Illusion of Prosperity?

Peter Boockvar, equity strategist at Miller Tabak. recently appeared on Tech Ticker claiming "it's dangerous to short this market":

Despite a penchant for bearishness, Boockvar says the rally can continue as long as the Fed keeps rates at zero.

"When you cut rates to nothing you're encouraging people to take risk," Boockvar says. "As long as asset inflation is [the Fed's] goal, the market could go higher but there are obvious consequences," including inflation, as discussed here.

The Fed is trying to create "the illusion of prosperity" by fueling asset price appreciation, Boockvar says, staying true to his reputation as a deficit hawk. Even if the U.S. stock market keeps rallying, "non-dollar assets" like commodities and emerging markets will continue to outperform, he says.

Unlike the U.S., emerging markets are "not weighed down by enormous debt levels" and local consumers are "much better off" than their American counterparts, the strategist says, expressing a strong preference for China.

"If you want exposure to global growth, it's going to be outside of the U.S.," he says, recommending the following:

• Follow the Money: Buy China-specific and Asian ETFs or mutual funds.

• Go for Gold: A longtime gold bull, Boockvar says a correction could be coming because "the trade has gotten crowded" and Ben Bernnake's recent comments about the dollar could spur a reversal. But "buy on any sharp pullback," he recommends, suggesting gold is very likely to revisit its inflation-adjust high of $2300 "in the next few years."

• Reject Domesticity: Avoid U.S. retailers, REITs and consumer-focused financials, Boockvar says, suggesting the U.S. economy and consumers will be under pressure for the foreseeable future. "If you want to invest in US, invest in companies with big exposures overseas," he says. "The growth is not going to be there in the U.S. "

As it turns out, last Tuesday I was in Toronto for a Global Insights conference where I got to listen to a senior economist for the IMF. She was excellent and she highlighted a few themes that that I outline below:

• The IMF is acutely aware that excess liquidity is bidding up risk assets globally. They are particularly watching developments in China where a surge in lending has led to a boom
• UK, and European banks have been slower than US banks to write down their impaired assets. The fragility of the global banking system will limit central banks from raising rates too fast and too high
• The explosion of sovereign debt among developed countries will eventually lead to a crowding out effect, raising the cost of private capital.
  

After the presentation, I had lunch with my favorite pension fund manager. He's the type of guy who is always looking ahead, not back, when making investment decisions. Here is a little snippet of our conversation (not word for word):

Me: Only for you would I come up to this part of town.

Wise One: Good to see you, so what you've been up to?

Me: The usual, working, blogging and pissing off senior pension fund managers.

Wise one: So what brings you to Toronto?

Me: Was here for a Global Insights conference. Interesting presentations, especially the one from the IMF. She brought up the issue of excess liquidity. As you know, I've been calling for a major liquidity rally fueled by all this quantitative easing and propelled even higher by underperformance from institutions who totally missed the rally off March lows.

Me: I also think we are going to have some upside surprises in the US employment reports in the next few months with major upside revisions to the previous month's report.

Wise one: I would agree with you on both counts but we do see our twelve month leading indicators rolling over. This means the growth rates will taper off.

Me: Makes perfect sense because the stimulus will wear off so you would expect growth rates to come down in a year or so.

Wise one: So what did the IMF economist say?

Me: She spoke about excess liquidity in China, and around the world. She also spoke about bank impairments and how they will limit central banks' ability to raise rates too high, too quickly.

Wise one: Interesting, the two things I am worried about is some problems with China or emerging market debt and central banks pulling the trigger too quickly.

Me: I doubt they will raise rates too quickly but if employment reports start coming in strong, consensus expectations might shift abruptly. Everyone is expecting the Fed to stand pat for another year or so, but that could change.

Wise one: Indeed, it could.

Me: Look at the last year. The big money to be made was in beta trades like long stocks, long investment grade corporate bonds. On a risk-adjusted basis, the best trade in the last year was to have gone long investment grade corporate bonds. But big beta moves are over. In 2010, relative value trades will be the key to making money.

Wise one: I agree, real alpha is the key to making money in 2010. I think growth slowly comes off over the year. You'll first see it in global manufacturing. Looking closely at relative value trades.

Me: Let me throw a curve ball at you. What if we get another asset bubble where asset bubbles decouple from fundamentals? I asked that IMF economist whether they track hedge fund flows, sovereign wealth fund flows, private equity flows into the financial system and she told me yes, but that they're more concerned with banks.

Me: If you get another asset bubble, it could last a lot longer than what most people think. Like Keynes said, "markets can stay irrational longer than you can stay solvent".

Wise one: Yes, that is always a risk in these markets.

Me: I got to grab my train to Montreal. Thanks for meeting me and thanks for lunch. Before I leave, please read Graham Turner's book, No Way to Run an Economy. It is excellent and I will eventually review it on my blog.

Wise one: Will do, take care.

Let me end by stating that I am not in total agreement with Peter Boockvar. While I do believe it's dangerous to short this market, I see the US dollar rising in anticipation of better than expected jobs reports and you'll get back to a period where both the US stock market and the US dollar rise in unison. The liquidity rally can last a lot longer than we think, but risk assets can get whacked if inflation expectations abruptly shift or if central banks aggressively remove liquidity.

I also don't buy the argument that the US will lag the world. It's worth re-reading my post on Galton's fallacy and the myth of decoupling. As much as I like Chinese solar stocks, the US is still the engine of global economic growth. No US recovery means no sustainable global recovery.

Finally, there is no illusion of prosperity for US investment bankers raking in record bonuses. They seem to be totally oblivious to the plight of millions looking for work. As long as they get more for themselves, they couldn't care less about what is going on in the real economy.