MARKET OBSERVATIONS

MARKET OBSERVATIONS - 1/20

The Final Spike?...Yes, we could be talking about the NASDAQ, the Dow or the S&P, but this time around it's the change in U.S. currency outstanding.  We won't bore you with another rendition of money and credit creation (as you know, we save that for the Tuesday discussion).  Sometimes simple charts say it all: 

The chart of the change in U.S. currency outstanding could be mistaken for a "newly discovered" Net stock, but alas it's the same old greenback.  We do want to raise one possibly important question.  Has the Fed simply lost control of the money supply?  Sounds far fetched, does it?  Think about it for a moment.  A huge amount of credit (and ultimately money) creation is happening outside of the control of the Fed.  It's happening at GE credit, GMAC, Ford Motor Credit,  Fannie Mae, Freddie Mac, FHLB, to say nothing of the Diamond Center at the local shopping mall.  This is what truly is different this go around.  Never before has so much credit been able to be created outside of the traditional (and regulated) banking system.  Outside of the direct influence of the Federal Reserve.  (Oh the joys of deregulation.)  Somewhere down deep, this has to be on Greenspan's mind.  Overlay the nominal value of derivatives that are being created almost exponentially around the growing credit balloon (again well outside of the Fed sphere of direct control/influence), and you can see that direct monetary policy has diminishing effects as more and more credit is created "outside of the Fed system".  Stepping back for a moment, do you really think that the Fed raising short rates 25 basis points in early February is going to mean diddly near term?  (Of course you don't.)  Could it be that forces ultimately determining the money supply in this country are now beyond the Fed's immediate control?  Quite possible.  Of course the implication of something like this that the possibility exists that a financial bubble could be created in this country, the likes of which would simply have no precedent or immediate limitations (outside of sheer self implosion at some point).  Before getting too worked up, remember that we already have a financial bubble of historic proportions and nothing bad has happened...yet.

Damn The Mortgage Rates, Full Speed Ahead...As evidence that the wealth effect is alive and well, December housing starts were the strongest in nine months.  December starts in single family homes actually increased at a seasonally adjusted annual rate not seen since 1978.  Not bad for an economy currently pushing historical growth limitations in terms of age.  More evidence that close to a 125 basis point increase in mortgage rates over the last twelve months has stopped nothing.  Of course weather in December was unusually mild this year, but strength is strength.  Once again we ask, with numbers like these, what is 25 basis points in early February going to mean to anyone?  As long as stocks push higher, don't look for any dramatic slowdowns in consumption sectors of the economy any time soon.  To be fair, there is a lag effect in the starts numbers for homes on "backorder", shall we say.  1999 was a busy year for builders.  Nonetheless, with the dramatic gains in stocks over the last 3 to 4 months, there's plenty of "new prosperity" to keep the housing party going for a while.

What makes us firmly convinced that it's the stock market pulling the economy forward is the following:

Total consumer debt as a percentage of disposable personal income has just never been higher.  Close to 95% at last count.  Despite this, mortgage activity for new housing is brisk.  (As you know, the current refi game is dead.)  With this type of deterioration on the liability side of the personal balance sheet, the only thing that can be supporting consumption and confidence is the rising tide of stock and housing prices.  Without these twin sources of asset growth, the U.S. consumer is simply walking off a balance sheet cliff.

Companies Behaving Badly...How is having revenue decline by 4% year-over-year and watching profits evaporate 11% over that same period bullish?  When you've already lowered the earnings expectations bar, of course.  For 4Q 1999, IBM didn't need to belly up to the bar, they could have kicked it with their shoes flat on the ground.  We've bellyached about the practice of lowering the earnings expectations bar only to magically beat it (and have the so-called analysts all aflutter) too many times.  If investors are continually stupid enough to reward companies for this type behavior, then shame on them.  Gateway has done it.  Hewlett, IBM, Dell.  The list just goes on and on.  You watched both Intel and Microsoft "beat the numbers" with non-operating items.  For INTC it was a capital gain.  For MSFT it was interest income.  IBM "magically" squeezed out 6 extra cents per share on their quarter by achieving a 9% drop in expenses.  Understandable.  After all, it was Y2K lockdown mode.  Without the 6 cents, IBM would have hit the heavy estimate reduction on the nose.  Now that wouldn't have been any fun, would it have?  Clearly a 9% reduction in total expenses, even in today's supposed "no-inflation" world, is nothing short of unsustainable.      

Of course as long as the stock market keeps going up, who cares?  To be fair, exports from the U.S. are also increasing sharply.  The downside is that global economies are also beginning to consume fast.  Global bond market participants are fully aware of the situation.  In fact, they have been properly anticipating it for some time.  Since Greenspan and the Fed will not seriously address the situation here at home, the bond market will do it for them (as it has done in the past).  We are convinced that the only explanation for the dollar not falling out of bed is a coordinated dollar recycling program engineered by the Big G countries.  With the imbalances being created and exacerbated in this country, we continue to wonder for how long will foreigners be so obliging vis-à-vis their incredible trade financing largesse?  Unfortunately the answer may be that they have no other choice.  The last piece of this puzzle that truly is troubling is the incredible vanishing U.S. savings rate.  It's just a damn good thing that the Fed has not gotten serious about monetary tightening...yet (as witnessed by the adjusted monetary base, adjusted reserves, etc.)  They talk a tough game, but are nowhere near tight.  As you know, mention the adjusted monetary base to most "new era" investors of today and they'll have no idea what you are even talking about.

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