The following is part of Pivotal Events that was published for our subscribers June 4, 2009.
Signs Of The Times:
It seems like it was ages ago, but it was only a year ago when "Peak Oil" was the focus of fashionable research:
"To be sure, a crash in the oil market seems improbable."
- Bloomberg, June 3, 2008
"How to Profit From Peak Oil?
- Doug Casey, June 5, 2008
Steel prices were also impetuous as U.S. Sheet-steel prices rose 20% in May, which amounted to a 76% gain since January 2008.
"OPEC has already done what OPEC can do and oil prices will not come down."
- OPEC President Chakie Khelil, Breitbart, June 24, 2008
Almost without significance on June 22, Shadow Government Statistics noted that "Annual contractions in Industrial Production do not happen outside of a recession." It took until December 2008 before the NBER decided that the recession started in December 2007.
Our view then was that the credit contraction that started in May-June, 2007 would eventually break all commodities. (More below.)
* * * * *
"Given the Fed's inability to cut rates further, the Fed should pledge to produce significant inflation."
"I'm advocating 6% inflation for at least a couple of years. It would ameliorate the debt bomb."
- Bloomberg, May 19 2009
The first quote was by Gregory Mankiw, and the second by Kenneth Rogoff. Our readers will recall that in December 2007, Mankiw boasted that nothing could go wrong because of the "Dream Team" of policymakers.
"U.S. To Suffer 'Hyperinflation' Approaching Levels in Zimbabe"
"I'm 100% sure that the U.S. will go into hyperinflation."
- Bloomberg, May 27, 2009
"The financial crisis hit commodities; otherwise the uptrend would have continued. China is not in a recession and commodities will continue the long-term bull market."
- Donald Coxe, BNN, June 2, 2009
"Commodities looking very good; will outperform equities. Uncle Sam has the biggest printing press - ever!"
- BNN, June 3,2009
* * * * *
The old saying in salesmanship is "When the going gets tough, the tough get going." This was in mind when advising, over the past two weeks, to be selling all equity sectors. As noted again last week, market conditions and the establishment had become just as excited as their counterparts were in May of 1930. Two key phrases we have quoted were "difficult to quench the fires of enthusiasm" and that the stock market was providing a "cheerful augury of a [business] revival in substantial proportions some months hence".
Last year's financial shock will bring more careful research to the forefront. Yesterday Credit Suisse noted: "Risk appetite has returned to levels not observed since November 2007, and equity-only risk appetite has reached euphoric levels."
Our review covered stock market dynamics, which some sectors generated momentum seen at important tops. Market sentiment also reached dangerous levels, as did establishment confidence, or perhaps hubris could be used.
On the later, the policy crowd is certain that its shopworn nostrums really did end the crash, and prompted the "recovery" in business, or as they now call it--the economy. As we have been arguing, this is a fairly typical post-fall-crash rebound. This also has been accompanied by revival in some items the establishment dwells upon. As the WSJ reported on Monday:
"Better-than-expected data on personal income, manufacturing and construction propelled the S&P to a new 2009 high."
However, the salient thing about the end of a great bubble is that the economy turns down virtually with the stock market. That was the case, using NBER data, in 2007, 1929 and 1873. It stands to reason that the big rebound out of a classic crash would be accompanied by an increase in business activity. The next step will be this declining, almost right away as stocks, corporate bonds and commodities roll over.
The next phase of the overall contraction has been expected to resume by mid-year. With the hit to the long bond, and now the hit to the popular gaming items, this seems inevitable. Also supportive is the rebound in the dollar, which become the focus of much derision, or concern. We really enjoy pointing out that the worst thing that could happen to speculative policymakers and markets is an outbreak of sound currency.
There is little point abiding with modern portfolio drivel about buying "defensive" sectors. It is doubtful that any equity sector will resist the next part of the bear and it is the epitome of folly to buy a "defensive" stock on the assumption it will go down slower than benchmark indexes.
Near term, this week's reversal could roll over into an intermediate decline, which is current analysis.
Historically, we have had a count going beyond the big rebound out of a crash, such as to April 1930 and May 1873, which was an important step on the path to a lengthy contraction. The next key step has been the failure that began some twenty months after the climax of the bubble. Following the peak in September 1929 and September 1873, the serious turn to another phase of illiquidity began in May 1931 and May 1875.
Regarding the latter date on May 29, 1875, The Economist wrote:
"A sudden change has passed over the money market since last [week]. Discovery of unsound business in quarters where no such discovery ought to have been made. The evil is not extensive, however, it may have the effect of inducing bankers to raise their [cash] balances to a degree."
Then the markets rolled over.
In May of 1931 the "discovery" was Creditansalt, the largest bank in Eastern Europe. The run on deposits began in mid-May when the Austrian National Bank, along with others, provided support. On June 6 The Economist reported that the Austrian government would guarantee all credits, and that the BIS, as well as ten leading central banks would provide credit in foreign currencies and concluded: "There is now good ground for hoping that the corner has been turned... and has a brighter side."
Of course, the reason for detailing this is to get around the dogma of interventionist textbooks that central bankers were "stupid" in the 1930s and deliberately contracted money supply. When reading actual accounts of that disaster it is difficult to avoid concluding that policymakers tried very hard to prevent that contraction.
When reviewing all five previous post-bubble contractions it is rather easy to conclude that each has overwhelmed the abilities of policymakers to re-inflate a bubble. It is not the problem of not timing the perfect rate cut to restore the phony prosperity of asset bubbles, but a huge systemic problem.
Indeed, financial history is a "due diligence" on central banking.
June is the twentieth month since the stock market high in October 2007 and this season's joy may soon be dispelled by the "discovery" of some bad banking.
We have been selling bank stocks while yearning that central banks were listed. Our proprietary Bank Trading Guide has become volatile which often signals change, but has yet to give the "sell".
Credit Spreads responded, along with other orthodoxies, to the change in currencies we called on March 9. On the bigger picture, the US dollar was likely to decline with the wave of asset re-inflation out to around May. The DX declined from a high of 89.1 on March 9 to 78.3 on Tuesday.
Within currencies, Monday's ChartWorks noted that the pattern on the Canadian suggested a reversal. Yesterday's hit to asset prices and the jump in the DX from 78.5 to 79.5 could be the first step towards a reversal - as was the 2-cent drop in the C$.
Obviously, it will take some work to accomplish the reversal and it seems to be starting at the right time. In which case, currency reversals will have bracketed both ends of the move. This makes sense as it is a world of asset deflations and then inflations.
The latter has been likely to run from the crash to around May. This would be within the massive credit contraction that started in May-June 2007. At the moment the street is convinced that the Fed has arranged for "hyperinflation" to repudiate debt. We think that "bond vigilantes" are back in slamming the long bond down in price. This, and the next leg down in all other classes of bonds will shut the door on the Fed's ambition to destroy the dollar.
For hysterical analysts who have been calling for a Weimar inflation - there was virtually no credit market in Germany in the early 1920s and policymakers could go directly to real printing presses. It is likely that continuing contraction of our unsupportable debt will deny policymakers most evil intentions. Mainstream theories depend upon the notion that the Fed's expansion of credit forces a business expansion. The problem is that this is a primitive syllogism whereby cause and effect is concluded when there is none.
Yes, credit does expand during a boom - just as roosters crowing in the morning "cause " the sun to rise. The best way to consider it is that credit and business expand and then contract together. At the top aggressive employment of leverage will guarantee that when the contraction starts power shifts from central bankers to margin clerks whose job description is vastly different to your basic central banker. Ironically, it seems that the Fed's job has been to get the accounts leveraged, or out of line, while the margin clerk's is to get them in line.
This came into force with the turn in the credit markets in mid 2007, and it is worth emphasizing that the reversal to disaster was on schedule. We noted at the time that the Fed had virtually no influence on the curve or spreads and that no amount of cuts in administered rates or "stimulus" would prevent the contraction. Last summer we expected a classic fall crash, like 1929 or 1873 and even if policymakers knew it was coming their efforts would be futile.
However, history then called for a fabulous rebound out to around May that would, briefly make the Fed look good. This is now in the market and, sadly, the establishment really believes it. Well, they have to - don't they?
Generally, prices have reached momentum levels that could turn them down. In which case, monetary power will return to margin clerks. Always a corrupt remedy, hyperinflation in dollar terms seems improbable.
Back to the numbers, on March 9 the BBB spread was 582 bps, and now it's at 280 bps which is a remarkable, and we would add, speculative decline. Junk has gone from 3800 bps to 1904 bps.
With this the yield has declined from 42% to 23.49%. One measure on momentum that we have is JNK which, with only brief history is at a level that ended two earlier rallies in price. Another is XCB on Canadian corporate bonds and with data back to late 2006, the RSI is at "stop" levels.
A price-rally with narrowing spreads has been expected on our historical work as well on the seasonal "good stuff" into May. Our advice is to get out, while the getting is good.
Link to June 5, 2009 'Bob and Phil Show' on Howestreet.com: http://www.howestreet.com/index.php?pl=/goldradio/index.php/mediaplayer/1236
Link to June 8, 2009 BNN (Business News Network) interview: http://watch.bnn.ca/#clip180994