"This Week: Ben Backed Into Stagflationary Corner" by Peter Navarro, Ph.D. FSO Editorial 06/09/2008

THIS WEEK: BEN BACKED
INTO STAGFLATIONARY CORNER
The Well-Timed Strategy for Week Ending June 7, 2008
by Peter Navarro, Ph.D.
June 9, 2008

Last week’s roller coaster cum bloodbath on Wall Street gives us a beautiful case study in the art of macrotrading and the importance of economic factors shaping market trends. The case study started last Wednesday with Fed Chairman Ben Bernanke’s professint not only rising concern with inflation but also a desire to shore up the dollar. Of course, it has been Bernanke debasing ye olde greenback through his over-aggressive rate cutting. With Bernanke now drawing a line in the shifting sands of fortunes of the dollar – a marked policy shift for the Fed -- the markets reacted just like the macrotrading text book indicates:

In particular, the dollar strengthened on the prospects of higher U.S. interest rates. This, in turn, sent oil and commodities prices, which are priced in dollars, down the chute. The U.S. stock market then rallied on the prospect that the oil bubble might be now burst, and the contractionary effects of high oil prices would be moderated.

Ah, but what a difference a day or two – and one horrific economic report – make. On Thursday, the ECB President warned of a possible rate hike. This gave a boost to the euro at the dollar’s expense. Then, on Friday, the jobs report came in with recession written all over it – with the unemployment rate jumping to 5.5% from 5%. With this single report slaying expectations of a Fed rate hike coming soon to fight inflation, the dollar fall was accentuated. Oil prices, in turn, spiked not only on the weak dollar news but also some saber-rattling by Israel over Iran’s nuclear program. The end result was a Friday bearish trifecta of 3% drops for the Dow, S&P, and Nazz.

So here’s where we stand. In the ongoing battle between our three possible economic scenarios – U.S. recession drags world down, global decoupling, and stagflation -- the clear winner last week for the second week in a row was stagflation. As I have previously lamented, this is the worst possible scenario for bulls because it is impossible to cure with discretionary policy fixes. Rate cuts exacerbate inflation and rate hikes exacerbate recession.

In fact, it is becoming increasingly obvious that Bernanke is being backed into a stagflationary corner. Last week’s desperate save the greenback gambit perfectly illustrates this point. No doubt, Greenspan’s favorite fall guy, AKA Helicopter Ben, was likely quite positive that his support for the dollar would make all things rights. Pity the fool – except when we are his victims.

As for next week, if you are really superstitious, then you don’t want to be long on Friday the 13th ahead of the CPI report. It is the most likely market mover next week in terms of economic reports and the risks to the downside outweigh those to the upside.

My market trend bottom line is this : My “sell in May and go away” warning in this newsletter on May 23rd remains in effect. This is not a market I want to be long

So now the focus shifts to the Veep choices. Interestingly, John Edwards has pulled his straw out of the eventual draw. While he has his reasons, you may find this analysis from the New York Times of interest:

“There are other reasons to doubt an Obama-Edwards ticket: David Axelrod, Mr. Obama’s chief strategist, worked for Mr. Edwards in the 2004 cycle, a relationship that did not end amicably. (In an interview with The New York Times Magazine last year, Mr. Axelrod explained the campaign’s failure by pointing to Mr. Edwards: “I have a whole lot of respect for John, but at some point the candidate has to close the deal and — I can’t tell you why — that never happened with John.”)

During the 2004 general-election campaign, Mr. Edwards was not seen as a team player on the ticket with Senator John Kerry. They couldn’t even agree on a campaign slogan: Mr. Kerry tried to rouse audiences with the chant, “Help is on the way.” Mr. Edwards stuck to his own version, “Hope is on the way.” While Mr. Kerry in 2004 had hoped that Mr. Edwards, a Southerner, would help with rural voters, there was little evidence that Mr. Edwards’s presence on the ticket made any difference at all. (He didn’t even win his hometown in North Carolina.)

In the 2008 campaign, Mr. Edwards performed very well with male voters; but Mr. Obama needs more help attracting female voters.”

1. At my most recent faculty meeting at the University of California, we were informed of a hiring freeze, a likely construction freeze on our new building, and the guaranteed lack of any COLA adjustment on salaries next year. How’s that for a canary in the coal mine for California’s growing budget crisis triggered by the recession and housing sector collapse. Note to the Governator: Republicans that act like big spenders in good times and then call for tax hikes in bad times need to find a new party.

Please see my latest You Tube report on the Sichuan quake. The backpack picture is beyond words.

Mike S. writes on the recent revelation that China has sold counterfeit Cisco routers to the U.S. military:

“No one knows what other capabilities have been engineered into the counterfeit equipment. In addition to the devices emulating the functions of a normal Cisco router or switch, it would be relatively easy to have additional circuitry onboard to copy and transmit the entire bitstream running through the device to an external destination known only to the counterfeiters or to those who designed the rogue circuitry. Since the gear has been procured by the Navy and other national defense entities, you can see that there is the potential for a monumental security breach.”

“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

Peter Navarro is a business professor at the University of California and the author of the best-selling investment book If It's Raining in Brazil, Buy Starbucks and The Well-Timed Strategy. His latest book is The Coming China Wars: Where They Will Be Fought, How They Can Be Won.

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.