UNEDITED!

While losses to the major indices were less than noteworthy, the stock market is beginning to demonstrate bear market characteristics. For the week, the Dow and S&P500 declined about 1%. The Transports and Utilities both added about 0.5%. The Morgan Stanley Cyclical index dropped 2.5%, while the Morgan Stanley Consumer index dipped 1%. The broader market was under moderate selling pressure, with the small cap Russell 2000 and S&P400 Mid-cap indices down about 1%. Technology stocks were mixed, with the NASDAQ100 ending the week about unchanged. The Morgan Stanley High Tech index declined 1%, and the Semiconductors fell 2%. Yet the NASDAQ Telecommunications index was unchanged and The Street.com Internet index added almost 1%. The Biotechs declined 1%. Financial stocks were mixed. The Broker/Dealers up 0.5%, as the Banks lost 1%. Insurance stocks, of course, were hammered. With bullion down almost $4.0, the HUI gold index dropped 4%.

The Treasury market enjoyed additional gains. For the week, 2-year Treasury yields dropped 7 basis points at 2.52%, with 5-year Treasury yields sinking 9 basis points to 3.31%. Ten-year Treasury yields were down 8 basis points to 4.05%. Long-bond yields ended the week at 4.85%, declining 6 basis points on the week. Benchmark Fannie Mae MBS underperformed, with yields declining 5 basis points. The spread (to 10-year Treasuries) on Fannie's 4 3/8% 2013 note narrowed 1 to 31, while the spread on Freddie's 4 ½ 2013 note narrowed 1 to 27. The 10-year dollar swap spread declined 1.75 to 43.5. Corporate bonds were mixed, with the auto sector under pressure. The implied yield on 3-month December Eurodollars declined 4 basis points to 2.245%.

At about $9 billion, it was a slow week for corporate debt sales. Investment grade issuers included Black & Decker $300 million, West Fraser Timber $300 million, Citgo Petroleum $250 million, ASG Consolidated $200 million, Heritage Properties $150 million, Protective Life $150 million, and Entergy Louisiana $115 million.

Junk bond funds received inflows of $42.6 million for the week (from AMG), the eighth straight week of positive flows. Issuers included Boise Cascade $650 million, Dresser Rand $420 million, Vimplecom $300 million, and Teco Energy $160 million.

Convert issuers included Shanda Interactive $200 million, APEX Silver $150 million and Cell Genesys $110 million.

Foreign dollar debt issuers included Northern Rock PLC $1.5 billion, Rentenbank $1.5 billion, Ontario Province $1.0 billion, Asian Development Bank $1.0 billion, and Korea Development Bank $550 million.

Japanese 10-year JGB yields dropped 12 basis points to 1.45%. Brazilian benchmark bond yields rose 15 basis points to 8.59%. Mexican govt. yields ended the week at 5.23%, down 7 basis points. Russian 10-year Eurobond yields were unchanged at 6.03%.

October 14 - Financial Times (Paivi Munter and Chris Giles)): "Borrowing by emerging market governments and companies has exceeded last year's record high as institutional investors facing poor returns elsewhere are increasingly seeking the higher yields on offer. With two months yet to run, emerging market bond issuance has reached $331.4bn this year, exceeding last year's total of $320.2bn, according to Dealogic the data provider. This year's amount outstrips issuance since the period leading up to the Asian and Russian financial crises in 1997 and 1998... This year's returns on the EMBI index are at 8.3 per cent..."

Freddie Mac posted 30-year fixed mortgage rates declined 8 basis points this week to 5.74%. Fifteen-year fixed mortgage rates dropped 10 basis points to 5.14%. One-year adjustable-rate mortgages could be had at 4.01%, down 7 basis points for the week. The Mortgage Bankers Association Purchase application index declined 4.9% last week. Nonetheless, Purchase applications were up about 17% from one year ago, with dollar volume up 36%. Refi applications dropped 14% during the week. The average Purchase mortgage was for $223,000, while the average ARM was for $299,900. ARMs jumped to 34.9% of total applications last week.

Broad money supply (M3) dropped $40 billion (week of October 4), actually a somewhat smaller decline than that posted during the first week of the third quarter. Year-to-date (40 weeks), broad money is up $471.5 billion, or 6.9% annualized. For the week, Currency added $500 million. Demand & Checkable Deposits increased $3.8 billion. Savings Deposits declined $12.7 billion. Saving Deposits have expanded $284.2 billion so far this year (11.7% annualized). Small Denominated Deposits were about unchanged. Retail Money Fund deposits declined $3.4 billion, and Institutional Money Fund deposits fell $8.3 billion. Large Denominated Deposits declined $5.4 billion. Repurchase Agreements dropped $13.7 billion, and Eurodollar deposits dipped $1.2 billion.

Bank Credit dipped $3.5 billion for the week of October 6 to $6.689 Trillion. Bank Credit has expanded $414.2 billion during the first 40 weeks of the year, or 8.6% annualized. Securities holdings declined $7.7 billion, while Loans & Leases added $4.2 billion. Commercial & Industrial loans fell $3.5 billion, while Real Estate loans surged $20.2 billion. Real Estate loans are up $247 billion y-t-d, or 14.4% annualized. Consumer loans were about unchanged for the week, while Securities loans declined $7.4 billion. Other loans decreased $5.1 billion. Elsewhere, Total Commercial Paper jumped $14.2 billion to $1.352 Trillion. Financial CP rose $9.5 billion to $1.219 Trillion, expanding at a 6.4% rate thus far this year. Non-financial CP added $4.7 billion (up 29% annualized y-t-d) to $132.7 billion. Year-to-date, Total CP is up $83.2 billion, or 8.3% annualized.

Year-to-date ABS issuance of $489 billion is 42% ahead of comparable 2003 (from JPMorgan). 2004 home equity ABS issuance of $311 billion is running 86% ahead of last year's record pace.

Fed Foreign "Custody" Holdings of Treasury, Agency Debt dipped $3.9 billion to $1.288 Trillion. Year-to-date, Custody Holdings are up $221 billion, or 26% annualized. Federal Reserve Credit rose $3.8 billion last week to $768.8 billion, with y-t-d gains of $22.2 billion (3.8% annualized).

Currency Watch:

October 15 - Dow Jones (Steven Vames): "Whether they like it or not, some Federal Reserve policy makers are becoming de facto representatives for the dollar. It has been subtle. A comment here and there that involves the dollar, often stating obvious facts that could just as easily have come from an Economics 101 textbook. They have mostly been related to how the U.S. economy will address the giant current-account deficit. Some have been academic, others more tongue-in-cheek. A prime example came from Dallas Fed President Robert McTeer, who on Oct. 7 mischievously let a New York audience in on a not-so-secret economic theory, by whispering through cupped hands into a live microphone that 'over time, there's only one direction for the dollar to go' and that's lower."

Declining about one-third percent, the dollar index closed today at the lowest level (87.22) since February. The leading currencies this week were the South African rand (up 1.74%), the Norwegian krone (1.53%), and Swiss franc (1.45%). Curiously, the Latin American currencies led the losers, with the Chilean peso down 2.1%, the Mexican peso down 1.88%, and the Brazilian real down 0.84%.

Commodities Watch:

October 14 - Washington Post: "U.S. crude oil output in September fell to the lowest monthly level in more than 55 years because of Hurricane Ivan and interruptions for maintenance in Alaska, the American Petroleum Institute said. The United States pumped 4.85 million barrels a day last month, down 830,000 barrels, or 15 percent, from a year earlier. Crude oil inventories fell 8.7 million barrels, to 273.1 million last month, leaving supplies 3.1 percent lower than in August."

October 15 - Bloomberg (Jack Kaskey): "Hercules Inc., the world's largest producer of paper-making chemicals, said it will increase North American chemical prices for the pulp and paper industry by as much as 10 percent due to surging raw-material costs."

October 15 - Bloomberg (Ann Saphir): "A Chicago Board of Trade seat sold for a record $1 million as investors bet the second-largest U.S. futures market will sell shares to the public or be bought by the Chicago Mercantile Exchange... Seat prices have doubled this year..."

With November crude up $1.62 to a record $54.93, the Goldman Sachs Commodities index added another 1.5% this week. This increases year-to-date gains to 38.4%. The CRB index dipped 0.7%, reducing y-t-d gains to 11.9%.  

China Watch:

October 14 - Bloomberg (Jonathan Underhill): "Chinese Finance Minister Jin Renqing said economic growth of 9 percent this year would be acceptable to the government, Associated Press reported. Jin told China Central Television on Wednesday that the government's efforts to slow the economy have achieved the results it anticipated..."

October 14 - XFN: "China's exports in the first nine months of the year rose 35.3% year-on-year to $416.24 billion, while imports in the same period rose 38.2% to $412.31 billion, the General Administration of Customs said... Exports rose 33.1% on a yearly basis to $55.8 billion in September, while imports rose 22.1% to $50.81 billion, the statement said. On a month-by-month basis, the country recorded a fifth straight monthly surplus, widening to $4.99 billion from $4.49 billion in August."

October 12 - Bloomberg (Tian Ying): "China's tax revenue in the first three quarters of the year rose 26 percent from a year earlier to 1.9 trillion yuan ($233 billion) on growth in consumption tax and value-added tax, the official Xinhua News Agency reported"

October 15 - Bloomberg (Joshua Fellman): "China has a widening shortage of skilled technicians, sales personnel and managers, the South China Morning Post said, citing a study conducted in April by the Ministry of Labor and Social Security."

October 15 - Bloomberg (Tian Ying): "China's car sales rose almost 14 percent in September from the previous month to 194,100 units, as a halt to discounts prompted customers who had been waiting for price cuts to return to showrooms."

Asia Inflation Watch:

October 14 - Bloomberg (Laurent Malespine): "Thailand's vehicle sales accelerated last month after slumping to a nine-month low in August as a record number of customers bought pickup trucks, Toyota Motor (Thailand) Ltd. said. New vehicle sales rose 14 percent in September from a year earlier to 51,113 units. For the first nine months of the year, sales in Southeast Asia's biggest auto market rose 15.7 percent to 438,913 units..."

October 13 - Bloomberg (Anuchit Nguyen): "Thailand's exports may rise at least 20 percent next year boosted by overseas sales of automobile parts, electronic goods and farm products, Deputy Commerce Minister Anutin Charnvirakul said."

October 13 - Bloomberg (Soraya Permatasari): "Indonesia's auto sales in the local market rose 32 percent in September from a year before, faster than the growth in August, PT Astra International said..."

October 15 - Bloomberg (Cherian Thomas): "Indian exports rose 17 percent in September from a year earlier, the Commerce and Industry Ministry said in a statement without giving any reason for the increase. Exports were $6.2 billion last month, the statement released in New Delhi said. Imports rose 41 percent to $8.6 billion, boosted by higher oil imports. The trade deficit widened to $2.4 billion from $800 million in August last year."

October 13 - Bloomberg (Anand Krishnamoorthy): "India's domestic automobile sales rose 14 percent in September as consumers availed of cheap loans and discounts... Local sales of cars, trucks, motorcycles and other vehicles increased to 691,115 units in the month from 606,307 a year earlier... Exports rose 31.5 percent to 48,892 units from 37,191 a year earlier..."

Global Reflation Watch:

October 13 - Bloomberg (Greg Quinn): "Canada recorded a C$9.1 billion ($7.9 billion) budget surplus in fiscal 2004, five times the government's forecast, as accelerating economic growth generated a tax windfall for Finance Minister Ralph Goodale. The surplus, the country's seventh in a row and biggest in three years, went to debt repayment by law. That reduced Canada's debt to C$501.5 billion, or 41.1 percent of its gross domestic product -- the lowest share in two decades."

October 13 - Bloomberg (Lindsay Whipp): "Japan's current account surplus expanded unexpectedly in August as companies including Toyota Motor Corp. shipped more goods to the U.S. and China. The surplus rose to 1.73 trillion yen ($15.8 billion) from 1.39 trillion yen in July..."

October 11 - Bloomberg (Duncan Hooper): "The cost of goods leaving British factories rose in September at the fastest annual pace in more than eight years, as a jump in the price of metals and oil pushed up costs. Producer prices rose a non-seasonally adjusted 3.1 percent, up from 2.8 percent in August and the highest since April 1996..."

October 15 - Bloomberg (Thomas Mulier): "Spain's government said home prices rose at an annual rate of 17 percent in the second quarter... The average price per square meter rose to 1,615 euros ($2,000), the government said in an e-mailed statement. The price rose 4.7 percent in the quarter."

October 14 - Bloomberg (Halia Pavliva): "Russia's economy is expected to grow faster than expected this year because of the high oil price of oil, said Arkady Dvorkovich, an economic adviser to Russian President Vladimir Putin. Dvorkovich estimated the economy will grow as much as 7.3 percent this year and as much as 6 percent and 6.5 percent in 2005. The inflation rate will be 8 percent in 2005..."

October 11 - Bloomberg (Halia Pavliva): "Russia's inflation rate probably will breach the government's 10 percent inflation target this year as fuel prices soar and the euro's strength against the ruble is pushing up the price of imported goods, a central banker said."

October 12 - Bloomberg (Halia Pavliva): "Russia, the world's largest oil producer, said this year's budget revenue will be a fifth higher than planned because of rising oil prices. The government, which said revenue will be 531 billion rubles ($18 billion) more than the 2.74 trillion-ruble target for 2004..."

October 15 - Bloomberg (Alex Kennedy): "Venezuela increased spending in August, including more funds for new social programs aimed at poor voters, ahead of a vote on whether to recall President Hugo Chavez. Spending rose 62 percent in August to 4.2 trillion bolivars ($2.2 billion) compared with the same month a year ago..."

October 11 - Bloomberg (Dylan Griffiths): "South African house prices rose an annual 33.7 percent in September after six interest-rate cuts in the past 16 months boosted demand for property, said Absa Group Ltd., the country's biggest home-loan provider. House price inflation was little changed from a revised 34 percent in August..."

U.S. Bubble Economy Watch:

October 14 - The Wall Street Journal (Daniel Machalaba and Bruce Stanley): "It's a different kind of gridlock. A knot of massive cargo ships is snarling the two busiest U.S. ports, causing a scramble among manufacturers and retailers counting on the on-time delivery of goods for Christmas. At the ports of Los Angeles and Long Beach, dozens of container ships are stuck waiting at anchor or in a berth at any given time because there aren't enough dockworkers to unload them. The backups, worsened by record shipping volumes as the economy gains more traction, are adding as much as a week to the typical vessel's monthlong journey from Asia to its final destination in the U.S. The two California ports are a vital cog in the U.S. economy, handling more than 40% of the cargo-carrying steel containers shipped into the U.S. and about two-thirds of imports from Asia."

October 13 - Bloomberg (Eddie Baeb): "The University of Chicago, which has ties to 77 Nobel laureates, plans to sell $280 million in bonds to finance a new building for the graduate school of business and two new science labs. The projects and others being funded by bond proceeds are part of a 10-year $527 million renovation and expansion..."

September Retail Sales increased at a much stronger-than-expected 1.5% from August, the largest gain since March. Retail Sales were up 7.7% from September 2003. By category, Gasoline Station sales were up 15.1% y-o-y, Building Materials 14.4%, Non-store Retailers 13.0%, Eating and Drinking Establishments 9.4%, Motor Vehicles, Parts 7.3%, General Merchandise 5.4%, Health Personal Care 4.9%, Electronics 4.5%, Food, Beverage 4.1%, Clothing 4%, Furniture 3.4%, Sporting Goods 3.2%, and Department Stores declining 1.3%.

The August Trade Deficit was reported at a miserable and worse-than-expected $54.0 billion. August's trade shortfall was 35% greater than 12 months ago and trailed only June's $55.0 billion. Goods Exports were up 16.8% y-o-y to $67.4 billion, while Imports were up 22% to a record $124.8 billion. It would require an 85% increase in Goods Exports to match Imports. Import Prices were up 7.8% y-o-y, the strongest rise since June 2000. There have been only three stronger monthly y-o-y price gain readings in the past 14 years.

California Bubble Watch:

October 15 - San Francisco Chronicle (Kelly Zito): "Bay Area home prices climbed 17 percent on a year-over-year basis in September but remained below their summertime peak... In addition, the combined September sales count for homes and condos was the highest in at least 16 years, (according to) a monthly report by DataQuick. ...The median price for a single-family home in the nine-county region was $544,000, down 1 percent from the all-time high of $549, 000 in August but 17 percent higher than the year-ago level of $465,000. The median price for a condo was $395,000, down from $396,000 in August but 16 percent higher than last September's $346,000."

October 13 - Los Angeles Times (Annette Haddad): "For the third month in a row, the median price of a Los Angeles County home was flat at about $407,000 in September as the annual rate of appreciation hovered at just above 20%. At the same time, the number of homes sold declined 7.8% from a year earlier, to 10,501, according to DataQuick Information Systems, a La Jolla firm that compiles monthly housing statistics. Last year's September was the strongest in 15 years.... Still, Los Angeles County hasn't yet seen any 'significant' price decreases, said John Karevoll, DataQuick's chief analyst. Last month, the median price...rose 21.1% from a year earlier... Karevoll attributed the flattening median in recent months to a leveling off of price increases in higher-end neighborhoods, while lower-cost markets continue to soar."

October 14 - Los Angeles Daily News (Gregory J. Wilcox): " The median price of a San Fernando Valley home surged nearly 25 percent annually in September to $490,000 as sales fell under the year-ago total but still remained strong, an industry tracker reported Thursday. But the market is quite different from two months ago, said the Van Nuys-based Southland Regional Association of Realtors. In September a 64 percent surge in inventory to 3,563 single-family properties brought equilibrium to the market and eased the sticker shock buyers face when they start house hunting, the association said. Including condominiums, inventory leaped 73.5 percent to 4,616 properties last month... During the past 12 months, the median gained $97,000, or 24.7 percent."

Mortgage Finance Bubble Watch:

October 13 - Dow Jones (Angela Pruitt): "The reverse-mortgage industry is poised to become a key vehicle for insurance companies looking to boost annuity sales to senior citizens seeking higher income. A growing number of seniors have been taking out reverse mortgages, borrowing from equity in their homes in lieu of monthly payments on a traditional mortgage, to purchase annuity products. The trend underscores the pursuit of retirees to improve their cash flow amid rising health care costs and insufficient Social Security benefits. 'We think this trend will grow," said Craig Corn, executive vice president of Financial Freedom Senior Funding Corp., a leading provider of reverse-mortgage products... Corn said reverse mortgages are becoming more popular as traditional refinancing slows down. 'On top of that, we are seeing insurance companies using proceeds from reverse mortgages to finance products for annuities, long-term care and life insurance for estate planning,' he said."

September was another blockbuster month for Countrywide Financial. Average Daily Application volume increased to $2.1 billion, the strongest since March. At $50.9 billion, the Total Pipeline was the largest since April. Purchase applications were up 34% from September 2003 to $17.0 billion. ARM fundings surged to a record $21.0 billion during the month (jumping 15% from August's record!), up 109% from a year earlier to 68% of total fundings. As a point of reference, ARMs were 30% of total fundings just twelve months ago. Home Equity fundings were up 88% from September 2003 to a record $3.2 billion. Subprime fundings were up 80% to $3.9 billion. Banking assets have more than doubled in 12 months to $33.8 billion.

October 10 - Bloomberg (Bill Banker): "Martin Zweig, a writer and fund manager for New York-based Zweig-DiMenna Partners LP, put his penthouse on Fifth Avenue in New York on the market for $70 million, the New York Post said... The three-story co-op apartment, which includes 16 rooms covering 11,000 square feet, sits atop the Pierre Hotel... A monthly maintenance fee of $48,000 includes twice-daily maid service and room service. Zweig, the author of 'Winning on Wall Street,' bought the apartment in 1999 for $21.5 million..."

Earnings Watch:

Highlights from Citigroup: "Revenue growth of 6% was driven by record revenues in the global consumer businesses, up 15% versus the prior year period." "In North America retail banking, average loans grew 15%." "In North America, cards income rose 31%, to $1.07 billion." "Internationally, retail banking deposits increased 21% and cards open accounts grew by 33%..." "(Global Corporate and Investment Bank) revenues increased 1% during the quarter." "Investment banking revenues increased 13%...Fixed income markets revenues declined 12%... Equity market revenues declined 14%." "Revenues in proprietary investment activities declined 44%..." Total Assets expanded at an 11.6% rate during the quarter to $1.437 Trillion. Consumer loans expanded at a 9.9% rate, with Corporate loans contracting at a 1.9% pace. "Fed funds and repo" assets expanded at a 28% rate to $208 billion, and Trading assets grew at a 31% rate to $264 billion.

Bank America reported Net Income for the quarter of $3.764 billion, up 28% from the year earlier period. Highlights from the quarter included "net interest income...(of) $7.84 billion compared to $5.48 billion a year earlier," "retail deposits grew 11 percent to $399.6 billion," "the company opened 1.6 million new credit card accounts...", "the company became the top U.S. deal manager in commercial mortgage-backed securities," "in the first nine months of the year, the company's market share in syndicated loans increased to 20.0 percent. High yield debt market share increased to 12.2 percent." During the quarter, Total Assets jumped $51.8 billion, or 20% annualized, to $1.09 Trillion. Total Average Loans grew at a 4.8% pace to $502.9 billion, led by a 9.4% annual growth rate of Average Total Consumer Loans (to $311.8 billion). Average Total Commercial Loans contracted at a 2.6% rate to $191.3 billion. "Federal Funds sold and securities purchased under agreements to resell" increased $23.1 billion during the quarter (70% annualized) to $104.6 billion, expanding $10 billion more than Total Loans. Trading Assets jumped $17.0 billion (80% annualized) to $102.9 billion. On the liability side, quarter-end "Federal Funds and repo..." increased $23.7 billion to $143.0 billion, while Total Deposits increased $15.8 billion to $591.3 billion.

Wachovia Bank reported third quarter Net Income up 14% y-o-y to $1.263 billion. Highlights included "Average core deposits up 25% and average loans up 7 percent." Total Assets expanded at a 17% annualized rate during the quarter to $437 billion, the strongest growth in a year. Total assets were up 12.3% from one year ago.

Credit Bubble "Blow-offs," the Abuse of Financial Power and Anniversaries

Conventional economists and analysts disregard "financial Credit." When examining Credit growth, they maintain that including financial sector borrowings in an analysis would involve erroneous "double counting" - since the assets acquired in the process of financial sector expansion would already be included in the liabilities of households, businesses, and governments ("non-financial" borrowings). Yet to ignore the ballooning of the financial sector is to miss a fundamental aspect of historic Credit Bubbles. Indeed, not since the Roaring Twenties has there been anything comparable to the recent surge in financial sector expansion and leveraging.

According to the Fed's second quarter "flow of funds" report, total Financial Sector market borrowings have increased $5.77 Trillion, or 106%, since the beginning of 1998 (26 quarters). I view this period as the "blow-off" of a Bubble that has evolved over the past several decades throughout the U.S. and global Credit systems. Over the past 6 ½ years, Commercial Bank assets have expanded 58% to $8.2 billion; GSE assets 157% to $2.8 Trillion, and Security Broker/dealer assets 115% to $1.7 Trillion. Combined ABS and MBS has jumped 108% to $6.0 Trillion.

To ignore the mushrooming financial sector is to fail to appreciate the profound "evolution" that has truly transformed the character of finance, marketplace dynamics, and raw power (marketplace, financial, political and otherwise) - not to mention effects and distortions to the real economy. Students of the late-twenties financial folly recognize the crucial role over-leveraging, reckless speculation, financial shenanigans, marketplace abuse/manipulation, and fraud played in fomenting acute financial and economic fragility. And having witnessed the keen aggressiveness with which our major financial institutions have pursued market power, we should not be the least bit surprised by recent revelations of profound arrogance, chicanery and corruption. Such goes part and parcel with attaining astonishing market power in the most profligate of financial environments.

Since the beginning of 1998, Fannie Mae assets have ballooned from $392 billion to $989 billion (153%), Citigroup $584 billion to $1.437 Trillion (146%), and AIG $164 billion to $736 billion (349%). I will not be easily swayed that it is merely coincidence that these, among the most aggressive and powerful institutions, have all recently faced allegations (and worse) of wrongdoing. And only a diehard optimist would not today fear that Mr. Spitzer's efforts have uncovered only the tip of the iceberg when it comes to financial sector misdeeds and market abuse (just wait until the mortgage finance Bubble bursts!).

Yet arrogance and the abuse of market power are but only one facet of the deleterious consequences of massive inflation in financial sector Credit. Monday's Financial Times carried an article by hedge fund manager James Altucher, "Hedge Funds Evolve into New Breed of Banks." "Can you get a car loan from a hedge fund? A loan to buy a television? A credit card? A school loan or financing to fund a movie? Yes. Hedge funds specializing in alternative financing rather than alternative trading have sprung up in every category of asset-backed lending and have taken up the banner in areas where banks have either been too bureaucratic or too risk-averse to make the leap. The result has been funds that are uncorrelated to the traditional financial markets and have so far been delivering above average returns at lower volatility."

While it garners little attention during the halcyon days of gross financial excess, the terminal Credit Bubble "blow-off" phase has fostered massive over-expansion throughout the entire financial system. Granted, unprecedented mortgage lending has to this point sustained bank-lending profits (while liquefying financial markets, stoking the economy, and holding Credit losses as bay). In the same vein, unparalleled leveraging has maintained speculative financial profits for banks, brokers, hedge funds, insurance companies and others comprising the "leveraged speculating community." And while collapsing spreads and continued low market rates have thus far generally been a boon to lender and borrower alike, this will certainly not remain the case going forward for those providing finance.

It is the very nature of market "blow-offs" that late-cycle euphoria fosters a tidal wave of liquidity to the (increasingly distorted) hot sector. The crowd of "investors," speculators and "bankers" fall over themselves to participate in what have come to be perceived as sure profits, despite the reality that years of escalating financial flows and resulting over-investment has already severely weakened prospects. The final manic speculative and liquidity onslaught guarantees future disappointment, a reversal (likely abrupt) of speculative flows, and eventually huge losses. It was only a few years ago that we witnessed precisely these dynamics in action throughout telecom and technology, although lessons were not learned. But, then again, similar previous learning experiences were ignored, including the '93 bond market Bubble, Mexico, SE Asia, Russia, and LTCM.

It is worth noting the market's tepid reaction to what have thus far been generally decent bank earnings reports. And while the mortgage/consumer lending boom may have not quite run its course, I am willing to aver that the best days for the banking system have passed, with future prospects increasingly maligned by historic late-stage excesses. It is consistent with the irony of market blow-offs that lending spreads/margins have collapsed (from over-liquefied conditions and gross speculative excess) at this most dangerous late-stage of Credit Bubble Excess. Going forward, the leverage speculating community and banks will partake in a precarious dogfight for dwindling financial profits.

It goes beyond financial trivia that today marks the two-year anniversary of Dr. Bernanke's first major speech as a Federal Reserve governor, "Asset Price 'Bubbles" and Monetary Policy." It is befitting - and worthwhile analytically - to concurrently note the second anniversary of the "great" Greenspan/Bernanke Reflation. In hindsight, the title of Dr. Bernanke's speech told us all we needed to know: Monetary policy inflated Asset Price Bubbles to historic extremes. And as students of inflation would have expected, the initial constructive aspects of Credit excess (liquid and booming financial markets, rising real and financial asset prices, stronger income growth and economic expansion) are now in the process of giving way to the inevitable detrimental effects of inflation.

Surging energy and commodity prices, along with rising import prices, have joined higher housing, insurance, medical and insurance costs. Sporadic inflationary effects only exacerbate economic distortions and imbalances, while general economic performance (especially job creation) disappoints. The inflating cost of doing business in the U.S. has significantly impacted our global competitiveness and further fiscal and monetary stimulation is certain to only worsen the situation. All the while, the nature of the financial and economic Bubbles require (as great inflations always do!) ever increasing amounts of Credit and liquidity.

It goes to the very nature of Credit inflation and speculative market dynamics that the 1991/92 Fed interest-rate collapse/reliquefication set the stage for the 1993 bond Bubble and 1994 collapse. Then the 1995 Mexican bailout incited the 1996 mania throughout SE Asia and, somewhat later, Russia and other emerging markets. Busts methodically followed booms. The Fed and GSE's 1998 reliquefication (post-Russia and LTCM) provided the inflationary fuel for the 1999/early-2000 technology blow-off. The Fed's telegraphed rate-cutting response to a bursting NASDAQ threw gas on the corporate bond Bubble "blow-off" that then nearly collapsed in 2002. The subsequent panicked Greenspan/Bernanke reliquefication similarly stoked a much more momentous "blow-off" throughout mortgage finance that has provided the liquidity for myriad Bubbles at home and abroad.

Now what? With massive U.S. Credit inflation manifesting predictably in a $600 billion annual trade deficit, there is little mystery surrounding the perpetually weak dollar. That the dollar has not been able to rally from a more than 2-year bear market despite strong financial markets, an expanding economy, and $500 billion of Asian central bank purchases over the past 12 months does not portend positive prospects for our currency or markets. Moreover, indications of Monetary Disorder are becoming more conspicuous by the week. Crude oil has spiked to $55, while wild volatility is wreaking increasing havoc in various commodity markets (copper!). Currency markets are becoming increasingly unstable, while the Treasury market is in the midst of a destabilizing "melt-up." Emerging bond markets have inflated to extreme valuations and issuance has ballooned, emerging as the speculative asset-class of choice in over-liquefied global markets.

At two years, this Reliquefication is well into old age. Granted, this is "the granddaddy of them all," and the capacity to inflate mortgage Credit goes significantly beyond corporate or emerging market debt. Yet the harsh reality is that we have clearly entered the problematic phase of this inflationary cycle. The financial sector must continue to inflate or commence the "dying" process. But inflating will only amplify increasingly destabilizing Monetary Disorder. And there is no turning back.

I find the current environment especially alarming. Despite a significant de-valuation of our currency, the trade deficit has only ballooned. Instead of higher interest-rates restraining Credit excess and initiating the required adjustment process, two years of declining rates incited a most extreme and destabilizing (domestically and globally) Credit inflation. This has fostered only more dangerous dollar and U.S. economic debasement, not to mention historic speculation and financial leveraging. And the weaker the dollar the greater the demand for non-dollar asset classes and reinforcing flows out of the greenback. There are, in addition, now serious issues with respect to the integrity of our financial system, with the search for wrongdoing drifting awfully close to "structured finance."

Examining the markets, I see vulnerable U.S. and emerging bond markets, a fragile U.S. stock market, and the dollar at the cusp of what I fully expect to be more troublesome next leg down. With crude oil at $55, I expect foreign central banks to be much more cautious when it comes to massive dollar support operations. And it is worth noting that we saw again today the recent phenomenon of rising U.S. yields no longer prompting dollar buying. Are we finally poised for a bout of concurrent dollar and bond market weakness? Now that would be an unwelcome development for our foreign creditors, the leverage speculators, the derivative players, and global central bankers. The timing is right - commemorating the two-year Anniversary - and I see all the makings for the re-emergence of The Great Bear Market.