Words to the Wise

Bloomberg.com is running a lengthy piece on China and its stock market that is not a great read, but has a quote that leads the thoughtful observer to be wary of what's going on in the Great Reflation. From China Stocks Cheapest to Analyst Targets After Slump:

While banks can provide 300 billion yuan to 400 billion yuan of new loans a month, that “may not be enough for the market to be reassured that’s enough to keep pushing prices higher,” Green (an "analyst") said.

Scary. (Not to mention the title of the article, which in an almost insane manner justifies stock prices on the basis of what "analysts" project the stock to sell for in the future. Talk about self-fulfilling prophecies! This is NASDAQ 1999 stuff--the worst mispricing of securities I have ever heard of.)

We have seen a great orgy of both creation of new credit and government guarantees of existing credit. As with "cash for clunkers", this will pull consumption forward, but it creates no wealth. And the U. S. has explicitly gone the New Deal route of raising prices by destroying existing product; for every new car sold under "clunkers", one was destroyed; even the engine parts could have been reused.

Trying to re-blow a burst bubble is, as with chewing gum splattered over one's face, messy and difficult stuff.

Meanwhile, one week ago, EBR pointed out some interesting bullish historical technical patterns regarding the long Treasury bond and contrarian rationales for why it could be an asset poised for capital gains as well as income, focusing on a proxy for it, the ETF TLT. As if the gods of the market were reading this blog, TLT closed about 3 points up on the week (over a 3% gain). The 10-year is challenging resistance at 3.40-3.43%; no opinion about its chances of success, especially in the very slow week upcoming.

The ECRI Weekly Leading Index Growth Rate rose to its highest level since May 1971, attesting to the rationale for the massive stock rally since March. What happened then in the midst of that structural bear market for bonds? The stock market promptly fell 15% and was down adjusted for inflation one year later. The long bond was mostly stable to down in yield (up in price) for almost a year and half later (despite all the money printing, war action, etc.) Past could be prologue.

The frenzied interest and action in dividendless financial stocks such as AIG, C, Fannie/Freddie, Ambac, etc., and the poor action in high-quality dividend-paying companies such as MCD and Northern Trust (NTRS), is a divergence of which EBR disapproves. It correlates with the speculation going on in China and the quote at the top of this post explaining that speculation.

Longer term, quality will out, and uninformed speculation and excessive credit creation will reap what they have sown.

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