No sign of our little green devil today. Perhaps even he is scared to buy. And like everyone else in New York, maybe he’s disappointed that the Federal Reserve only cut interest rates by half a point. Stocks in New York were charging ahead smartly late in the day. But by the time the ink had dried on the Fed’s half-point reduction, they’d fallen 74 points.
Investor confidence is fragile. The Fed wouldn’t have helped things by saying, “Downside risks to growth remain.” That’s a little like seeing a “Dog bites man” headline on a newspaper. It’s so obvious it isn’t even newsworthy.
If global central banks are worried about economic health and the chance of recession, though, we can’t see how providing more “liquidity” will do the trick. Remember, over-leveraging is the problem. That’s what needs to be reduced. Does providing cheaper credit reduce leverage? Hmm. No.
The Fed now has just a few bullets left in its interest rate gun. It will save those for an emergency. Think of the scene in Aliens when Hicks and Ripley are being chased in air duct by the creepy crawlies. “Hicks, don’t let one of those things get me,” Ripley says. “Don’t worry. If it comes to that, I’ll do us both.” Inflation, deflation, insolvency, lack of liquidity, deleveraging…so many battles for the Fed to fight. So few bullets.
The nuclear game changer in all this is now fiscal policy. Government spending. There’s no guarantee, by the way, that Senator Obama will win next Tuesday. The American media has made the huge mistake of inflating expectations of his victory by releasing all sorts of suspect polling data. The pollsters try to influence voting as much as they try to predict it.
In fact, in their rah rahing for Obama, the media has set up a really nasty backlash if Senator McCain somehow wins in Florida, Ohio, Pennsylvania, Virginia, and Colorado. It will appear to the average Joe Six Pack that the only way McCain could have won was to cheat, or because Americans are racist behind closed doors. If Obama doesn’t win, there are going to be some pretty unhappy people in the streets of Chicago (and Berlin, and San Francisco, and Melbourne).
But our point is that from a short-term economic perspective, it doesn’t really matter who wins. There’s going to be a big stimulus package passed in Washington. Just how big and who will pay for it, who knows? But if investors are looking for something to improve their expectations for the economy and earnings, it’s either more splashy government spending…or nothing else we can think of.
By the way, you might have missed it, but the yield on the 30-year U.S. Government bond plunged to its lowest level since the Feds began selling them in 1977. On October 24th, the yield on the 30-year dipped to 3.86%. Since then, it’s been rising. What could this mean?
Well, it could mean that the last greatest bubble in the world—the bubble in U.S. government bonds—is bursting. Why? Bond investors aren’t generally stupid. Everyone in the world has flown into Treasuries for safety as the dollar/yen carry trades collapsed and forced de-leveraging belted stocks.
Plus, if you were a big seller of commodities or emerging market stocks you’d purchased with borrowed dollars, you have to put those dollars into something (if you’re not paying them back that is). Treasuries, of which the U.S. government has been supplying plenty, were the preferred investment. Unlike money market funds (or say, mortgage funds), Treasuries ARE government guaranteed.
But now, bond investors see the Fed cut rates. They see plans for a massive New Deal 2.0 under a Democratic Congress and an Obama administration. And they see yesterday’s report from the International Energy Agency that global oil production may not keep up with demand without massive new investment. And what do they conclude?
They must conclude that after the markets have finished de-leveraging, you’ll have a new status quo in the world. The supply of government debt is on the rise. Governments are stimulating faster than a harem of masseurs in a Thai massage parlour. The respective adjusted monetary bases of the world are expanding. The money flood is coming! It’s time to build your ark.
You don’t want to own bonds or much in the way of low-yield fixed income when the money supply grows. That’s because inflation will eat away at your investment. So the stage is set, we believe, for the rotation out of cash and bonds and back into the only asset class that will outperform during inflation: equities.
In this we agree with Buffett. Investing in equities at this point is like emerging from a bomb shelter to find the streets of the town deserted…and littered with quality companies—especially energy and resource stocks—that have simply been dropped in the street as investors headed for the hills.
All you have to do is dust them off and put them in your pocket. You hope they aren’t radioactive, of course. Which is to say, you hope Nouriel Roubini isn’t right and that S&P 500 isn’t going to fall by another 30% or the ASX by another 25%.
But the penalty for being too much in cash could be severe. That’s IF we’re right and the growth in global adjusted monetary base is inflationary. By the way, copper was up 12% yesterday and oil 5%. When you compare yesterdays stirring in the commodity markets with (what we believe) was the pricking of the bond bubble last week, you have signs of a slow leak in the bond bubble…leading directly rising prices for real assets.
Money will bleed out of bonds and cash and into the most overly-sold producers of tangible assets. It’s not a risk free trade. But then again, what is risk free these days? Even doing nothing but being in cash is an action with risk. So the question today is where is the next danger to your money coming from: inflation or deflation? And what is the best way to avoid the danger, preserve your capital, and profit?
Neither are easy questions. It depends on how much de-leveraging still needs to be done by banks and hedge funds. But keep your eye on the bond markets and commodity prices. They are flashing warning signs of inflation. Cash should take notice.
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