O'Neill -shades of William MillerUS Treasury Secretary, fresh from his extended jaunt around Africa in the company of rock singer named Bono, continues to talk up the US economy and the stock market with sound bites, many of them inexplicable to the economically literate. He topped his dubious record last week with the comment that he thought the movement in the markets was inexplicable.
He acknowledged that there were clouds over the US economy in the shape of fears of further terrorist attacks and concerns over corporate governance but that the markets should reflect the underlying 'strength of the US economy'.
A number of comments can be made about this: first, the health of the US economy is questionable, and owes more to a dubious policy of encouraging Americans to go ever consume ever more by going to historically uncharted levels of debt. That string is about played out as job fears remain unabated and a corporate profits rebound recedes like a desert mirage. It has created a massive new bubble in the housing market, which, in turn, is also leaving in its wake possible massive financial problems. These include government sponsored mortgage enterprises, such as Fannie Mae and Freddie Mac that have been reduced to the state of Government sponsored hedge funds akin to Long Term Capital Markets (LTCM). But it also includes such establishment organisations as J P Morgan Chase, the blue chip organisation that has a mere USD 40 billion worth of capital supporting a derivative book of almost USD 30 trillion. For the mathematically challenged that is a 750 to 1 ratio, orders of magnitude more than LTCM.
Second, even this Secretary, who hails from Main Street not Wall Street, should realise that the day-to-day, even the year-to-year, movements in the real economy have only a very loose and imprecise correlation with the financial markets. After the longest, wildest bull market in history that extended from 1982 to 2000 the excesses in the US financial system are of such epic proportions that the US will be lucky to avoid the fate of Japan in the 1990s, after its bubble burst.
The stock market obviously suffers from excesses when it goes up and when it falls. It responds to the universal and timeless emotions of greed and fear. Unfortunately, the stock market, whilst down about 40 percent from its 2000 peak as measured by the Standard and Poors 500 index is still selling at a multiple of honest core earnings of about 40, whilst its long term average is closer to 15. The good Secretary should be fearful that the piper has not been paid and the likelihood is that things will get worse, possibly very much worse, before they get better.
Confidence in the US economy is slipping. The economy, which needs to import USD 1.5 billion a day to feed a USD 500 billion current account deficit, is now having trouble attracting foreign investment. This is slipping badly this year and the dollar's exchange rate is now reflecting this fact. The Rubin bull market in the dollar that began in 1995, when the US dollar index was around 80 and the it took 78 yen and the synthetic Euro equivalent was worth 1.4 dollars, now appears to have reversed. The yen fell to 145 at its weakest and the Euro to 82 cents. The yen is now 125 and the hapless Euro has climbed back to 96 cents. It is not impossible that the complete seven years bull market in the dollar with effectively round trip over the next few years. Gold could well have a glittering bull market as investors move to the asset of last resort in the face of increasing financial volatility.
Secretary O'Neill is now likely to be blamed for continued weakness in the stock market to which Americans are far more exposed than other nationalities. This, in turn, may tempt the Government to become more interventionist and attempt to support the market through direct and indirect intervention. There are increasing examples of a movement away from market fundamentalism in terms of steel tariffs, increased agricultural subsidies. There are also examples of government jaw boning in the markets, use of moral suasion and possible arm-twisting of participants through the shadowy Plunge Protection Team, supposedly working out of Secretary O'Neill's own Treasury.
Secretary O'Neill cannot be blamed for the bubble and the aftermath. He can be blamed for not recognising the problem and coming clean about the problems when he came to office, blaming it rightly on the Clinton Administration. The voters no longer remember Clinton. But they are likely to blame O'Neill and his boss if the markets suffer their inevitable hangover, when the real blame should lie with Rubin and Greenspan. His performance is reflective of the unlamented William Miller in the Carter Administration. (Gold reached $800 under his expert management.)
The process is looking more and more a repeat of those of Japan over the last decade.
We continue to favour gold and gold shares, especially unhedged South African shares such as Harmony, Goldfields and Durban Deep and Canadian juniors. We also like selected positions in Asian emerging markets, especially India and Thailand based on value criteria. On currencies, we favour the Euro, the Canadian, Australian and New Zealand dollars.
William R. Thomson
24 June 2002
Bill Thomson is Chairman of Momentum Asia, a distributor of Momentum's conservative (non-leveraged) alternative investment funds. He is also Chairman of the Siam Recovery Fund and advises governments and institutions in Asia. He was formerly Vice President of a major international bank in Asia and is a former US Treasury official.
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