Looking in the Wrong Direction

The whole market is focused on bank earnings and stress test results. They're looking in the wrong direction. Geithner says that most banks are well capitalized. Unfortunately, I made a huge error in realizing this before the market did, while not playing this bounce. The banks are "well capitalized" compared to the way they were a year ago. The problem is that all the capital has come from the Fed. The second problem is that they need to keep all that capital on the books to reserve against rapidly rising mortgage, credit card, and commercial real estate loans. The third and largest problem is that most people don't want to borrow. This sets up the Japan deflation scenario. And while fiscal stimulus may help the economy by putting unemployed labor to work, the truth is that the benefits are only as real as the work done. Paying people to dig holes and fill them up again is measured as GDP, but it's a sham. It doesn't improve anyone's standard of living. In econ-speak, the multiplier effect is less than one in most cases. I don't see any major projects really contributing to efficiency, innovation, or making our lives better.

Oh, and by the way, there a hint of news out of China. It seems that the government is just a little worried that the growth in credit is unsustainable. I think they're right. It's not. There won't be any bubble to chase this time. I think they'll move to tighten credit. If I see credit tightening as well as inflation starting to appear, that will be a bearish sign to short Chinese equities. Right now, all the news points to deflation.

In the meantime, I am looking for a re-emergence of the deflation trade we saw yesterday. Inflation has had a good six week run. I'd like to see three weeks of the deflation trade before taking some profits. A sign that it will be time to start getting out will be when the market sells off on good news. That will show that sentiment is getting too bearish and deflationary. Just as until recently, deflationary news has had the contrarian result of equity buying and bond selling, in anticipation of more money printing and bailout shenanigans from the government. I'm pointed in exactly the direction I want to be. I just need the wind to shift.