A Rally to Behold

This rally has been maybe the biggest rally since this whole thing started. The entire S&P 500 is basically up 20% in the last 7 trading days. The financial index (XLF) is up 50%!!! It has been monstrous and caught alot of people off guard. You could sense through the tape the traders desperately trying to get long exposure and get out of shorts. We held the 800 to 805 region today just like I thought we would and pulled back. My guess is the next 20 points in the S&P 500 will be lower not higher but the psychology has changed and outside a major event I think we are headed higher after a likely pullback. The FED is now the hero, not the goat. The banks are now on the way to prosperity not bankruptcy. The consumer will get a 2nd wind not dig a hole for a grave. The turnaround in market chatter has been remarkable. The thing is, there is no free lunch. The FED printing money has massive costs. Take banks. The yield curve flattened dramatically today. Well that takes away a large amount of bank profits (which, up until today, was the bull catalyst for banks). Greatly weakens the dollar which causes outside countries (remember those were the ones worst off than we were until today) to be more uncompetitive. NIKKEI is essentially flat right now after a huge surge in the Yen which hurts Japanese profitability. Resource prices will go up if we print more money. Does the FED then tighten 9 months out even if the economy is still weak? If prices start really rising without with no corresponding economic growth, it will cause the economy to be worse off. Then your really screwed. Printing tons of money, creating higher prices, and no economic growth which means everyone is worse off. I have been screaming about this for months.

From an equity investor standpoint, it makes it really really difficult. If you get a depression inflation type of scenario (something Bridgewater thinks is very possible) you have intrinsic valuations going down in absolute terms but going up in currency terms. The German stock market after WW1 skyrocketed with inflation before finally just getting wiped out. From 1914 to 1922 the stock market rose 89x from 100 to 8900. In January 1923 the German stock market was 21,400. In November (11 months later) it was 26,890,000, a rise (if my math is right) of 125,654%. I am not saying we are going to see anywhere close to that type of inflation (Let's pray we don't) but take some iteration of that. If we had 1/50 of that (even 100th), you would have large appreciation in the stock market from inflation even as intrinsic value drops. As an investor how do you play that?

Let me be clear. I don't think this starts tomorrow and I don't think we need to get in a panic but one must be watching very carefully the signs of large increases in prices while economic activity does not budge. I will continue my bullish chant on gold as something you want to own over the next 3 to 5 years.