Buy Japanese equities while you can! (page 5 of 5)

I concede that tightening moves may not be necessary for quite some time. However, I can see several scenarios under which even without tightening moves by the Fed interest rates would rise.

In one of these scenarios, asset inflation would spill over into the commodities, goods, and service markets and would be, in my humble opinion, discounted by rising bond yields - this well in advance of the price inflation showing up in the doctored inflation figures published by the government.

The sudden rise in interest rates amid still benign inflation figures would then prompt Mr. Greenspan to erroneously believe that the Fed hasn't eased sufficiently. Another tidal wave of liquidity would then be injected into the system in the hope of bringing down rates. But by then the bond and foreign exchange markets would no longer be fooled! A violent downward adjustment in the dollar exchange rate and in bond prices would immediately follow.

So, if the present easy monetary policies continue to be pursued - and, given the statements that have been made by senior Fed officials, Mr. Greenspan's track record of easing, and Mr. Bush's unshakeable determination to be re-elected, we must not doubt for a minute that they will be implemented at whatever longer-term cost to the economy - a further decline in the dollar and a rise in interest rates is only a matter of time.

Thus whereas from an investment point of view the early 1980s provided a once-in-a-lifetime opportunity to purchase bonds (when short term interest rates rose far above long rates), the current period is likely to provide a similar opportunity to sell bonds.

In fact, once interest rates rise to the kind of level that I expect they will rise to in the next ten years and the dollar weakens further, it will in retrospect have been totally irrelevant whether ten-year US Treasury bonds were sold at a yield of 3.5% or 2.5% or 4% (it would appear to me that the recent drop in the bond market is "impulsive" and is the first symptom that the bond market isn't going to be fooled by Bernanke& Co. for long).

In the kind of reflation scenario we are discussing, stocks will rise in nominal terms - at times, as we have seen, very sharply. But in real terms, they are likely to decline, as the coming additional US dollar depreciation (mostly against hard assets including real estate, collectibles, commodities, especially precious metals) will offset the nominal stock market gains.

The global reflation that I am talking about could last for several years and provide great, although very speculative, investment opportunities. Hard assets and emerging market equities aside, the latter which we discussed last month, Japanese stocks would be one of the prime beneficiaries of this (in the long term) financially suicidal central bank policy.

In a global reflation, Japanese interest rates would likely rise in percentage terms more than other interest rates around the world, and such a rise would bring about a huge reallocation of financial assets from bonds into equities. Thus, I reiterate my earlier recommendation to short Japanese bonds and buy Japanese equities.