The Fed's monetary policy dilemma (page 2 of 2)

Either bonds and the dollar will continue to tank while stocks, commodities and hard assets perform better - at least relatively - or the US dollar and bonds will hold and even strengthen temporary, while stocks and commodities perform relatively poorly.

My bet is that the Fed will move up interest rates very slowly for fear to deflate the various bubbles it itself created and encouraged with its ultra easy monetary policy.

In particular, the US housing market would seem to be vulnerable to a sudden sharp Fed Fund rise since more and more homes were purchased this year with adjustable-rate mortgages, which carry lower interest rates (at least now) than fixed rate mortgages and led to home price increases in California of between 17% and 33% year-on-year depending on the counties surveyed.

Still, with interest rates as low as they are today, it is unlikely that even a massive injection of liquidity into the system by the Fed will be able to generate new highs for the year in the various stock and commodity markets around the world, as the markets have begun to have second thoughts about the long term consequences of Mr. Greenspan's irresponsible monetary policy, which will, as just indicated, certainly lead to more inflation and higher interest rates later in 2004 and in 2005.

There are two more reasons to be cautious about equity markets. Mutual fund cash positions are at a historically low level. So, if mutual fund inflows slow down or if mutual funds are faced with net redemptions the demand/supply situation of the stock market would not be as favorable as it was over the last 18 months.

I may add that the home equity withdrawal phenomenon, I referred to above, led not only to higher consumer spending but also to purchases of equities by the household sector, since not all the money individuals extracted from their homes - as a result of the refinancing activity - was spent.

Therefore, if home equity withdrawal shrinks it could also affect the demand side of equities negatively, which might explain the recent sudden decline in inflows into equity mutual funds! Moreover, if there were at some point net redemptions in equity mutual funds, these redemptions could only be met by mutual funds selling equities. Also note how high cash positions were at the onset of the bull markets after 1974, 1982 and 1990.

Lastly, one group of people, who is usually relatively well informed - the corporate insiders - have turned decisively less optimistic. In the first four months of this year, US insiders have sold $14 billion worth of stocks compared to just $4 billion in the comparable period in 2003.

According to a study this is the highest insider selling on record since 1971 when these insider sales statistics began to be compiled. One must, therefore, wonder who will be right - the largely uninformed American public who has piled in into equity mutual funds at the highest rate since January and February of 2000, shortly before the stock market in the US peaked out (but failed in 2004 to move the market much higher), or the relatively well informed insiders who have been dumping shares!

I for one, I am betting on the insiders and would, therefore, use the current rebound in share prices around the world as a selling opportunity.