Litany Of Hope / The Daily Reckoning

verfasst von - Elli -, 08.07.2003, 16:14

-->Litany Of Hope

The Daily Reckoning

Paris, France

Tuesday, 8 July 2003

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*** Summertime, and the markets are hoppin'

*** Bonds down, stocks up, gold down, dollar up...up,
down...and so on, back and forth...whee!

*** The Oracle is back! It's like old times...tech stocks
are hot...fixing bikes...How to profit...and more!

Summertime and the livin' is easy...
Fish are jumpin' and the cotton is high.

Eric Fry is at the beach...and Addison is on his way to the
hospital, where his wife is expecting a baby.

Here in Paris, the sun is shining...the weather is warm.
Sidewalk restaurants and cafes are full...and even our
local oracle - a wiry little alcoholic who lives on the rue
de la Verrerie in the summer months - is back. We saw him
this morning on our way to work, stretched out on the
pavement like a plague victim.

But it was yesterday's triple-digit gain in the Dow that
put a bounce in our step and a song in our hearts. It was
like old times...1999 to be exact. It made us feel a little
younger...and even a little wiser. For whenever the sun
shines longest and hottest, we know what happens next: the
days get shorter.

While the Dow rose, the Nasdaq soared - up 3.4%. Morgan
Stanley's tech index rose nearly 4.5% and internet stocks
rose even more, 4.7%.

Everything had a retro look yesterday. Gold fell below
$350. And the dollar even rose against the euro; it was up
to $1.13 by the close of business yesterday.

And even though the nation has just gone through its
longest period without growth in the number of jobs since
WWII, USA Today thinks it sees improvement coming."Several
signs hint at recovery in the job market," says its
headline.

The good times rolled all around the world. The French are
enjoying a mini-boom in the bourse. German stocks look
good, too. And in Japan - where stocks recently achieved a
20-year low - the Nikkei seems to be heading up. Yesterday,
it reached an 11-month high.

Is it time to get back into Japanese stocks, asked a Daily
Reckoning reader, as if we would know.

'Maybe,' is our answer.

"I believe we are approaching a major low in the Japanese
stock market," was Marc Faber's guess in May. Now it looks
as though the low may have already come and gone.

"Sometime this year," Faber continued,"investors will have
to be long Japanese equities and short Japanese bonds. It
is only a matter of time before investors will pull out
money from the ridiculously priced bond market (yielding
less than 0.6%) and buy equities."

Yesterday, Japanese bonds dropped. So did U.S. bonds. And
the bonds of practically every other nation.

"Mexican bonds post biggest one-day loss in 4 years,"
Bloomberg reports.

After seeming to promise a 50 bps. rate cut, Alan Greenspan
disappointed bond investors with a piddling cut of half
that amount. Then, on Thursday, Wim Duisenberg of the
European Central Bank announced no cut at all.

Failing to cut rates would not normally be good news for
the cause of inflation, but such is the dizzy world we live
in that bond investors sell off bonds for fear that the
central banks may not drive rates lower...and that a Japan-
style deflation lies not right around the corner...and that
it may be summertime in the world's financial markets
longer than they had thought.

All the world's central bankers, of course, are on the side
of inflation. They do not merely tolerate it, but insist
upon it. Currently, both bond and stock investors are
betting that they will get what they want.

We are not so sure.

We spent much of the weekend repairing bicycles. Checking
tires for leaks, we noticed that if we put too much air in
the tube, it would bulge out in unpredictable places. For
amusement, we kept adding air. The bubbles multiplied; the
tube grew hideously deformed...until, finally, one of the
bubbles popped and the whole thing deflated.

"Hey, Dad, what are you doing to my tire?" Edward wanted to
know, bringing us back to the point of the exercise...which
was not to study the effects of too much air, but to give
the kid a working bicycle.

And so, we rushed into town and got a new tube, put it in
the tire...and off Edward went with his friends, Adrien and
Otto.

Predictably, we began to think about the way Mr. Alan
'Bubble' Greenspan has continued to pump more and more
credit into the entire world economy, despite grotesque
deformations. Pretending not to notice, he allowed the
biggest stock market bubble in history to develop. Then,
when it popped, he quickly applied a patch and began
pumping again. This time the bond market bubbled out. Just
as investors had come to believe that the Maestro wouldn't
allow anything bad to happen to stocks in the late '90s, by
the early '00s they were sure that he wouldn't, nay
couldn't, permit a collapse in bond prices.

Last week, a hissing noise started coming from the bond
bubble. Investors with sharp ears should listen carefully.
Because the refinancing bubble may have also sprung a leak.
Long-term mortgage rates have gone up since Greenspan's
latest 25 bps cut. If homeowners can no longer 'take out
equity' from their homes...what will they do? Will not the
whole bubble economy finally blow up in our faces?

How can you profit from the bond bubble's collapse? From
our colleague, Dan Denning, comes this advice:

"Here are two investment ideas, if you think the bond
bubble has been pricked but still has plenty of leaking to
do.

"First, check out the Goldman Sachs iShare Corporate Bond
Fund (LQD). It's the simplest way to be 'short' the entire
corporate bond market in one investment and it trades just
like a stock (meaning you can buy options on it too.) The
fund mimics the performance of the Goldman Sachs InvestTop
Index. 32% of its holdings are bonds in the consumer
sector, 19% in technology and telecom, and 26% in
financials. In other words, the bulk of the fund's holdings
are in sectors that have directly benefited from low
interest rates and have a lot to lose if and when rates
rise.

"Or, if you believe, as I do, that interest rates on long-
term U.S. Treasuries will rise (unless the Fed actively
intervenes), you can buy puts on Lehman's 7-10 year
Treasury bond index (IEF)."

[Ed note: for more of Dan's insights, see:

Strategic Investment
http://www.agora-inc.com/reports/DRI/AmazingGains/ ]

*** As we passed the skinny body sprawled on the street, we
gave him a nudge with our foot to see if he was still
alive.

"Hey...Oracle...wake up..."

"Heh? Oh...it's you..."

The man rolled his head on the cobblestone, from side to
side, trying to sober up. He opened his eyes wider...

"Can you spare a franc or two..." he asked, forgetting that
francs haven't been used in France for nearly 2 years...

"Yes, but first a question...is this the end of the secular
bear market that began in 2000? Or just a bear market
rally?"

"I told you the last time you asked. If you want this kind
of advice, it will cost you more than a couple francs..."

"Okay...how about this... a two euro coin..."

"Okay, that's more like it...ah yes...the secular bear
market...forget about it. Forget the stock market. The real
story is in the dollar. So what if the U.S. stock market
goes up another 10% or 20%...? If the dollar goes down 50%
as it did in the last cyclical dollar bear market, you'll
lose a lot more than you gain. But I have news for you.
This is no cyclical dollar bear market. It's secular...no,
systemic...maybe even epochal. The last time the dollar
went down, the U.S. had no current account deficit. None.
It was about even with the rest of the world. Now, it has a
deficit of more than 5% of GDP.

"And that was also just about the time Alan Greenspan took
his post at the Fed, and thus before he began to increase
the world's supply of dollar-based credit more than all the
previous fed chairmen combined - by more than $2 trillion.
You would have to be crazy to want to buy U.S. bonds under
these conditions...hah...you'd be better off lending ME
money! Here's my advice. Sell stocks. Sell bonds. Buy gold
whenever it goes below $350. Then, wait. Relax. By the time
this is over, you'll be able to buy a lot more bonds and
stocks with your gold. And if not, you can buy a bottle and
join me right here.

"There, that's worth 2 euros..."

Maybe more.

*** More about the bond market - among other things - from
our friend John Mauldin, below...

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The Daily Reckoning PRESENTS: Will Take 13 of the 'Fed Funds
Rate Cut Show' spur the economy to recovery - or at least
keep it afloat? John Mauldin takes a look at the Fed's
machinations, below...


LITANY OF HOPE
by John Mauldin

The world seems to be in recovery mode. Global stock
markets - and until recently, bond markets, too - have been
enjoying fantastic rallies. House prices largely remain on
the rise, and consumers continue to delve into their
pocketbooks. Sure, there's a bit of a problem with
unemployment, and the dollar doesn't look so hot, either.
Nor do the twin deficits. But hey...the Fed is steering us
into clearer waters, right? It's the price we must pay
to spark a recovery, yes?

Or is it? Let's take a look at the Fed's reasoning.

There are three main pillars of the U.S. economy: business
spending (capital investment), housing and consumer
spending. The Fed's current hope is that if the latter two
pillars, housing and consumer spending, can simply hold
their own long enough, normal (even if below-trend) growth
will eventually allow the economy to work through excess
capacity. The way would then be clear for the first pillar,
capital spending, to become once again a source of major
economic growth.

The problem is that housing and consumer spending only
thrive in two environments. Either low mortgage and
borrowing rates are needed to stimulate housing and
consumer spending, or the economy must be aggressively
growing well above trend, adding jobs and increasing
personal income so that even in the face of rising rates,
these markets will maintain steady growth.

The latter case certainly does not describe today's
economic environment. And so, the Fed has responded in the
only way it could: it has engendered a massive and
prolonged series of rate cuts, accompanied by significant
growth in the money supply. While some maintain it has
created two new bubbles in both housing and bonds, the Fed
has managed to maintain the strength of the housing market,
and with lowering credit costs, rising borrowing and 'cash-
out' from mortgages, the U.S. consumer market has remained
fairly resilient.

Thus, up until last week, the Fed policy of lowering short-
term rates (plus threatening to work on long-term rates if
necessary), had been enough to keep interest rates falling
and the economy moving forward...albeit sluggishly. But
perhaps the traditional lever of lowering short-term rates,
plus rhetoric, may no longer be enough.

Two weeks ago, for instance, the Fed continued its rate-
cutting policy by slashing 25 basis points from the Fed
Funds rate. But the release that accompanied the
announcement was almost identical to earlier, meaningless
statements. Looking at the most recent Fed release, Art
Cashin (UBS head floor trader and of CNBC Fame) wrote:

"Let's talk about the directive and its language to see
what we can learn of the Fed's informed view on the current
state of the economy and monetary policy. In paragraph two
they begin:

"'The Committee continues to believe that an accommodative
stance of monetary policy, coupled with still robust
underlying growth in productivity, is providing important
ongoing support to economic activity. Recent signs point to
a firming in spending, markedly improved financial
conditions, and labor and product markets that are
stabilizing.'

"That sounded vaguely familiar, so we started looking back
at directives over the last three years of rate cutting.
We found the theme was rather repetitive. Here's what they
said, or rather wrote, in early December of 2002.

"'The Committee continues to believe that this
accommodative stance of monetary policy, coupled with still
robust underlying growth in productivity, is providing
important ongoing support to economic activity. The
limited number of incoming economic indicators since the
November meeting, taken together, are not inconsistent with
the economy working its way through its current soft spot.'

"We did not make this up. You are encouraged to go to the
Federal Reserve website and read each of the directives
over the last three years.

"Net/net the latest directive is part of a litany of hope.
Thirteen rate cuts and the hope that things will improve as
they always have (according to the guidebook)."

Art and I discussed the Fed's articulacy - or lack thereof
- over dinner not long ago. Art made a very interesting
observation. What the markets really want to hear from the
Fed, he said, is that everything will be all right -
"Daddy's Home."

Given the violent rise in bond yields since that time, that
was not what the bond markets heard. Given the significant
rise in unemployment only a week after the Fed meeting in
which they proclaimed"labor markets...are stabilizing,"
the concern is that Daddy may be clueless.

In Art's analogy,"Daddy's Home" is supposed to represent
some sense of stability. Investors simply want to have some
reasonable certainty of the future. They have been willing
to give the Fed the benefit of the doubt, as long as Fed
governor speeches constantly and consistently proclaim
their intent to work on keeping long-term rates down.

But the recent Fed statement, with its same-song, 30th-
verse litany of hope, gave no sign of that. Some took the
Fed's reticence as a hint that it sees a strong recovery
and will be raising rates soon. Others thought that this
would be the last cut, therefore bonds had nowhere to go
but down. Confusion, the enemy of bonds, was evident.

The bond markets threw up. 10-year bond rates, which are
the key to mortgage rates, rose from 3.07% to 3.65% in a
week. Longer rates have risen similarly. The yield curve
has"steepened," which is precisely the opposite of the
results the Fed wants.

It is not hard to imagine mortgage rates rising 0.50%
fairly rapidly. Given the speed of the recent interest rate
move, could another 0.50% be in the future? Is a 1% rise in
mortgage rates enough to hurt the housing market? I am not
suggesting the housing market will implode, but given the
fragility of the economy and a rising unemployment rate, it
could slow the growth enough to send us into recession.

The Fed is playing a dangerous game. Bond markets in Japan
and Europe are also in wholesale retreat. The carnage in
Japanese bond markets makes our markets look calm by
comparison. On July 4, the Financial Times told us that the
S&P has threatened to downgrade Japanese bonds again in the
light of recent bond market turbulence.

If the recent bond market trend stabilizes, my concerns
will evaporate. Long-term rates are still low enough to
keep housing and consumer spending from falling out of bed.
But my concern is that a trend is developing that will
arrest the stability of the housing and mortgage markets,
pushing us over the edge into a recession and deflation.


Regards,

John Mauldin,
for the Daily Reckoning

P.S. None of this has to happen. The cure is simple. The
Fed simply needs to become transparent. They need to tell
investors, from institutions down to Mom and Pop, exactly
what to expect, instead of keeping everyone in a guessing
game. The market is saying that speeches are no longer
enough. Actions speak louder than words. We need to know in
an official release whether the Fed intends to keep long
rates down, and what it will do to accomplish this.

This is not to say that the Fed necessarily knows what it
will do. But the principles upon which it makes its
decisions and the process should be readily transparent, so
as to allow investors to make more informed choices.

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gesamter Thread:

• Litany Of Hope / The Daily Reckoning - - Elli -, 08.07.2003, 16:14