Prior Week’s Lessons: Growing Gap Between Prices And Reality – Part 2

Part 2: Conclusions and Lessons For The Coming Weeks


The following is a continuation from Part 1.

So what did we learn? Based on those lessons, what do we do?

The Top Market Movers Last Week


The Bearish


Virtually all normal fundamentals, including valuations (see here, here and here for examples), growth, and earnings trends, were bearish. See the next section for details on those.



The Bullish: Stimulus Amplifies Siren Call of Greed


Here’s what kept risk assets steady or rising in the face of all that bearish evidence. It’s the same things that have driven the rally in risk assets for months.



  • Continued hope that stimulus can prop up asset prices, as institutional cash seeks a hope and retail investors seek yield
  • Momentum And Hope of Breakthroughs To New Highs: Approaching decade highs on the S&P 500 and other indexes appear to beckon investors to come closer, like sirens luring ships to their destruction on rocky coastlines.
  • Excessive discounting of EU risk


These have indeed been potent. Look what they’ve managed to overcome.


Lesson 1: Growing Gap Between Asset Prices And Reality


Stocks and risk currencies continued steady or higher overall, remaining resilient in the face continually deteriorating fundamentals. Evidence of the past weeks includes:



  • Stock prices are steady or rising, while earnings estimates keep falling. See here for details. That might make some sense if we saw signs of improving growth that would boost those earnings. However instead we’ve got the opposite happening.
  • US GDP for 2012 was 1.5% for 2012.  Whenever it has been below 2%, it has meant recession every time since 1948, as mentioned in our prior post here.
  • US GDP is likely to worsen due to deleveraging, the most recent form of which is the reduced incomes from the expired payroll tax cut of 2011. Temporary government job losses from sequestration, due to hit in March, would exacerbate that reduced spending. Note that we also saw this week that retail sales haven’t contracted. However analysts expect some lag time before the effects of increased payroll taxes hit spending. See here and here for examples.
  • This week we saw that GDP across the Euro-zone continues to contract, (see here and here) as it does in the UK and Japan.
  • Meanwhile we’ve a lack of normal technical corrections that has some worried, and dangerously high levels of bullish sentiment, especially in view of the above headwinds.


In addition, there’s the ongoing risk that confidence in the EU falls apart, as we discussed here.


Lesson 2: G7/G20: Currency Wars Deferred: JPY, EUR Trends Free To Continue For Now



For anyone involved with Japanese stocks or Yen currency pairs, the big news of the week was that the G20 avoided any pressure on Japan to stop devaluing the Yen.


Yen Free To Fall


Green Light To More Yen Devaluation, Japanese Stock Appreciation


As noted above, Japanese stocks have been moving higher for months on anticipated Yen weakness, which should improve earnings and growth. There was concern that these meetings might signal opposition to the ongoing Yen devaluation, but that didn’t happen. Given the number of other nations attempting various forms of the same thing, it hardly seemed fair to single out Japan.


Still, we doubt Japan’s Asian competitors will allow Japan to gain market share at their expense for long.




The JPY is one of the primary counterparts to the EUR and USD currency pairs, so both of the two most widely held currencies got a boost relative to the others.


Japan’s competitors move closer to their own currency devaluations as their export market share comes under pressure.


Cheaper goods from Japan (as well as from Korea, China, and other competitors of Japan) mean less inflation, and worsening trade balances for those importing these goods. Both of those factors will raise the temptation for those importers to devalue their own currencies.



EUR Free To Rise?


Meanwhile, comments from ECB President Draghi, Bundesbank head Weidmann and ECB member Asmussen suggests that the euro is fairly valued. Does that mean further appreciation will be considered excessive and bring moves to drive the EUR lower?


With growth falling in the EZ, and additional bailouts needing funding via EUR printing, we continue to view EUR strength as temporary.



One Sure Thing: Don’t Have Everything In Just 1-2 Currencies


That’s because competitive devaluation remains very much a threat to all. We don’t know whose currency will suffer when. However the past week’s events continue to remind us that most of the widely held currencies are at risk of official efforts to devalue them for the sake of the greater economic good, even if savers and investors tied to those currencies get hurt in the process.


As noted above, the EU will likely need to devalue the EUR if the region’s contraction persists, and Japan’s competitors are likely to debase their own currencies when they believe their exports are threatened.


Meanwhile the Fed continues to print $85 bln/month. Many have pointed out that deflation remains a bigger threat for the US than inflation. A Bank of America report suggests that means we could actually see yet more QE, which would put further pressure on the USD.


The Aussie: No Worries? Sorry Mate


A variety of factors will influence the fate of the USD, JPY, EUR, GBP, and other major currencies in the coming year. Those currencies are hardly the only ones at risk. The AUD has enjoyed a great run higher in recent years as it has ridden the China growth story. However this past week the WSJ had a report on how the Aussie is due for a significant longer term pullback.


Don’t Wanna Be An American Idiot?


Green Day didn’t want to be one, nor should those based in US dollars (or EUR, JPY, GBP, etc)


Those based in US dollars have been played for suckers by their own government for years. See here for details. See here or here for information on a guide to a variety of lower risk, simple ways to protect your assets from being sacrificed on the altar of Bernanke’s policies.