(Caijing Magazine) A combination of growth optimism and inflation fear has catapulted asset markets in the past few weeks. These two concerns should drive markets in different directions: Inflation fear, for example, should limit room for stimulus and prompt stock markets to retreat. But the investment camps expressing these opposite concerns go separate ways, each pumping up what seems believable. As a result, stock and commodity markets are mirroring the behavior seen during the giddy days of 2007.
Regardless of what investors or speculators say to justify their punting, the real driving force is the return of animal spirit. After living in fear for more than a year, they just couldn’t sit around any longer. So they decided to inch back. The resulting market appreciation emboldened more people. All sorts of theories began to surface to justify the market trend. Now that the rising trend has been around for three months globally and seven months in China, even the most timid have been unable to resist. They’re jumping in, in droves.
When the least informed and most credulous get into the market, the market is usually peaking. A rising economy and growing income produces more funds to fuel the market. But the global economy is now stuck with years of slow growth. Strong economic growth won’t follow the current stock market surge. This is a bear market rally. People who jump in now will lose big.
Over the past three weeks, the dollar dove while oil and treasury yields surged. These price movements exhibited typical symptoms of inflation fear, which is complicating policymaking around the world. The United States, in particular, could be bottled in. The federal government’s fiscal stimulus and liquidity pumping by the Federal Reserve are twin instruments for propping up the bursting U.S. economy. The fiscal deficit could top US$ 2 trillion (15 percent of GDP) in 2009. That would increase by one-third the total stock of federal government debt outstanding. Such a massive amount of federal debt paper needs a buoyant Treasury to absorb. If the Treasury market is a bear market, absorption becomes a huge problem.
via Andy Xie: Tight Spot for Fed, Blind Spot for Investors.
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