Today's Market Observation  10.08.2009  Mon  Tue  Wed  Thu  Fri  Panzner Archive

Signs of Trouble

BY MICHAEL PANZNER | october 8, 2009

The latest results of Washington’s spending-and-borrowing spree are in and, as you might expect, they don’t look pretty. According to the Congressional Budget Office, the U.S. budget deficit hit a record $1.4 trillion in the fiscal year just ended; at 9.9% of gross domestic product, it was the largest such shortfall since 1945. In addition, September’s monthly deficit was the 12th in a row, a losing streak that has not been seen in least four decades.

More ominous, perhaps, is the fact that the FY 2009 deficit turned out to be just over 40% of outlays. According to research highlighted by Hayman Advisors in their October Letter, the fact that such a sizeable share of government spending is being financed with borrowed money has, historically at least, been a harbinger of trouble ahead:

There have been 28 episodes of hyperinflation of national economies in the 20th century, with 20 occurring after 1980. Peter Bernholz (Professor Emeritus of Economics in the Center for Economics and Business (WWZ) at the University of Basel, Switzerland) has spent his career examining the intertwined worlds of politics and economics with special attention given to money. In his most recent book, Monetary Regimes and Inflation: History, Economic and Political Relationships, Bernholz analyzes the 12 largest episodes of hyperinflations - all of which were caused by financing huge public budget deficits through money creation. His conclusion: the tipping point for hyperinflation occurs when the government's deficit exceed 40% of its expenditures.

Given the extremely bad habits Washington has adopted during the past two years, one has to wonder, as Hayman Managing Partner Kyle Bass puts is, whether America has “reached the critical tipping point”?

It’s possible, of course, that the prospect of hyperinflation in the U.S. is what is emboldening the equity bulls who view each and every negative data point as a reason to buy stocks. While it is hard to say whether we’ve reached the point where the crowd is convinced that share prices are never going to fall again, one interesting indicator, the MarketPsych Fear Index, does suggest that “fear” is no longer in many investors’ vocabulary (According MarketPsych LLC, the graph [below] shows a 10-day exponential moving average of the percentage of "Fear" words in the U.S. financial news displayed over a candlestick chart of the Nasdaq 100 ETF, with the relative percentage of Fear-related words on the left y-axis and the QQQQ value on the right y-axis):

(Source: http://www.marketpsych.com/mkt_analysis.php)

Still, while share prices remain remarkably resilient, that doesn’t mean we aren’t seeing some bearish warning signs. One example includes a shift in the relative performance of two key S&P 500 sectors since equities bottomed in March. During the early stages of the rally, financials, in particular, and technology stocks outperformed the broad market. More recently, however, these two groups have been treading water or drifting lower, depending on your perspective. While optimists might see this as a sign that the bullish baton is being passed to other sectors, I’m not so sure.

Finally, while spot gold closed at another new high, mining shares have not yet done the same, despite the fact that they have been rising at a faster pace than the yellow metal for almost a year. The point, of course, is that the two markets don’t always move precisely in line. That means if we experience another bout of turbulence like we saw a year ago, the shares could be more exposed than the underlying commodity.

Stocks ended modestly higher, aided by positive results from Alcoa, reports that Washington may extend the tax credit for new home buyers, and a slightly better-than-expected reading on weekly jobless claims.

At the close, the Dow Jones Industrial Average rose 61.29 points, or 0.6%, to 9,786.87. The S&P 500 Index climbed 7.90, or 0.8%, to 1,065.48. The Nasdaq Composite Index gained 13.60, or 0.6%, to 2,123.93.

December gold futures jumped $12.00 to $1,056.20/oz., while the U.S. Dollar index slid 0.6% to its lowest level in more than a year. Ten-year Treasury yields increased 7 basis points to 3.25% and November WTI crude oil futures surged $1.86 to $71.43/bbl.

Michael Panzner
Author, When Giants Fall and Financial Armageddon

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Michael Panzner
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