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Just Keep Talking and We'll Keep Buying
by Mark M. Rostenko
Editor, The Sovereign Strategist
June 14, 2004

Stocks rose last week as all the major indices hit new 1-1/2 month highs. The Dollar Index rebounded from a 2-1/2 month low to post a gain while gold retreated. Crude oil futures closed barely changed after rebounding from a 1-1/2 month low while prices at the pump fell for the first 3-week period since last December.

Despite high oil & gas prices, Gary Stern, president of the Minneapolis Fed reassured us last week that rising energy prices don’t signal inflation. Of course, they don’t Gary. Signals, by definition, indicate something that WILL happen. Given that rising inflation has been with us for quite a while now, rising energy prices simply confirm what anyone not living beneath an underpass and offering to wash windshields in exchange for cigarettes already knows.

But relax folks. Lifetime highs in crude oil prices, gasoline prices, milk prices, health insurance prices, 23-year highs in commodity prices: none of that signals rising inflation. As Mr. Stern also mentioned, inflation is a “monetary phenomenon.”

In other words, rising prices don’t necessarily indicate rising inflation. Rising inflation is the result of too many paper dollars chasing the same amount of goods while prices sometimes rise for other reasons (supply/demand considerations, for example.)

Given that Uncle Al has been responsible for more money creation than all the other Fed chiefs combined and that M3 money supply has been increasing at a pace not seen since the ultra-inflationary 1970s, I’d say, my dear Gary, that we’re looking at quite the “monetary phenomenon”. As well as a grocery store phenomenon and a gas station phenomenon. But nice try with that whole “deflect attention from the problem by using technical jargon that the average American doesn’t understand” strategy.

Inflation is obviously the big story these days with Uncle Al working overtime last week to manage the markets with soothing words all designed to communicate the message “Just keep buying those stocks and houses. We've got it all under control." You'll note how quickly the Fed went from “worrying” about deflation to jawboning double-time about inflation.

Why the urgency? Because these days, when the S&P 500 can trade near record-high multiples and housing can rise 20% a year even while bricks, wood, plumbing and windows decay and lose value over time, words matter and reality doesn't. Uncle Al is playing a game called “make the markets think I’m ready to handle the inflation thing so that I don’t actually have to handle the inflation thing because golly gee if I have to handle the inflation thing the whole stock and housing bubble thing goes down the crapper.”

Rising inflation is, you see, no big surprise to Uncle Al. The man who created it is not, I assure you, the last to realize that it has taken root. Inflation was the plan all along:" Inflate stocks, inflate housing, and let’s worry about all the other stuff like gas and food and health insurance later.”

And now that it’s obvious to all, Uncle Al is hoping that the markets will trust in his commitment to battle inflation without having to raise rates too much." Don't worry markets! I'm ready to go at it at a not-so-muchly-measured pace” all the while hoping he won’t have to. Keep the markets happy, sustain the illusion and let the bubble inflate a while longer.

It used to be that a rising market foretold an improving economy. Nowadays the market is inflated with a flood of cheap and easy money and exceptionally low interest rates in order to convince folks that an economic mend is on the horizon. If you can imagine Al Greenspan standing on your porch in the middle of winter, clad in his sexiest Bermuda shorts and a straw hat, holding a match under your thermometer and muttering “Golly it’s gonna’ be a hot one today!”, you’ll understand how this process works.

You see, the name of the game is to keep stocks and housing up for as long as possible while keeping interest rates as low as possible. Whatever has to be said to achieve those ends will be said. But you can’t fight inflation and keep stocks up and keep housing up and keep interest rates low all at the same time. Although you can go a long way by decimating the dollar. That is, if you decimate it at a “measured pace” the keeps interest rates from surging.

That’s the strategy, as I see it. Make dollars worth even less than they already are and you make stocks and houses appear to be worth more. Sure, it stinks that eggs, milk, butter, oil, gas, insurance, diapers, lumber, cement, etc. etc. cost more too, but jawboning about “fighting inflation” is supposed to make us all feel better about that.

What does all that mean for the stock market? Ask the stock market. Judging from its action all this year, it doesn’t know either. Hence the large trading range and chopping back and forth. With last week’s move above 1129 resistance on the S&P 500, it looks like a test of the mini-bull market high is forthcoming.

Here’s where the rubber meets the road. Does the market take out its high and continue higher? Or does it fail once again and break down? The answer to that question depends on how successful the powers that be are in convincing the market that the illusion of prosperity and growth can be sustained for still longer. That Uncle Al can successfully combat deflation and inflation and leap tall buildings in a single bound.

Or does it depend upon how successfully the numbers can be managed? It's fascinating how the Bureau of Labor Statistics had to postpone the release of the PPI data at a time when inflation is the critical issue. This would be the same Bureau of Labor Statistics pumping out a steady stream of nearly 300,000 new jobs per month (the Bush Administration forecast) just in time for the approaching election. Most of which have been proven statistical assumptions and fabrications by third parties doing their homework.)

But as always, we let the numbers do the talking. Trading ranges (like the one we’re now in) are notoriously fickle.They look very bullish at the top and very bearish at the bottom. The breakout is what matters and there’s no telling at this point from which side it will be.

Certainly there are signs of technical weakness: the steady progression of lower highs and lower lows and the relatively low volume witnessed on this latest advance, for example. I still see it as a major topping formation.

But I don’t live beneath the underpass, I don’t believe that inflation came out of nowhere and to the surprise of the Fed, and I’m certainly not about to believe that in an election year a few more points can’t be squeezed out on the upside.

We shall see...

© 2004 Mark M. Rostenko
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