Longer term readers will recall that I turned bullish on the stock market at the end of 2008. It
has been quite a ride. The very best time to own stocks is when interest rates are low and the
Fed is adding liquidity to the system (QE) to push the economy forward. During these periods,
you are trading high return for the assumption of low risk. With no QE in the system now, and
with very low private sector credit growth and grossly uneven distribution of income both in
evidence, the US economy and stock market are both skating on thin ice. The continuing low
visibility for further economic recovery is reflected in a major suppression of the stock market's
p/e ratio and unusually large credit yield spreads in the corporate bond market for this point in
the cycle. The economy can continue to expand if the credit markets thaw further and if the real
wage can continue to improve without a weakening of employment that may come with lower
inflation but less economic demand. The risk to the economy is now elevated and as I have said
recently, the Fed is gambling with the recovery.
I see the Euro zone ticketed for a deflationary recession ahead in the absence of a substantial
easing of monetary policy and perhaps large local stimulus plans as well. In addition, although
I agree that Euro bank leverage is far too high, the regulatory order to deleverage substantially
in the years just ahead is imprudent and carries large risks well beyond the EZ to Asia where
businessess have been highly dependent on EZ banks for trade finance. On to China. When I
started the blog in 2005 I referred to Hu and Wen as the new running dogs of capitalism. I
regard these guys as political hacks who further championed China's mercantilism, and the
acceleration of gross imbalances within the economy. The 2008 stimulus program, although
impressively grand, was largely a monetary and credit affair. With China broad money
supply reaching 30% yr/yr and with loan growth far above output potential, Hu / Wen
produced "banana boat" economics which left the PBOC with one of the largest monetary
excess mop up jobs ever. They are still struggling to get the ship properly righted. The US
cannot escape being affected by these difficult problems.
Stock Market Strategy
You can make money in the stock market without QE by the Fed. But you are taking on more risk,
risk which intensifies the longer the Fed stays on the sidelines or reduces its balance sheet in
real terms. If private sector credit is flowing freely, the market can do fine. I use very little
capital to go long the market during these periods because all of the big bear markets have come
when monetary liquidity, as opposed to credit, is flat or shrinking. Nice credit flow can ward
off the day for a while, but the bear will catch up with you sooner or later.
So, I'll do some long trades with light capital and some short trades with heavier capital and
I'll also watch the Fed carefully to see if : a) They have a positive change of heart; or b) They
are pushed to extend large currency swaps abroad. If circumstances are not too dire, the
latter could prove rewarding since the Fed is injecting liquidity into the mix.
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!