Time to Play Contrarian?

I was writing my own piece on this topic for my next blog post, but Barron’s said it for me this week (from Barron's Daily Round-up, November 27, 2009):

"…unemployment officially is 10.2% and 17.5% when those who can't find full-time work or have stopped looking are counted. Meantime, despite the Fed's massive easing of monetary policy, credit continues to tighten, as its most recent survey of lending officers showed.

"But with liquidity shut off from the real economy, it has flowed into asset markets and into the so-called carry trade -- borrowing at the near-zero interest rate resulting from the Fed's federal-funds target of 0-0.25% to invest in anything else that provides a higher return. And with the dollar losing value steadily against foreign currencies, it has literally paid to borrow to invest in anything else, with the key exception of the Japanese yen. Since it became cheaper to borrow in dollars than yen, greenbacks have become the key funding currency for carry trades.

"The cracks have not been all papered over from the output from government printing presses in the U.S. and elsewhere. While that liquidity did stanch the bleeding that followed last year's crisis, it also helped levitate U.S. equity markets nearly 60% from their lows. And the riskier the asset, the greater the gains, from small-cap stocks to junk bonds to emerging markets.

"But those trillions have not cured the underlying debt deflation at the root of the economic crisis. In past cycles, the reliquefication by central banks could be counted on to pump-prime the economy. Borrowing and lending would resume after having been restrained by tight monetary policy, and a new cycle would start.

"After the bursting of the debt bubble, the process isn't working. It may have stoked a speculative binge in commodities, currencies and risky securities, but the real economy continues to labor.

"As it does, grandiose projects such as Dubai World collapse under the weight of their huge debts. Risk, previously suppressed successfully by policy actions, begins to increase.

"That, in turn, forces the curtailment of risk positions, from hedge funds to Wall Street proprietary trading desks. Hedging costs rise, forcing further reductions of positions in a vicious circle. As year-end approaches, the willingness to hold risk positions is reduced still further, exacerbating the process."

I could not have said it better myself. And combine all of that with the fact that many people expect capital gains tax rates to be higher in 2010 than in 2009, and you could see a lot of profit taking between now and year-end. That could make for an ugly December for the stock, corporate bond, and commodities markets, but probably means that Treasuries and the dollar will surprise on the upside (where else can the money go?). Of course, as I have said many times before, logic can tell us with some comfort level what will eventually happen, but predicting the timing of this or any other market movement is nearly impossible. Still, it looks prudent to trim risk-asset positions here, and it's tempting to take that money I was saving up for Vegas next month and bet on the dollar and Treasuries for the rest of the year...