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Jeff Saut Presents: The Fed?!


Is the recent stock market decline just a correction, or the first leg down in a cyclical bear market?


"The papers are full of articles regarding what the Fed might do or not do with short rates. But how is it that nobody ever questions the very worth or non-worth of the Federal Reserve itself? The Fed has never been audited. Its legitimacy, its worth, is NEVER questioned – the Fed appears immune to questions. One problem is that nobody understands what a monstrous fraud the Fed is. When the U.S. government needs money, it doesn't just issue United States Federal Notes (dollars), which it certainly could do. In other words, incredibly, the U.S. government does not issue its own money. Instead, the government issues bonds, thereby loading itself with ever-increasing interest-bearing debt. Here's how this disgrace works –"

"The U.S. government issues a billion dollars of interest-bearing U.S. government bonds. It takes the bonds to the Federal Reserve – the Fed accepts the bonds and places one billion dollars in a checking account. The government then writes checks to the total of a billion dollars against the checking account – a billion dollars that has been created 'out of thin air.' Meanwhile, the debts of the U.S. grow and grow. And the government pays interest on the bonds. Yet that isn't enough for the U.S. government. It taxes its citizens, taking away a percentage of their passive and active earnings. And as if that isn't enough, it robs its citizens via inflation, so that as their living costs rise and simultaneously their savings are whittled away."

"The Fed has been in existence for 93 years. In those 93 years the Federal Reserve Notes that the Fed issues have lost 98% of their purchasing power. To cover up this monumental scam, we hear the Fed blather and bluster about how worried they are about the current inflation rate. The current inflation rate is the cover-up, what kills us is the systematic year-after-year loss of purchasing power of those billions of fiat Federal Reserve Notes. So the system allows this semi-private banking system to create money out of absolutely nothing (all of it a loan to our government) and charge interest on this debt forever. Thus, the Fed collects interest on the government's own money. It's a system that is beyond belief, but one that runs the life blood of the nation – the life blood of a nation is its money."

"A communiqué sent from the Rothschild investment house in England to its associates in New York noted, 'The few who understand the system . . . will either be so interested in its profits or so dependent on its favors that there will be no opposition from that class, while on the other hand, the great body of people, mentally incapable of comprehending . . . will bear its burdens without complaint.'"

. . . Richard Russell, 6/19/06

"Will bear its burdens" indeed, for since the Federal Reserve's creation, in December of 1913, the U.S. dollar has been in secular decline. Most recently, under Alan Greenspan's 18-year aegis, the "greenback" lost 50% of its value, which is why we always went into a rant when the esteemed chairman suggested that one of the missions of the Fed was to preserve the purchasing power of the dollar. Nevertheless, all eyes will be on this week's FOMC meeting where the various pundits will dissect every word of the "bias statement" in an attempt to glean when the tightening cycle will end. As is often stated in these missives however, "With everyone asking that same question, history suggests this is likely NOT the right question." History further suggests that stocks don't necessarily rally when the Fed stops raising interest rates. In fact, the preponderance of the time stocks actually declined following the final rate ratchet . . . or as one Wall Street Wag lamented, "The difference between perceptions and realities is where our opportunities lie!"

We have argued for months that rather than looking to Mr. Bernanke, and the Fed, participants might want to look to Mr. Fukui, who is Governor of the Bank of Japan (BoJ). Indeed, Mr. Fukui has been withdrawing liquidity from the Japanese banking system at a record pace. In fact, the year-over-year rate of change in Japan's monetary base is now negative. Since the world's hedge fund community has been feeding at Japan's zero interest rate "liquidity trough," levering that money and buying anything that was going "up," is it any wonder the commodities and the emerging markets have crashed? Meanwhile, the real question stock market participants should be asking is, "Is the recent stock market decline just a correction, or the first leg down in a cyclical bear market?" The answer to that question, at least at this point, is, "We just don't know." As stated, however, we are hopeful that the mid-June trading lows were the beginning of a "bottoming sequence," which is why we bought into those lows. Typically that sequence consists of a trading low, followed by a sharp "throwback" rally that lasts two to seven sessions and then a subsequent re-test of those trading lows. While that is the classic bottoming process, we noted that this week's FOMC meeting could muddy the "waters." As reprised in last week's verbal strategy comments, our friend and mentor, Lucien Hooper, useD to opine, "The stock market will do whatever is necessary to frustrate the majority of participants." In the current case the "maximum frustration" would be to continue the current rally into quarter-end, thus putting pressure on the under-performing, under-invested hedge funds to commit their cash right before a July re-test of the lows begins.

Interestingly, last Friday the Lowry's organization wrote:

"During the past 33 trading days, there have been 13 occasions that qualified as either 80% or 90% days* – more than one every three days, and never more than two days in the same direction. This qualifies as the most volatile period of market activity in the last 55 years. . . . History shows that periods of high volatility are usually brief, since it is difficult for anyone to profit from them for long. And, as relative normalcy eventually returns, the primary trend of the stock market should become more apparent."

Ladies and gentlemen, typically an increase in volatility has tended to foretell a change in the trend of the market. Over the past three years the market's trend has lent itself to "momentum investing" as participants layered on an increasing amount of "risk trades" (commodities, emerging markets, gold, etc.). The result was that anything going "up" in price attracted additional pools of capital amplifying the rally. For the past few months we have argued that with the world's central banks raising interest rates and withdrawing liquidity, the environment for momentum investing would likely change. And, that seems to be the market's message since the mid-May highs as the "things" that have rallied the most over the past few years have declined the most. Since we are believers in mean reversion for just about everything (P/Es, profit margins, etc.), and particularly for the equity markets, our sense is that a reversion to the mean for the S&P 500 suggests that the trading range strategy we have employed since October 2001 will continue. Fortunately, there is always a bull market somewhere and it is our job to find it.

From October 2001 until November 2005 we were adamant in the belief that there was a bull market in small/mid-capitalization stocks. From March 2003 we have been unwaveringly bullish on Japan and remain so. Additionally, we have steadfastly embraced "stuff stocks" (energy, timber, fertilizer, agricultural, base/precious metals, etc.) since October 2001 even though we have periodically rebalanced those investment positions to keep their portfolio weightings in-line with our objectives. Yet we continue to think "stuff" is in a secular bull market and evidently we are not the only ones given Anadarko's (APC) bid last week for Kerr-McGee (KMG) and Western Gas (WGR), which put "bid" into the entire energy space. Given the fact that most energy stocks have experienced 20%+ declines, we called our Houston-based energy analysts to get their top names. To wit: Ultra Petroleum (UPL), TODCO (THE), Patterson-UTI Energy (PTEN) and Comstock Resources (CRK). We continue to like the strategy of buying the "flops" in fundamentally sound companies.

The call for this week: All of the major market indexes we follow have broken down, volume is declining, the NYSE Bullish Percent Index is counseling for caution, the 10-year T-note's yield has tagged a new reaction high (5.23%), and if the major indices close down for this quarter they will have registered a quarterly downside reversal. While we are cautious, we are hopeful the markets are involved in a bottoming process.

* 80%, or 90%, of total points, combined with total volume, are either "up" (upside day) or "down" (downside day).

No positions in stocks mentioned.
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