Navarro

 


Navarro’s Market Rap:  An Economic Colossus in Crisis

           


“{N]o government anywhere in the world can go on taxing and spending as if its
is still operating in yesterday’s economy.” … “If the United States is to
remain an economic colossus, its fiscal authorities, like its central bankers,
will have to become paragons of prudence and restraint, implementing policies
that will put the nation in a position to bolster, not hamper, its competitive
edge.”


Richard W. Fisher, President and CEO, Dallas
Fed

 

Two weeks ago, when I argued that the
short side of the market indices now have a better risk to reward than the
long side, I took a broadside from a few ungentle readers — and a public
whipping on KNX for my bearish perspective.  Well, excuse me.   As the market
got further unglued last week, I continue to believe this is the case and will
judiciously add to my Nasdaq short.

 

And by the way, many
analysts and pundits are blaming rogue remarks from the Dallas Fed President
for last week’s market fall.   Guess what: It’s not what he said.  It’s what
he (and me) is seeing.  With sustained energy and commodity price shocks and a
rising structural budget deficit, we are being set up for a rerun of 70s style
stagflation.

The Week Ahead: An Atypically Meaningless
Jobs Report

 

Discriminating minds might find the
Fed minutes to be an interesting read next week — what with all the Fed
hoopla.   That said, the big report of the week will likely be the trade
report.  Any unexpected increase in the deficit will lead to weaker
dollar-more inflation worries and feed the inflationary worries scenario.  
Retail sales on Friday and the U Mich sentiment numbers are also always worth
watching.

Peter’s Portfolio: Shorts and Longs

 

My cubes short is now slightly in
the green while SVA continues to ramp up — albeit with a little healthy profit
taking last Friday.  Still looking to add to ARDI this week.   Watch it now
because if it starts running up in anticipation of the Oct. 27 earnings call,
you know that the insiders are making a buck.

Holding ARTX, ASTM, LVLT, EWG, and
EWJ.  Sure would like to get a little inspiration for a new stock but the fact
that I ain’t seeing anything is an indicator in and of itself….

 

Hedging Your Bets
With Matt Davio: That Was Then…

To look forward, we sometimes need to
look back. But one lifetime is not enough. Call me old-fashioned, but the
years of the roaring ’20s and the stock market and huge spending boom which
preceded the 1929 top do seem to foreshadow the period we are living through
now.

 

After the Tech and Internet Boom of
the 1990s, the market peaked and the stock market bubble burst. We now
remember 2000 ushered in a two year plus stock market slide, but nothing to
rival the Wall Street Crash of 1929-1932. The generosity of our modern Federal
Reserve has, so far, saved us from a slide into economic crisis. People have
kept spending, using cheap borrowed money, and easy credit supported by rising
house prices. As I write this, the property bubble is still growing, and our
American dream of never-ending abundant times are still intact. In those older
days of my grandfather’s youth, people were also ambitious and optimistic.
They traded up when possible, and borrowed money if needed, in order to
improve the quality of their lives.

 

 Within a few months, the economic
climate had changed, and my grandfather lost his job, making it impossible to
keep up the payments on a new car along with the new cars of many other
unfortunates who also lost their employment and their regular wages. And with
the job losses, the stock market crash of 1929 morphed into a severe downturn
in the economy.

The slowdown was aggravated by a
collapse in credit. In the roaring twenties, it was easy to borrow money, for
building new homes or buying new cars. Some, like my grandfather who had
worked as a mason, got credit beyond what that they could readily service. So
when the work dried up, and money got tight, the payments became impossible.
In the thirties, America became glutted with repossessed cars and houses for
sale. Demand for new products faded, and the wheels of industry slowed to a
crawl.

In Greenspan’s case, the motion he is
seeking is that of dollars, since the economists of our time bizarrely measure
growth in our economy in terms of spending, not in the number of jobs being
created domestically. Greenspan’s wheel was set in motion in the 1990s and
early years of this new century, when the Fed made repeated cuts in interest
rates. Lower rates, have worked like the accelerators on the economic machine,
triggering spending spurts as homeowners refinanced their mortgages. But this
Greenspan mechanism may meet the same fate as did great Grandpa’s generation.

 

Like the aggressive home and car
buyers of the 1920s, people of our time have believed it is safe to borrow
aggressively to improve their lifestyles, particularly when their homes have
risen in value. Higher debt levels in a falling interest rate environment
often come with little or no increase in monthly mortgage payments. So why not
take the extra money, by borrowing more, when it seems it will be so easy to
repay through a fixed payment, backed up by the security of a
fast-appreciating home.

 

It is not a closed system, nor is
this financing done in a vacuum. Money borrowed through our modern refi’s has
gone only partly into property investments. Consumer spending has shot up
also.

 

An important part of that money has
circulated out of the US to China and Japan to pay for the imported goods that
keep flowing into our country. Fortunately, our new bankers in the Far East
also want to keep the big wheel turning, since from their point of view, all
those exports to America create jobs back in China and in Japan. They also
realize that the competitiveness of their goods in the global market might be
endangered, if their currencies were to rise sharply against the dollar. So
they have been investing their growing surpluses of dollars back into the US,
usually buying Treasury Bonds. And this recycling operation has seemed like a
virtuous cycle for the US economy. Strong foreign buying of bonds, have
allowed Greenspan to keep both long and short term rates down. Confidence in
the momentum of the economy has grown, even though actual job creation has
remained anemic, weaker than is normal in a recovery coming out of recession.

 

The net result of the action of
Greenspan’s money machine is that Debt has grown in the US, while China and
Japan have accumulated massive holdings of US debt. Meantime, other investors
seeking better returns than on US government T-Bonds, have gorged themselves
on mortgage-related debt, the product of the refi boom. By mid-2004, U.S.
Household debt had risen to 86% of GNP, up from 64% just ten years earlier,
and foreigners hold a majority of US treasury debt, up from almost
insignificant amounts in 1994. (source: Comstock Partners, as quoted in
Barrons
, 25 Oct.2004)

 

So the wheel turns round and round,
with consumer goods flowing into our country. Because the money flowed back
from exporting countries- we have paid for purchased goods, not through
working and earning higher incomes, but simply by increasing our debt. So far,
this vendor finance, recycling operation has seemed painless. For a long time,
we hardly noticed as debt built-up rapidly in the form of increased household
mortgage debt and as massively increased liabilities of the US government. But
the bad news is that, slowly and quietly, the US has lost control of its own
destiny.

 

The economic models couldn’t get his
wheel to turn forever. And neither will Mr. Greenspan be able to keep the
foreigners money rolling into a profligate consumer economy. At some point,
the Chinese and Japanese will lose their appetite for US debt, and when that
happens we are likely to see a sharp collapse in the dollar. When that shock
hits, interest rates may need to rise to much higher levels to bring our
lenders back. And high rates will have a potentially disastrous impact on our
overheated housing market and the fragile US economy which has lost so much of
its manufacturing industry to workers in foreign countries. Meantime, the US
debt bubble grows inexorably, and the system becomes more unstable.

 

The inevitable friction reveals
itself in higher commodity prices, as the Chinese appetite for commodities
like Energy and Metals grows along with their expanding economy. They are
beginning to realize that it is better to hold commodities that they need to
fuel their economy, and gold which holds its value, rather than dollars which
are backed by nothing more than a future promise to pay.

 

I wonder what will happen to
Greenspan and our economy, when we wake up and discover that the wheel that
keeps turning on cheap money and seemingly-perpetually growing debt cannot go
on growing forever. The excess of the Twenties, were followed by the Long dark
days of Depression. Our excesses will also bring a long period of repair and
correction too. I can only hope it will not bring on another depression.

 

I am amazed when I recall that our
modern concept of "core inflation" excludes food and energy. As if we could
ever get by without these items. Instead, our current low inflation has been
kept low by all those cheap things, from clothes to shoes to phones, which can
be manufactured in China, which is maintaining its currency link to the US
dollar, perhaps artificially, by recycling all those excess dollars from
export sales to us.

 

It does sound bleak, and very
miserable. But the human spirit does not get crushed so easily. When everyone
is enduring hardship together, something often blossoms from hardship:
co-operation, generosity, and a sense of kinship.

 

If hard times do return to America, I
believe that once we get over the initial shock over the changes in our living
standards, things will be alright. In times of abundance, we forget our
neighbors. In times of hardship, we remember them, and they remember us. Then,
maybe the true spirit of America can be reborn. America the wasteful, and
America the world’s policeman, can both be assigned to the dustbin of history.
A new America, with a bigger purpose, can then emerge: the historical America
of the inventive spirit. We can help ourselves and the world to find and build
new forms of energy which will be less wasteful of limited resources, and
kinder to future generations and the flora and fauna with whom we share the
planet.

Peter Navarro is a business professor at the University of
California-Irvine (
www.peternavarro.com). 
Matt Davio is a managing partner at the hedge fund, Red Rock Capital Fund. For
investment management services, contact Matt at

redrock@peternavarro.com
.   Contact Peter at

peter@peternavarro.com

 

 

DISCLAIMER: This newsletter
is written for educational purposes only.  By no means do any of its contents
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instrument whatsoever.  Trading and investing involves high levels of risk. 
The authors express personal opinions and will not assume any responsibility
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