Wednesday, June 17, 2009
The bullish bias
In the piece, Xie makes some interesting observations about the intent and effects of government intervention into the capital markets. He thinks the recent run up in stock prices is not sustainable.
Rational expectation theory discredited Keynesian theory and laid the foundation for Paul Volker's tough love policy, which jagged up interest rates and triggered a recession. The recession convinced people that the central bank was serious about cooling inflation, so they adjusted their behavior accordingly. Inflation expectations fell sharply afterward. The credibility that Volker brought to the Fed was exploited by Alan Greenspan, who kept pumping money to solve economic problems. As I have argued before, special factors made Greenspan's approach effective at the same. Its byproduct was asset bubbles. As the environment has changed, rational expectation theory will again exert force on the impact of monetary policy.He also comments on the inherent bullish bias that resides within the institutionalized financial system, and how it has fueled all this nonsense about mustard seeds and green shoots.
Movements in Treasury yields, oil and the dollar underscore the return of rational expectation. Policymakers have to take actions to dent the speed of its returning. Otherwise, the stimulus will lose traction everywhere, and the global economy will slump. I expect at least gestures from U.S. policymakers to assuage market concerns about rampant fiscal and monetary expansion. The noise would be to emphasize the "temporary" nature of the stimulus. The market will probably be fooled again. It will fully wake up only in 2010. The United States has no way out but to print money. As a rational country, it will do what it has to, regardless of its rhetoric. This is why I expect a second dip for the global economy in 2010.
While inflation expectations are causing some in the investor community to act, the rest are betting on strong economic recovery. Massive amounts of money have flowed into emerging markets, making it look like a runaway train. Many bystanders can't take it any longer and are jumping in. Markets, after trending up for three months, are gapping up. Unfortunately for the last-minute bulls, current market movements suggest peaking. If you buy now, you have a 90 percent chance of losing money when you try to get out.
Contrary to all the market noise, there are no signs of a significant economic recovery. So-called green shoots in the global economy are mostly due to inventory cycles. Stimuli might juice up growth a bit in the second half 2009. Nothing, however, suggests a lasting recovery. Markets are trading on imagination.
While rational expectation is returning to part of the investment community, most investors are still trapped by institutional weakness, which makes them behave irrationally. The Greenspan era has nurtured a vast financial sector. All the people in this business need something to do. Since they invest other people's money, they are biased toward bullish sentiment. Otherwise, if they say it's all bad, their investors will take back the money, and they will lose their jobs. Governments know that, and create noise to give them excuses to be bullish.Xie does a great job of explaining many of the reasons I remain quite pessimistic about the state of the global economy and financial system. If you don't mind a logical argument that concludes with some pretty grim forecasting, than definitely read the whole thing.
10 Comments:
By 
Viking Kaj, at
Wed Jun 17, 11:37:00 AM:
The economic news and most of the company news has not been good. In any other economy we wouldn't have seen this rally which is based on "the numbers weren't as bad as we were expecting".
An awful lot of people are still out of jobs, ARMs are adjusting, and houses are still going into foreclosure. As TH showed with the graph, this will contine well into 2010.
Under the circumstances, I don't see how the rally can sustain itself. There seems to be a lot of cash on the sidelines ready to come in to the market, but until we have truly positive economic news there will have to be limits. It's looking increasingly like 8700 is a ceiling we are not ready to break through.
A couple of last thoughts. The combination of 0% money and trillion dollars deficits is going to be hugely inflationary. What happens to the rally when they have to raise interest rates?
By Viking Kaj, at
Wed Jun 17, 11:45:00 AM:
By the way, I have never believed in the efficient-market hypothesis dating back to the 1980's when I got my MBA. I got into heaps of trouble with my finance prof when I disagreed that investors always behave rationally and that markets are generally efficient.
I proposed an alternate which I called the "lemming hypothesis" named for that famous Norwegian rodent.
That hypothesis is as follows:
Markets are sticky;
People trade on inside information;
And, most importantly, when one rat goes over the cliff, the rest follow...
PS. I got an A in the class, but I don't think the prof particularly liked me.
By 
, at
Wed Jun 17, 12:14:00 PM:
I'm watching gold prices carefully, and if you are watching those prices too then you'll agree with me that, so far at least, there is absolutely no indication of inflation. In my opinion that's because the velocity of money is still much reduced from 2007 levels. If Americans begin to expect an economic recovery and begin to spend more freely, increasing the velocity of money, a serious price inflation is the inevitable result. Is there any other way out?
Of course there are other solutions, but those ways all involve spending less money and this administration is politically devoted to the inflationary path.
Telling California last week that the state has to solve it's own budget mess is the first responsible thing the administration has done. I'd like to applaud them, but before I do I want to actually see if this stance changes when public employees start losing their jobs and California voters start screaming about budget cutbacks. Call me cynical, but letting a major Democrat constituency like California twist in the wind just doesn't seem like something this White House will really do.
The administration should end the so-called "stimulus" right now. Most of it hasn't yet been spent. Don't spend it. That would be a big help.
Next, the administration needs to end the various nationalization efforts it's making. That would really be a big help towards recovering our credit.
Lastly, the administration needs to embrace the return of a positive savings rate, and even figure out how to foster it's growth. Long-term, it's what will help restore prosperity to our country. Ten years from now.
By Charlottesvillain, at
Wed Jun 17, 01:40:00 PM:
VK, I'd just like to pick your "cash on the sideliens" nit. Unless it is being directed to new issues, cash used to buy stock in the secondary market just allows the equity to change hands. The seller of the equity ends up with the cash.
(sorry, I'm just in that kind of mood)
By Charlottesvillain, at
Wed Jun 17, 01:41:00 PM:
Anon, I predict the blueprint for a Federal bailout of California will be in the works by Bastille Day.
By , at
Wed Jun 17, 02:23:00 PM:
Yes, I agree. They run out of cash at the end of this month though, so it might even be sooner.
Where to invest? That's the question. Normally, real property is OK in inflationary times but this time will probably be different, at least if Andy Xie is on target with his prediction. He's calling for another 40% or so decline in real property values (after inflation). Massive bankruptcies ahead for individuals and their banks if he's anywhere near correct.
By Charlottesvillain, at
Wed Jun 17, 03:57:00 PM:
That's the question. A recent piece by Jeffrey Gunlach at TCW (posted today at zero hedge) touches on this issue. Somewhat surprisingly, he suggests precious stones and warns not to go too far into TIPS.
Jim Rawles at survivalblog, who takes a more apocolyptic view, recommends moving all dollar denominated assets into productive farmland (preferably in a remote location), silver, and common caliber ammunition.
That's not feasible for everyone and I'll stop short of advocating the same for fear of provoking Chris Chambers. At the same time, we continue to move down a rather apocolyptic path (economically, anyway) so some hedging against the worst case scenario is probably a good idea.
By , at
Thu Jun 18, 10:41:00 AM:
I happened to see Paul Krugman again on the train yesterday morning, on his way down to D.C. Perhaps I should have asked him, what with the Nobel Prize and all.
/sarcasm>
By , at
Thu Jun 18, 10:59:00 AM:
Henry Blodgett posts some very interesting slides comparing the progress of this economic event to the Great Depression. Take a look.
By , at
Thu Jun 18, 02:19:00 PM:
CV, have you followed the mysterious case of the $134 billion in US treasury debt recently impounded by customs inspectors in Italy? Of course you are following it! It's juicy, if nothing else. If the bonds are genuine then one of our biggest creditors, probably Japan, is surreptitiously trying to unload some US debt. That's scary, since it means one of our very best friends is thinking they should sell, fast and big. That would mean our currency could also come under big pressure, as central banks rush to turn dollars into something else, leading to even more inflationary pressure.
We are really in a fix.
