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Bubbles Everywhere


A few weeks ago I talked about the action in the Japanese bond market (JGB) and it's implications to our market. Japanese banks that own JGB have been using the profits from that market's substantial rally to write off bad loans. This process has somewhat stabilized the Japanese economy. Now that those profits are fading fast, there comes a point where these banks feel tremendous pressure to sell those bonds; that pressure eventually will spill over into the U.S. bond market. The JGB from that last report have been accelerating down in price and were down 1% again last night; we are seeing some real money selling now. Based on the technical formation we are seeing we are comfortable in adding to our short position.

Adding to the pressure in world bond markets, the auction in European bonds (Britain and Germany) went poorly, showing a coverage ratio of only 1.5. The Financial Times headline reads, "Fears grow of end to bond bubble". Let me just say that the bond bubble in Europe is like a bubble in a bathtub compared to the U.S. bond "bubble". Steve Roach (that brave soul facing the bullish headwinds of the rest of the crowd) writes this month in "Endless Bubbles" how the equity bubbles are morphing into debt bubbles. Definitely the Japanese, now the Federal Reserve, and possibly the Europeans (although they are resisting better than the rest) have injected massive liquidity into the system, effectively creating massive public and private debt. Their hope is that over time the real economy will pick up enough to slowly deflate these "bubbles" that are now floating everywhere. The problem with using one bubble to support another is that they tend to get bigger than if you just let the first one go ahead and pop.

The bond markets of the world's biggest economies are more highly correlated than their stock markets, but not by much. Violent moves in the world's bond markets will eventually lead to violent moves in the stock markets. We must continue to watch the bond and currency markets for signs of trouble. And let's not forget the derivative bubble. Once one bubble pops...well, you know what happens.
No positions in stocks mentioned.

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