Friday, May 21, 2010

Money Matters: Wall Street in Turmoil

Several pundits had been predicting a correction in the market averages and they seem to have been right.  According to Morgan Stanley Smith Barney the Dow fell a hefty 376.36 points today and the S&P 500 fell an equally hefty 43. 46.  After some more decline the market could well recover, and if you want to time this correction there still might be some life left in the post-2008 Fed bank credit expansion rally.  Recall that the Fed tripled its bank credit on reserve with the nation's commercial banks in 2008.   It is unclear how far the potential liquidity will expand the stock market or how inflationary it will ultimately be. I would be wary of playing the short term market decline and getting in in a big way, although a small bet should the Dow hit 9500 and stay there for a few days might be interesting. 

The fact is that interest rates are now zero, and the Fed has no further slack to stimulate the markets. If it does, there could be a serious reaction from China and other overseas bond holders, who are seeing the value of their dollar-denominated assets decimated. 

The Australian and Canadian dollars  and a number of other currencies continue to fall. Chuck Butler of Everbank, which markets foreign currency denominated CDs, has an explanation.  Writing on Kitco Butler writes that there have been rumors of China's economy crashing.  A China crash would hurt commodity exporters like Australia and Canada.  Thus, commodities may decline along with various currencies.  This could well be a significant buying opportunity, say if gold falls below $900.

The current situation is a kind of self-contradiction  The Fed has been printing, expanding the supply, of dollars. Yet demand has exceeded supply because of a "flight to safety."  But the demand is short term, or else it relies on the assumption that Congress, the Fed and the President are reliable when it comes to economic self discipline.  If you believe that then you feel comfortable with cash as a long term holding, but I don't. Nevertheless, for the short term the markets are keeping me in dollars. I am currently about 70% in dollars. My other asset holdings, stocks (14%), commodities (10%) and currency (6%), have all been falling this week.

Butler argues that rumors of a China crash have come and gone before, so the currency declines might be good plays as well.  It is certainly nice to have a large share of cash right now, but I would not be optimistic about the future of the US dollar.  Butler puts it well:

"Speaking of deficits... I was thinking last night that I've been blind to something that I should have seen a long time ago, since I talk about both of them all the time! The National Debt in the U.S. is nearing $13 Trillion dollars... But... It's really $19 Trillion... Where did the $6 Trillion come from? Ahhh, grasshopper, it even too me this long to figure this one out... You see... The debts of Fannie and Freddie total over $6 Trillion... And since these two were nationalized their debts are our debts now... And just because the Gov't doesn't count their debts with ours, from now on, I will...

"How are we ever going to pay back $19 Trillion? (Oh and that's not counting the unfunded liabilities of Social Sec., Medicare, and Medicaid) Higher taxes? That won't work folks... Gov't spending cuts? That would help, but going forward with all the baby boomers like me nearing retirement, the unfunded liabilities become "funded" and those alone will be more than tax receipts and spending cuts can cover!"

If there is a sizable market decline and then some stabilization, I'm going to move money into the markets. I don't think the final crash with capitulation that will end the secular bear market is near.

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