Sunday, November 8, 2009

Fed Herding Investors to the Slaughter?


In his market blog, Simon Avery of the Globe and Mail asks whether the Fed is herding investors to the slaughter?:

Why do the markets enjoy the hardship of others?

Specifically, why does news that last month 190,000 jobs disappeared in the U.S. and another 43,200 vanished in Canada spur stocks? North American markets rose in early trading before going almost flat before noon. So how sadistic are these capitalists?

Well, for one good explanation it’s worth turning to the Pragmatic Capitalist, a much-loved blog on the markets. PC argues that the U.S. Federal Reserve’s policy of anemic interest rates is forcing investors to incur greater risk because traditional safe havens like insured bank accounts and government bonds don’t offer any return to speak of. Fed chairman Ben Bernanke is essentially pushing investors into the stock markets to find any sort of returns. As the markets keep rising, investors are buying into “Bubbly Ben’s” idea that a country can print its way to prosperity.

“The real question investors need to ask themselves is this: if we truly are in the middle of a Fed-induced liquidity rally where the fundamentals simply don’t matter, do you buy now or wait it out for the inevitable bust?”

There are plenty of perma-bears who share this view. Chief among them is Bob Prechter who says that stocks and commodities are topping and the US dollar is set to rally:

“I think stocks are topping out, commodities are topping out and the dollar is making a bottom,” says Robert Prechter, president of Elliott Wave International and author of “Conquer the Crash“.

According to Yahoo Finance - Tech Ticker, Prechter also makes the seemingly counterintuitive argument that the dollar will rally because there’s so much debt, rather than being doomed because of it. “If the economy turns sour again in 2010, as he predicts, Prechter says the dollar will benefit as more dollar-denominated IOUs get called by creditors seeking to shore up their own balance sheets, as was the case in 2008.

“A sustained rally in the dollar would have devastating consequences for stocks, emerging-market assets, high-yield debt and commodities. But gold might be the exception, because it represents ‘real money’ and more people are questioning the global paper money system, Prechter says.”

It might be a good time for all of you to review the three triggers of the global gold bubble and read the views of Dr. Doom vs. the Investment Biker on asset bubbles summed in the Globe and Mail by Simon Avery:

Nouriel Roubini, dubbed Dr. Doom for his prescient call on the economic meltdown, warns that global investors are inflating an asset bubble that could lead to a spectacular bust.

With oil prices up 80 per cent this year, gold up 24 per cent and commodity indexes up nearly 50 per cent, prices have risen “too soon, too fast,” the New York University professor said Wednesday.

“It is very hard to justify oil going from $30 (U.S.) to above $80 based only on the fundamentals of supply and demand,” Mr. Roubini said at the Inside Commodities Conference in New York.

Those predictions didn't sit well with Jim Rogers, the chairman of Singapore-based Rogers Holdings who is widely known for calling the commodities rally of 1999.

“What bubble?” Mr. Rogers said in an interview Wednesday on Bloomberg television. He was responding to a question about whether he agreed with Mr. Roubini's forecast. “It's clear Mr. Roubini hasn't done his homework, yet again.”

Mr. Rogers noted that many commodities are not yet near their record highs and he boldly predicted that the price of gold will double to $2,000 an ounce, or more, in the next decade. He said he remains pessimistic on the value of the U.S. dollar.

“It's not a bubble if something is up 100 per cent this year, but down 70 per cent from it's high. That's not a bubble, that's a good year,” he said, adding that equity markets are not about to crater.

However, Mr. Roubini, who is also chairman of the New York research and advisory firm Roubini Global Economics, thinks that the greenback is due for a major “snap back” that will see it rise as much as 20 per cent within the next year.

In an interview with CNBC television on Wednesday, he said that investors are executing the “mother of all carry trades” by borrowing dollars to buy commodities. Specifically, they are getting great rates on the weak dollar and investing in emerging markets, fuelling a bubble. He foresees the dollar swinging up when the asset bubble bursts.

“It's eventually going to occur, but it's going to be six months from now, a year from now,” he said.

As for gold hitting $2,000? “Utter nonsense,” Mr. Roubini said.

Mr. Rogers, in turn, didn't agree with Mr. Roubini's call on emerging markets.

“I don't know any emerging market stock markets that are so high I'd call them a bubble,” Mr. Rogers said. “They're certainly all up a lot, maybe they're too high, but being too high is not a bubble for anyone who knows financial markets.”

My views have not changed in the last six months. We got a coordinated, unprecedented liquidity injection in the global financial system and severe performance anxiety propelling risks assets higher.

The key question now is how long can this last? If history of the markets has taught us anything, the answer is a lot longer than what most investors think.

The biggest problem is trying to figure out liquidity. The linkages in the global financial system are a lot stronger in 2009 than they were in 1920. Moreover, with the advent of shadow banking and sovereign wealth funds, the financial system plays a dominant role in the real economy. Unlike past crises, the synchronized global downturn happened when banks stopped lending and global trade came to a grinding halt.

Then, as central bankers pumped trillions into the global financial system, banks made a killing off trading profits. And now, the message from the Fed is clear, let the bubble blow. The Fed is telling the banks to go ahead and bid up risk assets because we need to combat the perceived threat of deflation.

Of course, it would be highly irresponsible of the Fed or any central banker to come out and say they want inflation, but that is what they and the world's power elite want. The interesting thing is how they're going about it. The Fed is giving the banks the green light to go ahead and trade away, bid up risk assets and hopefully an asset bubble will lead to real economic inflation.

So, we can expect more bubble trouble as another bubble forms sooner than we think. Will this end badly, slaughtering investors down the road? Not necessarily. Think about Schumpeter's creative destruction and read Mort Zuckerman's recent op-ed in the Financial Times which argues that the free market not up for the job of creating work.

Its not all gloom and doom. I see a positive secular story developing in renewable energy, emerging markets, healthcare, infrastructure, nanotechnology and other technologies. But there is no doubt that the sea change will be disruptive to hundreds of millions who will face hard times before we restore sustained confidence and integrity in our global economy and financial system.

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