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Pushing on a String?

August 25, 2001

Talk about 'climbing a wall of worry'. . . after the Fed failed to chip-away at several pertinent concerns in any way (effectively stating the truth we all know about the U.S. economic condition, and flavoring overseas sentiment a little bit more negatively). It's most ironic that we speculated whether the Fed statement would be off-the-mark one more time, on their realization about negativity, just as it was about recovery in prior statements (much less the multi-month delay in policy shifts last year that investors find still resonating). Indeed, within hours Germany reported things coming back a bit, and even Argentina secured much-needed interim IMF funding. Then, we heard that business inventory data in this Country, continued to migrate lower, a direction we've suspected for awhile, and which could eventually strain-capacity for newer products.

Not yet of course; as we're still in the worry stage, where rating agencies lower paper rates for companies (like Gateway (GW) today, which we don't own, but is notable), and everyone focuses on the cost of money, rather than the expanded availability of it, which is much more important. That's the risk, in fact, as you ponder a larger debt structure, and recognize that this Country's main risk isn't inflation, but deflation. That is the reason we've called upon the Fed, all year actually, to aggressively reflate; not be lulled into some complacent philosophy that merely cutting rates is sufficient here.

As we look at increasing corporate paper moving into 'junk' classification, returns on Government paper are becoming ever-lower, and less compelling. Of course that is a primary directive of cutting rates formally, as inactive asset classes return even less, and then tend to gravitate towards equities. Certainly the adage about at least getting back one's principle applies towards Governments, but now that the Nation's markets have gone through the vast majority (washout finale or not), advantages in hiding will not only become lessened, but may become a liability when the economy recovers. If so, then today's low yields won't be the concern for longer-term paper, it will be drops in principle, if T-Bonds complete an overbought topping formation, and move lower, as yields start to firm. This may not happen for awhile, but that shift is on the horizon.

Meanwhile, a mindset is starting to grow, which postulates that no further Tax Cuts at all are possible for a couple years, as the perceived-surplus goes poof. We've noted that before, but sometimes wonder (well, actually rarely) if politicians really 'get it', as the stimulus and cuts in such scenarios are what helps drive the economy forward in the future, while just that occurrence aids the revenue coffers of the Treasury. Not to do so risks a deeper and/or longer-lasting recession, and that doesn't help revenue at all. Keep in mind that while some politicians fought the last Capital Gains cut, once it was passed, subsequent revenues increased, rather than dropped, partially because it unlocked moribund asset profitability for some, but also increased asset turnover. In essence, such cuts and stimulus have almost always enhanced recovery times rather than retarded them, and done the same thing for the Government's percentages, too.

And of course the entire spectrum of woes stems from the forecast collapse in 1998, followed by a patchwork rebound after the LTCM debacle late in that year, which was embraced for awhile, but which we viewed as possibly akin to the rebound from 1928 into 1929, whereas the internal top was reached back in 1927. Not that numerous or notable similarities extend beyond that, but we did emphasize back in those days (the '90's, not the '20's, thank you) that the inability to keep the market down, was just the kind of false 'confidence emboldening' scenarios that made investors feel impervious to market declines; which of course eventually followed. Here, optimism about rallies is a distant memory, which probably means that's exactly what markets might expect, if not from this particularly upside fling (though caught well), from others that emerge.

Now, while this is the longest period in subsequent (post 1930) history where 7 Fed rate-cuts have failed to move a market tremendously, we would note that outside of an ongoing tech-wreck, the market is not, and has not been, as disastrous as many perceive. That's not necessarily purely optimistic either; it's one of the reasons we've pointed to the bloated 'unkilled' multinationals in the Dow Industrials for example, in a way warning about how everyone has embraced what hasn't gone down, and fled away from the very downtrodden (including those likely to survive this entire morass), which may prove to be a less advisable strategy than is so broadly embraced. (Detail discussion of how this may impact next year is reserved for regular subscribers.)

As for the Fed, keep in mind they've already indicated that (rightly or wrongly) most of the preparatory work to prepare the economy for an ultimate recovery, has been set-in-motion, and that's it's a matter of providing 'time' to work-through inventory, get the benefit of tax cuts (not puny rebates of course), and have things work through natural course of events. Remember, this was the year for consolidation, climaxes, summer's hits, and even bankruptcies; with next year the year for guarded recovery and in time new Capital Expenditures. Because many firms have pulled-in-their-horns, revenues will more easily and readily accrue to the bottom-line when that occurs, contrary to all the negative economic viewpoints on this score. The market's cynicism about all this, besides being seasonal worries of course, is somewhat a reflection on the decline, or essentially the psychological inverse of the topping process. It takes time, but barring the Fed having been so late as to not be able to 'reflate', this will workout a bottom.

If we do get a 'crash' washout first, well, as we noted last night, that would be better as soon as feasible, rather than later. However, if this basically is a retest of Spring lows, you won't get that, at all. And you will simply horse around here, with one of these so-so rallies actually gathering steam as it surpasses resistance; so far not yet doable. But because it is going to occur from one of these, we have taken a stance of buying the purges, taking some gains as or if needed (especially when multiple shots at overcoming resistance are repelled), and just making sure we're not doctrinaire on the negative side, about the time the market is readying something more aggressive on the upside. That's why we emphasize the oversold condition, the Fed-fighting from the bears (whether they realize it or not), and the probabilities the August lows either have or are ending, washout or soon. Then we'll see how well we do the other way in an effort to again challenge progressive resistance and hope one of the moves takes. (As of the moment the 900.933.GENE hotline continues long from Sept. S&P 1158.)

It's probable the Fed exacerbated the selling Tuesday, by virtue of their statement on negativity, and it's important that there was no meaningful follow-through, nor was the pressure on Dollar-denominated assets notable. It helped set-up Wednesday's turn, in ways related to our points about washing things out and having Dollar stability. As for corporate profits being generally horrible; that's not news; and cutting more than a Quarter point wouldn't have changed the situation the Fed helped contribute to by the profligate expansion while they urged prior restraint, a couple years back. Further, as noted Tuesday, because things snapped from the forecast building bubble of the late '90's, this is a scenario that just takes time. And it's very oversold, in many ways, just as of yesterday, and that needed us to enter the market on the buy-side Wednesday.

As for the ongoing debates about what 'condition' our economy is in, well, we're past the time of stagflation; certainly aren't worried about returns to inflation; and continue with non-property-related deflation tendencies, that tend to erode pricing techniques, as they relate to projection or mapping of business and marketing decisions. We've never embraced perceptions that real inflation is caused by too much growth (and hope the Fed hasn't either), while we're believers (forecast a decade ago) that the problems abroad would help contain price levels in products here, whether imported or component parts for domestic-built goods. The Fed is definitely correct when they talk about 'price stability' being about the only 'ideal' condition sustaining some sort of balance and maintainable growth levels. A question is whether M's growth is ample.

This Fed pumped money in, before Y2k at exactly the wrong time; contributing very much to the speculation they concurrently railed against. Now is the right time for the pressure on expansion to be maintained (not rate cuts per se, but monetary growth), so that money won't simply shift and sit in the banks or the portfolios of bond holders, but will become dynamic; moving into the populace (spending) and thus having once more an increased velocity. To do otherwise risks the security of the Nation's future.

In any event, to lower rates and not adequately grow the money supply would be to infuriate an already-evident liquidity gap that has been brewing for sometime (just based on a growth in M's without much improvement in markets, though it's arguable things would have been even worse had the expansion not taken place to the degree it did). That's the kind of thing that can occur in deflations when Feds can't keep up. It is also true that cutting rates without an expansion in the aggregates that gets 'ahead of the curve', is akin to 'pushing on a string'. That's why a Fed needs to cast-aside worries about inflation, or being too conservative, by pumping up money supply flows while not worrying that much about the cost to rent money (rates). They've done that part essentially, and need to do the opposite of superficial Y2k scenarios, which saw hikes in rates while supply grew, but now continue cutting rates, recognizing that is the pushing on a string part, while expanding the M's until they get desired results.

In summary . . . the market was seen as poised to try a washout and turn, and that occurred, moderately, from the precise level desired (SPU 1158), though it didn't have to do that, and also reached the intraday goal of 1170, though it didn't have to do that either, but did. This first effort to turn-up was slightly labored and questionable as we suspected it would be, but if the market can act well on the defensive and then rally again, after (for example) the June Fed meeting minutes, that would be a plus.

McClellan Oscillator data saw obvious deteriorations on Tuesday, and slight rallies on Wednesday, with NYSE data now at +21 and on the NASDAQ at -13. Structure is still neutral, and interesting as it potentially remains much stronger than the perceived sentiment out there about equities, but these are overall 'snapshots' (especially the NYSE) that reflects non-operating as well as operating stocks, as discussed the other night, so that made the NY appear stronger than it likely really was. For the moment, the (900.933.GENE) hotline is long overnight. As of 7 p.m. on Wednesday, futures are up slightly from their regular Chicago close of around 1168 or so.

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