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PIVOTAL
EVENTS
FRIDAY, SEPTEMBER 20, 2002
BOB HOYE
Fed Chairman: "We were
confronted with forces that none of us had personally experienced. Aside
from the then recent experience of Japan, only history books and musty
archives give us clues to the appropriate stances for policy." - Alan
Greenspan, Jackson Hole, Aug. 30, 2002
Obviously, Mr. G. is not a subscriber to
Institutional Advisors nor does he seem to recall his own criticisms of
excessive accommodation by the Fed during the 1920s' new financial era.
Published in the Activist in 1966, it showed the clear reasoning typical
of libertarian economics.
For some years, we have thought that
Greenspan's libertarian side was running a crafty strategy. As Fed
Chairman, he would play the Keynesian accommodation role as best as was
possible. Then, when the inevitable post-bubble contraction was seen to be
undeniable, critical review would then be able to conclude that the
recurring phenomenon is due to systemic rather than policy failure.
Unfortunately, the gist of his Jackson
Hole address reveals confusion and inadequacy rather than Machiavellian
confidence. For those who haven't read it, Jim Grant's essay of September
13, 2002 is worth reading, as is the following excerpt.
"Although the Federal Reserve System
employs 485 Ph.D. economists, only one is a living symbol of the dynamic
U.S. economy. And now this one man says that he didn't know about the
stock-market bubble, couldn't have known and, even if he had known,
wouldn't have been able to make a move against it. It isn't a great
advertisement for a monetary dictatorship."
Nothing daunted, we would add that the
dollar's 90% depreciation over 50 years is a constant record of folly, of
which the inevitable result is sensational bouts of asset inflation.
Ironically, the collapse of the old era of tangible asset inflation is
celebrated as brilliant policy while the collapse of its equally
destabilizing inflation in financial assets is described as a deplorable
series of policy mistakes.
Stock Market: Some critical calls:
July 19, 2002: "Stockholders,
generally speaking, are replicating their behaviour typically found at
exhaustion lows that precede tradable rallies … the dollar index has
registered a Double Capitulation on the weekly reading and it can rally
with the similar readings registered on the stock market." [Low July
23]
August 23, 2002: "Both price
targets and technical dynamics sufficient to reverse the stock market have
now been achieved. That this occurred close to the expected time window
increases the confidence that the scheduled plunge to around December will
also be accomplished. The next target would be the July lows and, by
December, declines in the senior indexes could amount to 25% to 30%."
[High August 22]
Wrap: Technical deterioration since
late August is now accompanied by widening credit spreads, steepening
yield curve, as well as renewed weakening in base metal prices.
These moves have been likely to begin in
late September and are foreshadowing another phase of heavy liquidation.
Sector Comment: The slide has been
expected to encompass most sectors and could become severe enough to bring
down some of the golds.
Big Picture: The detailed study of
the culmination of every new era since 1700 has been invaluable in
identifying the top in January - March, 2000. Also invaluable has been the
ChartWorks' study of the consequences of the "Great Speculative Euphorias"
of the past 100 years. These, of course, were the Dow in 1929, Gold in
1980, and the Nikkei in 1989. The latest update is attached and, using the
Nasdaq as the proxy, an important low has been possible in the late
October to early January window.
In conditions that have perplexed
fundamental research, this form of technical analysis has provided
reliable guidance and some readers will focus on the term "cyclical" low
and "no offside day within the next two years". This should be placed in
perspective. [The August 20 ChartWorks noted Nasdaq overhead resistance at
1416. The high close was 1423 on August 23]
The ChartWorks is using a monthly count
from the March, 2000 high and the pattern has been close to those on the
"Post-Euphoria" examples. However, our "Post-Bubble" model, which includes
action in spreads and the curve, has used the count in years - 2002 being
a typical Year 2 after a bubble (other than the housing boom).
This model was based upon the observation that a number of significant
events in 1929 replicated the previous bubble-year of 1873. Then 1930 was
similar to 1874, etc.
This worked for 2001, which was Year 1
and so far has been working for 2002, which is Year 2. The
post-1873 contraction was less intense and more protracted than the
post-1929 example and lasted for 5 years, which compares to the bottom in
July of 1932, which was Year 3. With the unprecedented continuation
of the housing boom, the contraction has yet to become severe.
The net of this is that, while the housing
frenzy is vulnerable (mortgage default rates at 20-year highs), the
business side of the contraction has not been severe enough to contemplate
the end of a post-bubble bear market nor is it likely to become severe
enough for completion by, say, January. In which case, the stock market
recovery as developed by the ChartWorks could be rewardig but within the
confins of an 1875 style prolonged financial and economic contraction -
time, rather than orthodox theory, will tell.
INTEREST RATES
We have steepening in the treasury curve
and widening of credit spreads. The significance is that it is coming in
on schedule and, confirming that, the next phase of the liquidity crisis
has begun. This has been expected to become acute by around December.
Without getting into the definition,
Merrill Lynch's distress ratio is threatening to break to new highs. From
62% with the 1990 recession, it declined to around 3% in early 1998. As
part of the crises since LTCM in September, 1998, the ratio increased to
32.8% in December, 2000. With a couple of swings, it declined (improved)
to 16.8% in May. As part of the "bad stuff" likely to resume after
mid-year, it has increased 30.6% on September 16.
Breaking above 32% seems inevitable and
would confirm our expectations of dislocating conditions by December.
Our advice since 2000 has been that investors should minimize exposure to
risk. As we have phrased it, when looking at an offering, repeat the
mantra "On an if, as, and when redeemed basis.".
The Long Bond and The Curve: Our
advice to traders during June was impaired as the stock rally was delayed
until July 23. However, the advice to investors has been worthwhile.
Shorter rates were expected to decline after March (4),
but steepening wasn't scheduled until September when it would signal the
resumption of another liquidity crisis.
Our August 9 view was that investors
should use the rally to reduce exposure to the very long maturities. The
problems in the lesser credits in the fall could pull prices down at the
long end. However, by the 16th, that the refi action was becoming
impulsive was noted and on August 23 we concluded that the stock market
was about to roll over, which would "release another bond rally".
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