"This Week: Bernanke in a Coupled Box " by Peter Navarro, Ph.D. FSO Editorial 06/30/2008

THIS WEEK: BERNANKE IN A COUPLED BOX
The Well-Timed Strategy for Week Ending July 4, 2008
by Peter Navarro, Ph.D.
June 30, 2008

Followers of this column will note two common themes I’ve developed since my call to cash last November.

Theme One: At some point, U.S. Fed policy will be rendered neutral by emergence of inflation.

Theme Two: The market trend will depend on which scenario of these three scenarios finally declare themselves – the U.S. as global locomotive, a global economy decoupled from the U.S., or global stagflation.

Regarding Theme One, we have officially reached the point where the Federal Reserve is boxed in. It can’t cut interest rates any more for fear that the cuts would further weaken the dollar and drive up oil and commodity prices along with interest rates and inflation. Nor does the Fed dare raise interest rates for fear of driving a stagnate U.S. economy below the zero growth line.

Regarding Theme Two, the decoupling scenario, which is the only bullish scenario of the three, is becoming less and less likely. The underlying problem is that the U.S. has exported too much inflation to the world via the mechanism of a “weak dollar-rising oil prices” dynamic. Asia is on fire, European inflationary is above target, and much of the globe is now leaning towards interest rate hikes that will inevitably cause the global economy to begin grinding its gears.

With Fed policy neutralized and the rest of the world in an inflationary, interest rate hike scenario, it is almost impossible for market trends to point up virtually anywhere.

In such a time, the best thing patient investors can do is to begin building a “buy list” for when the market, and particular sectors, hit bottom. At some point, financials are going to look particularly attractive.

If you must trade, then trade sectors which are relatively insensitive to the business cycle. For example, most of the stocks I am now holding are biotechs driven by drug trials rather than the macroeconomy.

In the mean time, my call to cash in May remains in effect. (On May 23rd, I issued a “sell signal” and urged moving into cash. Since that time the U.S. market has fallen by close to 10.)

In a grab bag of rulings, the Supreme Court reminded us why voting for President has a lot more to do with than just picking who sits in the Oval Office. In fact, this week the Men in Black gave considerable succor to the right side of the political spectrum in their opposition to gun control and campaign finance laws and by limiting punitive damages in the Exxon Valdez case. (Bizarrely, this conservative court also opposed the death penalty for child rape while boosting the rights of the Gitmo detainees. Who says you have to be consistent.)

Whether you are on the right or the left, one thing should be clear: As November approaches, the Supreme Court will be used to energize the bases of both candidates.

Jim Rogers has issued a call to buy the Chinese market and says he’ll be investing in China for the rest of the century. I love Jim, but I’d take the other side of that trade.

Incredibly, German Chancellor Angela Merkel has announced that it will be impossible for her government to resist approving fuel subsidies for consumers. If the world responds to higher oil prices in this fashion, we are all doomed. That German would cave in is particularly scary.

“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
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