MKT AM 022607: resilience

MKT AM 022607:  resilience

 

Just got my trades closed, and now I am thinking more about mkt. Otherwise, I would tend to trade more and get my fingers bitten.

 

Financial mkts, bonds, stocks, commodities and currencies, are created primarily as resource allocation and risk hedging mechanism for the real economy. Financial mkts, however, have since incardinated on its own into a financial economy itself which is becoming more important than real economy, and where “buy low and sell high” is business 101 for every body, institutional or individual, investor or speculator. This is kind of what Marx called “alienation”.

 

“Alienation” is actually not a bad thing to the real economy. In commodity mkt, while speculators try to profit by guessing the future prices from current prices, the side effect of their trades is to eliminate such profit opportunities, making current prices are a quite accurate estimates of future prices.

 

In general and on average, financial mkts with a lot of real money on the bet, tend to predict the outcome of events in real world much better than other known mechanism, even on things such US presidential elections (Iowa Electronic Market forecasted better than major polls) and 2000 Oscar winners (Play money markets predicted better than 4 out of 5 columnists).        

 

Let’s try to peek into mkt’s mind.

 

Considering its short-term technical vulnerability, stock mkt has been impressively resilient recently, under the dark cloud caused by bad CPI number and Iran.

 

Short-term, I don’t know how long  stock mkt‘s resilience will ast. Even it is trying to climb the wall of worries the bear has built recently, the stock mkt index has to retreat back further to find out where it has enough support, and consolidate itself there.  It probably will break through the more recent support of 12600 easily.

 

For today, the mkt  had some temporary gains early AM, attributed mostly to the news that a private equity group is purchasing Texas based utility TXU for $32 billion, plus the assumption of $13 billion in debt.  Station Casinos also accepted a management buyout at $5.4 billion. 

One recent explanation of abundant LBO deals has been that from private equity group’s point of view : if you can sell high (bonds relatively priced high compared to the low yield, so sell bonds  or borrow to get funds), and buy low (equity is relatively priced low, considering companies’ earnings and their strong balance sheets), then why not ?

 

Speaking of bonds, Bloomberg.com writes:

Benchmark 10-year gilt yields slid to a seven-week low, tracking debt in the U.S. and the euro region as representatives of the UN Security Council's five permanent members and Germany meet in London to discuss penalties on Iran, which has defied a United Nations Aug. 31 deadline to stop uranium enrichment.

``There's a rally in every bond market,'' said Nathalie Fillet, senior interest rate strategist at BNP Paribas SA in London. ``Yields moved lower after the big rally in the U.S.''

The yield on the 10-year gilt, which moves inversely to the price, fell 6 basis points to 4.83 percent, the lowest since Jan. 10. The price of the 4 percent note due September 2016 rose 0.37, or 3.7 pounds per 1,000 pound ($1,965) face amount, to 93.66.

Bonds also gained on speculation global growth and inflation will slow, fueled by expectations reports in the U.S., the world's largest economy, will this week show a slump in housing is curbing economic expansion.

The reports are forecast to show the U.S. economy grew less than previously estimated in the fourth quarter, durable goods orders fell and new home sales dropped, according to a Bloomberg News survey.

 

So, there are two things on bond’s mind: Iran and CB’s rate prospect.

 

Let’s get Iran out of the way first.

 

In my previous post, I talked about how Iraq was supported by major powers during Iraq-Iran war which was caused by Iraq’s invasion of Iran. The reason was of course not just because of Iran’s clerical form of government, although it is really a “statistical outlier” in today’s world. The FA behind international’s “injustice” to Iran was of course, the balance of interest, will and power.

 

The rule of the international politics is still the balance of power, which by the way, is also the rule of domestic politics in most cases, although under some kind of cover.

 

The instated clergy in Iran has a “justifiable” mission of preserving and prospering Islam as a religion and a civilization, just at a “wrong” time and a wrong place and in a wrong way. Iran’s move, although with some value from humanity’s point of view is so lonely in today’s world busy with capitalism game. Nevertheless, nobody would care if Iran’s rejuvenation of Islam is carried out within its border and not backed up by the nuclear power it is acquiring.

 

Iran’s mission with a nuclear power in acquisition has deeply bothered its Arabic neighbors and world major powers as well. Again, this time it is still a showdown between one and many.

 

Iran knows that, so it definitely wants to have nuclear power to back it up, to survive the bullies from all others, now and in future.  We will see how Iran is going to end up this time.

           

 

 

Now, the CB’s rate prospect.

Stephen S. Roach of MS summarized the Fed, Japan CB and ECB’s rate prospect pretty well in his latest view.

 

Fed:

America’s Federal Reserve seems to settling for a long winter’s nap -- likely to keep monetary policy on hold through at least the end of this year, according to our US team.  While the Fed has expressed repeated concerns about last year’s minor upside breakout of inflation, it has also been quick to stress the coming deceleration on the price front. America’s Federal Reserve seems to settling for a long winter’s nap -- likely to keep monetary policy on hold through at least the end of this year, according to our US team.

 

Japan CB:

 

 

An inflation-targeting Bank of Japan seems to be of a similar mindset.  That’s mainly because of the distinct possibility of a minor deflationary relapse, with year-over-year comparisons in the CPI likely to move from being fractionally positive (+0.1% in January) to slightly negative by March.  Moreover, with the economy still judged to be on shaky foundations -- especially the ever-cautious Japanese consumer -- political pressure on the BOJ to refrain from any policy action has been intense.  After having succumbed to that pressure in January, Governor Toshihiko Fukui appears to have expended great political capital in orchestrating the BOJ’s second baby step away from its anti-deflationary ZIRP campaign.  In the end, a one-party Japan has little tolerance for central bank independence -- especially in light of a still very fragile state of affairs on the inflation front.  I suspect, as does our Japan team, that the mid-February policy adjustment will be the last move of the BOJ for a long time. 

 

 

ECB:

That leaves the European Central Bank as the only one of the three major central banks that is likely to make any type of a policy adjustment in 2007.  Elga Bartsch, our resident ECB watcher, puts the upside at 50 basis points of rate hikes.  This suggests that European monetary authorities -- the most dogmatic of the inflation targeters in central banking circles -- believe they are now only two policy moves away from their own normalization objectives in a still low-inflation world.  This view, of course, is predicated on the belief that the European economy continues to surprise on the upside.  Should that view be drawn into question for any reason -- hardly a trivial possibility in light of the recent increase in the German VAT tax, the lagged impacts of euro appreciation, and the ripple effects of Italian fiscal consolidation -- the risks to the ECB policy path could quickly tip to the downside.

 

Stephen Roach is the chief economist of MS, and he follows China very closely, and he is in general kind of bearish (not on China), thinking the current bubble in financial economy is caused by CB’s injection of money.

 

 

Stephen’s view of liquidity and bubbles in financial economy is that of monetarism. If Keynes and Marx were alive, they would argue differently. Keynes would point out that the lack of investment demand relative to savings, or in Marx’s term, the “capital surplus” is the long-term fundamentals behind the global liquidity surplus, and the consequently suppressed long term bond yield.

 

Speaking of China, Stephen represents the typical view of those West-centric economists, even though he is bullish. I highly recommend ChenJing’s two articles I posed recently. I would talk about it and its investment implications next time.