January 7, 2010

Global Market Comments
January 7, 2010

Featured Trades: (SPX), (DOW), (OBAMA),
(DBA), (GLD), (MOO), (PHO), (USO)

1) With all of the handwringing about the zero return on US equities for the last decade, I thought I'd better take a look at the long term charts. It's very clear that we have been trading in a gigantic sideways narrowing wedge for the last 16 years, defined by 14,000 on the upside and 6,000 on the downside. The clever investors out there, like hedge funds, have been selling every big rally and buying every dip, laughing all the way to the bank and leaving your average Joe pension fund beneficiary, 401k owner, and mutual fund investor holding the malodorous bag. What's more, I believe that this state of affairs is going to continue for another decade. You get what you deserve. This view is consistent with an economy that isn't inventing anything new, spends more than it borrows, and lets foreigners take the technological lead through sheer indolence and complacency. We aren't going to Twitter our way to prosperity. It also fits with 80 million baby boomers withdrawing wealth from the system, downsizing their homes, and plopping everything into the Treasury market. It didn't help that we had the worst presidential leadership in history. The stock market is telling us that the model where Bush provided the shining moral example and all the important stuff like defense and the economy, were delegated to others who knew better, like Cheney, Rumsfeld, and Paulson, clearly didn't work. All it got us was $6 trillion in new debt, a halving of most people's net worth, and the utter destruction of the financial system. This means that we are much closer to the end of this run in equities than the beginning. If you have any doubts, take a look at the data below from the Bespoke Investment Group showing that stocks are more expensive now than at any time in the last nine decades. Should one of the world's structurally more structurally impaired economies be commanding one of the highest PE multiples? I think not. This is why I have been using my electric cattle prod and my kangaroo skin bullwhip to herd investors into the hard stuff, like commodities (DBA), crude (USO), precious metals (GLD), food (MOO), and water (PHO).

2) While Obama relaxed in Hawaii, sipping Mai Tai's adorned with little pink umbrellas, hooking up with distant relatives, and watching Avatar, a potential nightmare is giving him sleepless nights. Let's say we spend our $2 trillion in stimulus and get a couple of quarters of decent growth. The 'V' is in. Then once the effects of record government spending wear off, we slip back into a deep recession, setting up a classic 'W.' Unemployment never does stop climbing, reaching 15% by year end, and 25% when you throw in discouraged job seekers, jobless college graduates, and those with expired unemployment benefits. This afflicted Franklin D. Roosevelt in the thirties. So Congress passes another $2 trillion reflationary budget. Everybody gets wonderful new mass transit upgrades, alternative energy infrastructure, smart grids, and bridges to nowhere. But with $4 trillion in extra spending packed into two years, inflation really takes off. The bond market collapses, as China and Japan boycott the Treasury auctions. The dollar tanks big time, gold breaks $2,300, and silver explodes to $50. Ben Bernanke has no choice but to engineer an interest rate spike to dampen inflationary fires and rescue the dollar, taking the Fed funds rate up to a Volkeresque 18%. The stock market crashes, taking the S&P well below the 666 low we saw in March. Housing, having never recovered, drops by half again, wiping out more bank equity, and forcing the Treasury to launch TARP II. The bad news accelerates into the 2012 election year. Obama is burned in effigy; Sarah Palin is elected president, and immediately sets to undoing all of his work. Republicans, reinvigorated by new leadership, and energized by a failing economy, retake both houses of congress. National health care is shut down as a wasteful socialist mistake, boondoggle subsidies for alternative energy are eliminated, and the savings are used to justify huge tax cuts for high income earners. We invade Iran, and crude hits $500. If you're over 50, and all of this sounds vaguely familiar, it's because we've been through it all before. Remember Jimmy Carter? Remember the 'misery index,' the unemployment rate plus the inflation rate, which hit 20, and catapulted Ronald Reagan into an eight year presidency? A replay is not exactly a low probability scenario. This is why junk bond yields are still stubbornly high at 12.5%, and credit default swaps live at lofty levels. It's also why the investing public is gun shy, favoring bonds over stocks by a ten to one margin. Are the equity markets pricing in these possibilities? Not a chance. The risk of economic Armageddon is still out there. Personally, I give it a 50:50 chance. Batten the hatches, and please pass the Xanax.