Pivotal Events

By Bob Hoye

Institutional Advisors

June 30, 2009

The following is part of Pivotal Events that was published for our subscribers Thursday, June 25, 2009.

SIGNS OF THE TIMES:

Last Year:

"If a stock I own goes down 50% I'd look forward to it. In fact, I would offer a significant sum of money if you could give me the opportunity for all of my stocks to go down 50% over the next month."

 – Warren Buffett, Wall Street Journal, late May, 2008

Well, fortunately it was not that quick of crash.

"Credit Storm Back With a Vengeance"

"GM back to December 1974 levels"

– Wall Street Journal, June 23, 2008

"Bargain farmland sought"

"Lured by skyrocketing grain prices, hedge funds and institutional investors...have poured billions of dollars into acreage.. In an effort to get in on the ground floor of what many economists are calling a transformation in the agricultural industry."

  – Financial Post, July 7, 2008

*   *   *   *   *

This Year:

"U.S. College grads shun Wall Street for Washington"

– Thomson-Reuters, June 11, 2009

As the saying goes; "The route to power in Washington is to go to Harvard and turn left."

"Set aside the rule of law, let's strip secured creditors and bondholders of their rights. Take them outside of the bankruptcy process and give them to Democrat allies. It's almost like looking at Putin's Russia. You reward your political friends at the expense of law."

 – Republican House Whip, Breitbart, June 11, 2009

"The cap-and-trade legislation passed by an House committee is Smoot-Hawley in drag."

 – George Will, June 7, 2009

*   *   *   *   *

STOCK MARKETS

With the "full faith and credit" of the US resting upon the ability of policymakers to continue to depreciate the dollar, we are living in very interesting times.

This is bizarre and would have been a fitting reductio ad absurdum if used in 1913 to describe the inevitable excess of undisciplined central banking.  Problem is that most would have instantly dismissed the critique, as being too far-fetched – back then. The problem now is that most think that the Fed's truly reckless behaviour can be maintained – at will – and are relying upon the absurdity.

This was also the case last summer, when it was ardently believed that "stimulus" would prevent something bad from happening. But market forces in the form of falling prices and deteriorating credit conditions created an almost perfect fall crash. Our view has been that the Fed would never willingly become prudent and accountable to anything other than arbitrary response.

And, as noted last week the establishment really believes that "stimulus" ended the crash and prompted the 'green shoots" of recovery that a majority of economists think will blossom in the third quarter. Monday's World Bank announcement of a drop in their GDP estimate from minus 1.7% to minus 2.9% was reported to be the hit to stock markets. It is a mark of distinction that they got the direction right, markets ran out of momentum a couple of weeks ago.

Our view has been that after euphoria in May liquidity concerns would resume around mid-year. Monday's "90 percent down day" in the stock markets is as good a start as any, and a nice follow up to the jump in short rates two weeks ago, as well as to last week's slight widening of long-dated corporate spreads.

Other warnings include the upside excesses in commodities that the ChartWorks registered. The CRB index jumped from 200 in late February to 266 on June 11, and the decline to 246 is part of the array of warnings.

However, the markets have had a surprise with the exhaustion of speculation, and a realistic GDP outlook from a high place. Beyond specifics, important tops are as much as a process as an event and this one will take some work to set the next downtrend.

Some key sectors, such as banks, slumped from 37.5 on Friday to 34.5 on Tuesday morning. The concluding rally carried to almost 44 in early May when we advised lightening up, with more aggressive positioning when our Bank Trading Guide registered the "sell".

That came on June 15, accompanied by the initial jump in shorter-dated treasuries. Slight widening of credit spreads since is suggesting that the resumption of troubles expected around mid-year is on track.  An illustrative chart is attached.

The hit to most popular games is timely and has become somewhat oversold, and our advice is to sell the rallies. As conditions get worse, as in last fall, relief rallies may only be "day-and-a-half wonders".

Credit Spreads: The great junk-selling panic ended on March 10 at a 42% yield, and the reversal to a weakening DX rejuvenated all of the "good stuff". This ended with what is likely the greatest junk-buying panic in history at less than a 22% yield on June 15, which was a couple of days after the low in the dollar.

The yield has increased a little as spreads have widened a little. Not much so far, but timely. This could deteriorate through the summer and in September head to another disaster. This would include most classes of bonds.

The Dollar Index: The Bible says that "[T]he love of money is the root of all evil". We would agree and add that sometimes even moderate affection can get one into trouble.

However, in Biblical times scribes could not have imagined paper and electronic money, let alone a central bank. The latter suggests a new proverb:  Central bank hatred of money is the root of financial evil.

Lately, this has generated a monstrous, but official, bear raid upon the US dollar. While this is driving goldbugs and Miseans to distraction, it is not driving the DX to new lows. There is a reason, and that is the whole world has been long hot stories and through the alchemy of leverage – short the dollar.

This was maximized in credit markets in May 2007 when the yield curve reversed to steepening and the usual post-speculation transition of power from central bankers to margin clerks started. The next step in restoring financial power back to conservative hands began as stock markets rolled over in October 2007. The killer step in the series was the classic fall crash, when the dollar soared.

Typically in post-bubble contractions, the senior currency becomes chronically strong against most currencies and commodities for most of the time. Ditto for most stocks and bonds. It's the way deflation works.

The moment the crash began in the fall it was written in stone that there would be a vigorous rebound out to around May, and this would do a couple of things: make some money for traders and it would prompt the establishment to conclude that the ancient recipes of intrusion were valid – at last.

bobhoye@institutionaladvisors.com

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