The New Normal And Asset Class Cycles

November 20, 2009


Figure 11. VIX Confirms Higher Financial System Fears


The Fed’s Easy Money (It) And Related Assets Bubble Will End When It Ends!

The FRB was easing in October and November 2009 with a new round of expanding bank reserves. There are three points that need to be made about the relationship between excessive reserves and asset prices.

1. Excessive easing in a financial crisis works best after the panic has passed, i.e., September 1929 - November 1929 and July 2008 to March 2009, when stock rallied about 50 percent and 60 percent after making market troughs.

2. Easy money flows into risky assets after a panic, such as from November 1929 - April 1930 and March 2009 to present.

3. The ability of easy money to lift assets wanes if enough speculators sell to take profits. Following the 1929-1930 rally, stocks declined in spite of easy money.

For example, FRB and government fiscal stimulus was 8.3 percent of GDP from 1930-1931, yet stocks declined 60 percent and were down 85 percent from September 1929 through March 1932 (credit James Grant).

So far, in 2007-2009, our monetary and fiscal stimulus has equaled 29.9 percent of our annual GDP. Much like
’s experience, at some point stocks will decline in spite of the high bank reserves. The example for the U.S. is
in the 1990s, which built massive bank reserves higher than the FRB's current levels relative to GDP.
’s 20-year battle with asset and consumer price deflation has given its people a debt-to-GDP ratio nearing 200 percent.
’s is not even half of that yet (it may be 98 percent or $13 trillion soon). Japanese stocks still are well below their 1989 highs, so high reserves do not always continue to flow into risky assets. Japanese stocks fell the most after reserve builds because their banks were unwilling to lend. Ditto for the

For now, growth in reserves is positively correlated to risky assets, but at some point, speculators might sell when the public or average person fails to support the uptrend. Then more traders take profits. Our current low volume market is the domain of speculators. It can revert to HELL with little warning.

The Chinese Renminbi (RMB) Or The Yuan

On March 25, 2009 in the Arrow Insights 75/50 Portfolio, we sold a 5 percent position in the WisdomTree Dreyfus Chinese Yuan Fund (NYSEArca: CYB) at $25.40. We sought the appreciation of the Chinese renminbi but our timing was not right. Recent events cited below have changed our view to one that is more patient for fundamentals to unfold. On Nov. 4, 2009, we added back the 5 percent exposure sold in March at $25.31. This trade repositions some of the sale proceeds from corporate bond sales made on Sept. 29, 2009.

The Chinese renminbi (RMB), or the yuan, is a currency pegged to the U.S. dollar, with minor revaluations over the last few years. We think the yuan-dollar peg will only last for a few more months, or at most, about 12 months because economic fundamentals support a higher yuan-dollar exchange.

Gold’s Breakout & Its Target Prices

Figure 20 was generated on Oct. 13, 2009, when we commented about gold’s recent breakout above its 1032 price resistance, which confirmed a continuation of its long-term uptrend. Gold made a weekly close above 1100 on Nov. 13. If so, I had thought that gold’s price could rocket to 1200 within a few trading days or weeks. I would not jump in with new funds to ride it, yet it would not be a surprise (Figure 12).


Figure 12.


Even though we expect gold to hit 1300 within a few months, we will sell enough of streetTRACKS Gold Shares Trust (NYSEArca: GLD) and Market Vectors Gold Miners (GDX) to rebalance to our target allocations near 12 percent of portfolio gross exposures for each ETF. If so, we would accelerate the first half of our PowerShares NASDAQ 100 Index ETF (NasdaqGM: QQQQ) purchase with a 7.5 percent allocation (15 percent is the target). Gold has been high beta in 2009. The AI 75/50 Portfolio will have a better beta-balance if QQQQ is added after rebalancing gold positions.


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