Bearish money manager John Hussman is not tempted to nibble on stocks after the recent swoon.
My impression is that the market remains in a tenuous state in that we have not meaningfully cleared the overextended syndrome that has been with us in recent months. Even so, we’ll respond fractionally to any clearing that we do observe (with a growing responsiveness as we move through the year). We’re certainly not inclined to “buy the dip” to a material extent, and I continue to anticipate a second wave of credit difficulties in the months immediately ahead. But I also believe that if we can move through 2010 without a second “crisis-level” wave of credit strains, we’ll be more able to rely on post-1940 criteria in setting our investment positions, with less concern about the more hostile “post-crash” dataset.
Suffice it to say that we’re not about to lift a significant portion of our hedges early in a selloff provoked by fresh credit strains, but that I also don’t intend to specifically factor in concerns about a second-wave for an extended period if we don’t observe them.
He also slams ECB boss Jean-Claude Trichet’s claim that he’s not engaged in quantitative easing because debt purchases will be sterilized:
ECB President Jean-Claude Trichet has been quick to deny concerns that the move by the ECB will be inflationary, emphasising that the intervention will be “sterilized” in order to prevent a major increase in the amount of euros outstanding. This is “totally different,” he argued last week, from the massive increase in monetary base that has occurred as the U.S. Federal Reserve has bought up over $1.25 trillion in debt obligations of Fannie Mae and Freddie Mac. A “sterilized intervention” is one where the euros created through the purchase of distressed Euro-area debt will also be absorbed by selling other assets from the ECB’s balance sheet, in order to take those euros back in.
In order to evaluate the arguments being made, it’s helpful to understand the balance sheet of a typical central bank. Whether in the U.S., Europe, or elsewhere, the basic structure is the same. On the asset side, the central bank has government debt that it has purchased over time. A small proportion of total assets might be held in “hard” assets such as gold, but primarily, the assets of each central bank has traditionally represented government debt – mostly of its own nation (or in the case of the ECB, euro-area governments). As a central bank purchases these securities, it creates an equal amount of liabilities, in the form of “monetary base” (currency and bank reserves).
Notice, for example, that the pieces of paper in your wallet have the words “Federal Reserve Note” inscribed at the top. Currency is a liability of the Federal Reserve, against which it has traditionally held assets such as Treasury securities, and prior to 1971, at least fractional backing in gold.
In this context, consider the ECB’s proposed 750 billion euro line of defence. Essentially the ECB is saying “We stand ready to buy as much as 750 billion euros of distressed Euro-area debt in order to defend the euro.” Simultaneously, despite the fact that Euro area countries are running large fiscal deficits, the worst being in Greece, Portugal and Spain, the ECB is saying “However, we intend to sterilize this intervention, which will ultimately require that we sell Euro-area debt into the market in order to absorb the euros we create.” The only way that both statements can be true is for the ECB to admit “Therefore, we are fundamentally promising to debase the quality of our balance sheet, by exchanging higher quality Euro-area debt with lower-quality debt of countries that are ultimately likely to default.”
Read his whole letter here.
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