A Time To Look For Bargains

Just as I predicted, U.S. stock prices have been extremely volatile and erratic although generally volatile downwards. From Monday to Wednesday they simply declined in line with my trend estimate. They then continued to decline during most of today's (Thursday) session, only to suddenly during just a few minutes of trade erase the losses of the day in line with my volatility prediction.

Today featured unequivocally bearish economic news with rising jobless claims, falling housing starts and a stagnant Philly Fed which is what together with increasing general anxiety is what triggered the decline that lasted through most of today's session. Then for no real reason the losses were suddenly erased at a record time. Again, this sort of extreme erratic volatility up and down is what one could expect in a bear market so bad that people actually consider the utterly useless U.S. government bonds to be a safe haven!

Expect more of that irrationality and erratic volatility in the near future. However, since the fundamentals support the bearish case, the trend will continue to point downwards for U.S. stocks.

Interestingly enough, many European markets have actually declined even more than U.S. stock markets in a bear market triggered by problems specific to the U.S. economy. To be sure, globalization has decreased the link between local economies and local stock markets, which is why some extent of global correlation between stock markets is actually justified. But it is certainly not justified for European stock markets to fall more than U.S. stock markets who still after all remain a lot more exposed to the U.S. economy.

This means that the indiscriminate declines in almost all stock markets have created bargains for investors. They probably exist on all stock markets -including the American ones- but they likely exist particularly on European stock markets where many stocks with limited exposure to America have taken a heavy beating from America-specific problems.

Nice Euphemism

Mark Thornton notes today's funny euphemism. In describing what he sees the need for a weaker dollar, Martin Feldstein of NBER, uses the euphemism "a more competitive dollar" to describe dollar depreciation.

Blame EU For Rising Milk Prices

The increased prosperity of China have led to a sharp increase in Chinese consumption of dairy foods. And while local production is soaring, so is imports. China's increased imports of dairy products have now led to sharply increasing milk prices in Germany, a large exporter of dairy products. This in turn have of course led to angry consumers in Germany. But these consumers shouldn't be angry at China. They should be angry at the EU and its farm policy.

The natural response to this increased demand would of course be for German farmers to raise more cattle and so increase milk production. But as is pointed out in this story, the EU and its quota system forbids farmers from increasing production by more than 0.5% per year until 2015, when the quota system will finally be ended. This proves for the umpteenth time the insanity and evil of farm subsidies which not only cost tax payers a lot of money, makes consumers pay more and even hurts most farmers.

About The Market Turmoil

It is difficult to know where to start when commenting on the extreme market turmoil of the last few days. A good place would perhaps be to read George Reisman's excellent summary of the background of the crisis. We should never forget to emphasize how this is all Alan Greenspan's fault.



After you've finished reading Dr. Reisman's piece, a few additional points should be noted.

1) Markets are more erratic than ever. I have followed financial markets on a virtually daily basis for more than 10 years and so I have experienced large up and downs in all markets. Yet I cannot remember the markets ever being quite as erratic as this week. This means not only that the short-term mood swings, the sudden swings between extremely bullish and bearish sentiment, are larger than ever. But most importantly that the swings are more detatched from news and rationality than ever.

Two movements were especially noteworthy in this context. On Tuesday, after the FOMC decided to keep a relatively hawkish stance, the stock market first fell on the news as expected. But then after just half an hour or so, it suddenly reversed cause and rallied sharply, a rally which continued on Wednesday. What gives? Well, supposedly Bernanke indicated that he wasn't worried about the subprime crisis and that was supposedly a reason to buy. As if Bernanke's comments had any relevance with regards to the underlying fundamentals.

Similarly, on Wednesday, oil prices first rose after a report showing declining crude oil and gasoline inventories. But then they turned down and finished lower than they started.

Not to mention of course, the swings between the sharp sell-offs late last week, the sharp rally Monday to Wednesday and the sharp sell-off on particularly Thursday.

With the markets behaving so irrationally it is dangerous to engage in short-term speculative movements. The erratic nature of the markets ultimately of course reflects nervousness about the housing bust and its repercussions.

2)The black helicopters did arrive. And not just the Federal Reserve helicopters but helicopters from the ECB and half a dozen or so other central banks and they all flooded the markets with newly created money to force down the interest rate on overnight loans to their target rates.

Note however that this does not represent a loosening in monetary conditions per se, only that the central banks prevented the markets from tightening them on their own.

The markets are now pricing in a Fed rate cut at the next meeting at latest, and perhaps even at an emergency extra meeting next week. I think the latter is unlikely unless we see a further dramatic deterioration in financial conditions, but the former now appears likely.

I have previously not believed in rate cuts anytime soon, but now it appears a lot more likely. I don't think they should cut as inflationary pressures are too strong, and I have a feeling that most FOMC board members too are more skeptical than the markets about the benefits of rate cuts. However, can they really withstand the pressure from the markets and pundits to lower rates? I increasingly doubt it. Not that rate cuts are going to save the day. A recession will likely appear anyway and by not rooting out inflationary pressures now, we are simply likely to see a prolonged recession and a weaker recovery later.

3) As previously noted, the markets are so erratic right now that short-term speculation is dangerous. However, since the underlying fundamentals are so weak we are first of all likely to see these erratic swings continue and any trend movements are more likely to be sloped downward rather than upwards.

Not Just Sub-Prime

A common argument among those with a more bullish view of the U.S. economy -i.e. there wont be any recession- is that while the subprime sector may be a mess, it isn't big enough to drag down the whole economy. Subprime credit losses are perhaps only $100 billion. A big number to be sure, but considering the $13.7 trillion size of the U.S. economy, not big enough to cause a recession.

But even setting aside the fact that subprime credit losses may be even bigger than that, it misses the point entirely. The point is that the problem of the bursted housing bubble is not just a subprime problem. Subprime borrowers and lenders are of course hit hardest as their finances were almost by definition most fragile from the start. In any financial crisis, those with the most fragile finances are hit the hardest.

But the bursted housing bubble is causing ripple effect that damages others too.The decline in house prices causes residential investments to continue to decline. The decline in house prices (and increaseingly stock prices too) also creates a negative wealth effect that will make all home owners -not just those with subprime mortgages- cut back on consumer spending.

Meanwhile, weak demand, falling profits, falling stock prices and higher risk premiums on corporate bonds will make corporations less willing to invest.

All of which adds up to a recession.

Obvious Empty Threat

China threatens to sell off U.S. bonds if the U.S. Congress imposes tariffs on Chinese goods.

Now really, that is a quite laughable threat, one which most anti-Chinese U.S. politicians are likely to answer with: "Go ahead, make my day".

The reason for this is that the reason why China bought these bonds in the first place was to prevent the yuan from rising in value, and it is this policy which is the background for the threat of tariffs. In other words, China is threatened with tariffs because they prop up the value of the dollar. And so now the Chinese say that if tariffs are imposed on them, they will stop the policy these tariffs are designed to end! Not much of a threat! Moreover, the reason that the Chinese have had to hold down the value of the yuan is to boost exports. Does anyone then believe that they would be willing to aggravate the negative effects on exports by dumping the dollar?

While Chinese currency policy have long been irrational, this threat is not only irrational but pathetic too.

Jim Cramer On Rate Cuts

While the formal outcome of today's FOMC meeting is more or less a foregone conclusion (Fed will leave rates unchanged), the short-term direction of the stock- and bond markets will be decided by the wording of the accompaning statement. The Fed is an institution so powerful that a single word in a statement could destroy or create hundreds of billions of dollars in financial wealth. The key is whether or not they will open for rate cuts in the near future. If they do, stocks and bonds will rally. If they don't and instead continue to emphasize inflation as a greater threat than weak growth there will be a sell-off in the bond market and probably even more in the stock market.

Most statements from Fed officials indicate they will basically leave statements, but it cannot be ruled out that the increased anxiety over the subprime mess and the risk of a recession have caused them to change their minds.

Someone who's mental health will be in great jeopardy if they leave the statement unchanged is Jim Cramer, host of CNBC show "Hard Money". His buddies at some of the subprime banks are losing money and that is making him very upset and makes him lose anything resembling objectivity and rationality. The female host looks rather shocked and embarrased by his performance. Watch it for yourself here:

Financial Journalist Analysis In Action

For weeks, stock- and bond markets have been jittery due to the subprime mess and the likelyhood that it will spread to the overall U.S. economy. So, the likelyhood of a significant weakening of the U.S. economy isn't news. Nothing new happened today to support that scenario, and indeed if anything the stock market rally today would contradict it.

Yet when oil prices fell sharply today (after weeks and months of rising prices), clueless financial journalists attribute it to.... worries about the subprime mess. While I am certainly not a believer in efficient market hypothesis, even fund managers aren't that slow in catching on. The real reason for the sell-off was that some fund managers became worried that oil was over-bought and then after some started to sell, mass psychology prompted other fund managers to go with them. The price decline was only about a dollar early in the day, but more than $3 by the end of the day after bearish sentiment spread. We saw a similar, but opposite movement in the stock market, with the market rising at first only moderately, but as the Dow and S&P; 500 broke through the +1% barrier for the day, mass psychology caused bullish sentiment to spread and the S&P; 500 ended up 2.4%.

This again illustrates why the analysis of financial journalists are unreliable (with a few exceptions). Just study the raw data they provide and then ignore their analysis which are all too often clueless.