HTS Hog Wallow

              “Are the markets building an “Echo” Bubble?

    We’ve been sharing information over the past few weeks, all seemingly with a similar theme that the disparity in equity flow between the financial and the nuts and bolts sectors of the economy is creating another bubble in the equity and commodity markets. The recent return of speculative behavior in these markets has been termed an “echo” bubble by economists. This type of bubble follows and mimics the previous larger bubble from last year.

    Governments flooding the economy with money are always the cause of larger bubbles. The “echo” bubble is the result of a second infusion of easy money to repair the damage from the first. Because we are doing this soon after the first bubble, the appeal of speculation is still fresh in investors and traders minds and they are easily drawn back to the allure of easy money. Bill Gary tells us that economist Edward Chancellor indicates that “echo” bubbles are always smaller and end quicker than the first bubble. He suggests they recover about 405 of the size of the original bubble before bursting again and forcing markets back to levels the economy can justify. Speculators usually fail to realize that the infusion of government stimulus that creates the second bubble is temporary and reversible. In other words, instead of returning the economy to healthy growth and investment, the second bubble is solely dependent on a temporary infusion of liquidity that must eventually be withdrawn.

    Traders and investors buy stocks on better earnings, even though it’s apparent that projected profits are the result of cost cutting rather than expanding sales or industry growth. Hedge funds are buying crude oil futures even though world inventories are at record levels and still in a building phase. Speculators are buying wheat futures because they are going up, not because the US is competitive in the world market. The lure of quick profits is the driving force behind the markets and the insatiable appetite for paper ownership seen in the first bubble returns. These echo bubbles are by definition, inherently illogical! 

    The biggest problem we have in watching this second bubble is, it could last for two years, or it could last for another week. Echo bubbles usually result in another crash, leading to creative destruction. Only then is the table set for a more real, sustained growth. Meredith Whitney, a banking analyst that was one of the very first to predict the stock market bubble, and subsequent crash last year, suggests that she hasn’t been this bearish since last year’s first bubble burst. She’s preparing for a double dip recession as she points out that stocks, from Tiffany’s, to Bank of America to Caterpillar are showing great profits with no fundamental reason. Consumer credit contraction is the greatest ever as 1.5 trillion dollars of borrowing power has been taken out of the market through credit card limit reductions. Not even was it this bad in the Great Depression, she points out. Forty-eight of the 50 states are under funded and several are on the brink of financial collapse. The government bailout has capital markets and big banks trading well over book value and they will ultimately fall back to book values. And to stay with the scrooge theme, she also said it would not be a good holiday season for retailers and finds no justification at all for what’s happening in the markets today.

    And finally, in his speech today, Bernanke suggested squelched any talk of rate hikes saying that the economy isn’t strong enough today for them to raise rates. He recognizes that the country hasn’t developed enough jobs yet and fears if not ready, the country could fall back into a terrible recession. He also recognized that the strength of the world economy is coming from China, and alerted investors not to be overly optimistic thinking that things are back on the mend. Bernanke is more intent on allowing our economy to recover and for US consumers’ savings to increase before he takes steps to raise rates. Obviously the stock market liked what he had to say today as we continue to build toward the mid-10-thousand level. Interestingly enough, after Meredith Whitney finished her scathing interview, the market did drop…temporarily. It’s just not popular to sell the market…yet!

 Those who cannot remember the past are condemned to repeat it.

                                                                                                      George Santayana