Pollyana, Cassandra or Praetorian? Waiting For the Market "Fat Lady" to Sing

Fed Chairman Ben Bernanke's statement last week that the U.S. economy is likely to "slow noticeably" this quarter and that high commodity prices and a weaker dollar may stoke inflation was definitely NOT what the market Pollyanas wanted to hear, as the comments came while oil was pushing $100/bbl, major global financial institutions were announcing big write-downs on structured credit toxic waste, and China was talking about diversifying its massive reserves away from the US dollar.

Investors are now playing a game of "whack the mole" with major global financial institutions. Citibank (C), Merrill (MER), Morgan Stanley (MS), Wachovia (WB) --who's next? The securitization model that has resulted in an explosion of credit derivatives since the 1980s is beginning to implode, and will be highly deflationary. The scary notion is when investors realize that the Fed under "helicopter Ben" is basically impotent against the power of deflating credit. While market seasonality (i.e., election year and the Halloween effect) favors higher stock prices until early next year, it's looking like investors will have to weather yet another sharp sell-off first.

Major financial heads are rolling, but the "fat lady" has yet to sing. Indeed, no one knows for sure exactly who the fat lady is. Which big financial institution will bite the dust and provide the catharsis that marks the end of the structured credit crisis?

While the Japanese economy and stock market are mere bit players in this saga, government and private economists can no longer ignore "one-off" negative news, as the leading indicator has deteriorated to zero and already poor Japanese consumer confidence has noticeably worsened.

Normally, this would be bearish for the yen, but the renewed run on the U.S. dollar has traders and investors scurrying into other currencies. Spiking currency market volatility has again raised the specter of another mass unwinding of the yen "carry trade" with leveraged players dumping Japanese stocks wholesale.

As we have previously pointed out, the Japanese stock market is now inversely correlated to yen strength, which means there is further downside risk for Japanese stocks as long as the yen is rallying.