The Bubbles Mr. Greenspan has created! (page 2 of 2)

It would seem to me that the realization by the investment community that Greenspan's game cannot end well has begun to reverse expectations. Suddenly, out of the blue, the bond market has collapsed and brought down stock and commodity prices along with it.

As I have maintained before, this is not a time to play hero like the brain-damaged president of the US in Iraq. It is a time to stay of out of all assets and be patiently waiting for better buying opportunities. In particular, I am concerned about the US housing market.

In some areas of the US, housing prices have been rising at almost 30% per annum in recent years and overall prices have doubled since 1997. The question, therefore, arises when this housing boom, which was fueled by ultra low interest rates and allowed people to refinance their homes, will come to an end.

This is an important question because US consumption since year 2000 was not driven by capital spending and employment gains, but purely by asset inflation in the housing market, which allowed people to take out larger and larger mortgages and spend the additional funds (well understood, "borrowed funds") on consumer durables such as cars and consumer non-durables.

Now, however, there is a problem with the housing market. If the US economy continues to strengthen, interest rates, which are negative in real terms, will have to rise considerably and this could lead - if not to a housing crash - so at least to a less buoyant market. In addition, the inventories of unsold homes are at a record.

Therefore, should higher interest rates, driven by a stronger economy, lead to less home purchases by individuals, home-builders who are holding these inventories could get hurt quite badly.

I would, therefore, recommend to all investors who believe that the US economy is expanding solidly to sell all homebuilding companies' stocks here or on any rebound.

Personally, however, I am not so sure about the strength of the US economy, since consumption is purely driven by additional borrowings and government spending, which leads to larger and larger budget deficits. In fact, I have just bought some US treasury bonds with the view that, in the next few weeks, investors' expectations about future growth could be somewhat disappointed.

After all, every asset-inflation, which drove consumption in the past, such as was the case in Japan in the late 1980s and in Hong Kong prior to 1997, came to a bitter end. Thus, with bond prices being near-term oversold, any disappointment about economic growth could lead to a modest or even strong rebound in bond prices.

If you look at the figure below, which shows the recent performance of 10 years US Treasury bonds, it would appear that there is some support around this level and that a modest rebound is probable.

Still, this short term rebound aside, bonds may shortly be completing a longer-term head-and-shoulders top, which would mean that in future we could see lower bond prices or much higher interest rates.

Such an outcome could spoil all other asset inflation parties and lead to lower home, commodity and stock prices. Therefore, once again, patience and staying aside from the markets may be the best option.