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December 31, 2007

Brief Holiday Update

John P. Hussman, Ph.D.
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Just a quick update, given no material change in market conditions thanks to relatively slow holiday trading.

The Market Climate for stocks remains characterized by unfavorable valuations and unfavorable market action, holding the Strategic Growth Fund to a fully-hedged investment stance. The Market Climate in bonds is characterized by moderately unfavorable yield levels and relatively neutral yield pressures, holding bonds to what is essentially a trading range. That trading range can be thought of as a downward sloping diagonal with periodic vertical spikes – that is, a tendency for yields to gravitate lower based on persistent concerns about economic weakness, but with periodic upward spikes on inflation surprises (which will tend to persist until credit problems broaden more severely). Again, the overall set of conditions lends itself to something of a trading range for bonds.

In precious metals, the Market Climate remains favorable, and the Strategic Total Return Fund currently has just under 20% of assets invested in precious metals shares. The U.S. dollar, having cleared its oversold condition, may be vulnerable particularly if employment figures are not particularly strong.

On the subject of employment, it's useful to recall that the non-farm employment figure for November came in at 138,467,000, up by 94,000 (which is very sluggish to begin with), but the figures for the prior two months were simultaneously revised lower by 48,000, so that the net gain over the number reported in October was only 46,000 jobs.

The tendency of the jobs numbers to be subject to major revisions introduces noise into their month-to-month interpretation, but figure that the total non-farm employment number reported in November was 138,467,000. If the December figure comes in below about 138,539,000 (a gain of 72,000 jobs, net of any revisions), that would represent year-over-year employment growth of less than 1%, which is about the level where prior recessions have started. Anything less than 138,663,000 (which is nearly certain) would represent 6-month growth less than 0.5%, which is also a slowing that is typically seen as the economy tips into recession. As for the unemployment rate, the start-date of a recession frequently coincides with the point where the rate moves about 0.4% above its 12-month trough. That trough was 4.4% in March, so a move from the current 4.7% to even 4.8% would be consistent with an economy rolling over.

In the ongoing saga of misleading and largely illusory “liquidity provision” by central banks, I should note that on Monday, the ECB will have to enter a large “liquidity absorbing” transaction of about 150 billion euros, in order to roll over the expiring one. That action will predictably garner little press, but the maturity the ECB chooses will be important anyway. That's because on Friday January 4, the huge 16-day 350 billion EUR refinancing from December 19 expires. This ensures that the media will (misleadingly) report a huge apparent “injection” of liquidity by the ECB on Friday. The question is how huge.

If the ECB rolls over its 150 billion euro “liquidity absorbing” transaction on Monday with another action that expires on January 4, the “liquidity providing” rollover on Friday will only need to amount to 200 billion EUR, or the equivalent of about US$300 billion. Unfortunately, that's already enough to create some misleading headlines. But if the expiration on Monday's “absorbing” transaction goes beyond Friday January 4, the new rollover will have to offset that too, so Friday's apparent but mistakenly interpreted “injection” will be about 350 billion EUR, or the equivalent of US$500 billion. In short, it's quite possible that investors will be treated to another round of misinterpreted “news” of a massive ECB “liquidity injection” on Friday, which will in fact be nothing but a predictable rollover of existing repos. Hopefully, they'll catch on to this sideshow before long.

You can monitor the ECB data here: http://www.ecb.int/mopo/implement/omo/html/index.en.html
(Look at "Allotment" fields to identify amounts. A zip file with full history of ECB actions is about half-way down the page. Note that Europe typically quotes dates as DD/MM/YYYY)

As for the Fed, a few of the short-term repos the Fed provided for holiday liquidity will expire on Thursday. Until then, the extra $10 billion or so of repos in the system may put a bit of pressure on the Fed Funds rate, holding it below the target of 4.25% for a few days (see http://www.ny.frb.org/markets/openmarket.html ). The most likely day for any apparent “liquidity injection” will be that same day (Jan 3) due to the expiring repos, but again, the big misleading central bank event of the week will most likely be the illusory ECB “injection” on Friday.

Have a Happy New Year!

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