Monday, June 12, 2006

Stock market thoughts

Once it's perceived that US housing is in trouble, and that this is deflationary, I expect the Bernanke Fed to do a turnaround. The Fed is mortally afraid of deflation. Bernanke built his reputation on his studies of the Great Depression and the painful results of deflation.

During 1995 to 2000 we saw wild inflation in the prices of tech stocks. The "marvel of tech" plus rising productivity was supposed to usher in a new era for America. Then, following the 2000 top, we saw the tech stocks deflate. The losses were catastrophic, and as of now the Nasdaq stock average is still more than 50% below its year 2000 high.

And I'm wondering whether the same sequence may happen to housing. If housing starts to collapse, as it did in Japan during the '90s, the Fed will oppose those deflationary trends with all the power it can muster. The move to re-inflate will be huge. It should be quite a show.

Rising volatility means that investors are at the stage where they can be easily frightened. They are buying puts for insurance. The Lowry's statistics are very bearish. We have seen two 90% down-days, May 17 and June 5. This is bear market action. Foreign markets have been hit hard, particularly the stock markets of Asia and the Mideast.

Much of the world's surging liquidity has come from Japan and its zero-interest rates. The Japanese "generosity" is starting to reverse. We're seeing the end of the "carry trade" where speculators borrow from Japan at extremely low interest rates and then buy higher interest-rate items, pocketing the difference. The carry trade is now unwinding.

The central banks have created a giant balloon of liquidity, and now the balloon has been punctured. Markets tend to go too far both on the upside and the downside. Now it's the downside's turn. My greatest concern is that the deflating balloon is going to impact the US's DEBT. This could be extremely dangerous. The US economy is not positioned for an attack on its debt. The situation could get nasty.

The first place to feel pain is always the stock market. The most vulnerable area of the stock market is margins, which is simply stock market debt. If the contraction in liquidity continues, it's going to hit margin debt first. That could precipitate anything from a rotten stock market to a crashing stock market.

My advice -- if you're on margin, get off margin. If you have debt that you might have trouble servicing, do everything you can to get rid of that debt. If there's to be real trouble ahead, it will come first from the stock market. The punch bowl isn't just leaking, it's being taken away.

Today's stock market: 754 advances and 2497 declines. Down volume was 89.0% of up + down volume -- very poor action.


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