STOCKS

The DJIA, Nasdaq, and S&P 500 all remain in a strong technical position despite broad macro-fundamental headwinds. The big debate now is whether a bottom -- or a false bottom -- has put in. You can argue it persuasively either way – which means it’s a tossup from a risk/reward perspective. That, in turn, means that cash still remains king unless you are a very short term trader.

BONDS

After more than two decades of a bull market in bonds, we may now be entering what is likely to be a long term bear market. The culprit is “cost push inflation” putting upward pressure on yields and downward pressure on bond prices.

Like “moral hazard,” which became the pundits’ favorite buzzword in the midst of the credit crunch, “cost push inflation” will be fashionable on the tube and in the papers over the next some months. Cost push inflation comes from increases in the prices of production inputs like energy and natural resources. It may be distinguished from “demand pull inflation,” which is too much money chasing too few goods when an economy is growing robustly. 

Demand-pull inflation is easy to cure. The government just raises taxes or interest rates. This triggers a contractionary shock and this type of inflation eases as economic growth slows.

Cost-push inflation is a totally different matter. The worst case scenario is when you have cost push pressures AND a slowing economy. That’s the “stagflation scenario.” 

Right now, cost push pressures are building throughout the world. The deflationary basket case of Asia – Japan – just saw the first rise in core inflation since 1998 because of non-core elements creeping into the core. Not surprisingly, this inflation news triggered the worst one-day fall in Japanese bond prices in five years as yields rose significantly. 

The Big Picture 

It’s easy to get lulled into a false sense of security with the U.S. stock market indices bouncing nicely up. However, there are too many damn and disparate pressures building in the U.S. and globally to get really comfortable with any bullishness. 

• Much of Europe is facing strong inflationary pressures even as Spain and Italy circle round the fiscal profligacy/housing bubble drain. 

• Much of what we used to call the “Third World” is suffering from high food prices and protests – with a ripple effect of government interventions bound to totally screw up world grain markets. .

• China and Vietnam are experiencing their worst inflation crises in decades. Remember that Tiananmen Square was not about democracy but inflation. 

• The U.S. consumer continues to fade out of the picture, making a quick recovery all the more uncertain. 

• OPEC won’t produce more, Russian production has begun to fall, and Venezuela provides a textbook case in how nationalizing oil production winds up reducing production and revenues. 

• Talk of nuking Iran continues to heat up in the face of Iranian nuclear proliferation. 

I could go on…but you get the idea. 

QUICK TAKES

1. A week after my lament about Peggy Noonan’s column was relegated to the WSJ back pages, she gets put on the main editorial page for the week. The irony is that it was her worst column of the year. 

2. My over-arching point on the Clinton-Obama dustup is not about which candidate would be a better president. It has simply been that Obama, with his inexperience, is going to get easily ground up by the Republicans leading up to the November election. That this SHOULD be a major concern to even the most ardent Obama supporters should be evident in the various events of the last few weeks and the hits Obama is taking. Super delegates take note. 

3. Dem Chairman Howard Dean is causing a lot of Dean-like screeching on the Obama side of the ledger. In a Financial Times interview, Dean was quoted as saying the super delegates should vote for whoever has the best chance of winning the November election – not who wins the most regular delegates or popular. That’s a sharp counterpoint to Nancy Pelosi’s dictum. 

4. Keep your eye on CYD, China Yuchai. It was one of my picks last week on CNBC. Nice story stock about diesel provider of choice in China. 

5. How about we wake up and stop subsidizing the use of corn to produce fuel. It’s a net negative on both fuel efficiency and environmental grounds.

“Any trader or investor who ignores the power of macroeconomics over the world’s
financial markets will, sooner or later, lose more than they should—and if they are
trading on margin, perhaps more than they have.”
 -- If It's Raining in Brazil, Buy Starbucks

The Market Edge Market Summary from www.marketedge.com 

CONTACT INFORMATION
Peter Navarro
Irvine, California USA
Email  |  Website

DISCLAIMER: This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling, or holding of any financial instrument whatsoever. Trading and investing involves high levels of risk. The authors express personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The authors may or may not have positions in the financial instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future performance.