The following is part of Pivotal Events that was published for our subscribers April 22, 2010.
SIGNS OF THE TIMES:
"The best palliative to a panic is a confidence in the amount of the bank reserve, and the efficient use of that reserve."
- Walter Bagehot, Lombard Street, 1877
He was Editor of The Economist and provided much the same advice during the bubble that concluded in 1873. That great contraction ran from 1873 until 1895. Senior economists began to call it the Great Depression in 1884.
"Bankruptcies of governments have, on the whole, done less harm to mankind than their ability to raise loans."
- Prof. R.H. Tawney, Religion And The Rise Of Capitalism, 1926
This is a nice turn of phrase that states that the problem is excessive borrowing, the result is bankruptcy followed by restraint. We can't speak for all, but the latter would be a relief and the interesting thing will be the path to government restraint.
It might have something to do with long expansions and long contractions.
"Each of the eight recessions since World War II has been prevented from turning into a depression."
- Lester Thurow, circa 1983
Thurow was a popular interventionist economist in the 1970s and 1980s. His statement shows a lot of theoretical knowledge, with little regard for empirical evidence. The last Great Depression ended in the mid 1940s and the greatest bubble since 1929 completed in 2007 - on the eleventh business expansion.
The previous Great Depression ended in 1894 and the subsequent Great Bubble completed in 1873 - on the eleventh business expansion.
One would think that a prominent economist would know that great contractions don't start, even accidentally, at only eight business expansions or recessions from the end of the last one. They should also know that once a financial mania completes on the eleventh business expansion the initial recession is severe.
Financial conditions have been reported as the worst since the 1930s.
The unique feature of the completions of the bubbles in 1873, 1929 and 2007 has been that the recession starts virtually with the bear market.
When will interventionist theories begin to incorporate financial history?
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"Fortune 500: Profits Bounce Back"
- CNN Money, April 15, 2010
"April's survey shows a growing number of investors envisaging a Goldilocks scenario of above average growth and benign inflation."
- Merrill Lynch, April 15, 2010
The ladies are back. On the quest for Lady Bountiful, Rosie Scenario leads the way to Goldilocks - only to find Mother Nature waiting.
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There could be a new rule developing. The more studies by the ChartWorks, the closer markets are to important change. Within Ross's research is the growing number of stocks showing Upside Exhaustions. This only occurs at important highs. Glowing statements about the market are accompanied by sentiment readings such as those reported by Investors Intelligence, which are as good as they get in a rebounding market.
We have some rules to help identify a developing change. This time it will be to the downside.
Is the market up when it should be? - Yes, the rally would likely run into March-April.
Are there signs of confidence? - Yes, It is "Goldilocks" time again.
Are there signs of speculation? - Yes, the growing number of stocks showing Upside Exhaustions is one indicator. Another that was mentioned last week was that the NASDAQ reached the highest RSI since the blow off in March 2000.
This describes the condition of the stock market and the concluding event will be the senior indexes setting a lower low or a lower high on a weekly basis.
The "helpers" have been reliable and have reached momentum readings sufficient to end the move - and their "help". Crude oil and base metal prices have reached RSIs sufficient to limit the move.
The same holds for the gold/silver ratio, which can be an important indicator at a time for change. This also reached a key downside momentum level and is working on turning up. Rising through 65.5 would signal the arrival of the next wave of liquidity concerns.
Today's report "Greek debt crisis gets worse as EU revises figures" reveals an ongoing problem that will "suddenly" be viewed as really bad when the stock market rolls over.
Investors can increase the rate of selling and traders can play the short side.
The critical message is in the continued increase in the three-month Libor rate. The recent low was 249 bps in December and it sat at the 252 bps level through February. Last week it was at 304 bps and now it is at 313 bps.
As we have been noting this is mainly indicating mounting credit concerns and has little to do with the pickup in business activity. Last week we thought that the increase to 304 bps was a "warning behind the positive headlines about Greece".
Mounting concerns show in the Ted Spread as well. This increased to 165 bps on March 29 when the "End of Greek Crisis Lifts Commodities" story eased worries. On the good news, "Ted" declined to 131 in the next few trading days. Now it is at 168 bps - through the previous high, or when talking about spreads through the previous "wide". Greek problems are back in the news heading for, as Zorba said, "The full catastrophe". The scene from Zorba The Greek is available on YouTube.
At the height of the crash in October 2008 the Ted widened to 463 bps, as longer dated junk went "no bid".
Out at the longer end of the curve junk-spreads, for example, are still narrowing. As are spreads for investment grade and high-yield. There can be seasonal narrowing into May and the reversal in May 1998 set up the collapse of LTCM - a huge hedge fund. On top of seasonal forces, changes in short-dated spreads often lead changes in the long end.
The trend for long corporates has been so steady that there is no technical excess. However the price is back to the levels of October 2007 when the bear began.
The yield curve is trying to complete a reversal to flattening. We haven't updated for a couple of months and the history is worth reviewing. We expected the inverted curve to run with the boom until May-June 2007 when the reversal to steepening, as with the end of previous such booms, would signal the end of the party.
The change started in that fateful May, with enough change accomplished by early June for us to observe that the "Greatest train wreck in the history of credit" had begun.
Trading desks have been in the "steepeners" for more than two and a half years. It seems that the whole world is playing steep and the change will put this position offside with great discomfort.
On the 10s to 2s (StockWatch $ust2y:$txn), the "low" was .0205 and the rebound has been to .0295 at the first of the month. The decline was to .0260 last week. At .028 yesterday, rising through the .030 level will set the trend to flattening.
This could inconvenience many traders. It will also indicate the next phase of the credit problems.
The long bond found support at just under 115 and has been heading for our target at the 118 level. Perhaps next week there could be enough technical action to make another decision on the long-dated treasuries.
You can just imagine the head guys over at the Fed saying "Damn dollar wants to go up again". What can they do to depreciate the currency? Not much - in a credit-based economy the central bank really needs legions of ambitious borrowers to get its portion of credit expanding. But private credit is still contracting. This could become more evident when the corporate bond market weakens.
Federal government credit is still expanding and continuation depends upon the size of the bid for treasuries, and eventually this will get frightened away.
If enough asset prices decline, including the long bond, the Fed will be unable to depreciate the dollar. No matter how hard it tries.
Disclaimer - we do understand that the world is convinced that the dollar is going to be trashed.
The Canadian dollar continues to hang around par. Wednesday's Chartworks updated the C$.
Link to April 23, 2010 'Bob and Phil Show' on Howestreet.com: http://www.howestreet.com/index.php?pl=/goldradio/index.php/mediaplayer/1621