Thursday, March 10, 2011

Taking the Prophet Seriously

As was reported by me here just a few days ago, the head prophet of U. S. and global financial markets, named Ben S. Bernanke, is said to favor an end to debt monetization aka QE2 by the end of June. As if on cue, any lesser prophets such as Ray Dalio of Bridgewater Associates or Bill Gross of PIMCO were ignored. Dalio was bullish on stocks for 2011? Yesterday's news. Gross hates Treasuries? Fuggedaboutit: mark 'em up, buddy; so stocks sold off and Treasuries soared. Risk off.

Let me offer a "Yes, but" to today's market "wisdom".

It is the third year of a president's first term; he hopes for four more years. It is the first year that the allegedly reformed and reforming Republicans are back in control of the House. Both those powers want an economic boom so voters forget the recent 'change' elections and endorse the 'ins'.

Ben's reappointment as Fed Chairman by Mr. Obama likely came with a commitment to accommodate the Obama agenda, which clearly involves large deficits as far as the eye can see. These will get financed, sure as shooting.

Since 1935, there has been a recession in America on average every 5 1/2 years. The last one began 3 years and 3 months ago. Thus we can target mid-2013 for the next one, just by the averages, of course with a wide error range. I'm aware of bear markets, but no recessions, with this sort of massive stimulation out of Washington. (Of course, many of us feel that we are really in an ongoing depression and that the recession never truly ended, with a cyclical upturn underway due in large part to global insane money printing rather than a sensible purging of the malinvestments of the prior several years.) But we're talking mainstream terminology for now.

2011 will mirror 2010, with the Fed turning off the liquidity pump to see what happens. The Fed has printed a huge amount of electronic dollars. In chemistry, when a medium or reagent is in excess, it is simply in excess. More can't affect matters for the better. So it is with dollars: they are in excess, and the other players in the national and international bond market have a say, and they in fact do say: We don't need more blankety-blank dollars. And Dr. B needs to operate by consensus as the central banker to the largest seller of bonds to foreigners in the world. Thus the Fed would like to see private lenders and foreign central banks pick up the money creation slack from it, with the Saudis and others also financing our debt by drawing down savings (heavens forfend Americans do that for their (our) own sake!) without printing more money. If this happens, it can be back to "risk on", as in most prior economic expansions. Gold did fine in 2001-7 without big-time Fed debt monetization, after all.

Currently I continue to see a bubble in short-term debt and a general overpricing in almost all financial assets, though not so much in gold or a growing number of houses that are below depreciated replacement value. Now, it's time for recent large profits to be taken, with the fundamental excuse being not a day of rage in Saudi Arabia Friday but instead being a bleat that the Fed will take away the punchbowl.

To restate my views, the Fed will only keep the booze away if another bartender, such as the banking system collectively and/or kind strangers, make sure the party keeps going long enough to give the pols the best odds of staying in their chosen jobs after next year's election. If those other enablers don't do their job, the Fed will do what Ben B must have assured all the President's men and women before securing the renomination. The show will go on.

In this scenario, fIscal and monetary laxity (stimulus) tend to make buying the dips the right thing to do rather than fight the clear intent of the central authorities.

Overvaluation alone rarely kills a bull market, even one built on such sandy and even stony soil as the current stock, commodity and (longer-term focus) bond bull markets are all rooted in. It usually takes enemy action, such as, to continue the analogy, a gardener with a mission to thin the foliage. (Of course, gardeners Alan G and Ben B were often loath to trim at all and then often over-did the thinning; such are the downsides of central planning.)

Thus I look at Thursday's ugly market action as follows. Because cash is being trashed, I'm buying the dip rather than sitting long-term in cash; timing and asset class to be determined. Given the intensity of the stock and commodity rises the past half year, this dip could be panic-inducing. I'm thinking of the sharp, short down-moves in muni bonds and gold during the past few months and thinking that stocks could well do the same thing.

A warning, though. I do sense more complacency about events that might happen in Saudi-land or Kuwait than I feel is warranted. Thus a core investing focus of mine involves companies that own important energy assets in the Americas, as well as gold in the ground also in politically stable areas. If events get out of hand there, the dip will be a bear market of significant proportions, though probably it would be good for gold and appropriate energy stocks.

I'm looking forward to an interesting Friday.

Copyright (C) Long Lake LLC 2011

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