Please, click here to read this article in pdf format: october-6-2009

I think at this stage, a brief summary of our latest thoughts since our last update (Sep 22) is warranted. This may read like a monologue, but I only want to put forth the main ideas developed since then, and what may come in the near future:

-Neutral on equities:
Since September 22nd , I have turned neutral on equities (S&P500). So far, the market is telling me I was right. With yesterday’s bullish action, I now would like to see the S&P500 close above 1,044pts on three consecutive sessions, before I review my opinion. What made me turn neutral? Unlike the bears out there who predicate on fundamentals, I did not turn neutral based on macro data, or lower-than-expected revenue or earnings or even increased probabilities of default. No! I turned neutral because I believed in the weight of these three factors: No clarity on exit strategies, dispersion in monetary policy answers and increasing political instability (refer www.sibileau.com/martin/2009/09/23 ). So far, all three factors are proving their collective merit. The late uncertainty over the speed or timing on exit strategies has bred a renewed debate over the future of the USD. In the last days, every research note on rates or macroeconomics deals with the subject. At “A View from the Trenches“, we dealt with it two weeks ago! This brings me to my next point:

-Gold:
In relation to the dispersion on monetary answers, I wrote about the weakness in the Sterling Pound and commented on Robert Mundell’s recommendation to fix the EUR-USD exchange rate. Although an interesting idea from a theoretical perspective, I did not consider it feasible on political grounds. As I showed that gold had sold off on Thursday Sep 24, right after Mundell’s comments published at 8:53am (or was it coincidence? Feedback welcome), I concluded that since the convertibility of the Euro was not feasible, gold represented an opportunity (refer www.sibileau.com/martin/2009/09/29 ). Since then, the price of the ounce rose from $992 to $1,017 (+2.5%, in the last four trading sessions).

-Liquidity:
Lastly, as my view was not based on fundamentals but on liquidity, on Sep 30th (www.sibileau.com/martin/2009/09/30 ) we noted that the trend on the 3-mo Libor – OIS spread had reversed, rising from 10+bps to 13+bps (On this particular issue, on its Oct 2nd publication, Bank of America’s Global Rates Strategy Team wrote an interesting comment about its implications for curve modelling). Simultaneously, the US yield curve had become flatter. A lot about liquidity has been published recently, with analysts keeping track of funds flow, issuance levels, analysis on the results of quantitative easing programs and comments trying to elucidate what central bankers are trying to communicate without saying anything, etc.

Thus, without any major guidance, the market has started a slow attack on the USD. The recent activity in equities and credit is nothing else but the reflection of a vote on a weakening currency. As such, I cannot interpret yesterday’s gain in the S&P500 as a “rally”. In terms of gold or other currencies, the picture looks different.

In my view, all the liquidity programs thrown at us have left us without sound money, if you think of money as “the” medium of indirect exchange. Central banks have denied us the right to “measure” fundamentals. Asset prices are meaningless except on a relative value basis, without any relation to productivity (following Wicksell’s notion of “natural rate of interest” or even what Keynes called “the shape of physical supply functions”, in Chapter 13 of his “General Theory”). However, productivity rates do exist. In the meantime, we are thus left to navigate in an undetermined world, because we have more unknowns than equations to answer our questions. Where is the “determinant” for this algebraic system? It is neither in gold (yet) nor in currency crosses (they are undetermined by definition) or fiscal policies. The determinant will come and introduce itself with the release of Q3 earnings. Are we ready to accept it?