Can Policymakers Manage a Financial Mania?

By: Bob Hoye | Mon, Jun 30, 2014
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The following is part of Pivotal Events that was published for our subscribers June 18, 2014.


Signs Of The Times

"Cash hoarding is so last year. As U.S. companies cut deals at a faster clip, spending is back in vogue."

- Bloomberg, June 9

"China is hoarding crude at the fastest pace in at least a decade."

- Bloomberg, June 11

"Wholesale Prices in U.S. Unexpectedly Decreased in May"

- Bloomberg, June 13

"Stocks Are Booming, But Not The Economy"

"Corporate America is buying back its own shares, bolstering the markets but failing to invest in new business and equipment that could propel the economy."

-, June 14

"Bank of Canada still uneasy over low inflation."

"Target is 2% on an annual basis."

- Financial Post, June 16

Stock Markets

It is time again to review "inflation". To the establishment, which includes gold and silver bugs, it means the rate of increase in consumer prices. Inflation in financial assets has yet to be widely understood.

The old definition of inflation was "An inordinate increase in credit", which is accompanied by soaring asset prices. And as history has shown so many times, great inflations in financial assets have been more dangerous than inflations in tangible assets. The reason being is that financial bubbles are accompanied by an aura of general prosperity. This contrasts with a soaring cost of living as well as shortages suffered during inflations in tangible assets.

The problem is that the apparent prosperity of a bubble lasts only as long as the boom lasts.

So our interest is in when will the public and policymakers again discover that bubble prosperity is ephemeral?

One hint is that "Corporate America" can't stand liquidity and has been buying its own stock. Captains of industry and Wall Street were not doing this five years ago in February-March 2009.

They are doing it now with sentiment and momentum readings seen only at cyclical peaks have been accomplished.

As noted last week, Investors Intelligence percent bulls reached 62.2, which is about as high as it gets.

On momentum, the Nasdaq has reached the highest Monthly RSI since the heady days of March 2000.

Both sentiment and momentum should be a caution, but the establishment is again convinced that policymakers can "manage" a financial mania.

Even greater folly is evident in the credit markets.

Credit Markets

Quite simply, it has been the biggest bubble in lower-grade bonds in history. And as we have seen, when a bond bubble is on there is not enough karma around to bubble commodities, including precious metals. And, of course, it was the other way around in the 1970s. No karma for bonds then.

Not even for long-dated treasuries at 15 percent yield.

The irony is exquisite. Policymakers still really believe they are running things. But the public chooses what will be driven to a buying frenzy and what will be driven down. With eternal blessings for all, technical research gets to measure the excesses. Historical research is charged with the duties of forecasting.

In 1933, within the early stages of the last post-bubble contraction a NY bond house seriously reviewed the wreckage with the title: "Foreign Bonds: An Autopsy".

It included the melancholy observation about previous disasters in lower-grade bonds: "It had taught us nothing".

Our study "Sovereign Debt Follies" is attached.

As mentioned, the action in Spanish and Italian bonds has registered "Downside Capitulations". This is rare and we have been watching for the trend-reversal.

The Spanish yield declined to 2.56% on the 9th and has increased to 2.75%. Breaking above 2.93 would set the uptrend.

The action in JNK, for example, has been largely driven by leveraged funds pushing the carry. The Weekly RSI has reached 80 which is now high enough to say that the speculation has maxed. Under almost as bubbly conditions in May last year, the RSI reached 77 and in the subsequent "mini-panic" the junk yield jumped from 5% to 6%.

The failure could be soon as the time spent with the Weekly RSI above 70 is longer than that which preceded the hits in 2013 and in 2011. The calendar is within the season when bond speculators can get trashed. This would include speculators within central banks as well.

The karma of the marketplace is about to overwhelm the dogma of policymaking.


Commodities are again looking hopeful.

Muslims without borders have become belligerent again, adding to the disturbances in Ukraine. Crude's spot price rallied from support at 101.60 earlier in the month to 107.68 on Friday.

This reached 70 on the Daily RSI, which is close to the level that ended the rally to 105.22 in March. That price stopped two rally attempts in April and in May and now the chart pattern has changed.

Our secondary target of 112 is still out there, representing strong overhead resistance. We have dragged out the old seasonality chart and it shows volatility in June, followed by a rise into September.

This could provide guidance should the latest outbreak of extremism continue.

Wheat became oversold enough to be interesting. Actually, the action has registered a Sequential Buy. An etf is WEAT. Sentiment plunged to 20%, which is very low.

The index of agricultural prices (GKX) has clocked a huge swing in the Daily RSI. The high on the RSI was 88, which got us out. The low was 18 set on Monday, marking the biggest swing since 1997. It is worth noting that that example was within a lengthy bear market.

The low for GKX was 357 yesterday and there is resistance at the 380 level. This is a target.

Base metals (GYX) continue the struggle between the bulls (who see dollar depreciation) and involuntary bears in China (who are facing Mr. Margin).

From the probable low in December we got one quick trade out of the GYX and exited the play. The action has been soggy ever since, but the latest rise is holding above the 50- Day ma at 3.45.

A rally to resistance at the 360 level seems possible.

Over in lumber-land, the contract was out of phase with other commodities. It rallied from 276 in June 2013 to 384 at the end of the year.

From moderately overbought, it declined to 295 last week. The Daily RSI plunged to 20, which seems enough to prompt a rally of some 6 to 8 weeks duration.

Firming commodities could be a plus for the resource stock sectors and could be called a "Mini-Rotation". However, it could hit highly-inflated bond prices. This lamentable probability could also hit the general stock markets.


Gold/IA Commodities Chart

A Decade of Iron Ore Prices

A Decade of Iron Ore Prices Chart


(Previously Published February 23, 2010 and June 29, 2011)

The possibility of another episode of sovereign defaults is not being discussed, which prompts the question about just how bad can it get? The above quotation is from a 1933 study of that example of government defaults and as the writer notes, it was preceded by a "new borrowing orgy". The word "new" is important because the literature often includes the description "new financial era". The first one, the South Sea Bubble, culminated in June 1720 and it has essentially been the model for five subsequent ones, including the example that completed in 2007.

Although the stock market attracts the most attention during a great financial mania, the action has included the equivalent mania of investors reaching for yield and brokers reaching for commissions. There is a typical path that defines a post-bubble contraction that includes widespread remorse and chagrin.

During the New Era that culminated so extravagantly in 1825, London was the financial centre and the City floated issues by Russia, Prussia, Spain, and a number of Latin American countries as well as cities.

For example, Peruvian 6 percents were done at 88 in 1822 for a yield to maturity of 6.95%; then again at 82 for a 7.50% yield in 1824, and at 78 (7.85%) in 1825. Then the market became illiquid and eventually collapsed with the usual post-bubble deflation. Some 70 U.K. banks stopped payment and Rothschild assisted in preventing the Bank of England's default.

With the usual swings in the business cycle, the contraction continued until the mid- 1840s.

The next long expansion ended with a mania of asset speculation in 1873. At the height of that mania and as credit markets were becoming stressed an important New York newspaper editorialized that nothing could go wrong. The main point was that the US did not have a central bank that would be constrained by the gold standard in accommodating the needs of Wall Street.

Instead there was confidence that the Treasury System and its admired secretary could issue massive amounts of credit by buying bonds out of the market.

While recklessness was rampant, there were rational comments. The Economist's April 27, 1872 edition advised:

"Avoid states which are constantly borrowing, which must therefore be paying off the interest on their old debt with the fresh loans."

The progress of a disaster in sovereign debt in 1873 was nicely chronicled by headlines in The Economist:

June 7: "The Approaching Spanish Repudiation"
July 5: "[Spain] Making Arrangements for the Payment of Current Coupon"
August 2: "Spanish Interest Will Not Be Paid"
August 30: "Anarchy in Spain"

The Argentine crisis of 2001 was documented by headlines from a number of publications. It is worth noting that as late as June there was confidence "Appetite for Credit Risk has Improved Considerably".

July 18, 2001: "Markets Laud Argentine Debt Accord - Calms Fears of Default"
August 3, 2001: "Flurry of International Contacts to Prevent [Argentina] Default"
December 14-20, 2001: "Angry Argentines Take Their Displeasure to the Streets"
  "State of Siege"
  "Looters Ravage Cities"

There seems to be a common pattern on the transit from confidence to dismay, and it will be interesting to see how it works out this time around. The distinction is that the 1873 example included many countries and as the historian, S.G. Checkland, wrote "Many half-barbarous states pressed eagerly for funds, and spent them with no display of wisdom."

The Argentine problem in 2001 was not accompanied by insolvencies in a number of countries.

However, there is no question that the 1930s disaster in all lower-grade debt was part of a massive post-bubble contraction. It was reviewed in Foreign Bonds: An Autopsy, a rather appropriate title, published by Howland Swain Company in 1933:

"The fiscal history of Latin America … is replete with instances of governmental default. Borrowing and default follow each other with almost perfect regularity. When payment is resumed, the past is easily forgotten and a new borrowing orgy ensues. This process started at the beginning of this past century and has continued down to this present day. It has taught nothing."

How bad can it get? Typically the post-bubble contraction afflicts all aspects of the financial markets - including sovereign debt. The process is devastating and continues until both lenders and borrowers vow to never be reckless again.


Sovereign Follies 2010:

Jan. 14: "Greece Unveils Stability Program"

Jan. 21: "Investors are concerned that Greece won't be able to finance its budget deficit."

Feb. 14: "Years of unrestrained spending, cheap lending and failure to implement reform."

Feb. 17: "Greek Tragedy Averted, For Now"

Feb. 24: "Greek Police, Protesters Clash"

April 11: "Emergency Aid Approved"

Aug. 10: "Greek Debt Crisis Finally Over"

Aug. 10: "Greece is one part of the crisis and it has faded from the headlines."


May 29: "Thousands of protestors denounce Greece's entire ruling class."

June 28: "Greek Debt Crisis Leads to Mass Strike"

June 28: "Greece Faces 'Suicide' Vote on Austerity"

"Bankruptcies of governments have, on the whole, done less harm to mankind than their ability to raise loans." - Prof. R.H. Tawney, Religion And The Rise Of Capitalism, 1926

Two-Year Greek Government Notes

Two-Year Greek Government Notes 2010-2011 Chart



Bob Hoye

Author: Bob Hoye

Bob Hoye
Institutional Advisors

Bob Hoye

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