Posted on 05/09/2003 5:29:23 PM PDT by arete
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The U.S. Peso Falls Again
Buy the Rumor and Sell the News Earlier today I was busy working on allocations within client accounts while the Dow was up about 40 points. About two hours later I looked at the screen to see that the index was up over 100 points. What happened to launch stocks higher? Seemingly nothing! I am interpreting todays move as, Buy the rumor and sell the news. It seems that the market is responding to the economic weakness sighted by the Federal Reserve in their press release this past Tuesday. There are now rumors abounding that we could see a rate cut at the next Fed meeting in June. I scratch my head and ask myself if the spin of a possible rate cut is needed to keep Treasury bond prices high, and to keep demand for Treasury instruments high so that the dealers that bought the $58 billion in Treasury debt this week can keep selling it to the public. If there is no rate cut next month, both stocks and bonds should come down. Is that what the Fed is alluding to? Lets take a look at their statement from Tuesday. The Federal Open Market Committee decided to keep its target for the federal funds rate unchanged at 1-1/4 percent. Recent readings on production and employment, though mostly reflecting decisions made before the conclusion of hostilities, have proven disappointing. However, the ebbing of geopolitical tensions has rolled back oil prices, bolstered consumer confidence, and strengthened debt and equity markets. These developments, along with the accommodative stance of monetary policy and ongoing growth in productivity, should foster an improving economic climate over time. Although the timing and extent of that improvement remain uncertain, the Committee perceives that over the next few quarters the upside and downside risks to the attainment of sustainable growth are roughly equal. In contrast, over the same period, the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level. The Committee believes that, taken together, the balance of risks to achieving its goals is weighted toward weakness over the foreseeable future.
We could spend lots of time taking the press release apart piece by piece, but lets focus on one particular sentence in their statement. This one sentence has got to take the prize for the Spin of the Week. In the third paragraph they state, In contrast, over the same period, the probability of an unwelcome substantial fall in inflation, though minor, exceeds that of a pickup in inflation from its already low level. First of all, lets be sure that the time frame that they are referring to is, The next few quarters as noted in the preceding sentence. For conversations sake we can safely say sometime in the next nine months. The next key to the sentence is the word probability along with some clarification to the degree of probability stated as though minor. This should be translated as more than a 50% chance (probable) though minor (lets call that less than a 70% chance) that we will see, An unwelcome substantial fall in inflation. What is Inflation? With all of the disinformation out there, most people dont even know how to define inflation. All these years we have been spoon fed the notion that an increase in inflation is a bad thing. Most people think of inflation as having to pay more money for the things we need and use. To be more specific, it is usually referred to as consumer inflation. That is why inflation is usually measured by the CPI (Consumer Price Index) and the PPI (Producer Price Index). We usually hear that low inflation is a good thing. So how can the Fed say that it will be an unwelcome large decline in inflation? Also note that they could have said deflation instead of a fall in inflation. Funny use of words. Wouldnt you welcome a decline in price for school tuition, homeowners insurance, medical and prescription costs, lower gas prices, more affordable gas and electric bills, knock 20% off your weekly grocery bill, etc.? So how can it be considered unwelcome? Ill tell ya how. Its called ASSET DEFLATION. What are the biggest assets Americans hold? I would have to say they are stocks, bonds (meaning debt instruments of all kinds) and real estate. That is the only way the deflation would be considered unwelcome. To digress for a moment, inflation occurs when the Federal Reserve INFLATES the supply of money relative to the economic expansion of goods and services (GDP). When excess money is created it has to go somewhere. Back in the seventies, Americans endured tremendous inflation of consumer goods after the excess money creation of the sixties that was used to fight the war in Vietnam. The dollar link to gold was broken back in 1971 and the consumer inflation took-off straight through the seventies. This last time around, it has been very different. The excess money creation of the nineties (massive monetary expansion) found its way into financial assets. Remember that now-a-days, debt is considered an asset. All things financial have been over-inflated. The first victim has already been the stock markets. Could they fall more I would have to say, Yes based on todays price to earnings ratios over 30, when traditionally anything over 20 is considered overvalued. Could bond prices come down? I would have to say, Yes again, since we are at 40-year lows on interest rates. Theres just not much room for bond prices to go much higher. Can real estate prices come down? I again would have to say, Yes. After the last few years of 20%+ gains in real estate values, there is plenty of room to come down. When bond prices decline, forcing interest rates higher, how will unemployed workers or even working people for that matter, be able to afford todays home prices if mortgage rates were to go back above 10% as they were back in the eighties? Higher mortgage rates will lead to lower prices so that people will be able to afford the monthly payments. Im beginning to ramble, but lets pull it together. I would like to replace the Feds sentence in the above press release with my own interpretation of what they are saying. It would go something like this, Sometime over the next nine months we will probably see a substantial deflation of financial assets. In my mind, it will probably happen sooner than later, because next year they will need to clear the way for an election-year rally to get President Bush re-elected. We shall see if the Fed cooperates. So far it looks like they will as there seems to be no hesitation to continue pumping liquidity into the system and pegging long term interest rates below 5%. That is why we continue to see the dollar in decline. The Fed is really between a rock and a hard spot. They cant raise interest rates to strengthen the dollar, as higher rates would crush any chance of an economic recovery. They continue to expand money faster than GDP which will put continued downward pressure on the dollar. First quarter GDP came in at an annualized rate of 1.6%, but monetary aggregates (as measured by M-2) have been growing at an annualized rate of 7.2% for the last year. With all the spin on Bubblevision, it looks like they are trying to force the excess liquidity back into the stock market to re-inflate the bubble. We need foreigners to invest roughly $1.5 billion per day to support our negative balance of payments. With a falling dollar it will be difficult to attract foreign investors. For now, well just keep plodding along. Watch out for the complacency in stock prices. That is when investors tend to get caught off-guard when stocks tumble. The Fed is actively buying debt instruments off the market which is providing excess liquidity to prop-up stocks. If the dollar falls too far, too fast, they will have to back off on the money pump. We shall see how it all unfolds as we continue to monitor the markets. In the meantime, best of luck to you in all of your investment decisions!
Copyright © 2003 Mike Hartman
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The Fed is really between a rock and a hard spot. They cant raise interest rates to strengthen the dollar, as higher rates would crush any chance of an economic recovery. They continue to expand money faster than GDP which will put continued downward pressure on the dollar. First quarter GDP came in at an annualized rate of 1.6%, but monetary aggregates (as measured by M-2) have been growing at an annualized rate of 7.2% for the last year. With all the spin on Bubblevision, it looks like they are trying to force the excess liquidity back into the stock market to re-inflate the bubble. We need foreigners to invest roughly $1.5 billion per day to support our negative balance of payments. With a falling dollar it will be difficult to attract foreign investors.
"Sometime over the next nine months we will probably see a substantial deflation of financial assets.
That sounds about right.
Richard W.
I hope that everyone has an opportunity to listen to yesterday's Roger Arnold's interview with Dr. Frank Shostak. Today's Roger Arnold links include the 9:00 to 11:00 am show (Arnold is subing for Tom O'Brien) and Roger's regular one hour 11:00 am show.
Again both shows are excellent.
Richard W.
Foreign investors in American real estate are seeing it happen right now before their very eyes. Maybe this will burst the real estate bubble.
You're not alone in the confusion department, but I'm sure that there are big changes coming in the way many have been looking at both the economy and the financial markets. If you haven't done it already, I suggest that you follow the Roger Arnold links that I posted on yesterday's and today's Market WrapUp's. It is like getting a 6 hour seminar from some of the best financial thinkers out there and it won't cost you a single dime just some of your time. Most people don't want to do the "homework" so they tune-in to CNBC for 30 min and take the garbage they hear there as truth. Listen to the Arnold interviews and shows and you will be able to make your own investment decisions without getting taken by the scam artists and Wall Street criminals.
Richard W.
Yes !
Will the real estate bubble burst or not?
Yes !
Is it a good time to buy house?
Depends. It is always a good time to own real estate. It is not a good time to be in debt for the illusion of owning real estate.
Do earnings generated by cost cutting mean anything?
Yes, but they are in the noise.
I didn't say it was good time to buy, I said it was a good time to *own* real estate.
I won't touch the stuff either.
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