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February 2, 2005

Strange Brew

A few days ago, I commented that the recent rally looked weak because the spec stocks were not participating. Today Google tacked on a mere 7% (and was up over 12% at one point) after reporting numbers that made Google fans run around in a Viagra-overdose-like frenzy. To answer several e-mails I got, the answer is “no,” I don’t think this heralds a return to the speculative rally. There is just not broad enough participation to come to such a conclusion. Yahoo was up in sympathy with Google, but most other spec stocks were either flat or down.

The bulls and bears are still tugging strongly at each other, and whomever wins will depend on whatever brew of enlightenment may be coming our way in the near future. Given the current state of affairs, my bets are that it will be a negative brew. There is simply too much distortion in the capital markets, a gift of bad monetary policy (and any monetary policy is usually bad since the markets can take care of themselves), and the environment is bound to create a whirlpool of uncertainty which will drive inflated prices downward. As Jim Rogers says, “Reality always wins in the end.”

The Lords of Monetary Illusion decide to step back their counterfeiting today as represented by the 25bp hike in their Federal funds target rate. Much salty sweat has been lost by the bulls who fear these rate hikes will topple the market. They just might, but the question is when? It is important to remember that just because the Fed is raising rates does not mean they are tightening. The term “tightening” means implicitly that the Fed is draining liquidity (reserves) from the banking system. Such a drain will only happen if they are targeting a rate above the free market rate, because it is in that situation that they have to sell assets (usually Treasuries) to raise rates (by selling assets, the Fed receives money, thereby removing it from available reserves). Until that tipping point, the Fed is simply buying less assets… so it’s likely the printing press is still churning, just at a slower pace than before.

Author’s Disclosure: Short YHOO


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