From Cool to Cold.

A few words of Greenspan and a correction on a minor and restricted Asian stock market made tremble the Global Stock Markets. My view is that we are again in bubble territory – not only in Shanghai, see below (Feb2007) – and what really must concern us is that current USA Kitchin cycle is exhausted.

What a Bubble!!!

The main question that we all should ask is if the last fiscal and monetary expansive shock created the conditions for a longer and self-sustainable cycle. My answer is that they did not, that expansive shock looks like the typical well synchronized fiscal and monetary stimulus that as average produces a “four” year cycle known as Kitchin. USA policy makers did their best till mid-term election 2,006. And we can see it first in the Chart of USA GDP Growth Rate. See below.

Fiscal Stimulus - Monetary Stimulus Kitchin Cycle

The First sign of a “close” recession is the inversion of the yield curve. It started in 2,006 and became very clear and more severe between 0207 and 0307. Greenspan apologized talking of 33.33% of probability; Yield Curve says we are clearly over the 50%.

Leading Indicator, that “leads” + or - 8 months (Is it the Greenspan calendar?), is close or below cero and in a clear down trend. Current Kitchen Cycle started coinciding that both three indicators were all over 0. Chart below shows Kitchen Cycle is effectively exhausted.

Kitchin Cycle.

Supply Side: As every major event a Recession requires that happen a serie of “minor” events. The first one is with us: The Housing Sector is under Recession, as you can see below. Coming from a bubble it can only get worse; it seems just the beginning.

Kitchin Cycle. Housing Cycle started earlier. The following important sector is Manufacturing and it is close to start a phase of negative growth; its down trend is clear. Similarly, Non-manufacturing Sector, ordinarily known as Services, and the most important of all, is still in good shape but its down trend is as clear as the one of Manufacturing.

Kitchin Cycle.

Services Cycle started earlier and it is a little bit larger than the on of Manufacturing. It is just a question of few months in order that Factory Orders be under Recession.

Kitchin Cycle.

Demand Side: Media tends to hope that Services and Consumer “save” the situation. We have seen that Services will help for a while but, what about The Consumer? Well, do not hope much from Private Demand, its down trend channel is even worse.

Kitchin Cycle.

Kitchin Cycle.

Consume rarely goes negative in nominal terms under not severe recessions. BUSINESS MARGINS: Any stock Market Investor, private or institutional, must be driven mainly by expectations in profits and in a period of soft (or negative) demand only well managed inflation can sustain them. Well, Inflation won’t help them; as expected and considering the phase of the Long Term Cycle in which we are, it could even turn negative.

Kitchin Cycle. The worst on this area is in the side of the Producers – a place not to invest –. Considering them as a whole they are in Deflationary Territory.

Kitchin Cycle.

Manufacturing is heading in to an area where excess of capacity will be a problem, something that obviously means less investment. How to invest Capacity Utilization falls! See chart below. Excess of Capacity and not only Energy explains the Deflation on Producer Prices. Less Investment means Less Aggregate Demand and Less Growth. It is the final event that precedes a Recession. The fall in Investment will be the final demonstration that USA was just in a Cycle induced by Fiscal and Monetary Expansion and will confirm my thesis commented at the beginning of this paper.

(Space for a Chart. Skip to next page)

Kitchin Cycle.

Kitchin Cycle.

All this data were supposed to be known by Market Analysts and all the trends I just showed you are strong, sustained and down. If you add that we are in a down trend in the Price Earning ratio and earnings growth is falling, we should conclude that we are in a Bubble. In terms of Manufacturing Capacity Utilization Dow Index should be close to 11,000. When growth become negative it will be much lower and soon Baby boomers will start to get liquid from their pension founds, giving to the Stocks Markets a longer bearish trend.

Sure it will reverse to the mean but first will cross it.

It is true that there could be some contagion from sectors with a different cycle to others fogging trends, but that only makes the future correction worse.

Some economic and political agents hope that this Deflationary Landscape shown above will let the FED reduce rates and then everything will continue as “great” as usual and starting this way another Kitchin Cycle, letting their management to be as complacent as usual. Wrong. We will need that plus another Fiscal Shock of the size of the War in Iraq and, right now I do not see it possible. Housing will be Exhausted for a decade and unless the Import Inelastic Economic Areas of Asia and Europe substitute it that still

requires a Public Expansion of a size of the War commented. And even in this case, it will take time till we notice a recovery in the Aggregate Demand of the USA and the Recession ahead could be as strong as the last one: so “Greenspan” Recession looks worse.

Foreign trade is another area with space (5.6% GDP) for new growth and its “hole” has peaked but I am afraid the size and the time of adjustment, even when a different attitude of the G8 plus China were different, needs of a long time. It is true that there is some additional “space” in the monetary side to stimulate the economy, as the chart below shows, but again some time is needed.

FED Anti-Cyclic Margin of Action

Yes, Bernanke best skill is his understanding (and econometric models) of Inflation and that is why he will react in advance to the first Deflationary signs, but he has not enough ammunition to beat the wave (a Tsunami?) that comes behind. The risk that the Stock Markets go back to the levels of 2,003 is very high. So be bullish on speculation and bearish on investment. I end saying that the problem was not Shanghai, or that Greenspan made us a great favor with his first commentary (and not at all with the second) The real problem is a short term cycle that is exhausted. But, who knows, may be I am wrong and the strong sustained down trends will reverse fast; but, if I am not, previous Management is useless under the scenario we will face soon. Such adverse scenario has serious consequences for the Global Financial Markets, but the discussion of such a complex matter goes far beyond the space of the present study. I hope that at least this diagnosis be helpful to you in your work and or in your decision making process. Warm Regards, Luis Riestra Delgado 03/09/2,007 Predicting the Past is Easier.

P.S. The only purpose of this paper is to comment public news with my own relations and as a response to some of your questions, so DO NOT post this document without my permission. Private use only.