In our November 12, 2007 letter (Pollyana, Cassandra or Praetorian? Waiting For the Market "Fat Lady" to Sing), we openly wondered which big institution would bite the dust and trigger the extreme policy response that eventually broke the negative credit spiral. While there are conspiracy theories that Bear Stearns (NYSE:BSC) was deliberately shot down by rumor-mongering so it could be bought for a song, some are also suggesting that Bear Stearns may also represent the equivalent of the “fat lady” singing i.e., the beginning of the end of this credit crisis opera.
The Fed has pulled out all the stops to get its arms around a massive credit crisis. Most importantly, they have opened the Fed’s discount window to securities firms for the first time since the Depression, while the government has relaxed the capital rules for Freddie Mac and Fannie Mae, ostensibly to put a prop under the collapsing US mortgage market.
A temporary reversal in the dollar’s slide has already triggered profit-taking in commodity markets, which had gone ballistic on what had become a panicky response to dysfunctional credit markets and institutional investor risk aversion. We had previously suggested an interim correction (+/- 30%) in gold could occur once the $1,000/ounce milestone was breached, as appears to be happening.
What this means for Japanese equities is how all of this will affect US 10-YR treasury yields. Of all the various overseas factors that affect Japanese stock prices, the trend in 10-Year US treasury yields appears to have the closest correlation to the Nikkei 225.
While extraordinary action by the Fed and the US government may temporarily slow the US dollar’s descent, the US will now have to deal with a recessionary economy implying that Fed policy will remain loose for the foreseeable future. If this is the case, the downward pressure on US treasury yields will continue. Thus the call on the Nikkei 225 is essentially the same as the call on US treasuries, i.e., the Nikkei 225 will turn when US 10-Year treasury yields stop declining and begin to rise.