Long-term Realities Trump Volatility


Will the U.S. government get its budget deficit under control? A great deal depends upon what the stock market does — a market that may be entering a “boar market” phase where unpredictability is the tusked creature’s game. Stock market action over the last six weeks has been predictably bullish because of the consistent investment activity of trend following systems following the March technical reversal. Interestingly, the market may have become too bullish as a buying panic erupted recently — a bull stampede that created a micro-bubble in the weekly uptrend line. If this rally fails to hold as it attempts to resolve the bubble toward the multi-week trend line, near-term trading platforms will flip to a short bias. If improving fundamentals do not shore up the rally at its first break, longer duration trend following systems could begin reversing as well. In short, the rally could become unstable, possibly whipsawing as it seeks to establish a more gradual, sustainable uptrend line.

Savvy hedge fund managers will exploit any emerging trend breaks, even if the short term news environment remains bullish on a relative basis. Aggressive exploitation of any breakdown in uptrend lines could undo the Soros reflexivity effect that has been repairing the underlying economy as stock market confidence climbs in the face of weak fundamentals. Consequently, while continuing economic improvement is likely, trouble in the stock market could undo the underlying economic stabilization. The stock market’s continued recovery is predicated upon the maintenance of uptrend channels as bolstered by money flows. In other words, temporary economic recovery may be more dependent upon speculative sentiment than the decision making of government officials. This is a return to the money chasing money game.

The range for stock index equilibrium is debatable. Equilibrium on the DJIA appears likely in the 9,000-10,000 range when one looks at ten year charts. While a bounce to DJIA 10,500 - 11,500 is a real possibility in the emerging economic context, such a bounce would reflect reactionary pricing. It would be a rebound disequilbria — a repercussion of the DJIA’s March spill to around 6,500. Disequilibria pricing is unlikely to hold. A new retreat carries special risks because of the weight of trend following trading systems in the hedge fund universe.

The base building activity for the current rally was narrow. Without further base building the narrowness of the bottom reduces the prospects of an extended bull that could test historic market highs. But history’s ability to forecast this market’s price action is truncated by the emergence of new variables. Hence, it is possible that Wall Street’s major stock indices will NOT retest the March 2009 lows. This does not suggest, however, that the biggest trouble is behind us. The real trouble still lays ahead.

The growing likelihood is that the U.S. government will find itself unable to roll over its debt by 2020 — and maybe much earlier. A good deal depends upon how rapidly the Social Security Administration’s FICA surplus disappears. Once the SSA is no longer in a position to bid for U.S. Treasuries, the U.S. will have lost a great deal of its power to keep interest rates low. The problem will become compounded once Social Security begins competing with the general government as an aggressive borrower.

While the problem could be addressed by raising FICA taxes, it would serve to slow the economy, perhaps costing the government more in lost tax revenue than gained by the tax increase. The Fed could continue with ‘quantitative easing’ (creating money out of the blue), but too much dollar printing will weaken the dollar and inflame speculation in commodities. Crude oil above $100 will undermine the economic recovery and further impair the current account deficit. Thus, because of the oil price constraint, the Fed cannot print its way out of this economic downturn; that is, unless it can protect the dollar by convincing central bankers everywhere to sacrifice their state currencies.

If most countries’ central bankers continue adding liquidity, runaway global inflation will result. The Fed has a strong vested interest in seeing that no such thing happens. The sovereignty of state governments will be laid on the altar long before “price stability” receives the sacrificial dagger. Nevertheless, it is true that inflationary effects are far more widespread than the Fed chooses to notice.

When it became apparent in August 2008 that Wall Street was over-extended, a worldwide credit crisis ensued. Governments converted private debt into public debt as a means of heading off the crisis. The effect of governmental intervention has been to speed the rate at which states around the world are trending toward insolvency.

When the international state solvency crisis arrives it may blossom rapidly or develop incrementally as interest rates climb. In a rapid crisis stock markets may be shuttered before prices tumble extremely far under short-selling pressures. In this case a worldwide financial system restructuring could produce a reopening of stock markets at prices well above March 2009 lows — assuming the current rally continues, albeit with irregular trend lines. However, if the crisis develops incrementally as interest rates grind higher, stock indices could test and break March 2009 lows.

We are in a boar market because the rapidly moving economic recovery must be weighed against the growing risks of crude oil inflation, interest rate increases and eventual U.S. government insolvency. Many traders will conclude there is a lot of bull money to be made before the day of reckoning arrives. Probably so. Yet, the “easy money” may lie behind us in the eight week period where trend-driven speculation made honest wage labor seem dull — such speculation working to undercut the saliency of productive contribution and other essential cultural norms.

A crisis with national economic sovereignty does not require new bear market lows. The economy can improve while the outlook for U.S. economic sovereignty declines, owing to net effects and evolving demographics. Two discrete battles are being fought. The Fed is fighting to return the nation to economic growth, regardless of any prospective loss of economic sovereignty. Conversely, American patriots are struggling to defend the core ideas of America and our constitutional heritage, regardless of the cost to economic growth. The interest of investment bankers is at odds with the interests of populist reformers since the current banking establishment needs an international political regime to harmonize speculative norms.

The landmark agreement reached by the Washington Beltway establishment and the Wall Street establishment is that financial reforms must prevent the crisis of 2008-2009 FROM EVER HAPPENING AGAIN. There will not be a repeat of the recent crisis. President Clinton and President Bush were led into all kinds of errors to insure that incalculable amounts of money could be made by certain interests during the eruptive era of global free trade. President Obama — in spite of being impressively intellectual and honorably intended — is being induced into promoting new regulations the effects of which will be far less populist than widely supposed. In a different environment these regulatory reforms would work to populist ends. But not now! The emerging reforms will work to prevent the general public from ever again getting a chance to throw off its financial lords at their own ruin. What the voting populace will get is the chance to throw off their traditional government when it becomes apparent that government must serve in the role of “the bad bank” that is to be destroyed after becoming the garbage dump of every kind of debt.