Please, click here to read this article in pdf format: september-15-2009

The week started on a positive tone, with plenty of optimistic outlooks, new trading recommendations, updated views on every market as well as the political front. Before we can add anything, let me mention that yes, I did notice that almost every market analyst on Monday attributed Friday’s sell-off to President Barack Obama’s imposition of tariffs (starting at 35%) on tire imports from China.  The decision backed a United Steelworkers union complaint.
Thus, after reading the news, I wondered why I would have not seen the connection between the new tariffs and the sell off I commented on yesterday’s letter (www.sibileau.com/martin/2009/09/14). Yesterday, I browsed the Bloomberg News application and found out that the announcement had first been officially released on Friday at 9PM Easter Time. Yet, Friday’s sell off was triggered at 11AM, right after the Fed purchased Agency debt. Furthermore, the sell off was significant and in EVERY relevant market: FX (vs. USD), oil, equities, credit, etc. How could an announcement on new tariffs that affects only $1.7BN in imports (as reported by Bloomberg) have caused a worldwide sell-off ten hours earlier? On the other hand, the complaint had been already filed in April of this year, and the Obama Administration had until September 17th to make a decision. Perhaps I am wrong, but I find it way more likely that a worldwide sell-off be caused by a sudden change in the outlook on quantitative easing policies than a tariff announcement on a trade of $1.7BN per year on rubber tires.  However, I perfectly understand the negative reaction on Monday morning to this announcement, which challenges the cornerstone of policy response during this crisis, namely international coordination.
Now, why am I confident the outlook may have changed? Yesterday, and in line with my comments, Richmond Fed President Lacker speculated the Fed may not end up purchasing the entire $1.25Tr of Mortgage-backed securities, during a speech at the Risk Management Association of Charlotte, North Carolina (It was not explicit in his speech, but a reputable analyst at an also reputable investment bank reported this as having been “commented”. For transparency, I let the reader decide. The speech can be found at: http://www.richmondfed.org/press_room/speeches/president_jeff_lacker/2009/lacker_speech_20090914.cfm)

Proceeding now to review yesterday’s action, I think one word says it all: Liquidity! Yes, the 3-month Libor – Overnight Index Swap spread reached a lower low, at 11.85 bps, as 3-mo Libor hit 29.5bps! As we wrote on September 9th (www.sibileau.com/martin/2009/09/09 ): “ …going forward I don’t think liquidity will have the power to fuel the rally to new highs, as the law of marginal returns kicks in, but at least forms a formidable wall against any rebellion…”. We had a rebellion on Friday, but liquidity ruled and we saw the S&P500 again reach for the 1,050pts and the CDX IG Series 12 touch 105-106bps.
This macroeconomic backdrop has forced a multitude of analysts to update their forecasts. At “A View from the Trenches”, we don’t have to do so, for we understand that there is nothing more practical than a good theory. Thus, after having read at “Human Action” (1949) from Ludwig Von Mises (highly recommended) and Gottfried Haberler’s, “Money and the Business Cycle” (1932) a long time ago during our time at the University of Buenos Aires, we wrote back on April 14th (our first letter) that: “…We will keep reading the bearish comments from those who see a bear market rally in stocks, as they single out all the horrifying figures of the real estate, labor, retail, etc. markets. There is nothing wrong with those figures, but this is not a bear market rally. It’s just the “relative” inflation Gottfried Haberler wrote about 77 years ago… In conclusion, as long as the Fed and all the other central banks keep flooding buckets with liquidity and feed us with daily announcements, we can see prices NOT falling…” In the meantime, most analysts at the major investment banking firms are unanimously constructive or “cautiously optimistic”, given the success of the quantitative easing policies worldwide.

I would like to continue writing here, but I am afraid I will have to defer to upcoming letters. But there is a lot more to say to this new stage we are in. To begin with, a recent wave of M&A activity is telling me we are about to enter stage 4 of the inflationary process, as I first laid out exactly five months ago, on April 14th  (www.sibileau.com/martin/2009/04/14).  If this wave is solid and the Iranian threat does not become a reality and/or politicians do not destroy what they have achieved so far, we may see a surge in capital expenditures, we may get closer to a rise in intermediate/capital goods and energy prices, and finally see the famous CPI numbers tell us that inflation is with us to stay. It takes time, but we are patient, particularly when we profit from patience.

Finally, an interesting development is taking place in interest rates and credit curves, which I intend to address shortly. In the meantime, for reference if you are interested, you can read about the origins of such development on our letter from May 7th (www.sibileau.com/martin/2009/05/07).