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Jeff Saut: Does Wall Street Believe?


Washington's Neverland fantasy.


Editor's Note: The following article was written by Raymond James Chief Investment Strategist, Jeff Saut.

Washington, DC is not considered a city noted for theatrical productions. Most of the central city empties out after work heading for the suburbs, and much of the downtown area is virtually deserted after dark. There are good bars, restaurants and hotels, but that seems to be the extent of nighttime activities. There was one play that did have a lengthy run in Washington. J.M. Barrie's Peter Pan, starring Sandy Duncan as "The Boy Who Never Grew Up", had the longest run at the time of any play produced in the nation's capitol. In an interview, Ms. Duncan was asked why the play had lasted as long as it did. Her answer was, "I think it's because people in this town relate easily to fantasy." I saw the play with Mary Martin in the title role. At each performance the actress playing Peter Pan turns to the audience and says, "Do you believe in fairies? If you believe, clap your hands!" The last line is repeated until the house is clapping wildly.

-- Ray DeVoe, The DeVoe Report (2003)

I recalled Ms. Duncan's comments last week, about people easily relating to fantasy inside the DC beltway, as I sat in front of a camera waiting to do a segment on network TV.

While I waited, the voices of the members of the Financial Crisis Inquiry Commission (FCIC) resonated in my ear. While it's true they're not currently members of Congress, most of them have been in politics at one time or another, and all of them were appointed to the FCIC by our Congressional leaders. Accordingly, most of them are just as political as Congress.

There was one member of the commission, however, who is truly qualified (in my opinion) to opine on what caused the financial fiasco. Brooksley Borne, a name likely unknown to anyone outside of my business, warned of the pending crisis when she was chairwoman of the Commodity Futures Trading Commission (CFTC) in the late 1990s, but her warnings were ignored by our Congressional leaders and therefore by the regulators responsible to Congress.

And that, ladies and gentlemen, is the real story behind the financial crisis.

Indeed, as I sat there listening, I found myself screaming at the cameraman, "Tell the producer to put me on the air." My rants were driven by the clearly political ramblings of most of the commission's members as they engaged in the normal Washington Waltz of the blame game.

To be sure, having lived/worked inside the beltway I've seen this "beltway bamboozle" before as politicians point their collective fingers at everyone but themselves, to pander to an uninformed public about who was responsible for something.

The reality is that it was Congress who fell asleep in bed with a lit cigarette by telling regulators to "lax up" on the rules already on the books that would have prevented the financial institutions from leveraging their balance sheets 50, 60, 70 to one, which was the real cause of the problem.

It was also Congress that, in the interest of trying to put a roof over everybody's head, told various agencies to "lax up" on mortgage requirements permitting people who couldn't afford the driveway, let alone the roof, to buy houses they couldn't afford.

Verily, we have met the enemy; the enemy is our politicians (both Republicans and Democrats, alike). And, the lack of outrage by the nation's uninformed electorate is a very sad commentary on the state of our union.

Like our Congressional cheerleaders in "Neverland" (read: Capitol Hill), Wall Street's cheerleaders were at it again last week chanting "I believe" in an attempt to further levitate stocks.

Hereto, however, the current difference between perception and reality is somewhat far afield by our pencil. As our friends at the celebrated GaveKal organization deduce, there are basically two options confronting the US equity markets; and, the valuation disparities between the two have rarely been so great.

Option Number 1.

Global growth is just extremely strong and investors remain far too defensively positioned. This would explain the very sharp rally in cyclicals in recent weeks, the rebound in shipping, ports, logistics, materials etc. Of course, if global growth is now much stronger than most expect, a "bad cop" will at some point have to show up at the party to tell the hosts to keep the volume down. Right now, the G7 central banks seem most unlikely to fulfill that role, focused as they are on preventing another Japan. In our view, this means that the "bad cop" might have to be the long end of the bond market, though interestingly the yield curve is already about as steep as it has been in 20 years.

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No positions in stocks mentioned.

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