Terrible Swift Sword ([info]kenshi) wrote,
@ 2009-09-16 11:29:00
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Market Update: September 16, 2009
The rally is still proceeding apace, but it's starting to look very tired. Significant psychological milestones are piling up. Bernanke has announced that the recession is over. Television news shows are runninng market tracking and investment segments again, cheering up days as loudly as they did near the top. A broad consensus of economists holds that recovery is immanent throughout the economy. Optimism is running rampant. Advance/Decline ratios are showing 90%-plus bull commitment. P/E ratios have hit their highest levels ever. Mutual fund cash-to-asset ratios are below 5 percent again. Dividend yields are back below 3 percent. The Big Bull psychology has re-established itself with a vengeance, even though every possible measure of economic vitality is negative. All that's missing is the final blow-off into a euphoric spike marked by front-page news about how we're all saved and the buy-and-hold crowd has been vindicated.

That could happen literally any day now, although I'm thinking at this point a final push over 10,000 in the DJIA is still in the works. I'm 50% short and selling the spikes.

I'm getting "sell" signals across the board in every market I track except the US Dollar, which looks very much like it's about to bottom out around 76.0. USD bulls have utterly capitulated to a level not seen in years. Bearish sentiment is approaching historic levels...those typically associated with major bottoms. I know this is contrary to everything most of you are thinking about the future of the dollar, but bet against the greenback right now at your peril. We're about to get at least a year of very severe dollar deflation, probably starting in Q42009. The USD index will make a new interim high, and could easily crack 110. Cash in your mattress is about to become a viable profit strategy.

The Gold market appears to be the last hold-out of the commodity bubble, probably because it didn't participate in the blow-off to the same extent as the other commodiities and has substantially lagged oil (which has had a weak rally and looks ready to take another dive). We may get a last blow-off in gold as well, but the gold-bugs seem to be losing their momentum. I'm not ruling out the possibility that Gold will be the very last of the Great Asset Bubbles, but that seems much less likely now than it did several months ago. Gold may crack its all-time high of $1035 before reversing, but reverse it will. A downside price range of $600/oz or less is not out of the question. Silver has either already topped or is about to do so.

We live in interesting times. If you have any debt, you'll want to get rid as much of it as you can manage as soon as you can. Owing money in a deflationary spiral is doubly painful.

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[info]madbard
2009-09-16 06:43 pm UTC (link)
>We live in interesting times. If you have any debt, you'll want to get rid >as much of it as you can manage as soon as you can. Owing money in a >deflationary spiral is doubly painful.

Why is this? If the debt is in USD, and the USD drops in value, shouldn't it be easier rather than harder to pay off debt?

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[info]kenshi
2009-09-16 06:50 pm UTC (link)
If the USD drops in value, that's true. Since that's the opposite of what I'm saying here, you'd want to get out of debt fast. Deflation means the value of every extant dollar is increasing and prices denominated in dollars are falling proportionately.

Carrying debt into a deflationary period means you borrowed dollars when they were cheap and have to pay them back when they're expensive: a really bad idea.

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[info]nokomisjeff
2009-09-16 07:14 pm UTC (link)
What's your YTD performance in all markets?

Jeff

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[info]kenshi
2009-09-16 08:55 pm UTC (link)
I was up 116% from March 2008 to Feb 2009, took a big hit Feb 2009 to Apr 2009 as I misjudged a few things and the feds started intervening to prop up the Dow, taking my overall return down to about 16%. I've been neutral since then until now, though if you look back through some of my posts here, I did call this rally fairly accurately even if I was too chicken to trade it.

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[info]nokomisjeff
2009-09-16 09:01 pm UTC (link)
Hey, 16% is better than what you'd get in a CD.

Jeff

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[info]ernunnos
2009-09-16 07:21 pm UTC (link)
I think you're right about the dollar and gold, but very cautious because I want you to be right. I need another buying opportunity before it all goes to shit. If you are, it's going to be hell for the carry trade though.

(Reply to this)

Bet you a buck that there will be some USD decrease
[info]betternewthings
2009-09-16 07:38 pm UTC (link)
More specifically, I'll bet you a greenback from me to a loonie from you that USDCAD will break under 1 in the next 12 months, and I'll take 2:1 in my favor that AUDCAD will break over unity.

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Re: Bet you a buck that there will be some USD decrease
[info]kenshi
2009-09-16 08:51 pm UTC (link)
I won't take the AUDCAD bet since I don't know that market well.

I will take variant of the USDCAD bet, though:

I'll bet you one CAD from me vs. one USD from you that six months from today (March 16, 2010) USDCAD is below 0.85.

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Re: Bet you a buck that there will be some USD decrease
[info]betternewthings
2009-09-17 02:22 am UTC (link)
I thought you were bullish USD?

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Re: Bet you a buck that there will be some USD decrease
[info]kenshi
2009-09-17 03:09 pm UTC (link)
I am. That's why I think 1.0 CAD is going to be worth less than 0.85 USD in six months.

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Re: Bet you a buck that there will be some USD decrease
[info]betternewthings
2009-09-17 03:26 pm UTC (link)
I just clicked and saw you linked to the CADUSD chart, and I thought you were quoting USDCAD. My bad.

I'll take that bet.

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[info]michaelduff
2009-09-22 10:28 pm UTC (link)
Can you put this in kindergarten terms for me?

The Fed is "printing" money at an unprecedented rate and the government has poured billions into the economy in a very short time.

All of this says inflation to me, i.e. a decrease in the value of the dollar, i.e. an extraordinary increase in prices in the next 12 months.

But you're saying the dollar will actually be worth MORE soon, despite all of this, leading to a decrease in prices?

What force is spurring deflation, when interest rates are still at zero?

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Deflationary Pressure - Part 1
[info]kenshi
2009-09-22 11:05 pm UTC (link)
Inflation in our monetary system is credit-driven. What that means is that, because of fractional reserve lending, each actual, physical dollar created by fiat at the Federal Reserve Bank, nine or more credit dollars will appear in the economy as banks extend credit and back their obligations with only a fraction of that liability in real cash. More importantly, a lot of credit is also extended based on asset values other than dollars as collateral. This is true for real estate lending, and also lines of credit collateralized by equity portfolios (which was very common in the go-go 1990s when people had ATM cards linked to their brokerage accounts, but is less common now). A dollar of house asset market value makes its way into the system just as surely as a printed greenback, and itself becomes part of the credit expansion. Same with a dollar of appreciated stock portfolio value.

This is why asset values are an important consideration in the operation of a credit-driven fiat monetary system. It isn't just the physical monetary units that are the base for credit expansion: it's also the increasing asset values that are fuel more credit increase as collateral at the same time that credit increase is driving the values of those assets up. That's what creates a credit bubble.

In fact, until recently there were only about $800 billion actual physical dollars in existence...the supply of which monetary economists call "M0". Yet, if you add up all the outstanding debt and asset values out there which are denominated in dollars, even at current depressed prices, you get a value base (MT) of something more like $63 trillion. Every dollar in existence prior to recent Fed activity had therefore already been inflated by nearly 80,000 times prior to the Fed's recent monetary shenanigans.

In the last year, the Fed has a little more than doubled the number of M0 dollars by buying US Treasurys on the open market. If asset values had remained stable and consumers' appetite for credit had remained unchanged, then the inflationistas would be right: the result would be massive inflation.

But that's not the whole story. The Fed's creation of all those new greenbacks was in direct response to two things:

1) a gigantic decline in asset values across multiple markets, including real estate, and,

2) a change in consumer preference (due to increased risk) toward saving rather than borrowing.

It's not possible to have trillions of dollars of asset value declines occur in investment and real estate markets and not have that be enormously deflationary. At the very least, it removes lots and lots of asset-value dollars which could support creation of new credit dollars. At worst, it kicks the chair out from under the pyramid of credit dollars for which the asset values were the primary support, and the whole mess goes bad: causing a number of dollars equal to a significant multiple of the asset decline value to simply evaporate into nothingness.

So, when the stock market lost a trillion bucks in market cap during 2008 and early 2009, and the real estate market took a 30% hit on asset values, many more trillions of dollars in now-bad credit also suddenly disappeared along with them. Though a lot of the effects of all that bad credit are still coming to light (with lots more in store), even then enough credit dollars vanished to create very large deflationary pressures in our economy.

Combine that with a change in borrower behavior and increased risk-aversion among lenders, and the rate of new credit creation has entirely stalled out.

(See Part 2, following)

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Deflationary Pressure - Part 2
[info]kenshi
2009-09-22 11:05 pm UTC (link)
So, asset value dollars are disappearing at a furious rate as asset values decline. Much of the credit which is collateralized by those asset values is now effectively worthless. That gives us a firestorm of dollar destruction to the tune of tens of trillions of dollars going "bye-bye".

Now, the Fed makes up a bunch of new greenbacks by purchasing Treasurys and monetizing them, doubling the supply of the actual currency. They haven't even yet reached the point of making a trillion of these new dollars, but many more trillions in asset values are already gone. The Fed hopes to reinflate the dollar by having those new greenbacks be expanded by fractional reserve lending to a money supply many times the size of their number. Yet, the banks aren't lending, and potential borrowers are saving their cash and cutting back on their need for credit.

The system has completely broken down and is on the precipice of a gigantic deflationary spiral just like Japan has been suffering since 1990. The Fed could quadruple the dollar supply and print up $8 trillion new greenbacks, and it probably wouldn't make much difference at this point.

Of course, when things ultimately start to turn around, they'll have created a hyper-inflationary slingshot lurking in the economy. But that's another problem for another day. Frankly, I think we'll see a default and reorg of the US government before we get there.

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Re: Deflationary Pressure - Part 2
[info]michaelduff
2009-09-25 08:53 pm UTC (link)
Again, oversimplifying.

But isn't this exactly what Krugman is asking for in every column he writes? This is what he means by "the stimulus won't be enough." He wants the government to quadruple the dollar supply and replace all this vanished asset value with government money.

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Re: Deflationary Pressure - Part 2
[info]kenshi
2009-09-26 11:42 pm UTC (link)
Krugman may be a deluded fool, but he isn't stupid. In this case he's right. The stimulus won't be enough. It won't even be close to enough. The only thing that could really fix it would be nationalizing the entire financial system and monetizing all the debt.

Of course, doing so would be enormously inflationary because Krugman and his butt buddies are strongly opposed to the other key parts of making a fix like that work: outlawing fractional reserve banking and maturity transformation, and capping the dollar supply in perpetuity. Without those, a "reset" will just result in Zimbabwe.

But a reset is what the system needs. It's like an old boxer who's been knock-out killed standing up. He looks like he's still in the fight, but he's brain-dead and about to fall. Any activity you see is just residual autonomic nerve firing as the tissue dies.

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