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Prieur Perspective: Markets Still Running from Economic Reality


Risky assets falter, China corrects -- but investors may still not be ready to face the music.

During the week marking the second anniversary of the start of the credit crunch, stocks, copper, nickel, zinc, and sugar recorded fresh 2009 highs.

But the celebrations came to an abrupt end as caution crept back into investors' vocabulary on Friday when it dawned upon pundits that markets were running away from economic reality. On top of that, Chinese equities -- a leading stock market on the way up -- saw a reversal of fortune and declined to a 5-week low.

This is where the Ecclesiastes-based lyrics of the Byrds's classic, "Turn, Turn, Turn" started resounding in my head: "To everything (turn, turn, turn), There is a season (turn, turn, turn), And a time for every purpose, under heaven, A time to gain, a time to lose ..."

Paul Kasriel, chief economist of Northern Trust, reports that the meeting statement of the Federal Open Market Committee (FOMC), released on Wednesday, was a bit more optimistic about the near-term economic environment, changing its language from "the pace of economic contraction is slowing" at the June 24 meeting to "economic activity is leveling out." However, the communiqué also said that household spending would be constrained by "sluggish income growth" in addition to the other constraining factors mentioned in the June 24 statement -- "ongoing job losses, lower household wealth, and tight credit."

"Given our current view that the recovery is going to be subdued and uneven over the next several quarters, we do not expect any federal funds rate increases from the FOMC until June 2010, at the earliest," said Kasriel.

Shorter-dated US, UK, and other government bond yields -- securities that are sensitive to interest rate movements -- declined on indications that benchmark interest rates would remain at low levels for an extended period of time. Longer-dated US yields also fell after the Fed announced that its Treasury purchase program would be extended until October. "The point is the Fed said it would keep the punch bowl open an extra month but it would not increase the punch that is already in the bowl. It will just dole it out in smaller increments over an extra month," remarked Bill King (The King Report).

To James Grant (Grant's Interest Rate Observer) the level of Treasury yields spells danger. He said:
"Vacation-time thought experiment: With the knowledge that the US government will be borrowing as much as $3.5 trillion from the public in fiscal years 2009, 2010 and 2011, approximately matching the Treasury's cumulative borrowing between 1789 and 1994, would you have guessed that the yield on the 10-year Note would today be hovering in the neighborhood of only 3.7%? If 'yes' is your answer, you must not go away on vacation this month. You have too hot a hand to stay away from the office."
The past week's performance of the major asset classes is summarized by the chart below, showing risky assets starting to take a breather.

A summary of the movements of major global stock markets for the past week, as well as various other measurement periods, is given in the table below.
No positions in stocks mentioned.
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