Pivotal Events

By: Bob Hoye | Thu, Feb 4, 2010
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The following is part of Pivotal Events that was published for our subscribers January 28, 2010.

SIGNS OF THE TIMES:

Last Year:

"A nation cannot prosper when it favors only the prosperous."

- President Obama, January 21, 2009

"You Feel God is Speaking to You"

- Inaugural attendee, CNS News, January 21, 2009

Obama's crash in popularity is at record, if not Biblical, proportions.

Although described as progressive, his "Shock and Owe" policies are extremely intrusive and increasingly costly. This is prompting what could be described as the Second American Revolution. Perhaps, like the "Glorious Revolution" in England in 1688, the public can reform a disastrous experiment in authoritarian government without bloodshed. Fortunately, there is recent example of such reform as symbolized by the Berlin Wall in late 1989.

The independent "Tea Party" movement will continue to gain influence (Massachusetts is a critical example) and will eventually find its own leader.

* * * * *

This Year:

"I'd rather be a really good one-term president than a mediocre two-term president."

- Barrak Obama, January 25, 2010

The second alternative seems unlikely, and it seems too late to be hopeful about the first.

"High-yield corporate bonds may help investors maximize returns."
"Now it is about cherry-picking great high-yield companies."

- Financial Post, January 23, 2010

We would expect that "great" high-yield bonds are the ones that never go down in price.

"Investors are so concerned that Greece won't be able to finance its budget deficit that it now costs the government more to borrow for two years than Germany pays to raise funds for 30 years."

- Bloomberg, January 21, 2010

One of the promotions of the European central bank was that unified discipline would lower overall costs of borrowing as it narrowed spreads from one county to another. Some believed that, for example, yields for Italy and Germany would be the same. Long Term Capital Management (LTCM) was a hedge fund staffed with brilliant PhDs. The pedigree was so good that most senior central banks eagerly lent it money and even the Bank of Italy took an equity position.

The wager was that legislation would narrow all European sovereign spreads and culminating in 1998 LTCM bet beyond prudent limits. The problem was that the whole spread market became overdone and a seasonal widening of spreads trashed the fund, many reputations and prompted some best-selling books.

Before that collapse we pointed out that a gold standard would provide a fiduciary discipline beyond what could be imposed by the Euro central bank. Even with that discipline in the 1800s, spreads between such as Spain and England were distinctive. With this, we thought the fiat experiment in narrowing spreads would not work.

Lately, some sovereign spreads (Greece) have been widening.

"China has told some banks to limit lending and will [move to] restrict overall credit growth."

- Bloomberg, January 20, 2010

"Japanese demand for bank loans dropped the most in more than five years as companies stopped spending."

- Bloomberg, January 21, 2010

There is considerable irony in China talking about tightening credit late in 2009 and continuing into January. Japan's policymakers did the same in late 1989 and into that fateful January. The Nikkei set its remarkable high on the last trading day of that decade and the start of the bear signaled the beginning of a long contraction.

* * * * *

STOCK MARKETS

As The Economist wrote under similar conditions in the 1870s "A profound change came over the markets in the past week." There has been what appears to be a profound change and it began two weeks ago when the resource-driven Toronto index recorded an outside reversal to the downside - on the weekly basis.

Last week, the Dow and the S&P suffered the same reversal from a rush to get in to a sudden call from Mister Margin. Such a reversal from a more than a month of very high sentiment readings would have to be described as profound.

Particularly when within the turn-of-the-year period when a number of outstanding speculations have completed.

Interesting setbacks have occurred in junk bonds, spreads and commodities. Copper is working on the big reversal - on the monthly basis - a study will be sent out by Saturday.

What next?

As Ross has been mentioning, this unified move in the formerly hot games could have some respite at the 20 week moving averages. This was reached yesterday and taken out.

We have been looking for a "rounded top" to the stock market followed by an intermediate decline. Instead, the buying surge accomplished an "over-thrust" from which the initial decline has been rather hard. So hard as to change our outlook from an intermediate decline in the NYSE senior indexes to the possible resumption of the global bear market.

The key indicator is the gold/silver ratio rising to 67 today. This is distinctively above the level of 65, which we have noted would be the warning on the next phase of liquidity concerns.

The last time the ratio gave the warning within a rounding top pattern for the stock market was in August 2008. The previous and critical example was in June 2007. The attached chart reviews the pattern. The gold/silver ratio has a long and reliable record in anticipating change. This time to the downside.

Not a comforting picture and it is worth adding a personal comment. Lois and I were close to downtown early Saturday evening and decided to drop into Hy's Steak House. This has been a favorite within the brokerage community since the late 1950s and it was like going back in time. Without a reservation we were content to sit in the bar-lounge. As we were savouring a nice Amerone, a couple sat nearby. He was a regular and while waiting for his table was on his mobile phone.

I had no inclination to listen, but the words "margin call" came through - briefly - had that problem in 1969. Last week was bad in most markets, and this week's hit to copper is riveting.

Investors could take money off the table and traders can play the short side.

INTEREST RATES

The 115 level was expected to provide support and it did. Once there, the rebound could bounce to a trading range between 118.5 and 119.5. The high has been yesterday's 119. Today's drop to 118 seems in sympathy with general selling pressures.

Beyond trading bond swings, it is worth noting that the swings have been describing a rising trend for long rates. The low yield was 2.55% in December 2008 and now it is at 4.55%. In a precarious credit market and economy this is not good - a particularly if rates do not significantly decline as commodities weaken.

Going the other way, the decline in corporate yields as commodities soared has been remarkable. The yield for the Baa has declined from 20.7% in March to 8.53% on January 14 as the CRB commodity index has soared from 200 to 293 on January 6. On the same move junk went from 42% to 11.85%.

Clearly, high-yield corporate bonds have been hot participants in the resumption of asset inflation. A proxy (CYE) set both weekly and daily Upside Exhaustion readings, that when registered on most price series sets an important top within a couple of weeks.

From the low earlier in the month, the high-yield has increased 30 bps to 8.53%, as the spread widened from 382bps to 428 bps. Junk yields increased 63 bps to 12.36%, as the spread widened from 723 bps to 781 bps.

This is an important step in ending an unusually aggressive employment of the carry trade. It will take a test to confirm the trend change, but the hit to copper is suggesting the resumption of weakening business activity.

Weakening commodities indicates weakening pricing power for business and that reduces earnings, which reduces the ability to service debt. Eventually, this is noticed by credit rating agencies.

Currencies: The Dollar Index continues its rally which is on forecast and it is beginning to chill a number of the formerly hot games.

In looking at the chart, there is minor overhead resistance at 80 and more substantial at 85. Reaching 80 would derail the ability of speculators - including central banks - to boost prices. Reaching 85 would really finish the great rebound out of the first post-bubble crash. It would again severely damage the reputation of interventionist economics.

This seems to be the case for the yen, which has been strong against the US, which makes it THE currency. Deflationary pressures continue, and Tamisuke titled our book "How To Make Money In Kyoko". Kyoko means the long contraction. Other than the title, the book is in Japanese.

Link to January 29 'Bob and Phil Show' on Howestreet.com: http://www.howestreet.com/index.php?pl=/goldradio/index.php/mediaplayer/1543

 


 

Bob Hoye

Author: Bob Hoye

Bob Hoye
Institutional Advisors

Bob Hoye

The opinions in this report are solely those of the author. The information herein was obtained from various sources; however we do not guarantee its accuracy or completeness. This research report is prepared for general circulation and is circulated for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each security's price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance.

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