Sidelined for now...

Wednesday, May 7, 2008
Sidelined for now...

Been doing a lot of reading and research last 5-6 days and to be honest not really getting me anywhere - there are several conflicting themes playing out right now:

1. Inflation vs. Reflation. Clearly commodities are pointing to inflation risk, but market understand that ultimately commodity spikes leads to deflation rather than inflation, which is the scenario central banks wants the least.

The reflation scenario is based on that EMG countries, realising slower growth is busy ramping up demand through infrastructure investments, and in the US tax rebate and soon to be announced help in mortgages makes for perfect ingredients in reflation soup.

For now the reflation themes wins - but the risk being crude above 150, even towards 200 US dollars could reverse EVERYTHING back to credit crunch.

I take note that the US is building its strategic reserves in times of record high crude prices – and it seems from the “intelligence environment” that Bush has approved covert operation in Iran and that the Pakistan lease is getting shorter (Stratfor analysis). The main outside risk right now to the bullish market is on of geopolitic tensions in the Middle East, if so our year old call for 170 USD crude could be validated.

2. Coupling or decoupling. The bulls wants to believe in decoupling as it free up arguments for why you should be invested in EMG and Asia/Middle East.

The truth probably in the middle rather than either side. Europe clearly (Latest factory and retails data confirming IFO) in period of downward adjustment of growth forecast - while Asia is booming.

On the corporate level the managers are all guiding higher as they can not see things slowing(for now), which lead me to an excellent argument which Alain Bokobza, Head of European Equity & Cross Asset Strategy from Soc Gen made to me in private presentation today; the issue with corporate often more one of bottleneck than lack of orders, companies like Siemens guided lower due to constraints on delivering on orders(Which cost them fines) rather than lack of demand, the same goes for much of the infrastructure industry, but end of the day having orders, not being able to deliver will lead to lower margins, and this is before "recession cycle" really starts to impact demand/orders. The infrastructure business is problaby overvalued and overexposed, and that’s without considering the industries long term contracts with its lack of control over rising labor and input costs!

Growth and FX differences. The Middle East and Asia clearly needs to let their currencies strengthen or face further social unrest. The food crisis is now for real, the best and fastest way to limit the negative impact is to let currency go stronger - this will be followed by fiscal stimulus, probably in the shape of subsidies hands out (I see more and more talks about Alaskan like once-a-year dividend).

Bottom line; one part of the world is facing rising inflation, the other likely to see deflation, and central banks are confused where to turn first.

Market positioning. Market is now long, and with good reason. Technically 1405 was line in the sand for S&P and next level should be 1450 - however with 100% support from Newsletter analyst’, the market is clearly committed after the 12% move from the lows. Why are we still hovering around 1417 if this was positive?K

Keep your eyes on The Congress, they are working hard to reduce the economic pain for Joe Average American, it will not be long before some kind of relieve in real estate is announced. Similar to Bill Gross I believe its imminent and the "cheapest" way to stop the ever falling housing market.

Fact is for now the Fed has done EVERYTHING to safe the banks, and close to NOTHING so safe the average American. Only 3 in 10 people in the latest Uni. of Michigan survey expected to spend their tax rebate, the rest would use the cheques to reduce debt - if that is NOT a sign of new times and trend in consumer spending, I do not know what is.

Conclusion. Rather than "betting the fund" on something I cant predict I remain open and ready to act, for now the upside looks more likely than downside, but the odds are 52/48 in my optic.Good luck,