Sand Spring Advisors LLC
The Illusion of Prosperity
January 7, 2004
by, Barclay T. Leib
There was a short book written in the late 1980's entitled The Illusion of Prosperity. Within it, the author outlines all the various political machinations that were involved in the original 1985 Plaza Accord to drive the dollar lower, and how a declining dollar created a boom in U.S. equities -- at least until the 1987 market Crash.
Late 2003 and early 2004 are indeed reminding us a great deal of 1987. In 1987, come early spring, first gold and silver took off; then a few weeks later, bonds started to drop; and eventually the dollar went into a free fall. All of this basically started in March 1987 and took until October 1987 to to come to a head. This is when James Baker blithely pronounced on the weekend of October 18, 1987 something to the effect of: "Tant pis for the Germans if they don't like the U.S. dollar decline." In our opinion, Baker basically served up the coup de grace in that statement to an already very shaky financial system. Today of course we have Fed Governor Bernanke saying similar stuff -- once again playing with fire.
And while the popular press heralds the return to a new equity bull market, take one look at the chart below of the S&P denominated in European euros, and you will gain a better sense of the truly illusory world within which we currently live. The entire March 2003-Jan 2004 U.S. equity rally, adjusted for the dollar's decline over the same period, looks pretty pathetic.
We will be watching this S&P in euro chart very carefully in the coming weeks. To our eye, it may not be quite ready to turn back down quite yet. Instead, it may have one final thrust left in it to the upside -- just to hook a few more suckers.
In 1987, it was of course the bond market that eventually revolted to the weak dollar/strong equity/perky commodity "threesome." The active nearby bond futures contract specifically fell from above 100 in April '87 to touch 76 in Oct '87, before moving 5 limit moves higher to 88 the day after the equity Crash. If any such fixed income path were to ever transpire in 2004, I wish Fannie Mae the best of luck in hedging their mortgage portfolio's negative convexity.
We are sorry to have been so quiet of late, but we are still quite honestly stepping our way through exactly how and when this current "happy" and illusory mess will come undone. But with time, it must.
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