Excellent wrap up from Puplava tonight:
financialsense.com
The Land of Extremes
To market historians, there is much to worry about these days. There are anomalies everywhere. The dollar is falling while interest rates are plunging. Yields
are falling while inflation is going up. Inflation is visible in the prices of everything you need from food, energy, medical, education, to insurance premiums.
Yet, everyone is talking about deflation. Outside falling prices for technology, deflation isn’t visible on Main Street where prices for most families are going
up including the price of a home. The fact that rates are falling in the U.S., which is running one of highest deficits, lowest savings rates, and highest
government deficits makes lower rates here in the U.S. seem even more remarkable. The U.S. has become the land of extremes and anomalies as the
monetary and fiscal alchemists concoct new means of creating wealth without saving or producing anything. The U.S. government is back to record deficits
and the Fed’s credit creation machine is running at full throttle. Stock prices are selling at record high multiples and the bulls believe it is a new bull market.
To the untrained eye with no perspective of history, it would appear to be so. Prices are up, there is no denying that, and for these reasons the bulls are
back in full swing running hard over the bears. Unless you have looked at a long-term chart, or studied the history of the markets you wouldn’t know any
better. You would believe that all is well.
Bears have become disheartened because the market is running ahead when it should be retreating. Nothing is as it should be which is making it more
difficult to analyze unless one has read history. What we are witnessing is not that unusual if you look at what has gone on before. Bear markets don’t end
when valuations are this high or when investor sentiment is at this level. There are now almost four bulls for every bear. You would have to go back to
autumn of 1987 to find bullish sentiment this high. Bullish sentiment is as high today as bearish sentiment was at the bottom of the bear market in 1974.
When sentiment figures go to this extreme it tells you that some time soon an important sea change is about to take place in the markets. When everybody
is sitting on the same side of the boat, a sudden wave could suddenly capsize it. From a historical perspective, everything is in place for the perfect bear
trap. Tim Wood, who has studied Dow Theory and market history, points out what all Dow historians know, which is every phase of a bull or bear market is
marked by a sharp rally. This market has been no different. Absent in this bear market is a series of selling climaxes or 90 percent down days, a period
where the selling volume and down points overwhelms the upside volume and upside points in the market. There have been only of few of these types of
days in the market the last three years and never in succession. Throughout the decline, investors have held on, refusing to sell in the hopes of regaining
their losses.
What has given rise to these hopes and enabled investors to ride out this bear market is a
flood of credit. This flood of credit has created asset bubbles in mortgages, real estate, and
consumption that have given consumers and investors a false sense of prosperity. Take, for
example, a middle class family that owns a home. Let us say that this typical family has a net
worth of $100,000. The $100,000 net worth figure consists of $25,000 in investments in
401(k) plans and IRA’s, and the other $75,000 is in the equity of their home. If their stock
investments fall 50 percent but their home equity has gone up 50 percent their net worth has
still increased. The value of the equity in their home has more than offset the decline in their
investment portfolio. Furthermore, as their equity has increased with the value of their home
they have been able to reduce the carrying costs of that home by refinancing their mortgage.
A Flood of Money
This is what I believe accounts for the general bullishness that can now be viewed in the
markets. Investors held on because they never really felt most of the pain of a bear market.
A new bull market in housing replaced the collapsing market in stocks. Now we have both
rising housing prices, rising bond prices, and a rising stock market, or three simultaneous
asset bubbles instead of just one. It is the presence of these multiple asset bubbles, which
have been created by an ocean of credit that is responsible for the general bullishness of
investors and consumers. There is money floating everywhere. There is plenty of cheap
money to buy a new home. There is even more money available to refinance one,
especially one that has been owned for a few years where there is at least some equity.
There is even free money available if you want to buy a car where interest rates are zero.
The same applies to furniture where interest rates are zero and no down payment or
payment necessary for the next two years. If you need money, there is no shortage of it
and there are plenty of institutions willing to lend it to you, good credit or bad.
The general flood of money isn’t restricted to just consumers. The bond markets are ripe again with companies refinancing old and expensive debt at the
lowest interest rates seen in more then three decades. Credit spreads between high and low quality debt has narrowed considerably. The markets are
implying by the pricing of debt that risks are minimal.
If you are a hedge fund or speculator there is also plenty of money to be had in which to speculate. You can borrow at 1 percent and invest the money at
3-4 percent. The Fed has created many opportunities for speculation. They, in effect, have notified the markets that it is okay to speculate by saying rates
will be kept low indefinitely. The green light for speculation is flashing ‘go ahead,’ we stand behind you. You now have the largest and most powerful central
bank in the world going all out to create inflation in order to avoid asset deflation or the bursting of a bubble, or in the case of the U.S., multiple bubbles.
This ocean of money and credit is affecting everything in the financial markets and the economy. In the economy nothing is being created; it is simply being
consumed. The financial markets are levitating at the same time with yields dropping, bond prices rising and stock markets going parabolic again. All of this
is leading up to a potential detonation, as reflation will mean inflation, and higher interest rates will rise sooner rather than later. The long-term
consequences of the greatest credit bubble ever to take place in history should be frightening, as the appetite for debt in the U.S. has become insatiable.
I’m talking about trillions of dollars of new debt added each year. It should at least be alarming to someone that it now takes almost $5 of debt to produce
$1 of GDP in the U.S.
It now appears that a temporary relief rally is underway and in full swing as the credit narcotic works its way through the financial system and then spills over
into the economy, mainly in housing, and the consumption of foreign goods. What this will mean is greater debt burdens for consumers, corporations, and
government, larger trade and budget deficits, and eventual defaults down the road. Debt cannot grow indefinitely and there is a limit to its creation.
Eventually those that own paper will become cognizant of its evaporating value. Once it becomes obvious that the value of paper is being actively
destroyed, a flight out of paper will follow. It has already begun with the dollar, which has lost 30 percent of its value. Foreign investors are dumping their
dollars and looking for other forms of paper to flee to in order to protect capital. The only thing holding up the dollar and keeping it from going into a freefall
is intervention by the People's Bank of China and the Bank of Japan. There will come a time when these Asian central banks view the stimulus coming from
intervention too expansionary for their own economies. When that happens there will be nothing left holding up the dollar, and then the back up in interest
rates begins. The ability of the gold markets to hold up in a strong equity environment may be telling of things to come in the future.
At the moment this still remains a speculators market with the Fed wanting to create inflation while trying to control all of the side effects by suppressing the
real rate of interest. Therefore, asset bubbles will continue to inflate until a pin pricks the bubble or the financial markets hit an iceberg. The real question is
trying to find where those icebergs exist in a sea of heavy fog. My guess is that they reside underneath the surface in derivatives or on the geopolitical side.
Today's Market
Meanwhile another wave of speculation overtook the financial markets as stock prices rose in spectacular fashion as a result of a favorable reading coming
from a Fed survey in New York. The Fed report showed that manufacturing in the region improved last month. Today's better then expected reading has
many fund managers believing this weeks economic reports will all be on the upside, including the Thursday release of the Philly Fed, and the ISM
numbers. Fund managers now have a fresh supply of money to invest after 13 straight weeks of new money flowing back into mutual funds. All the major
indexes rose as the market becomes more confident that the Fed can engineer a recovery in the second Drug stocks led today's rally along with technology
and Biotech. On the losing side was energy, which has generated the most profits, if not the majority of the profits for the S&P 500 this year. Analysts think
the sector is overvalued.
Volume hit 1.3 billion on the NYSE and 1.9 billion on the NASDAQ. Twelve stocks rose for every five that fell on the Big Board.
Copyright © 2003 Jim Puplava
June 16, 2003 |
