy when the newly created Fed real estate
bubble deflates? When that happens we will sink slowly into depression, or even worse, experience the ravaging effects of a currency implosion
similar to what has happened to Argentina, Brazil, and much of Latin America.
Already Wall Street investment banks are calling for the US to depreciate the dollar by 15-20%. Wall Street and Washington would also like other
central banks, mainly Europe, to reinflate their economies to help the US out of its predicament. In the words of one Goldman Sachs analyst, “A
falling dollar may push inflation in the United States as imported goods become more expensive, that would be good for a country dancing on
the edge of deflation (depression).” In the words of Wall Street, the US should burn the currency while the rest of the world reinflates. The
messages are loud and clear: inflate or die.
Decidedly Downhill From Here
Meanwhile in the technical picture, the market continues to worsen for the Dow, S&P
500, and the Nasdaq. All three major indexes are breaking down from their late July
rally. Money managers are decidedly bullish with over 70% of portfolios allocated to
stocks. Investment newsletters have turned bullish again. The 10-day CBOE put/call
ratio has fallen lower again and major newspapers and print publications have
called the July lows as a market bottom. Meanwhile within the economy, economic
indicators from the LEI (leading economic indicators), consumer confidence,
consumer good orders, help wanted advertising, to slumping retail sales point to
trouble ahead for the markets. The corporate picture doesn’t look any better. The
majority of companies are reporting revisions for their sales and profits for the second
half of the year. At the moment there appears no sign of improvement, but rather
renewed signs of economic weakness.
In addition to these problems, the economy and the financial markets have to deal
with the uncertainties of war and higher oil prices. Oil prices of $30 a barrel are
associated with recessions. There has been a direct correlation according to Bank
Credit Analysts this year with rising crude prices and falling equity prices and weaker
economic growth. US crude stocks of oil have fallen by 31 million barrels since their
peak back in March of this year. Inventory of crude is now at levels not seen since
March of 2001. These inventory levels will continue to fall unless the US can secure
additional supplies from foreign imports immediately. This leaves the country in a
precarious position as we contemplate war with Iraq. The US has only about 300
million barrels of oil in inventory compared to 1991 when inventory levels were at
400 million prior to the break-out of hostilities. Natural gas supply is falling as
production is expected to drop anywhere from 5-10%. Demand for natural gas
continues to grow as a result of existing new power plants that have been brought on
board over the last five years. Canadian production, which has served to make up US
natural gas supply deficits, is also expected to decline. This is resulting in higher
natural gas prices, which are up substantially like oil since the beginning of the year.
The only thing preventing our next energy crisis from occurring is the weather. Given
the vagaries of the weather pattern lately, a harsh winter cannot be ruled out. If the
weather pattern changes for the worse this fall, we will have an energy crisis at the
same time we are contemplating war.
Add all of these factors up and it is not hard to see that the next leg in the market will
be hard down. Outside massive intervention in the financial markets, a surprise rate
cut by the Fed, it is not hard to see that the financial markets are headed for a severe
plunge this fall that should take prices down to new bear market lows. This is especially true now that mutual fund redemptions are rising month to
month. As investors bail out of stock funds, the markets are deprived of additional fuel to spark a rally and prevent lower prices from occurring.
Judging by the drop in stock market volume and mutual fund redemptions, investors have been using any rally in stocks as an exit point to get out
of equities.
For the week the S&P 500 lost 2.6%, the Dow dropped 2.4%, and the Nasdaq lost 4.8%. The late selloff today was attributed to traders going to
cash ahead of the long holiday weekend. Only 900 million shares were traded on the big board on Friday. Market breadth was positive by 4-3 on
the NYSE and negative by 8-7 on the Nasdaq. It appears that all three major indexes are headed for their third year of double-digit declines.
Overseas Markets
European stocks rose after a U.S. manufacturing index climbed more than analysts expected, buoying companies that do business in the world's
biggest economy. Bayer, Unilever and ING Groep advanced. The Dow Jones Stoxx 50 Index added 1.3% to 2709.45. Nestle accounted for about
15% of the rise as speculation waned that the food maker will bid for Hershey Foods Corp. by itself. All eight major European markets were up
during today's trading.
Japan's Topix stock index rose after an industry report showed that the nation's carmakers shipped more vehicles overseas for a seventh month in
July. Toyota Motor Corp. led gains. The Topix gained 0.4% to 941.64. Automaker stocks accounted for a fifth of the rise. The Nikkei 225 Stock
Average fell 0.01% to 9619.30.
Treasury Markets
Long-dated government bonds ended with heady gains after flip-flopping throughout most of the morning as the data hit the tape. The 10-year
Treasury note was up 3/32 to yield 4.13% while the 30-year government bond advanced 17/32 to yield 4.93%. The bond market observed an
early 2 p.m. close ahead of the Labor Day weekend.
© Copyright Jim Puplava, August 30, 2002 |
