Lets Look at the big Game - A Top Down Look at Stocks

There is a lot going on and things can go a lot of different ways. Parts of the economy are going into slack demand and higher prices, I think that is called inflation or maybe currency devaluation, but that is what we see in commodities, basic materials, and gold.

International markets may demand that interest rates go up, and if the Federal Government cannot afford to buy so many mortgages in the RMS market then that could cause mortgage rates to go up, and this could hurt housing prices, then impact the economy. I think that with gold and commodities surging then one should be wary of real estate, home builders, home improvement retail. There are real risks and real pressures which could exert negative impacts on these sectors.

Its really strange to see commodity and basic material stocks rising at the beginning of a economic cycle, usually these stocks are late cycle stocks. The China growth story is still in effect that was the driver for these stocks before the crisis and it may still be intact. The other reason could be the massive liquidity injected into the market trying to find a home.

Its something to ponder and in away it is a form of inflation. To much money in the hands of people leads to CPI inflation, to much money in the hands of banks may just lead to inflation in certain stocks.

So in normal recessions, banks are doing good, due to the spread on money because the Fed has dropped interest rates very low, and banks are making money on the steep interest rate curve.

Well, at this point home builders are usually a good buy; does that look like a sector that will rally in 2010? Not really. How about in Brazil? Gafisa is homebuilder I have kept my eye on for years. I understand that condo prices in Hong Kong are the most expensive in the world, so maybe Chinese homebuilders, or realty developers would be a good place to invest. Auto stocks have been a good place to invest in the early part of recoveries. I have noticed the rising shares of Honda and Toyota, although these are levered to the U.S. market, once again a pure auto builder in China may be a good place to look at.

Lets look at U.S. debt and interest rates. The short end is nearly zero and the long end is low and falling. There are few potential signals that are being telegraphed. Investors are supposedly buying the short term paper to avoid being bite by inflation. Investors are supposedly buying the long dated (10-year treasuries) in anticipation of worsening economic conditions, such as a full onset of deflation or a worse business contraction due to the increasing unemployment rate. This doesn’t square at all with the stock market rocketing up for the supposed reason of seeing a sharp V-shaped recovery somewhere.

Something Gotta Give
It appears the market has something for everyone these days, the doom and gloomers can point to the interest in buying long dated U.S. debt bodes ill, but the stock market is anticipating a sharp recovery with positive signs being scene everywhere.

Tying It Together
I have seen some speak about an inflationary depression, and I have noted there are clearly sectors experiencing inflation, Oil, without the growth boom of a few years ago and there are a lot of sectors still contracting. The world maybe in the state of a depression with a general flight from currencies giving the false growth signal of inflation in energy, basic materials sectors.

So if we assume that market forces were to resume, and the dollar sell-off prompts the Fed to raise short term interest rates. Now the steep curve doesn’t look so steep and banks are immediately impacted. Supposedly banks are collecting savings and paying out very little with the nearly zero interest rates and then are buying treasuries at 3.8%. This is a nice riskless spread. So now banks loose a revenue stream, do they stop buying 10 year treasuries and lend, pumping credit, dollars and ultimately inflation into the system? The yield on the 10-year could then rise rapidly. The USD has traded as a function of liquidity, not as a function of the yield on treasuries versus other higher paying currencies. So maybe the USD weakens even in spite of rising interest rates, that is a negative feedback loop and we could see interest rates quickly spike higher then we would expect.