Featured Trades: (Q3 GDP)

3) There is Less Than Meets the Eye in Q3 GDP. There was much celebration that the US economy managed a 2.0% growth rate in Q3, sending double dippers to the dust bin of history, where they rightfully belong. Of course, you already knew this was going to happen last January, because this is exactly the number I predicted then in my 2010 Asset Allocation Review' (please click here for the call) . I made this prediction because I thought that American companies doing business with the white hot emerging markets would generate just enough growth to offset the huge drag created by moribund industries, like housing, real estate and every shrinking state and local government portions of the economy. This is precisely what unfolded.

A closer examination of the breakdown show that even this modest, lackluster figure may be overstating the true level of business activity. By the time you strip out the 2.2% GDP deflator and the inventory build of 1.4%, real GDP growth was actually negative. The GDP deflator is no doubt being overstated by the huge expansion of the Fed balance sheet. Much of the inventory build was a one time only affair which has since ceased and can't be counted to repeat in the future.

What all this says about the US stock markets is that further rises are going to be driven mostly by a QEII that will lift all boats, especially the yachts. They will be supported less by actually profit making activities of US companies. That is sort of a long winded way of saying that we are in the middle of a mini stock bubble. Party away, but stay close to the exit at all times.

Featured Trades: (JAPANESE YEN), (FXY), (YCS)

3) Pricking the Bubble in the Yen. Analysts have been puzzled by the relentless appreciation of the Japanese yen, which went out at ?80.40 on Friday, and seems poised to break out to the ?70 handle and an all time high. Having written the authoritative tome on the Japanese banking system 30 years ago (it's in the Library of Congress), I can shed more than a little light on why.

Unknown to most in the trading community, foreign banks have engaged in a massive recapitalization of their Japanese subsidiaries since over the last six months. Since May, excess foreign bank reserves held in yen have soared from $246 billion to $562 billion, an increase of a staggering $316 billion, creating immense upward pressure. Some $136 billion of this poured into the yen in September alone. By comparison, there are only $7.3 billion worth of net longs held in futures markets by speculators.

Ask Japanese senior bankers why this is happening, and you get lame excuses, like anticipation of stiffer capital requirements from the Bank of Japan to head off any future financial crisis. The truth is that banks are using their balance sheets to speculate in the currency markets and boost profits. Adding fuel to the fire has been efforts by the People's Bank of China to diversify out of the dollar as a reserve asset by pouring new cash flows into the yen. This is showing up in a huge jump in overnight bill purchases by foreign investors.

In days of old, countries used to destroy their neighbors by sending in invading armies of screaming warriors swinging great long swords. Today, you simply buy their currency; drive it to ridiculous heights, making its industry hopelessly uncompetitive in the global market place, thus collapsing its economy. This is what China is doing to Japan today.

This explains why the central bank's intervention efforts to slow the yen's appreciation have been an abject failure. In September, total BOJ sales of yen amounted to only $61 billion, and has been spread among a range of lower tier assets, like 'BBB' rated corporate bonds, exchange traded funds (ETF's), and REIT's. The Japanese government is slumming with its own version of QEII. But the amounts so far are miniscule compared to the inflows. They might as well be pissing in the ocean.

There are two ways this kabuki play will go end. The obvious one is for the BOJ to boost its intervention to the $1 trillion that worked the last time it was in this pickle eight years ago. I sense that a Pearl Harbor type surprise attack of this sort is setting up. Suck the shorts in with a series of small, ineffective interventions that invite laughter and derision, and then all of a sudden, its tora, tora, tora and bombs away. The shorts get taken to the cleaners.

The second approach will be more subtle. Banks are currently earning 10 basis points on their excess reserves. Turn this number negative, as Germany and Switzerland did, and the banks will bail on their excess reserves in a heartbeat. It's not a matter of if, but when they do this. Then the 15 year double top chartists have been waiting for will be in place, and one of the great shorts of the decade, and the (FXY) and the (YCS) will be in play. This all may happen very fast, so keep you finger poised over that mouse.

Is the Bank of Japan Planning a Surprise Attack on the Yen Shorts?

Why the Bank of Bank of Japan's Intervention Efforts Aren't Working

Featured Trades: (MUNICIPAL BONDS), (NCP), (NVX)
Nuveen California Performance Plus
Nuveen California Dividend Advantage Muni Fund II

 

2) The Fascinating World of Municipal Bonds. I was fortunate to catch the muni bond wave this year with my recommendations to buy the funds in this sector, the (NCP) and the (NVX) (click here for 'California Municipal Bonds Are a Steal'). I turned negative on bonds of every description in August, fearing that the popping of the government bond bubble could take down the rest of the fixed income universe down with it (click here for 'The Great Bond Market Crash of 2010').

However, there may be some circumstances unique to certain individuals where hanging on to you muni bonds may make some sense. Treasury bond investors are not being compensated for their risk at current yields, but muni bond investors are. Ten year tax free munis are now yielding 2.58%, delivering an effective taxable rate of 3.97% for those in the top end 35% tax bracket.

If the Bush tax cuts are not extended, that yield jacks up to 4.27% for top earners. In the 30 year arena, the effective taxable rate is 6.38%, and a very generous 6.87% without the Bush cuts. That's a lot in this zero yield world we live in. And let's face it, taxes are going up a lot, no matter who wins the election, making these bonds even more valuable.

The risk of an outright default on this paper has been vastly overblown by the media. California's $70 billion in general obligation debt, which is used mostly for infrastructure spending, is at the very top of the seniority structure, followed by $150 billion in retirement benefits debt. These claims are untouchable.

All of the budget cuts going forward will take place with the junior claims in the obligation structure, mostly schools and social services. That is why we are seeing rioting at UC Berkeley and demonstrations at welfare offices. And with the stock market up 78% in 20 months, capital gains will start kicking in, which in peak years account for 40% of total state tax revenues.

For those who would rather leave slugging it out in the markets every day to the younger crowd, who despair at figuring out the 'new normal', or who don't want to deal with the harsh reality that 'buy and hold' is dead, this may be a good option. Sure, you almost certainly will have to take some ugly marks down the road. But if you are willing to hold this paper to maturity, it might be worth it.

Don't Let Them Scare You Away from Muni Bonds

Featured Trades: (PEAK TREASURY BONDS), (TBT), (TMV)
ProShares Ultra Short Lehman 20 + Year Treasury ETF
Direxion Daily 20 Year Plus Treasury Bear 3X Shares ETF

2) The Fat Lady is Still Singing in the Treasury Market. To say that things have gone well for the Treasury bond market this year would be one of the understatements of the century. First there was a global flight to safety triggered by the European debt crisis. Then there was the mad rush by hedge funds to cover shorts in securities they believed were the world's most overpriced assets. Then Ben Bernanke appeared on the scene with QEII, sending bond prices everywhere to 50 year highs.

Every academic study showing that government paper had 30 years of underperformance ahead of them, including my own, only seemed to drive prices higher (click here for 'A Visit to the Insane Asylum'). In fact, my report on 'The Great Bond Market Crash of 2010' lagged the actual peak in bond prices by just five days (click here for the piece). At the August high, the Treasury market was effectively discounting 0% inflation for ten years, an insanity I was happy to bet against.

The recent action in the markets suggests that the turn may finally be behind us. Why have bond prices been falling for the past month, despite an assumed promise by the Fed to provide unlimited amounts of liquidity? Why has a ton of Chinese and other foreign buyers failed to set a new high. Is it possible that the fat lady is at last singing in the Treasury bond market?

Let's say we get a 'RISK OFF' reversal in global financial markets. The short Treasury Bond ETF (TBT) bottomed at $30 at the end of August and has made it back up to $34.? Take it back to this year's high of $52 and that gives you a 73% gain off the bottom. The 2009 high gets you to $60, an even 100% return. If you don't feel like betting the ranch here and want to approach this in a sober, risk controlled manner, look at the cheap, out-of-the-money March or June, 2011 $45 calls on the (TBT). Get this one right and the profit will be several fold.

Featured Trades: (THE COMMODITIES BOOM)

1) Here Come the Seventies Again. Better drag your leisure suits, bell bottoms, and Bee Gee's records out of the attic. The seventies are about to enjoy a comeback. The near universal run all commodities are enjoying now takes me back to that time in my youth when making money was as simple as buying an ounce of gold, a barrel of oil, or a bushel of corn. Cotton hit its highest price since the Civil War yesterday, when Union a blockade of the South sent prices skyrocketing (see Gone With the Wind). (Smart Alecs out there please don't bother to ask if I fought in the Civil War. That was my older brother).

QEII is truly lifting all boats, even the leaky ones, like the US stock market. The debasement of the dollar this policy assures will keep money pouring into virtually every tradable asset in the world, including stocks, bonds, currencies, commodities, precious metals, and yes, even real estate. The great thing about QEII is that Ben Bernanke doesn't have to do it, he only needs to think it, or to hint about it, and the private sector will execute it for him. Has anyone noticed that is exactly what's happening now, with all asset prices rising in lockstep globally?

I have a feeling that this love fest is going to end the same way it did in the eighties too. The Fed knows it is creating a monster with the enormous amounts of money it is now creating, and that someday, it will have to drive a giant steak through its heart in the form of huge and cathartic interest rate rises. That will not happen this year, or next. But when it does my prediction that the short Treasury bond ETF, the (TBT) will roar from $30 to $200 could look conservative.

Until then, party away as if you are an extra in John Travolta's Saturday Night Fever. The Japanese have a wonderful expression that applies here which I constantly heard throughout the eighties: 'When the fools are dancing, the greater fools are watching.'