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A Prescription to Keep the Bull Alive: More Crises, Please

May 23, 1999|TOM PETRUNO

Random notes on the markets' scorecard:

* What Wall Street needs right now is a good old-fashioned foreign currency crisis--the kind we've come to count on every few months or so.

There were rumblings of trouble last week in Argentina, where rumors had the deficit-ridden government abandoning its 8-year-old policy of pegging the Argentine peso to the U.S. dollar.

The rumors have smashed the Argentine stock market down 13% over the last two weeks, including a 4.3% dive on Friday.

If the peg were abandoned--and the government insists that won't happen--Argentina would become the newest member of the global Devaluation Club.

Why might U.S. investors enjoy yet another devaluation? Because if it was accompanied by the usual worldwide market turmoil, Federal Reserve policymakers--who last week voted to adopt a "bias" toward raising interest rates--could get unbiased in a hurry.

The devaluation wave, which began in Asia in mid-1997 and most recently swept Brazil in January, managed to keep the Fed at bay for that entire period, despite the U.S. economy's strength. Fed Chairman Alan Greenspan was so fearful of devaluation-itis last fall, in fact, that he cut rates three times in three months.

Wall Street has figured this much out by now: 1) The Fed is highly unlikely to stoke the flames of a foreign economic brush fire by raising interest rates amid the crisis and 2) Every decline in U.S. share prices triggered by a foreign crisis since mid-1997 has been a great buying opportunity, precisely because the Fed has been forced to keep money loose.

If Argentina doesn't want to play along, rumors still simmer that China will devalue sooner rather than later to take back some of the competitive export advantage it lost to East Asian rivals that have devalued since '97.

* If the rest of the world fails to cooperate with our need for a crisis in the next couple of months, the U.S. bond market is almost certainly going to be forced to act out one of the classic roles in a bad Western film: the loser forced to "dance" as the gunslinger fires round after round at his feet.

The bullets, in this case, will be the regular economic reports flowing out of the government, the Fed and other sources.

Are the economic data stronger than expected? Then bond yields are practically guaranteed to go higher, given that every bond trader will rush to the same conclusion: Every bit of strong data adds to the pressure the Fed has already brought upon itself with its "bias-to-raise" posture.

Weaker-than-expected data? Yields could decline, but probably not unless there is a convincing succession of reports suggesting that the economy really is rapidly losing steam.

This dance will go on until at least June 30, when Greenspan and fellow Fed policymakers meet again, and beyond that date if the Fed keeps its same posture.

Bonds ended last week on a positive note, as yields fell Friday (perhaps enjoying a bit of "flight to safety" amid the rumors about Argentina). The bellwether 30-year Treasury bond yield ended at 5.76%, down from 5.91% a week earlier.

But this week will bring a flurry of economic data. Key reports: April existing-home sales, due out Tuesday; April durable-goods orders, Wednesday; and April personal income and consumption, Friday.

* The 1990s have been all about breaking many of the rules financial markets lived by for much of the post-World War II era.

Dividend yields on blue-chip stocks were never supposed to go as low as they have, for example (an average of just 1.2% today), and the Standard & Poor's 500 index was never supposed to rise 20%-plus per year for four consecutive years (which it did from 1995 through 1998).

One more rule in the process of being broken: that gold's price will always provide an early warning about inflation.

Gold hit a fresh 20-year low of $273.10 an ounce in New York futures trading Friday, just a few days after the government's April inflation report showed consumer prices rising at the fastest monthly pace in nine years.

Maybe the gold market knows that the April number was a fluke? Possibly. But other classic indicators of higher inflation have been doing their jobs.

Most major commodity price indexes have at least lifted from their lows of last fall, for example. And as money management firm Bridgewater Associates pointed out in a report last week, so-called inflation-indexed bonds issued by Uncle Sam and five other nations all are signaling with their price action that inflation expectations are rising worldwide--not dramatically, but rising nonetheless.

Then what's the trouble with gold, supposedly the ultimate inflation hedge?

The problem is that some of the biggest owners of gold on the planet--nations' central banks--are either selling some of their reserves or are thinking about it.

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