The Volcker Purgative

One would expect Paul Volcker, hawk among hawks, to say something like this (in a recent interview):

I think this period we’re going through is kind of a curative process; it’s a purgative. There is something to the old view that you have to have a recession once in a while to deal with the excesses of a boom. And I think we had excesses in this boom, for sure, and we’ve got a really difficult recession. You want to relieve the sharp edges, without any question, but I don’t think it’s been possible to pump it up so there’s no recession at all.

I suspect many in the corridors of power (at the Fed for example) feel the same way but can't say it in such a straightforward manner. It wouldn't be too politically astute to say something like: "You know what? All those job losses, all the financial suffering are actually good for the economy...in the long run."

Inflation: A Tale of Two Views

In an interesting speech, San Francisco Fed chief Jane Ellen acknowledges the current cognitive dissonance in inflation expectations (emphasis mine):

In my career, I have never witnessed a situation like the one that exists now, when views about inflation risks have coalesced into two diametrically opposed camps. On the one hand, one group worries about the long-term inflationary implications of a seemingly endless procession of massive federal budget deficits. At the same time, others fear that economic slack and downward wage pressure are pushing inflation below rates that are considered consistent with price stability and even raising the specter of outright deflation.

The fear of higher long-term inflation reflects, to a large degree, worries about Fed monetary policy. Our array of new programs to spur the economy have pumped up our balance sheet and created a huge quantity of bank reserves in the process. Some worry that we won’t be able to shrink our balance sheet because of political pressures, and in the process we will end up monetizing the government debt. This fear is real, growing, and disruptive. That’s why it’s so important for me to say the following loud and clear: We at the Fed are and will remain fiercely independent from politics. We have the means—and we certainly have the will—to tighten policy when the time is right. In fact, by raising the interest rate that we pay on excess reserves we can tighten monetary policy even before our balance sheet shrinks. And we are, as always, steadfast in our determination to achieve both of our statutory goals of full employment and price stability.

Whether she and the Fed in general will be believed is another story.

The Speech

I thought this part - towards the very end - of Obama's health care speech was a great answer to the recent nuttiness:

You see, our predecessors understood that government could not, and should not, solve every problem. They understood that there are instances when the gains in security from government action are not worth the added constraints on our freedom. But they also understood that the danger of too much government is matched by the perils of too little; that without the leavening hand of wise policy, markets can crash, monopolies can stifle competition, and the vulnerable can be exploited.

And they knew that when any government measure, no matter how carefully crafted or beneficial, is subject to scorn; when any efforts to help people in need are attacked as un-American; when facts and reason are thrown overboard and only timidity passes for wisdom, and we can no longer even engage in a civil conversation with each other over the things that truly matter – that at that point we don’t merely lose our capacity to solve big challenges. We lose something essential about ourselves.

The Crowd Speaks Technical Analysis

Nice write-up on the benefits of adding some technical analysis to a rational, fundamental worldview by Anthony Bolton, the recently retired manager of the top-performing Fidelity Special Situations fund. A few excerpts (emphasis mine):

My contention is that if you are trying to predict the mass action of thousands of investors, most of whom are investing on a rational or logical basis, you won’t be able to do this by taking the same logical approach as everyone else.

As the stock market can’t be predicted by logic alone, I believe investors have to use two conflicting approaches. First, they need their own views of the correct value to be placed on a company, worked out through fundamental analysis and by making predictions about future prospects etc.

But investors also need to listen to what the market is telling them and see what they can learn from the behaviour of other investors. It is one of the reasons why I use technical analysis to complement my fundamental analysis; technical analysis is good at showing the mass action of investors.

The Heretics of Finance

I've been reading the entertaining and sometimes illuminating The Heretics of Finance by Andrew Lo and Jasmina Hasanhodzic. It's basically a series of interviews of Technical Analysis luminaries such as Ralph Acampora, Bob Prechter, John Murphy, Alan Shaw, Laszlo Birinyi (the self-hating technical analyst) and Linda Bradford Raschke (the only active trader among them).

Professor Lo of MIT is the first (and only so far) major academic who's been curious about, then supportive of technical analysis and this book is, in a way, his token of appreciation to the TA community. Most of the discussions address basic TA subjects and controversies. The target audience seems mainly to be people who might be curious about technical analysis but have heard negative things about it ("it's no different than astrology" would be one such negative preconception), so our TA heroes try to debunk the negatives and promote the positives ("if you believe psychology and history play a role in the markets, then you must believe in TA's contribution to the analysis of markets" is how I would paraphrase their response). They don't always succeed though and their contradictory answers to a number of questions may give pause to many an open-minded reader but overall they come across as a passionate, knowledgeable bunch.

I enjoyed Elliott Wave guru Bob Prechter's insightful remarks on the role of emotions in trading:

"No one assessing or trading markets is unemotional about it. This job is not like building cars. It's like trying to outwit a pack of murderous inmates in an insane asylum. You can't do it calmly because you don't know what they're capable of, and they don't have to use reason."

A trader friend of Bob's describes the trading life as: "hours and hours of boredom punctuated by moments of sheer terror".

On a somewhat related subject (under "when analysts fail"), this epic NYT magazine piece by Paul Krugman on how the economists got it so wrong, complete with a brief history of economic thought is a must-read. Even Greg Mankiw likes it.

On yet another somewhat related subject (under "economics"), I have noticed, reading the always-entertaining comments on Seeking Alpha, that "Keynesian" has become an insult now, one that misinformed readers hurl at anyone making a cogent point about the Fed or the economy. It's only a matter of time before cogent, rational, informed, intelligent and other adjectives to that effect joined the list. What an Orwellian world we live in!

We're All Nutjobs Now

It seems that The Big Picture blog's own Barry Ritholtz agrees with some of the very points the "Seeking Alpha nutjobs" have been making. Now, Barry is definitely not a nutjob, he's a knowledgeable, rational, very smart and highly entertaining fellow. And I happen to agree with most of what he says or writes generally. I believe he may have gotten a little carried away in his demonization of the Fed (although I agree that Greenspan's Fed was definitely more evil than Bernanke's Fed) but the points he's been making about the Fed over the past year are not to be dismissed; he may turn out to be right more often than wrong.

Barry mentions this great article where Newsweek's Dan Gross (one of the best financial journalists outside of the blogosphere) touches on something I alluded to previously, namely that "some people, blinded by their political views and ideologies, are hating this rally".

Another must-read article is this FT Alphaville post on gold (here's another good one). Whether this breakout is of the launching pad or the head fake variety, one should expect some serious volatility in gold.

Seeking Alpha Nutjobs

As a Seeking Alpha contributor and reader, it saddens me that many of the commenters there seem to be members of what Paul Krugman would call the angry far-right irrational fringe.

A fairly cogent article (not by me, I hasten to point out) on the current attack by Congress against the independence of the Federal Reserve and its potential consequences got destroyed by about 100 remarkably self-similar comments the contents of which can be summed up as follows:

1. Whoever wrote this article is ignorant and stupid, and should stop writing articles.

2. The Fed is a criminal enterprise which has:

- debased the dollar

- betrayed the Constitution and all this country holds dear (liberty above all).

3. Ron Paul is our hero. He's the only man in America who truly gets it. He wants the Fed dead, therefore we want the Fed dead.

4. To the writer of this article: you are so ignorant and stupid, you can only be a paid shill for the Fed.

I couldn't help (I'm weak that way) adding a nutty comment of my own, which will probably be pilloried:

"Let me see.... Let's say a guy who publicly states day in and day out he wants you dead suggests you and he should go hunting together someday, would you go? Well it's the same thing: Ron Paul has stated a million times that the Fed is an evil institution that should be taken out back and put out of its misery. And now he wants to audit it, just audit it? Give me a break!

One problem with giving Congress more authority over the Fed (and I'm not saying there are no advantages) is that when time comes for the Fed to start raising interest rates while unemployment is still high (in about a year or so), Congress will try to stop it at all cost. I agree with most posters that the Fed has already lost a lot of its independence, particularly after all the "innovative" (irresponsible?) steps it took during the financial crisis. Less independence means less ability to fight inflation. So why make the Fed even less independent by giving Congress more say into what it does?

As far as Ron Paul is concerned, he wants to kill the Fed, auditing it being only the first step. He's been crystal clear about it. I see a lot of commenters agree with that goal. Fine. But don't give me any BS about the merits of transparency when all you want to do is look into the Fed's entrails to better rip them out!"

Financials Vs. S&P 500

(Click to enlarge)

This is the daily chart for XLF, the financials ETF, relative to SPY, the S&P 500 ETF. It's interesting to note that the 50-day moving average (of XLF/SPY) very recently crossed over the 200-day moving average, which confirms the financial sector's outperformance over the overall market.

As a reminder, the 50-day MA crossed under the 200-day MA back in March 2007, signaling a financial sector underperformance. Obviously, as an overall market sell signal, that was a little early as the market as a whole kept going up until October 2007, so I'm not saying this is an all-clear buy signal. That would be premature, especially as we enter a historically turbulent time of the year. It is however an interesting piece of evidence that the market internals are changing in a major way.