Wild Times May Lie Ahead
05/02/2007 8:31 AM
Heading into this year and right up until this week, I'd been arguing that the broader macroeconomic and market setup was that "heads, bulls win; tails, bears lose."
That is, if the economy does fine and grows and the Great Earnings Boom of the 21st Century (ooh, that's a new term I'll keep. Do I need to trademark it?) continues, the market will likely continue to rally and may even expand multiples on top of that earnings growth.
And if the economy turns south mostly because of real estate's demise -- or if real estate itself gets bad enough, regardless of its impact on the broader economy -- then the Fed would likely cut and juice the market. In the end, the Fed is a political bureaucracy whether it admits that or not, and a cut would certainly help the short-term politics by letting people see their dollar-denominated assets appreciate.
That's long been my playbook, as readers know by now.
But a couple of weeks ago, I started changing that thesis, as Aaron Task and I discussed in this video. That is, the collapse of the dollar in 2007 has likely begun to undermine the Fed's ability to cut.
I think the market is starting to tell us that too, as Aaron noted in a Columnist Conversation post yesterday. We're seeing the market rally on strong economic and earnings data, as that "heads" part of the equation holds true. But the "tails" part is getting trickier, as the global markets sell dollars. Because that tells the Fed it can't devalue our currency by juicing things too blatantly such as by cutting rates, our own stock markets don't rally on weakness anymore.
For most of 2002 to 2006, I'd repeatedly written about how "steady" this economic boom has been. That steadiness is less so in 2007. It's likely to make for some volatile and wild times, with big potential for both double-digit spikes and double-digit declines as the year progresses.
With the domestic economy looking ever cooler and consumers looking like they'll finally make the permabears right about their pending collapse (via Target, Circuit City, Wal-Mart and so on), I'm not thrilled about paying up for earnings juiced by the effects of FX. I'll definitely be looking for some short-side pairs to my longs.
At the time of publication, the firm in which Willard is a partner had no positions in the stocks mentioned, although positions can change at any time and without notice.
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