Posted on 08/23/2007 6:28:05 AM PDT by Hydroshock
The Fed hit the market with a surprise 50-basis-point discount rate cut that caught many traders leaning the wrong way Friday. The rate cut came in response to the subprime crisis and is giving the credit markets the one thing that they need the most, liquidity.
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The Fed is hoping that by injecting liquidity into the credit markets, it can avert a meltdown of the financial system. If the Fed has to take further action in response to the subprime crisis and continue pouring in liquidity, we may see another asset bubble created. This time, the bubble may be created in the emerging markets.
The case for this happening is simple and hangs together well. Each time the Fed has responded to a financial crisis by lowering rates, the surge in liquidity has led to the creation of an asset bubble. Each asset bubble then collapsed and led to the next crisis.
Follow me. The 1997-98 Asian crisis led to rate cuts as the Fed poured in liquidity and stabilized the economy during the global financial crisis. This action worked, but the excess liquidity led to the technology bubble and implosion in 2001.
The bear market created by the "tech wreck" prompted the Fed to cut rates and once again inject liquidity to counteract the effect of collapsing stock prices on the economy.
The excess liquidity created this time led to the housing bubble and the subprime disaster, as lenders abandoned good lending practices during the speculative frenzy.
Now the Fed is reacting once again by cutting rates and injecting liquidity. A rational person has to see the pattern here. We believe that the excess liquidity created this time will flow someplace and create another bubble. The emerging markets are an excellent candidate.
Bubbles need a theme or a concept behind them, and it needs to be new. Investors are unlikely to create a bubble in the same asset class within living memory. What we mean by this is that traders are unlikely to go back and create a new tech bubble while the memory of the last collapse is still fresh.
A much more likely scenario is that investors find something new to get excited about and create a bubble in a fresh investment theme. The emerging-markets story has everything needed to create an asset bubble.
The opportunity there is potentially enormous, while being hard to define. It's simply a great story, and the strength of these markets over the last couple of years should attract liquidity, creating a "virtuous" cycle to the upside.
The Fed action will have consequences, and we would keep a close eye on where the liquidity flows as the Fed tries to clean up the subprime lending disaster. A relatively small amount of liquidity could push these emerging markets into overdrive in the coming year.
” Emerging Markets: The Next Fed-Inspired Bubble? “
Brings to mind the Cavuto show a couple of weeks ago — where the ‘round table of experts’ spent 5 minutes telling us how the US economy is just peachy-keen-WONDERFUL and strong — and then went on to unanimously recommend investing in NON-US markets....
Ike’s Law of Talking Heads: Irony is lost on ‘experts’.....
Oh, paleeeze. It must be a slow financial news day when you have to revert to terms like "meltdown of the financial system". Who are these bozos trying to kid, anyway? If they want to call it "thinning the herd" or "high risk takers take it in the shorts", fine. But, please don't even try to say the entire financial system is in the dumper.
Not sure that is really irony. Just because the U.S. economy is strong doesn’t mean U.S. stocks are the best place to put your money over a short to medium term horizon.
Nailed it. I am sick and tired of this “financial meltdown” type talk. A bunch of greedy cretins lent gobs of money to people who would never ever, normally get credit and now everyone is shocked that these debts have gone sour. Yeah, a lot of these guys who swung for the fences are taking it in the shorts, and there is some collateral damage, but hardly the crisis the MSM seem to like to sensationalize!
Round and round the wheel turns, where inflation lands, no one knows.
Will it be in bonds or equities?
Will it be here or overseas?
Will it be consumer products (quaking of the knees)?
Real estate’s shot, US equities caught, bond interest is low.
Hey, I know.
Let’s buy gold.
Too late? Oh, drat, I really, really liked that.
Wait I know, let’s buy time . . .
Great article. The Fed is a serial bubble-blower, there can be no argument about that. The transition between the NASDAQ bubble and the housing bubble was absolutely seamless.
I guess one indicator of the next Fed-blown bubble will be when we read of some financial transaction that makes absolutely no sense whatsoever. When the housing stocks were collapsing in early 2006, one fine day for no reason whatsoever one of the builders (I can’t remember which one) announced that it was going private for some ridiculous premium over the collapsing stock price, then it raised that offer like twice more in the next two months. In retrospect that must have been an early indicator of “liquidity” (the polite word for “counterfeit money”) gone wild.
The MSM always takes this attitude when covering any subject too technical to be included in a journalism degree program. A story doesn't sell papers, or site clicks, unless it's a Total! Financial! Meltdown!
Good point...
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