What Castro taught me; Dont trust stock indexes

My good friend Yoshi is back with an excellent piece on the markets called:

What Castro taught me; Dont trust stock indexes


"Those who profit are the ones at the top. They keep the doughnut for themselves and give the hole to the people." by Alexander Lebed (1950-2002), former Russian general & presidential candidate

On 10th of October 2008, George Bush said, "We are in this together and we will pull out of this together." My English translation is "My pals and I put you in this mess and you pull us out." In November 1999, Fidel Castro simplified the next president by the comment of this decade, "He is not smart."

His insight came back alive when I saw the Cuban TV showing some politicians dozing away and others chatting away with someone in the back row while Castro was speaking. I felt this guy might not be so bad, so I braved out to the streets of Havana. The poor socialists in the shops and on the streets looked ok in contrast to the discontent capitalists in the US. Castro was not their god and my long suffering salsa teacher candidly said, "Let’s talk politics." Looking back now, we have been too naïve to prepare for the emerging shift in the world: redistribution of the wealth and resources outside the developed economies.

Then Paulson said today "The needs of our economy require that our financial institutions not take this new capital to hoard it, but to deploy it.'' He left the most important objective on the goodwill of the 9 nominated banks knowing full well what happened in Japan: the Japanese banks didn’t lend, they used the injected capital, the zero interest rate and the deposit money to push the 10y JGB yield down to 0.75%. The banks recovered eventually, but the rest of the country lost a decade. So we may see another zero sum game again. The government gives $750 billion and 1% Fed fund; the banks buy Tresuries (so bigger the issuance, more profits for the banks). It’s much better than selling the toxic assets to the government since that could give the banks a chance to recover some of the loss later). Therefore, I don’t want to be too excited about the stocks and too bearish on the long-end of government bonds beyond November until the FX mkt gives me a signal: the redistribution of the wealth and resources outside the US in the form of USD devaluation and inflation.

I am now shifting my mid-term view to neutral on the government bonds: the government everywhere is wasting the scarce resources on the inefficient part of the economy at the cost of the efficient parts and tax payers. I am not confident if the real economy will follow the bounce on the financial stocks beyond few weeks. Looking at the coordinated global response to date, the world seems to have decided to keep the existing financial structure a while longer by continuing to lend to the US.

Below are the current index weightings of the financial groups in the US, UK and Europe:
SPX: 9.2%
Euro Stoxx50: 23%
FTSE 100: 21%

Despite the fact that $750 billion and other guarantees in the US and $1.8 trillion in Europe are being committed, the financials are the only sectors showing positive numbers hinting the mkt hesitation. The global demand and the main streets are weakening while the financials are boosted by the governments. Don’t be fooled by the indexes, they will no longer represent the overall economy accurately. I think the financials’ weightings will increase to high 30s in Europe and mid 20s in the US to obscure the negative effects on the real economy.

Yoshi