10/5/07

YEEEEEE—HAAAAAAA!

All the pent-up energy building since the dog days of August has finally exploded in a cascade of inexplicable investor frenzy, driving the Dow and S&P back through their July highs and beyond. (Even the Nasdaq is a little over half its March 2000 value!) All this is coming on the back of oil at an all-time high. And gold at a 27-year high.

The US dollar is at an all-time low against most major currencies (touching $1.42 to the Euro). US Treasury prices are on the decline (the yield on the 10-year note is hovering around 4.53%). And the US housing market, long the boost behind the economy lo these last five years, is in its worst slump in history.

Major homebuilders and some large money-center banks are posting horrendous third-quarter results and drawing up layoff lists. The wave of M&A activity which reached arc-welding temperatures in the first half of this year froze solid in August and is only just beginning to thaw. And politicos, pundits, and pugilistic pontificators alike have been whacking around the R-word tetherball again.

What the hell?! Why is this happening? Has night become day, down become up, fuschia become the new black? This has the makings of being one of those bottomless conundrums of the universe, like abiogenesis or the fact that if Pac-Man were three-dimensional, he would resemble a French cream doughnut.

It is the instinctual impulse of Oryctologus cuniculus to discern the cause of the mania, rather than simply embrace it. Dem’s dat does, commences ta perishin’, once the teeth and claws come out. (And they always do.) O, temptation is strong and omnipresent; to just chalk it up to human pigheadedness, as the Financial Times’ John Authers succinctly put it in his 10/3 editorial, “Party Like it’s 1999?”: “The instinctive reaction of many in the fixed income markets is to put this down to stupidity. Equity traders simply do not know what they are doing, or at least do not understand the ramifications of the damage that has been done to the structured credit market.”

Zounds. The bunny thinks the good columnist might be on to something here. For months, he has been experiencing a sense of déjà vu. Maybe it’s been the preponderance of hedge-fund Capulets and Montagues dueling at the Red Cat and Gotham Bar & Grill with flashes of gold and platinum plastic (distinguishable by their French-cuff shirts with dazzling cufflinks, made more visible by the absence of jackets and ties). Or perhaps it’s the eerie similarity, not just to 1999 but early 2002, in which a Fed rate cut dovetailing with a cut on overseas tax earnings pull a US economy mired by recession and the fallout from 9/11 out of stagnation and into—a bubble. (Some have made the case that not only 2001 begat 2007, but 1998, with its rate cut following the Asian financial crisis triggering the dot.com bubble, begat 2001—karma bows to no one.) All the elements are in place—a Fed rate cut, lenient capital-gains tax rates, and a weak dollar which is now favoring large-cap multinational corporations which book a higher percentage of profits from their overseas operations. And the plunging greenback’s overseas effects may not look so bad from a Beltway standpoint. While being able to claim that a weak dollar helps goose exports and lower the trade deficit, it also functions as a tariff-without-a-tariff on those from whom we import manufactured goods (i.e., China), and puts inflationary pressure on those from whom we import commodities (i.e., Saudi Arabia).

This has made for an environment favoring capital flight—whether into the bonds of foreign governments paying higher rates of interest than our own, currencies stronger than our own, or the flavor-of-the-moment investment with the wide-ranging title “emerging markets”.

The bunny does not waver from his dictum that Cheap Money Creates Problems. Bond traders are betting that today’s jobs data will preclude another rate cut at the next FOMC meeting later in the month, but the bunny begs to differ. The next bubble isn’t coming, it’s already here, and the markets setting new records despite the ever-lengthening shadow of the unwinding subprime mess might just bear him out. The hedge funds and buyout firms now squealing like rats in the vacuum of a fast-sinking ship grew out of such a troublesome witch’s cauldron. Capital is no longer flowing into the US in record amounts, but out of it.

And yet Wall Street is whooping it up like the cowboy out on the town at the beginning of Near Dark, and he got exactly what he was looking for. The game will end (and it always ends) once the money stops being cheap, and the signals of the tightening that precede it are already evident. The bunny is well-attuned to listening for the sound of bared fangs in the night, and he knows that no amount of whoopin’-it-up can stave off the whuppin’ those pointed canines carry.

But hey, who’s worried, really?

A selected bunny bibliography:

“What Bad News? Stocks Roar to a Record High” by E.S. Browning and Justin Lahart, Wall Street Journal, 10/2/07

“Party Like It’s 1999? Faith in Emerging markets Fuels an Equity Market Rally” by John Authers, Financial Times, 10/2/07

“Dow Hits Record Despite Losses at Big Banks” by David Reilly, Robin Seidel, and Carrick Mollenkamp, Wall Street Journal, 10/2/07

“Stock Strength Seems to Belie Economic Reality” by Justin Lahart, Wall Street Journal, 10/1/07

“Multinationals Drive US Rally on Weak Dollar” by Francesco Guerrera and Michael Mackenzie, Financial

Times, 10/3/07

“Emerging Markets and Oil Bubble Up” by Justin Lahart and Joanna Slater, Wall Street Journal, 9/20/07

“World Economy in Flux as America Downshifts” by Michael M. Phillips, Wall Street Journal, 9/20/07

“Falling Dollar Squeezes US Trade Partners” by Joanna Slater, Wall Street Journal, 9/21/07

“Our One-Dollar Dilemma” by Judy Shelton, Wall Street Journal, 9/27/07

“Housing Chill Grows Worse, Bites Consumers” by Sudeep Reddy and Michael Corkery, Wall Street Journal (date unknown)

“Merger Frenzy Winds Down After 6 Years” by Dennis K. Berman, Wall Street Journal, 10/1/07

“Treasurys in a Fog Over Rates” by Deborah Lynn Blumberg and Laurence Norman, Wall Street Journal, 10/3/07

“Stocks Rise, Through it All” by Peter A. McKay, Wall Street Journal, 10/1/07

“Cautious Words from a Chastened Bull” by Henry Blodget, New York Times, 10/3/07