Wednesday, December 07, 2011


All markets are linked and what that means for you

One of these charts did not make sense to me. I know that stock, bond, and commodity markets are tied together by Federal Reserve policy. That is, the Fed has been providing cheap liquidity and buying bad debt (Quantitative Easing) to keep interest rates low and to keep deflation at bay. It would make sense that stocks, gold, and oil would bottom on the same week, if not day, and that bonds would be topping if the Fed started buying more crap paper. The stock market likes it because the deflation is bad for stocks. The bond market, and commodity markets, don't like it because more dollars out their will be inflationary.

But why does it hurt the dollar? Well inflation would erode the dollar. D'uh. But then the dollar came back which is what puzzled me. But it isn't that puzzling because the dollar's value is against the value of other currencies and right now the dollar looks pretty good versus the euro.

Now that that mystery, in my mind, is solved let's look at the problem of the Fed fighting deflation with QE and easy money. Easy money is a problem when it causes inflation and erodes the value of your currency. That isn't happening thanks to the collapse of the European welfare state. Europe's collapse has bought us some time. How much time? I suspect very little but right now the stock market looks to be as good of a bet as any. At least technically, the fundamental side of the equation, however, is not so sanguine.

For two decades the Federal Reserve has bailed out stock markets, he argues. Former Fed Chairman Alan Greenspan cut interests rates to near zero percent at the slightest indication of economic decline. And today, Chairman Ben Bernanke has followed the same course, stimulating the market so drastically in 2009 that after stocks crashed they took only three months to recover to a long-term upward trend.

"This pattern is unique," Grantham writes. And now that the Fed's balance sheet is stuffed full with debt, he adds, it may not come to aid during another stock downturn.

"GMO has looked at the 10 biggest bubbles of the pre-2000 era and has calculated that it typically takes 14 years to recover to the old trend," Grantham says. The important point of all this, he writes, is that almost none of today's professional investors have experienced anything like this because the Fed has come to the rescue.

"When one of these old-fashioned but typical declines occurs," he writes, "professional investors, conditioned by our more recent ephemeral bear markets, will have a permanent built-in expectation of an imminent recovery that will not come."

That sets up an environment that Grantham dubs, "No Market for Young Men." Grantham shows how long it may take U.S. stocks to recover if they crashed today.

Go to the link for the scary looking chart. I used to get very nervous reading stuff like this, not so much now. Not that I think his analysis is wrong, it isn't and the tight linkage between stocks, bonds, and commodities is excellent proof that all markets are being wagged by the Fed. What is different for me is that I know that fundamental analysis can take a long time to play out, even if it is right. IOW, markets can remain irrational longer than you can remain solvent. Until the up trend shows a clear break down I will remain nervously bullish.

P.S. In case you haven't figured it out being long gold is being long the stock market.

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