Friday, August 15, 2008

Why the Market Isn't Repecting Fundamentals

It is respecting the PERCEPTION of fundamentals.

BIG difference.

Right now, we are seeing a period of dollar strengthening due to poor economic conditions in the EU, England, and Japan.

These 3 economies are also the main currency pairs with the dollar. Technically speaking, the dollar has become oversold against the Euro. Same for the Pound and Yen. All it took for a catalyst was the German economy report (bad) and Trichet's refusal to touch interest rates tosend the dollar higher. That in turn is buoying the equities -specifically financials - but also is crossing over into weakness inthe oil and gold trade.

This is all going on in spite of bearish government reports - CPI,unemployment, consumer sentiment, etc.

Another thing I've noticed is that we are going through a period ofde-leveraging. Big institutional money (e.g. hedgies and investment banks) are being curbed by the SEC, Treasury, and CFTC. Margin requirements are being raised not just in the retail commodities markets but also the lesser known credit markets (e.g. LIBOR, credit swaps, overnight lending, etc.). Basically, the government is forcingthe money managers to raise cash by liquidating their long positions in: oil, gold, and agriculture as well as short positions infinancials. This was part of the bargain they entered into inexchange for opening the discount window, getting short protection,and having the gov nationalize Fannie/Freddie.

This is why fundamentally gold is oversold DESPITE war fears, high inflation, etc. I don't think the equities market will truly enter a bearish phase until this fall (defined as post-Labor Day). A higher dollar will rally everything until then. Ironically, this higher dollar will also be the triggerfor the equities rout. Higher currency values will eat into ourexporters' strength and widen our trade deficit.

To repeat, we are entering a period of temporary deflation. That is..until the fall, when the feds turn the printing press full steam tosave the housing people. Then gold and oil will rise again on hyperinflationary fears.

*(I have been pessimistic about the EU's prospects for a long time. 3reasons: Demographics, socialism, and divided politics.Demographically, the EU is rapidly aging w/fewer births. This will strain government pension and health care funds worse than our Social Security and Medicare will. Socially, the EU nations are dominated bytrade unions that extort ridiculous concessions from the governmentand business. The cost of business is very high in Europe. Finally,the EU is a monetary confederacy divided by a centuries old legacy ofdifferences. England is far worse than the US. Up to 1/3 of theireconomy is dependent on financial svs and their housing bubble wasextended way beyond ours. Japan is shackled by aging demographics andan economy still recovering from the 1980s).


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