September 2007


I was watching CNBC (aka crapvision) during my breakfast and they had Dennis Gartman there.

The whole interview took 30 seconds. First they introduced him, then he said that he is short US stocks and long Chinese stocks. Then they interrupted him to say that 3Com got acquired and then switched to something completely different, not even saying thank you or goodbye to the guy.

I think this is why the stocks go up, too much of brainwashing and too little of education. In general, when I listen CNBC I have the impression that about 50% of people they interview have just no clue what they are talking about. I’m a big fan of Rick Santelli, but he usually keeps his opinions muted

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The Commercial Paper report is just out, the decline of outstanding paper is another $13 bln for the last week, but it’s better comparing with pre-cut decline of $48 bln. The total decline from end of July is 15% comparing with 22% decline during the 2000-2002 period. The speed of decline is astonishing.

The price to fix the credit markets is high:

  • Dollar is at all-time low right now. Not just 20-year low, 40-year low. It’s the lowest level on record
  • Oil is all-time high
  • Gold is 25-year high

I don’t think Bernanke has a room to cut in October, unless credit markets will be materially worse

I know it’s painful for some neighborhoods to lose jobs to offshore locations. But I believe into creative destruction that makes the effective distribution of productive power across the globe to be imperative.

Instead we better fix on the issue of education, making our educated workforce more competitive. It’s no secret that our educational system, though quite good and superior to most Middle East and African countries, is still trailing the systems present in parts of India, China, Eastern and Western Europe as well as other civilized nations.

Though we can probably throw even more money that we borrow from China into education I think those money are going into wrong pockets. Instead I propose a solution that will be cheap, effective, but painful, because I believe that painful problems need painful solutions. We need a legislation that will mandate that:

  1. Any public school (or a class within the same school) may expel any student who is scoring below 80% of this school (class) average score
  2. Any public school (or a class within the same school) must expel any student who is scoring below 60% of this school (class) average score
  3. This rule does not apply to the lowest scoring school (class) in given district

I know that we’ll have the protests of dumb parents and their dumb children, but we know that the majority will not be affected, so those protests will be ignored. As a result we’ll have just few years until best students will bubble up to the best schools and the doors will shut close to those unfortunate who are not worth the efforts, however cruel it could sound. I don’t think we can afford to waste the best teachers time and distract good students by having few dummies in the same class.

First, there are two must read posts from the Sudden Debt blog, which are very much in sync with the statements I’m making lately. Read here and here.

Second, tomorrow is the most important day, we will finally know the changes at the commercial paper market that happened after Bernanke cut. If we’ll see improvements I would say “business as usual“, if we see further deterioration I would say “get out of the stock market now!

Both Mish and Russ are fighting the myth that Feds are pumping liquidity into the system.

They are not. What uneducated media takes for liquidity and inflation is just a credit bubble. Remember, money is a claim for goods, credit is a claim for money. If the borrower is in financial difficulty the credit is not as good as money and is very hard to collect. All this “inflation” is just speculation on margin.

What most economists are missing or are too shy to mention is that the last time the credit bubble of current magnitude happened it was back in 1920s and never again since then. More about that in my Kondratieff wave page

Let examine more carefully the relationship between stocks and treasury bonds. The StockCharts start from 1980. The first decade:

bonds 1980

It’s pretty clear that stocks and bonds are generally moving in the same direction all this time. The next decade:

bonds 1990

The relationship is the same. It’s very important to note that the relationship is not affected by recessions. Lets look at the next period more carefully:

bonds 1998

It’s pretty clear that stocks and bonds diverged in late 1997 and kept moving in opposite direction all the time except a short period in 1999 and early 2000. The current decade:

bonds 2000

Stocks and bonds are diverged all the time from 2000 to late 2003, when the divergence ended and they started to move in the same direction again.

The divergence started again in early 2007 and became very pronounced during the market volatility periods in March and August.

So what does it mean? My opinion lately is moving toward conclusion that deflation scare is a typical attribute of the Kondratieff Winter period and the relationship between stocks and bonds and is good indicator of the timing of this scare.

While I’m usually talking about the inflation/deflation cycle, in fact in the economy there are three monetary conditions: inflation, disinflation and deflation. Disinflation is just a slowdown of inflation but not the outright deflation.

In the Spring, Summer and Autumn the deflation is never a problem, which is manifested by synchronized movements of stocks and bonds. The inflation is bad for both stocks and bonds, the disinflation is good.

Not so in the Winter phase. Nobody is scared about inflation anymore. It is totally unprecedented to see new market highs during record oil and gold prices and after 17 Fed rate hikes. Usually runs in commodity prices and increases in interest rates are bearish. But when the Winter comes it’s all changing. When the Winter is coming inflation is good.

Every book on Intermarket Analysis will tell you that stocks and bonds are moving in sync, because that’s the case during the Spring, Summer and Autumn of the Kondratieff wave and everybody already forgot what the Winter is.

The conclusion is that the Intermarket Technical Analysis must adjust for seasons of the Kondratieff Wave, you simply cannot apply all the same rules all the time.

Based on the charts above let specify the timings of all known Kondratieff Winter periods in U.S. history:

  • 1835-1844
  • 1875-1896
  • 1929-1949. No living economists and investors remember that period, so there is no much discussion about this period outside academic circles. That will change soon, I suppose
  • 1998 – first deflationary scare in the current cycle. The Winter phase coming was prevented by the Internet Bubble
  • 2000-2003 – the dress rehearsal of the Winter phase, which was reversed back into Autumn by the Housing Bubble and LBO Bubble
  • Early 2007 – bonds and stocks diverged again, which probably spells the trouble, as the Winter has to come sooner or later and now it feels quite chilly

Conclusion: watching the Intermarket relationship between stocks and bonds is the clue to spot the Kondratieff Winter phase

This blog explains all the reasons behind the Fed rate cut. Their hand was forced. Discussion is over

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