'An orgy of liquidity'

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Saturday May 12 7:30 AM ET

Luxuriating in Summer Bull Market?

By Pierre Belec

NEW YORK (Reuters) - Looking ahead for something positive? How about luxuriating in a bull market this summer? Yes, this is the stuff that some people are predicting.

But be careful. It all could be a mirage engineered by those economy-saviors -- the Federal Reserve (news - web sites) bankers -- who are desperately pumping up the nation's money supply to save the economy from a recession.

``The dynamics for a big rally are in place,'' says Martin Roberge, quantitative strategist for National Bank Financial, a unit of National Bank of Canada.

``First we've had interest-rate cuts by the Federal Reserve and investors are now starting to take the view that things will not get worse. The final leg will be the expectations that corporate earnings can only recover with the Fed continuing to lower rates,'' says the Montreal-based strategist.

Indeed, the mood on Wall Street has been more upbeat than it has been all year long. Investors are actually putting a positive spin on bad news. The view is that things can only get better from now on.

For example, the market for initial public offerings of stocks is slowly coming back to life, and the junk bond market is stirring a bit. The capital markets are coming back from the dead after getting booster shots from Federal Reserve Chairman Alan Greenspan (news - web sites) who has slashed interest rates by 200 basis points in four big cuts each of 50 basis points. Another rate cut is expected from the Fed's policy-setting meeting on May 15.

If those deep interest-rate moves don't work, then the politicians in Washington are waiting in the wings with tax cuts.


Roberge says investors' fear of missing out on the next bull market will be one of the catalysts for what he called a ``monster of a summer rally.''

``But this rally will be special,'' he says. ``It won't be a six-month market comeback but a compressed rally lasting only about three months.''

The upturn will be magnified by a rush by short sellers to buy back stocks. The market's rubber band-like reaction could be spectacular because the number of short positions in both the Standard & Poor's and the Nasdaq 100 futures contracts hover at record highs.

Also sparking the bounce will be the return of nervous money, which has been sitting in the safety of bonds and cash while the market went through a nail-biting plunge during the past year, Roberge says.

``What will help the market will be the 'New Equity Culture,' which is the new reality of managing money,'' he says. ``Even though people may not like the fundamentals of major names like Nortel Networks (Toronto:NT.TO - news) (NYSE:NT - news) or Cisco Systems (NasdaqNM:CSCO - news), their biggest fear will be in missing the next run-up and having their investment portfolios underperform.''

Roberge says deeply oversold markets have historically been fertile ground for counter-trend rallies, which is what happened last month.

The Standard & Poor's 500 index has risen 15 percent since April 4 and the Nasdaq composite index has surged 34 percent from its 2-1/2-year low set on April 4. The Dow Jones industrial average is flat after shaking off a drop of more than 10 percent.

The snapback suggests that a lot of investors believe that a market bottom has been established.

Roberge reckons that the summer rally will push the Dow to between 11,500 and 12,000, putting the ``Old Economy'' index in record territory while the S&P may climb to 1,350 and 1,400 and the Nasdaq to 2,800 and 3,000, both short of their record highs.


The rocket fuel that will get the next bull market off the ground will be the Fed's huge injection of cash into the system to stimulate economic growth, says Don Hays, president of Hays Advisory Group, an investment consulting firm.

``The next bull market, which could be substantial, will depend on how long Greenspan keeps pumping money into the economy and how long people think that he can pull miracles to save the economy out of near recession,'' he says.

Greenspan, who knocked the wind out of the economy by raising interest rates six times between 1999 and 2000 to slow growth, now hopes his policy shift will do the trick.

But the prospects that the economy will rebound may not be the prime factor in driving stocks up this summer, he says.

``Don't look for the economy to strengthen any time soon because there are things that have to be cured, such as the massive consumer debt and other excesses,'' Hays says.

The veteran Wall Streeter expects Greenspan will continue to pump up the money supply right through the end of 2001. His views though are at odds with some Wall Street firms, where most dealers look for an end to Fed monetary easing soon.

Greenspan has opened up the Fed's money faucet, sharply increasing the nation's money supply, which is the most powerful tool the central bank can use to stimulate the economy. The Fed manages the money supply by raising or lowering the reserves that banks are required to maintain.

Hays says that over the last 13 weeks, growth of the Money of Zero Maturity or MZM -- cash that can be readily used by consumers -- has jumped by some 25 percent, a record increase. By comparison, in the months leading up to the feared Y2K computer bug, the Fed boosted money supply by 15 percent, which was then a record.

MZM is a neat measure because it counts all money not tied up in checking and savings accounts, thus the reference to Money of Zero Maturity.


``There is an orgy of liquidity currently building up all at the same time,'' says Roberge. ``As we learned from the Y2K episode, this liquidity could easily find its way into financial markets.''

In the autumn of 1999 prior to Y2K when the world's computers were expected to confuse the year 2000 for 1900, the central bank greased the banking system with plenty of cash to prevent a seize-up in the financial system if panicky Americans made a massive run on banks.

Y2K fizzled like a wet firecracker but Americans who had stashed away spare cash for an emergency that never happened now found they had lots of change rattling around in their pockets. The money that could not be spent on buying a second sleek red sports car or a villa in the south of Spain found its way into the stock market. Some analysts say this propelled a speculative bubble in the technology-rich Nasdaq market.

The Nasdaq composite index was up a whopping 87 percent by the end of 1999 -- a record for any U.S. stock market -- as buying of tech stocks on credit or margin became a national pastime.

``I don't expect a replay of 1999 when we had an explosive market because since then the pyramid schemes -- margin debt and companies' use of their high-priced stock to buy other companies -- have been destroyed by the crash in technology stocks,'' he says.

``The tech stocks have a chance of rallying but I would play them cautiously because there is a high risk their earnings will suffer in the coming year,'' Hays says.

Financial stocks will lead the parade, thanks to falling interest rates, followed by health care stocks and energy shares.

``The Fed money growth level is obviously creating excess money sitting on the sidelines,'' Hays say. ``So far, it seems that most of the glut of cash has been parked in money market funds.''

Roberge says the last time all of the Fed's money gauges rose in sync and as fast was in 1995-96, which was a bullish period for stocks.

``Unfortunately, it will be a Fed-engineered market bubble,'' Roberge says. ``It will be a new speculative mania with new money because the Fed wants to fight a recession rather than tackle inflation.''


``The bull market should be in a topping phase around October or November, which will probably be about the time that Wall Street will realize the economy is not going to bounce back up and there will be a recession, regardless of what Greenspan does,'' Hays says.

Hays' bet: The Nasdaq has the potential of rallying to 3,000 while the Dow could take a stab at 12,300.

For the week, the Dow Jones industrial average dropped 130 points to 10,821. The Nasdaq composite index lost 84 at 2,107 and the Standard & Poor's 500 index fell 21 to 1,245.

-- (M@rket.trends), May 13, 2001


When the Fed lowers the discount rate, this is an indication the banks are finding it increasing difficult to find money. So the Fed loans the money. Since the Fed is creating money out of thin air, this will cause another round of inflation.

-- David Williams (DAVIDWILL@prodigy.net), May 13, 2001.

With the Summer energy crunch coming, particularly in the West, it's only a matter of time befre a liquidity-fueled Wall Street bumps into this recession-promoting force. The two don't mix.

Thus, I figure, about Fall, Wall Street will join the inexorable decline of the economy in a downward dive.

-- Wellesley (wellesley@freport.net), May 13, 2001.

I figure this summer will be a good time to get ready - by becoming an active U.S. treasury bond investor - particularly of the highly leveraged zero coupon bonds. A lot of money can be made this way, if there is a fall Stock Market blow-up.

-- Wayward (wayward@webtv.net), May 13, 2001.

Could you expand for this tired pate?

-- David Williams (DAVIDWILL@prodigy.net), May 13, 2001.

One reason Greenspan and the central bankers are promoting money supply growth is due to the enormous increases in energy costs, both already and more to come; plus theirascading effects on many other prices. Accommodation with money supply growth results in "inflation", a general increase in the price level and a decrease in the value of each dollar. But the alternative is for the energy price hikes to act like an enormous "tax" increase, where money becomes scarce, times hard, unemployment high, with cascading debt defaults and bankruptcies. In other words, a severe recession or even a depression.

Greenspan and company knows full well that the System Of Payments that is the cornerstone of the survival of the institution of Money is about to be tested like never before, as the world's sixth largest Economy literally crashes and burns this summer and fall. High inflation benefits debtors and cushions the "blow." California will need all the "cushion" it can get to avoid a fatal trauma as it hits the ground after this summer's "free fall". As no help will be forthcoming from either the Bush Administration or the electric generator cartel, Greenspan's independent power is the main remaining source of partial relief.

Greenspan isn't being altruistic either, as California's insolvency will very likely cascade throughout the banking system in a wave of cascading debt defaults, with high "systemic risk" (as Greenspan puts it.) Ballooning the money supply during the "free fall" stage cushions this high systemic risk to the banking system.

-- Robert Riggs (rxr.999@worldnet.att.net), May 14, 2001.

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