22 DECEMBER

[Decline in stock market leads to lower IR, mortgage rates lower leads to additional debts.
8.5 critical ratio- SP/euro - europeans liquidate
commodity currency weakness foretells economic weakness Q1/2]

In other words, we'll need to be especially alert to the possibility that next year's stock market decline will end prematurely if weakness in stocks leads to extreme strength in bonds and if this bond market strength precipitates a powerful surge in money-supply growth.

That second "if" is the more difficult one because in order for a large bond rally to generate a surge in money-supply growth it would be necessary for US home-owners to react to the drop in long-term interest rates by going on yet another mortgage-refinancing binge, monetising another few hundred billion dollars of their collective home equity in the process. This is exactly how they have reacted to every other substantial drop in long-term interest rates over the past several years -- and why the money-supply growth trend has followed the bond market with such remarkable consistency -- but it is quite possible that US home owners/buyers, as a group, are now 'tapped out'. We'll see.

We'll therefore be watching the S&P500/euro ratio closely over the coming weeks because a drop of only 3% or so from the current level has the potential to set off a wave of liquidation from European investors.

Relative weakness in the commodity currencies (e.g., the A$, the C$, the Rand) over the past few weeks might be forewarning of a substantial correction in commodity prices during the first half of next year. This would, in turn, be consistent with our expectations for stock market weakness beginning during the first quarter and economic weakness beginning by early in the second quarter. We plan to cover this topic in more detail in the next commentary.


posted by Dil at 3:41 PM