Key News

• Britain posted its largest April budget deficit since monthly records began in 1993. (Bloomberg)

Quotable

“Do not worry if you have built your castles in the air. They are where they should be. Now put the foundations under them.”

                           Henry David Thoreau

FX Trading – A lot to worry about

The stock market of late seems to be noticing them. But commentators seem to be looking right past them—systemic risks. Why do I say that? Well, it seems every time I flip on the TV to a financial show, one mutual fund manager after another is trotted out to tell me this is a great buying opportunity. They do it with such confidence. They are dressed so well. They are usually fairly good looking, trim and fit—not dumpy and ruffled like me. All part of the sales package is my conclusion.

Granted, I think a lot of these managers do actually believe what they say. But they really do lack perspective. I would prefer if they said something like this:

“It may be a good buying opportunity if this is a correction, but the reality is that we human beings never really know if a correction is a correction or a major change in trend. I don’t care how good you say your technical indicators are—you never know until the gift of hindsight is handed to you.”

So Mr. Fund manager, a little more humility might be in order given what we do know as potential systemic risks lingering out there; they aren’t insignificant:

1. The potential demise of the Europe monetary union
2. China deceleration in growth linked with credit bubble woes
3. War between North and South Korea
4. War between Israel and Iran
5. US job market deterioration
6. Civil war in Thailand
7. Eurozone demand falls off the cliff on austerity measures
8. The US consumer goes back into his shell scared by stock market
9. Global deflation becomes the new norm; corporate pricing power tanks
10. China thumbs its nose on yuan appreciation and US retaliates with trade barriers

Any one of the items above can create problems of varying degrees. And two makes matters worse. Oddly, the potential for many of these things to occur at the same time is real.

I think this is the takeaway, in which the events above collectively will damage stock markets when linked with: The regulatory “reform” in the US and increasing German control of EU budgets—a seeming big part of becoming premiere bailout paymaster in Europe, has one major thing in common—it reduces the amount of credit getting to the real economy.

Interestingly, at the same time China continues to press down on credit at the margin, deflation, we think, is embedding itself deeply into the developed world economies. (For those who believe rising government debt MUST be inflationary, we point again to Japan as an example of rising debt and rising deflation. It is not about debt, it is about how the real economy uses credit. Bank lending in Japan went south for many years no matter how much government built up debt.)

Consumer Installment Credit Outstanding 1943-2010: Notice something very interesting in this chart? Consumer credit is turning over in a big way for the first time in forever!!

Ask yourself how that happens when monetary and fiscal policy are working overtime in the US to create credit. Then ask yourself if this is an inflationary or deflationary shift in the economy.

Monthly Consumer Credit Year-Over-Year % Change (black line) vs. S&P 500 Index (purple): Not a great deal of rebound that seemingly the stock market was forecasting?

We think commodities markets, commodity currencies, and stock markets may be reflecting:

A) Headwinds in the real economy related to what might represent a secular change in the way Mr. Consumer views credit and debt.
B) The regulatory credit cycle now in motion designed for politicians more so than markets.
C) The fact that nasty geo-political events historically germinated at times similar to this.

That is a lot to worry about.

Happy Friday! Be careful out there.