Friday, May 21, 2010

Flight to Treasuries Like Dancing with the Tallest Midget

As the stock market moves toward fair value, breakdowns are occurring amongst the financials that are not especially money-center banks. For example, UMBF and NTRS (Northern Trust) are mid- to large-sized regional banks. Both stocks were breaking out on the upside and very recently had major reversals. We can understand weakness in JPM and GS given action on financial regulation, but the sense here is that something more is at play.

It is the same old story. There is too much financial manipulation and too little real innovation. This extends to the definition of what an "earning" is to ignoring asset values in valuing stocks that have volatile and unpredictable earnings.

Making matters worse is that the U. S. dollar, for all the many imbalances and profligacies, remains the currency of the one military superpower and thus is the tallest midget right now amongst fiat currencies.

However, it just looks as though there is not a lot of underlying vigor in the U. S. economy, unlike the 1950s when amazing salary growth rates were seen.

How serious will the Feds and the states get about having sound finances, and on what time frame? The fickle finger of global markets points in ways non-Masters of the Universe cannot fathom. Will a high-interest rate crisis force prudence? Might this occur much sooner than anticipated?

Long-term U. S. government bonds have credit risk that is not priced into the bonds, and have immense inflation risk. If there is little price increase seen these days, it is simply because the economy in earlier times, under a gold standard, would be experiencing price decreases. These decreases would do what they did in 1921-2, and allow a sound recovery. Instead we have a European-style mixed economy, with free markets in discount retailers (though with many of their customers' incomes derived from transfer payments) but unfree markets in finance, autos and of course housing. No matter what Bush-haters and defenders of the Community Reinvestment Act may say, a real form of socialism has come to America in many key industries. No one quite voted for it other than in healthcare, but here it is. And it came as soon as the Democrats gained control of Congress in the last session and is now here with a vengeance. The next step is One World-ism, typified by the amazing administration attacks on the Arizona immigration enforcement law and the even more amazing approval of the Mexican President attacking this law during his recent visit to D. C.

Get ready for Eurosclerosis in America.

In my field of medicine, let's see how worsening working conditions for doctors play out in terms of early retirements. Quality care for all with fewer doctors. And so inevitably there will be rationing of basic access to a physician. This is another form of inflation with price increase: decreased quality. It's like paying full price for Brand X, when the real brand is actually superior. Yet government bean counters will say there is no inflation because Brand X does the same thing as Real Brand.

So in medicine they may well go Soviet-style and ramp up physician extenders: nurse practitioners and the like.

Short term, however, there is just too much talk of an imminent stock market crash. In the overfinancialized world of the U. S. and its investment opportunities, it's not clear that stocks are any more overvalued than other vehicles. A cyclical economic recovery losing steam is not the same as a recession. Thus I don't find the short side interesting either. Financial assets simply remain in a secular bear market. I am hearing glimmerings that commodities such as platinum are seeing commercial buying after their big setbacks, so maybe commodities are nearly finished being beaten up. With central banks easy as pie and large countries getting ready to import deflation from the austerity being imposed on Greece, Ireland and other countries, I am wary of those who claim that we are in the endgame of an overfinancialized system. As always, this is a time that high-quality assets are the best bets for most investors.

Sadly, the long U. S. government bond is no longer such an asset. Probably it's better than a junky NASDAQ stock, but AAA? Nuts to that. It's just another trading vehicle with a coupon. The yield on the 10-year bond has plummeted a massive amount in a very short time. Those wanting to play the bond from the long side will likely have better entry points soon. And if not, so it goes.

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