GIC Bear Market Rally Is
Over |
{Chart 3 year Dow Industrials and the six-month Put/Call} The next 2,000 points is now down, Fed fuels consumption as inflation risks
accelerate: What of productivity? There have been some highly intelligent thoughts on the validity of the Fed's productivity argument. Dr. Frank Shostak posted a thorough overview of the delusion behind much of the data (The Labor Productivity Myth), as have others, and we've already covered the subject ourselves in the summer time. Please refer to A Nation of Storytellers. The delusion begins with a fundamental misunderstanding between money supply and economic growth, as measured by the GDP, GNP, or what have you. The fact is that the statistic that we are familiar with as Gross Domestic Product is in reality, only a measure of the money supply. Please refer to Dr. Shostak's case as our reference for this, and for the sake of brevity here. It is really important to understand that what we qualify as economic growth is effectively a credit induced expansion in the money supply, which tends to expand only when the horses still choose to (or can) drink the generously supplied water. At the core, productivity is total output per hour of labor, which goes into producing the output. But by using our national income statistics, this number simply divulges the total amount of money spent per hour of work. And although that number has been rising, it has taken ever more credit money to influence each dollar of actual expenditure (consumption). I guess that the rest goes to servicing our rising "aggregate" debt levels, or to other non-productive wealth redistributing activities.
Nevertheless, our increasing leak should continue to erode the effectiveness of monetary policy at the Fed, and as the effectiveness of monetary policy erodes, so too, will the (above) productivity number ultimately decline. But it doesn't stop there, our ignorance that is. It has understandably become important for us to understand how much real money it costs to produce a level of real output in an hour. So, perhaps in order to acknowledge that total output measured in dollars (the unit of account in this case) is only a monetary output statistic, the concept of nominal and real GDP is introduced into the argument. Yet the adjustment is arbitrary, because it is only a government estimate of how much purchasing power the money has lost. Still, this arbitrary number helps them arrive at what is a more generally acceptable measure of real economic performance. Anyhow, the whole idea that the measure of productivity imparts what many "experts" say it does is nonsense. Our hope is that we can help explain why it doesn't. So, if productivity = real hourly output
/ hourly unit labor costs, then… Calculated this way, the productivity data tells us how much (arbitrarily adjusted) money we can create per hour of work, and if we can do it profitably, thus efficiently. Then we can compare the data to last week, last month, or last year, in order to determine if our country is printing and spending this money with greater "efficiency" or not. In other words, if this number is high, then inflationist monetary policies can still work - as opposed to break down. Thus, productivity (calculated this way) is simply a measure of the productivity of inflation. Obviously, this is a meaningful statistic for a central banker to have. An example All you would need to do is encourage consumption (sort of like persuading the horse to drink water from the trough) and therefore credit, thereby increasing the supply of money. Now, the trick is to ensure that the money is not spent on real things, all at once. Rather that the bulk of the excess money supply is poured into the asset markets, preferably the paper asset markets, so that more credit can be created. This way there is a positive drag on the reported inflation rate, which then influences (discovers) a maximum value for the numerator. And in such an economy, where the asset markets can generally inflate at will, foreign investors are attracted to this "productive" inflation, are willing to finance its perpetuation, and effectively encourage the cycle of consumption by inflating our global economic purchasing power (by bidding up the value of dollars). In such an economy, what employee would turn down the lure of the stock option to cash? Remember, in this economy, stocks go up at will. Anyhow, if enough participants (people) do choose this method of remuneration, conceivably, the effect would be to depress the denominator in our equation. Thus, the productivity rates in our hypothetical economy would surely rise. But what if one day, stocks do not go up anymore? What employee is going to prefer a stock option plan to cash? And if wages begin to rise as a result (of many things really), will not the denominator in our equation be forced higher? {Insert hourly wage charts} That is where we are. The future of our economic delusion rests with the effectiveness of monetary policy. But total stock market capitalization has not been able to expand for well over a year, even though the Fed has allowed, and encouraged, the monetary aggregates to grow wildly throughout this period. So if people are not buying stocks with this new money (liquidity), and they continue to lose confidence in the increasingly abundant paper, what might happen in our simple economy? {Chart the SP500 against M3 - 3 years} Participants may stop saving altogether and spend all of this never-ending supply of credit money on real things, rather than on stocks. So, the top number becomes smaller now, well, as soon as the lag in the government statistic (the price deflator / CPI) is washed out, that is. And if the process continues to be fueled by a cowboy Fed policy, it will prompt accelerations in the reversion to an objective valuation for the dollar. {Chart oil prices against M3 - 3 years} Thus, taking all of this into account, we too will join the growing chorus of analysts "predicting" that the US productivity data will begin to decline, except that we think the number will decline for some time. The reason is because we fully suspect that the inflationist policies of the Fed have been breaking down, terminally. Therefore, we also predict that the purchasing power of the dollar will continue to erode, against most things, and until the foundations of excess are purged. So you see, the number does mean something to us, but it also means something to the Fed Chairman. Mr. Greenspan's productivity edict is intended to mean that he assures us, and believes, that the inflation can still work. That monetary policy is still effective. As long as productivity rates rise, the inflation can still work, and so, every time Mr. Greenspan lowers the interest rate, stocks will rise on command! So, what are they buying, besides oil? An economic slowdown, or an "inflation" warning? {Chart the long bond yield against the short-term yield} What these two charts mean is that long-term interest rates are going up and short-term interest rates are going down. Simple, huh? Whether the analyst interprets this chart as a sign that a short recession may be behind us now (and that the yield curve is thus simply normalizing), or that inflation expectations are on the rise, will depend on his or her understanding of what inflation actually is. If inflation is (interpreted as) the result, on the general "price level," of some form of aggregate economic demand exceeding some contrived concept of total economic capacity, then the analyst will tell you that the normalizing yield curve is the result of a slackening in demand, and further, that it (the curve) is predicting the end of the economic weakness, and ultimately setting up for a turnaround. But this form of analysis overlooks the real possibility that prices may rise even as "aggregate" demand (consumption) weakens. That is because the analysis refuses to take into account the influence of individual preferences on the purchasing power of the money used in any given transaction, at any specific moment in time. If the analyst is driven by the truth, however, he (or she) will understand that the concept of a price level means adding apples to oranges to a pair of jeans to an automobile in order to arrive at an average that is representative of something too meaningless to qualify as abstract, in the first place. This analyst should then also realize that the one thing, which these very different things do have in common, is the money in which they are priced (exchanged for). Thus, the quantity of money combined with an individual's unique preferences, at any given moment, will determine the value of that money, and thus the price of a specific good. Furthermore, the analyst will know that the lower short-term interest rate is not only an artificial policy induced rate, but that it will ultimately fuel the inflation. Unfortunately, this is a result that comes nowhere near describing an economic trough, but rather a continuing crisis. Let's keep it simple, shall we? When this is happening, it is a really bad idea to lower interest rates! {Chart the 2 year CRB and the GSCI} Why? Because when people become confused about the value of things, which they so often do, and their central bank keeps throwing new (credit) money at them, they will in turn throw it in the direction that suits their economic interests. Thus, the meaning of the phrase, liquidity seeks inflation. And if the system arrives at the point where everybody is cashing in his or her chips because nothing else is inflating anymore, the inflation that has been so well managed and organized, will become disorganized. Government policies will beget bad ones, as they have no choice but to defend the value of the (overly issued) currency with everything that they have got, which never is enough when it comes to a war over real things, and the entire economy implodes. Not even higher interest rates can stop this process when it gains momentum. Only the hoarders will make money. But so be it… the social consequences of dishonest money. Again, we post these two charts as we did in late December, and we ask Mr. Greenspan to please lower interest rates again… {Chart the 2-year Dollar index vs. Gold prices} We did ask nicely, didn't we? Nostalgia Dollar confidence will then have to rest with a leaky (leaking inflation everywhere except in the government figures) dollar and fiscal policy? Yikes. So, get this, and I hope you are sitting down for this. We are so insolent… Who am I kidding? Yet, this kind of talk is the only way to make US monetary policy effective again. Here is why: First, because it would unquestionably knock the heck out a stock market, which is expecting lower interest rates. And then, maybe then, a 50 basis point rate cut can work to re inflate the stock market… maybe. For the record, Mr. Greenspan already made his first mistake by not listening to us when we suggested (in December) that he shouldn't lower interest rates until after the stock market sells off. Anyhow, even if he were to talk the talk, I know it cannot possibly sound quite as honest as written above, but the point is only incidental anyways… not a serious prediction, more like a guess, a gut guess. But consider some of our more logical support for the stock market call. The Sensitivity Index If two public companies concurrently announce better than expected earnings, assuming all else being equal, and one's shares react (rise) stronger than the other, in the market, you could make dumber mistakes than to assume that it was the right one to buy. What else we do not like about this "stock"
market… In December, we suggested that the Nasdaq was ripe for a bounce, but we also concluded that the bounce would presage a crash in the blue chip averages, as it would crowd out the remaining liquidity. The Fed responded by slashing interest rates in order to provide additional liquidity, thus delaying the move. Early last week, we thought the bulls had enough time to gather momentum and concluded that if they didn't demonstrate any meaningful territory, the bear would reassert its position shortly thereafter. On Tuesday morning, rumors that Mr. Greenspan was going to hint at a minimum 25 basis point cut at his testimony, on Thursday, sent the equity markets on what may have been their last gasp. A glance at yesterday's Dow leadership was revealing. The top quartile of performers included General Electric, American Express, Boeing, Coca Cola, Home Depot, Intel, and International Paper. Below is a brief overview of the technical (chart) condition of each stock. The top 7 performers all rallied over 2% on Tuesday January 23rd: General
Electric, American
Express Boeing Coca
Cola Home
Depot Intel International
Paper Conclusions The Nasdaq indexes spent the short week (last week) rising in countertrend, but bumped up against the bearish stronghold just a little too hard and ended up gasping for more air by the time they got there. It was a 150-point rally on the week, at best. Volumes weren't bad at all for the week. We could hear the bulls snorting away and aching to go all week long, still in denial of the forces, which have already turned the primary trend against them. Can they make it to 3000 (another couple of hundred points or more)? Possibly, but can they make it to 3500? That is what they will have to do to turn this market around. But, you might ask, that's a pretty good rally... up 25% from here? It is, but for a market (index at that) to rise by 25%, it has to "look" like it can rise a lot further than that. That said, they (bulls) did manage to leave behind a 500 point one month diamond (a popular pattern this month) and push through the faster 50 day moving average, raising the odds for a short spurt to the 3000 handle on a day when the bears aren't looking. The move, in fact, may be just what the doctor ordered to create the next liquidity crisis for the Fed. Thus, the stock market is a sell. {Chart
the Dow against the Nasdaq} Sincerely, |