Navarroââ,¬â"¢s Big Economic Picture ââ,¬â€œ Raise the Ante or the Roof?

This market reminds me of a poker game in a hurricane.  Inside, while the shutters are rattling and the roof is shaking, everybody is throwing in a small ante, never betting big, and folding at the slightest sign of trouble.  The result is a boring game with little volatility that goes nowhere. 

Meanwhile, outside, the storm of rising inflation, oil price spikes, Iranian nukes, Iraqi and Nigerian civil wars, a deflating housing bubble, and humongous budget and trade deficits rages.  Isnââ,¬â"¢t it only a matter of time before one (or more) of these flying projectiles smashes into the house and the winds send all of the money on the table flying and the players running for cover? 

Now, if you want a little meat on your bones rather than metaphors, you need look no farther than the Federal Reserve report of last week that shows that during the Bush II regime, middle class incomes have been stagnant, the poor have gotten poorer, the rich have gotten richer, and the massive equity gains from the housing bubble have not even matched the massive gains from the previous stock market bubble.  Bleeding heart liberals will wring their hands over the inequity of its all, hard nose conservatives will say this is how it should be, but both miss the broader point that economies do not prosper unless more and more real money (in the form of wage gains) is put in their hands ââ,¬â€œ rather than fake money through a highly inflationary fiscal and monetary policy ââ,¬â€œ which is my queue to hand off this column now to Matt Davio, who once again outdoes himself.

Hedging Your Bets With Matt Davio: Divergences Abound

Sometimes, it is better to just let others do the talking for you.  Consider, this week, then, these two bearish gems from two of Americaââ,¬â"¢s finest former public servants:

"Under the placid surface [of the economy], there are disturbing trends: huge imbalances, disequilibria, risksââ,¬Â¦ call them what you will. Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lotââ,¬Â¦The difficulty is that this seemingly comfortable pattern can't go on indefinitely. I don't know of any country that has managed to consume and invest 6 percent more than it produces for so long. The United States is absorbing about 80 percent of the net flow of international capital. And at some point, both central banks and private institutions will have their fill of dollars...I don't know whether change will come with a bang or a whimper, whether sooner or later. But as things stand, it is more likely than not that it will be financial crises rather than policy foresight that will force the change."
-Paul Volker, Former Chairman of the US Federal Reserve, April 10, 2005.

"The traditional immunity of advanced countries like America to Third-World-style financial crises is not a birthright. Financial markets give us the benefit of the doubt only because they believe in our political maturityââ,¬Â¦in the willingness of our leaders to do what is necessary to rein in deficits, paying a political cost if necessary. And in the past that has been justified. Even Ronald Reagan raised taxes when the budget deficit soared. If this kind of fecklessness goes on, investors will eventually conclude that America has turned into a third world country, and start to treat it like one. And the results for the U.S. economy wonââ,¬â"¢t be pretty."
-Robert Rubin, Former US Treasury Secretary, in a paper written with 2 other authors presented to the American Economic Association, January 2004.

I bring these quotes as we are in a clear moment of inflection as I have overstated in past months.  Without increasing taxes and/or interest rates, the US can not continue to print money without a causal relationship and its effects on the US dollar and the broader economy to connect at some time. 

In this regard, for the 13 weeks ending Feb-13-06 (last figures available), the growth of M3 was +7.9 pct from the comparable period 52 weeks ago, and +9.4 pct compared to 26 weeks ago. Moreover, the money supply growth year-over-year, has escalated over last weekââ,¬â"¢s figures. 

This growth is reflected in the first near term chart of the dollar:  This is a picture of the US Dollar making lower highs with possible near term highs. 

The second longer term chart is indeed very bearish. I think the US Dollar is a better picture of the condition of overall US markets then equities, since it takes more and more dollars to get the markets where they sit today.  Gold confirms that inflation is larger than the hedonic measures that are spit out by the CPI and PPI numbers.  Unless interest rates rise, along with taxes, the continuous printing of money and deficit spending offer little desire for long term investors.

I began with two contemporary Americans.  I will end with one of the great students ââ,¬â€œ and professors ââ,¬â€œ of the interest rate cycle.

"There is no means of avoiding the final collapse of a boom brought about by credit (debt) expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit (debt) expansion, or later as a final and total catastrophe of the currency system involved."
-Ludwig von Mises

This Weekââ,¬â"¢s Macroeconomic Calendar: Week of Volatility Ahead

This will be a very heavy data week and should spark a lot of market volatility.

The home sales data ââ,¬â€œ new on Monday and existing on Tuesday ââ,¬â€œ will be particularly instructive as there was a divergence last month that needs to be reconciled.  Clearly, existing home sales are declining rapidly but last monthââ,¬â"¢s new home sales showed surprising strength.  If both point down this month, look out below ââ,¬â€œ BUT warm Midwest weather may help both.

Consumer confidence, which has been rising over the last three months, also flies on Tuesday.  When you figure out why, be sure to let me know.

On Wednesday. auto sales, personal income, and the ISM all fly while on Friday, we get another bite of the consumer apple with consumer sentiment and the ECRI weekly leading index which continues to show strength.

All in all, this should be a fun week for traders.

Stock Picks and Pans

One of my former students dissed my HEPH stock and touted HTI in its place.  Methinks he may be right, at least about HTI -- Halozyme Therapeutics.  The company focuses on recombinant human enzymes for the infertility, ophthalmology, and oncology markets.  Itââ,¬â"¢s had a nice spurt in the past several weeks and is near its 52-week high and may need a rest but its one for my watch list.

One stock featured in IBD this week may be worth a look.  GILD ââ,¬â€œ Gilead has a very strong chart, is a nice defensive play in bearish times, and has a new HIV drug coming on line. 

Iââ,¬â"¢m holding AKSY, ARTX, HEPH, PFSW, PPHM, QMCI, SVA, TMTA, VION, and XOMA.  Iââ,¬â"¢m short QQQQ and the financial ETF XLF.  PFSW and PPHM are doing particularly well.  Methinks its time to dump XOMA.

Bon Chance!

Peter Navarro is a business professor at the University of California-Irvine, and can be contacted at pn@peternavarro.com. Matt Davio is a managing partner at the hedge fund, Red Rock Capital Fund, and be contacted for hedge fund services at redrock@peternavarro.com.

DISCLAIMER: This newsletter is written for educational purposes only.  By no means do any of its contents recommend, advocate or urge the buying, selling, or holding of any financial instrument whatsoever.  Trading and investing involves high levels of risk.  The authors express personal opinions and will not assume any responsibility whatsoever for the actions of the reader.  The authors may or may not have positions in the financial instruments discussed in this newsletter.  Future results can be dramatically different from the opinions expressed herein.  Past performance does not guarantee future performance.