Who's Telling the Truth?
Timing is everything!
Editor's Note: The following exchange was on this morning's Buzz, but we wanted to share Scott's excellent insight with those who ain't Buzzin!
Question for Professor Reamer (and great seeing you last night at the abbreviated Succofest):
If the reflation trade is being reversed, as per your Buzz on the dollar, how can equities be flying high?
Great question Todd; John and I discussed it last night in detail. Here's the capsule.
If indeed time preferences are decreasing globally - and risk aversion and deflation are the result (and Austrian economic insight) - then one would expect each major financial market to adhere to that meme: risk aversion. (1) Commodities are suggesting as much (some have already peaked, others are in the process of doing so like oil). (2) Currencies are suggesting as much, benefiting the USD (the perceived least-risky currency). (3) Treasuries are suggesting as much with their last 6 weeks action (again the perceived lowest risk liquid instrument on the planet). (4) Corporate bonds are suggesting as much (record widening as per John's comments.)
The only market that has yet to fully embrace this decreasing time preferences idea are stocks. But to be fair the jury is decidedly still out here: remember we peaked in all the indices in March (Jan for the Nasdaq). Our models are suggesting this bounce from the April lows is a counter-trend bounce that should result in a secondary (lower) peak and then lead to the stock market 'catching up' to the other markets in terms of its full embrace of the deflationary forces. The NYSE index has clawed back 50% of its March-April decline while the Small caps (SML) have clawed back 66% or so and the SPX nearly 78.6% (SPX 1209 is that number).
The risk in our bearish assessment here is that the deflationary, risk averting forces taking place in the rest of the world might well cause a flood of liquidity (recall how much money other central banks too have produced in the last 5 years) into US assets. Arguably the US has the best relative laws, regulations, and capital markets into which foreign monies seeking a safe harbor could flow. If those flows are large enough (and clearly they are large, just look at the nearly straight line decline in the 10 yr yield), US stocks could continue benefit in a sort of mini-reflation trade whose liquidity is sourced from the wellspring of foreign investors and central banks.
Our models do not suggest that is the most probable resolution of the worldwide deflationary forces we think are present. But it is a risk that John and I are acutely aware of. And now you are too.
In the final analysis I suppose it comes down to this: either you believe stocks are telling the truth about the macro future and commodities, corporate bonds, currencies and the US Treasury markets are lying OR you believe that stocks are the lone 'outlier' that have not yet caught up to those other (huge) markets. Hope that clarifies things a little.
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