With this recent rush of upbeat economic news, it’s no wonder commentators are trumpeting the rebound of the U.S. economy.

But I think it’s time to short U.S. stocks.

Shocked?

Don’t be.

What most experts see as a strengthening U.S. rebound, I see as an increasingly dangerous “false dawn” – for these two key reasons:

• An overly expansive monetary policy that’s almost certain to spawn inflation.
• And a record-level budget deficit that will cause interest rates to spike, crimping economic growth.

A Foundation for Trouble

U.S. policies that were intended to combat the financial crisis that broke last year – as well as the recession that’s been plaguing us since December 2007 – have actually inflicted a lot of weakness upon our economic system.

For instance, the federal government has made $11.6 trillion in financing commitments, many of which will saddle us with debt for generations – some of it forever. Outlays of that magnitude in a $14 trillion economy are bound to have lasting implications: Think of the consumer who has a series of maxxed-out credit cards – he’ll make the minimum payments, but the actual balance will never get paid down.

And the foundation for this financial fiasco was actually constructed several years ago.

After the bursting of the 1996-2000 “dot-com” bubble, the U.S. Federal Reserve re-inflated the money supply. That caused stocks to resume their upward march, and as we now know, also inflated a housing bubble of such enormous size that it caused a general financial-system crash when that real estate bubble burst in 2007-08.

This time around, the Fed has been even more expansive. The benchmark Federal Funds Rate was 1.0% in 2002-04. This time it is 0.25%. What’s more, this time around we’ve had a $2 trillion expansion of the Fed balance sheet, a doubling of the monetary base and $300 billion worth of direct central bank purchases of government debt. Given this orgy of Fed expansionism, it’s likely that the onset of inflation – whether it’s in consumer prices or asset prices – will be correspondingly worse. In fact, we’re already seeing that gold prices are once again making a run at their all-time high. And crude oil hovers at about $70 per barrel, a level that would have been unimaginable before 2004.

Now that he’s been nominated for reappointment, U.S. Federal Reserve Chairman Ben S. Bernanke says he will tighten monetary policy in good time. But why should we believe him? If he tries to tighten significantly, he will incur the wrath of the Obama administration and the Democrats in Congress.

Even back during the 2001-04 time frame – when there was an administration in place that claimed to believe in monetary stringency – the Fed didn’t tighten. Bernanke himself was among the most aggressive opponents of tightening. Back in 2002, in fact, when inflation was running at a perfectly respectable 2%, Bernanke actually spun myths about the imminent onset of “deflation.”

Given what we know, it seems that if the current economic bounce shows even the slightest signs of faltering, Bernanke won’t tighten – he’ll pump even more money into the U.S. financial system. Rest assured that the administration, Congress, and much of the media will be cheering his move.

Borrow Now, Hurt Later

If an overly expansive monetary policy was the only problem we faced, it might not be so bad. Unfortunately, there’s more.

Lots more.

Unlike in 2002 – in fact, unlike any other time in U.S. history – this country now has a budget deficit in excess of 10% of gross domestic product (GDP). For fiscal 2009, that was forgivable: We’ve had a major recession, and a shattering financial crisis, which the federal government has tried to battle with aggressive bailout programs.

Here’s the problem, however: The projected deficit remains above 10% of GDP for fiscal 2010, even though no additional bailouts are contemplated and the Obama administration is projecting a modest-but-steady economic recovery.

The result is harder to predict – this country hasn’t travelled down this particular path before. This strategy bears some resemblance to the position Japan found itself in during its so-called “Lost Decade” of the 1990s. But even Japan’s deficit never reached this 10% threshold.

In Japan, the effect seems to have been the gradual abandonment of small business finance, and the resulting starvation of the most critical factor in economic growth – entrepreneurship.

The small-business sector creates most of the new jobs in the U.S. economy. But in a challenging environment, it’s easy to see why this sector gets overlooked. Without political connections or large contracts to hand out, the small-business sector ends up being last in line in the financing queue when the economy faces strong headwinds. Why should banks or other people lend to small businesses when the U.S. government bond market stands as such as huge, safe parking place for their cash?

Interest rates will also become an issue. With the inflationary pressures we expect to see from the overly expansive monetary policy we’ve described, long-term interest rates are likely going to rise anyway. As was the case in Japan’s decade-long malaise, these forces will combine to spark high default rates in the banking system, low or zero economic growth, and a general downward trend in the stock market.

All of this will make it tough for small businesses to obtain the cash they need to grow, meaning this key job-creation engine will have to sputter along.

It’s still early in the game, and there are many factors to consider, so the future economic picture remains a bit murky right now. But my guess is that the bubble in asset prices will be largely confined to commodities, that economic growth after this current initial burst will relapse, and that U.S. stocks will prove to be the same generally unattractive investment that they were in 1970s – the era of the so-called “Nifty Fifty.” If the stock market bubble gets even more exuberant from here, the relapse will be correspondingly more painful.

Profitable Pockets

Despite this dour backdrop, three things are worth remembering:

• First, all U.S. stocks are not created equal. Although I’m saying it’s time to short U.S. stocks, and I see tough times ahead for the key indices, there will always be individual stocks worth consideration, such as the “Alpha Bulldog” stocks I highlight in the Permanent Wealth Investor service.
• Second, the best way to play this looming downdraft – either as a direct profit opportunity or as a way of hedging your current portfolio – is through the use of what I like to call “Stage 3″ investments. An example of one such investment is long-dated “put” options on the Standard & Poor’s 500 Index, which trade on the Chicago Board Options Exchange. If you buy these options when they are way “out of the money” with a strike price far below the current price, in a real bear market (like that of 2007-09), you will see them really zoom up in value as the S&P drops down closer to the strike price, or possibly even falls below it.
• And third, understand that my pessimism about the U.S. market doesn’t apply to every other market around the world. While the monetary problems are more or less global, the budget-deficit problems are not. For instance, you might want to consider investments in Japan, where a recent election should spawn the kind of economic changes that will benefit savvy investors. Germany, too, looks to have avoided the contagion of “stimulitus,” which is why its economy is now viewed as one of the healthiest in Europe. Consider the iShares exchange-traded fund (ETF) entry for each of those two markets: The iShares MSCI Japan Index Fund (NYSE: EWJ) and the iShares MSCI Germany Index Fund (NYSE: EWG). They each warrant a look.

Source: The Two Reasons it’s Time to Short U.S. Stocks

After 54 years of near-single-party rule – not to mention two decades of economic malaise – it’s not surprising that voters eager for change delivered a landslide election victory to the opposition in that key Asian nation.

Last weekend’s Japanese election represents a major milestone for Japan, and may well change the world’s second-largest economy in unexpected ways. Many of things we think we know about Japan may simply have been policies of a Liberal Democratic Party (LDP), which has been in power for all but about 11 months over the past 54 years.

The “new Japan” may in certain respects be very different.

For example, we think of Japan as a country dedicated to exports. The big exporters are aided by cheap loans. Upon retirement, senior government bureaucrats get jobs with those exporters, a practice known as amakudari – descent from heaven. Not surprisingly, Japan runs a more or less permanent trade surplus.

Under the new Democratic Party of Japan government of Yukio Hatoyama, that may change. Hatoyama has pledged to end “amakudari” – even as he reorients the economy towards domestic spending. If he succeeds, the exporters may do less well, but the economy may be more balanced. As a result, Japan’s economy may finally begin the economic recovery that Japanese consumers have been awaiting for 20 years.

Japan is also famous for its infrastructure spending – at its peak in 2001, state-funded infrastructure spending was equal to 6.5% of that country’s gross domestic product (GDP) – a level that’s twice that of Japan, the next-biggest spender.

While anyone who has dealt with Northern Virginia traffic knows that infrastructure spending can be a good thing, much of Japan’s spending was wasted on remote rural areas, which happened to be homes to politically connected LDP barons.

Hatoyama has promised to redirect about 3% of GDP from infrastructure spending to payments to individuals. He will pay each family with children $3,000 per child per year. This should help Japan’s demographic problem – its population is declining and is heavily weighted towards retirees. It will also boost consumer spending, especially among middle-income families.

Hatoyama’s program offers no supply-side remedies for Japan’s economic ailments. Those were the policy of Junichiro Koizumi (Japan’s prime minister from 2001-2006), who seemed to be bringing Japan back from recession. Koizumi’s faction lost out in the LDP power struggle, but may make a comeback. Big-spending Prime Minister Taro Aso has resigned from the party leadership, and his most likely successor, former Japanese Health Minister Yoichi Masuzoe, is a supporter of Koizumi’s approach.

Nevertheless’ Hatoyama’s policies will reorient Japan’s economy towards domestic spending. The danger is Japan’s budget deficit (8.9% of GDP in 2009, according to estimates by The Economist) and its debt. With GDP down this year and spending up, the International Monetary Fund (IMF) has estimated Japan’s debt at 217% of GDP by the end of 2009. Only one country has recovered from debt that high – Britain, whose debt hit about 250% of GDP in 1815, only to reach that level again in 1945, at the end of two huge wars.

Hatoyama must hope that Japan’s recovery from this recession is a swift one. A sharp bounce in GDP, maybe 5%-6% growth in the first year, would make the debt level much less daunting, and allow good progress towards balancing the budget. After almost 20 years of near-recession, that’s perhaps not too much to ask.

For investors, Japan looks attractive. The stock market is still trading at less than 30% of its 1990 high. However, the Japanese companies you have heard of are not the ones to buy. They are too large and too oriented towards exports. The construction companies should also be avoided – they have benefited from the fixation on infrastructure.

However, buying smaller Japanese companies is a problem, because they do not have actively traded American Depositary Receipts (ADRs) so you really have to buy them on the Tokyo Stock Exchange. The good news is that some brokers, notably E*TRADE Financial Corp. (Nasdaq: EFTC), will allow you to trade Japanese shares.

If you intend to trade on the Tokyo exchange, you might want to look at some of the Japanese retailers and consumer-goods companies. Even with these more-upbeat prospects, though, you should be careful not to overpay – a Price/Earnings (P/E) ratio of 20 should be your upper limit.

For those without access to the Tokyo market, there are two alternatives. One is the exchange-traded fund (ETF) covering the entire Japanese market, the iShares MSCI Japan Index (NYSE: EWJ). That has market capitalization of $5.26 billion, meaning it has adequate liquidity.

However, too much of it will also be invested in shares of the big exporters and construction companies.

The other alternative therefore is a mutual fund, the Fidelity Japan Smaller Companies Fund (Nasdaq: FJSCX). That has expenses of 1.1% and a total size of $394 million. It represents the most readily available way of investing in domestic Japan.

With the new government, Japan will look very different in a few years. Profit opportunities will arise.

As investors, we should look to capitalize on these changes – as well as the opportunities they create.

Source: Landslide Election Victory in Japan Will Lead to an Avalanche of Future Profits for Global Investors

Even worse – for anyone who was feeling optimistic about that market, the sharp decline in the prior quarter’s GDP was revised upwards, as well.

Japan’s embattled prime minister, Taro Aso, who came to office in September just as the downturn was beginning, has introduced several stimulus programs of extra public spending, but nothing seems to work. The stock market is trading lethargically at a level that’s about 80% below its 1990 high. And there’s an election that has to be held before September.

It’s not a pretty picture.

The Japanese are well aware of this; they were not particularly cheerful about their economy even before the present downturn.

There’s actually a great Japanese movie that I watched last weekend, called “Bubble Fiction,” that illustrates this very well. In the 2007 film, a young girl is down-on-her luck, deeply in debt, and being harassed by yakuza (organized crime) debt collectors. She goes back in time to 1990, in an attempt to stop the policy mistakes that burst the Japanese bubble. Back in 1990, she finds Tokyo a much more fun place, with money everywhere and everyone happy – she even meets her yakuza debt-collector, who is graduating from Tokyo University, and who has lined up a great job with the Long-Term Credit Bank of Japan Ltd. (which went bust in 1998).

Eventually, with the help of a buddy in the Ministry of Finance, she gets to the top guy in the Ministry whose policies caused the crash, and discovers that it is all a plot between him and some rich foreigners, who plan to become billionaires by exploiting the destruction of Japan’s economy. She foils the plot, returns to 2007 – and finds it magically changed, in a long burst of prosperity, with no government debt and her Ministry of Finance buddy just appointed prime minister.

So that’s the Japanese fantasy – to find some way to undo the malaise of the past 20 years and make the country’s economy work properly again. To some extent, Junichiro Koizumi, prime minister from 2001-06, played into that fantasy. He sorted out the banks, started to privatize the Japanese postal system and cut back on wasteful government spending. It seemed to be working, too, as Japan began to enjoy decent – albeit modest – growth again.

Since Koizumi left, however, the governing Liberal Democrat Party (LDP) has abandoned his policies, and current Prime Minister Aso is very much a part of the problem – and not the solution.

Whatever you think of “stimulus” strategies, there can be no question that it is the least likely to be effective in a country that already has a large budget deficit, and that already has public debt that’s more than 160% of GDP. If the Japanese economy is currently in a pit, Aso’s policies are creating a much deeper bottom.

Just last weekend, the opposition Democratic Party of Japan provided a genuine alternative. Its previous leader, Ichiro Ozawa, was an authoritarian personality who had formerly been a senior member of the LDP, and who had shared many of that party’s more unpleasant traditions. He was forced out by an election-funding scandal and the new leader, Yukio Hatoyama, is a milder personality, and a person who appears to offer a genuine alternative.

In his acceptance speech Monday, Hatoyama emphasized “sweeping away wasteful uses of tax money” and “moving from [a] bureaucrat-led to [a] citizen-led government.” He also denounced “amakudari” – the “descent-from-heaven” process by which top bureaucrats become powerful private-sector oligarchs.

The DPJ is an amalgam of LDP rebels and moderate members of the old Japan Socialist Party, and its basic philosophy has a plank of opposing “bureaucrat-led protectionism.” It is currently leading in the opinion polls, and with Hatoyama as its leader may well appeal to the Japanese longings embodied by “Bubble Fiction.”

All of this gives the DPJ a good chance of succeeding in the Diet elections, which must be held by Sept. 6, meaning Hatoyama & Co. would form the next Japanese government.

If Hatoyama does, indeed, clean out the bureaucratic deadwood and cut public spending – while at the same time restraining those on his left who will want more-extensive social programs – he will have an excellent chance of bringing the Japanese economy out of its 20-year downturn and restoring it to its former glorious technology-led growth.

That would cause a huge rebound in the Tokyo stock market, from which we should be poised to profit.

A lot can go wrong. But at current levels, the Nikkei 225 surely cannot go much lower, and Hatoyama now appears to offer a chance of restoring 1990, or at least the early 1980s, when the Japanese market was the best investment in the world. It must be worth a modest investment in the largest Japan ETF, the iShares MSCI Japan index (NYSE: EWJ).

At current levels, EWJ is sporting a Price/Earnings (P/E) ratio of 17, but that’s based on earnings in the recession – before the Time Machine takes off!

In Spite of a Grim Economic Outlook, Japan is a Promising Investment Play

The problem I have with this dogmatic definition of a bear market rally is the following: Assuming (and this isn’t a forecast, since I really haven’t the foggiest idea where stock markets will be in six or 12 months’ time) the S&P 500 moved up to 1350 and then declined to 500, as an investor should you care if the move to 1350 — a 100% gain! — was a bear market rally?

My impression is that investors’ fixation on the recent rally being a bear market rally has actually kept most investors on the sidelines and hoarding cash. Now, put yourself in the shoes of a fund manager who, in the last 18 months, has lost 50% of his clients’ money and missed the recent rally (34% for the S&P 500). What is he likely to do? I would think that he would be inclined to purchase equities as they correct the sharp advance since early March, especially as the economic news in the near term becomes less negative.

Based on our conversations with numerous managers in recent weeks, we believe that most quantitative managers’ portfolios were not positioned in expectation of a rally. Of the nearly 80 managers we have talked to, only one manager said they were up since March 9th and the clear majority admitted to being notably down or stopped out on their positions. These managers were both long-only and long-short quant managers using market neutral and non-market neutral strategies, sector neutral and non-sector neutral strategies, longer term and intermediate-term holding periods. It is fair to say that just about everyone is bewildered and trying to understand when this rally will end.

Another factor to consider is that there has been a significant improvement in the technical position of world stock markets. In the US the largest number of new 12-month lows was reached in October. At the November 21 low at 741 for the S&P 500, the number of new lows had already contracted, and even more so at the index’s March 6 low at 666. Also, market breadth and the number of stocks moving above their 200-day moving averages have taken a decisive turn for the better, indicating that the stock market advance is broadening and that the number of stocks that have bottomed out (at least in the intermediate turn) is expanding.

I have explained repeatedly in the past that if a government is really determined to try and postpone an inevitable collapse by “printing money” in order to lift or support asset prices, it can be done. However, the result of such a monetary policy is to lower the purchasing power of its paper currency, with catastrophic long-term consequences for its economic and financial volatility.

It forces individuals and institutions with cash to buy something…anything. So, this cash is channeled into gold and/or different paper currencies, commodities, equities, bonds, real estate, and consumer goods and services, but obviously with different intensities and at different times. For instance, at some times, such as in 2008, more money will be allocated to gold; while at other times, such as since early March, more money will flow into equities and industrial commodities. It is well understood that these money flows are driven largely by speculative activity (and more than a little dose of manipulation). The result in all asset markets is very high volatility and price fluctuations that don’t appear to make any sense to most market participants and observers who don’t understand the new rules of the investment game that were brought about by “money printing”.

This is where we are today, irrespective of whether or not you and I like policies of “quantitative easing, massive bailouts, and frightening fiscal deficits” and their long-term consequences! Another positive factor for stock markets is that a large number of Asian stock markets and individual stocks in the region had already bottomed out in October and November of 2008 and didn’t confirm the new low in the S&P in early March.

In Asia, the Taiwan and Shanghai indexes, and Korea’s Kospi Index, are all up by more than 50% from their late October 2008 lows. (The Shenzhen Index is up 90%.) But it is not only the Asian equity markets that have outperformed the US and Western European markets over the last few months; since late January 2009, the RTS Russian Index is up 66% and the MSCI Emerging Market ETF is up by 55% from its early November 2008 low.

This is not to say that the global economy is about to embark on a strong and sustainable growth phase. It also doesn’t mean that a new bull market in global equities à la 1982– 2000 has begun. But I think that, at least in nominal terms (inflation-adjusted), the global printing presses being run by the world’s central banks and fiscal deficits have begun to impact asset prices positively. Therefore, in the case of resource and mining stocks, as well as Asian equities (and, for that matter, most emerging and other stock markets around the globe), the lows thatwere reached between October and March of this year are likely to hold — that is, for now.

The markets that have the highest probability of having made major longer-term lows are resource-related equities, emerging markets, and Japan. Conversely, the asset market that has the highest probability of having made a secular high (such as Japan in 1989, or the Nasdaq in March 2000) is the US long-term government bond market.

Despite a still-weakening economy and massive quantitative easing, long-term bond yields appear to be on the verge of breaking out on the upside. I have listed again below all the equity recommendations I have made since December 2008. Some of these equities have already moved up substantially (resource and mining companies, in particular) and, therefore, I would only buy most of these recommendations on a correction.

In addition, a number of BRIC and other (mostly emerging market) closed-end country funds and ETS were recommended, such as Brazil ETF (EWZ), the Templeton Russia Fund (TRF), the Greater China Fund (GCH), the Asia Pacific Fund (APB), Taiwan iShares (EWT), the Japanese ETF (EWJ), the Japan Smaller Capitalization Fund (JOF), the Morgan Stanley India Fund (IIF), the Turkish Fund (TKF), and the MSCI Emerging Market ETF (EEM).

In the US, late last year we recommended buying the iShares iBox Investment Grade Corporate Bond (LQD) and Nicholas Applegate Convertible & Income Fund (NCV), while earlier this year we recommended the accumulation of stocks of high-tech companies such as Cisco (CSCO), Intel (INTL), Oracle (ORCL), and Yahoo (YHOO). More recently, we recommended beaten-down insurance companies and financials as rebound candidates, including Leucadia National (LUK) and CNA Financial (CNA), Citigroup (C), the BKX, the Financial Bull 3x Shares (FAS), and the Financials Select Sector SPDR.

The market’s advance had been broadening and that more and more groups such as airlines (AMR), homebuilders (TOL, CTX, HOV), and cyclicals such as Dow Chemical (DOW), International Paper (IP), and Alcoa (AA) are showing signs of having bottomed out. Among commodities, I am particularly intrigued by natural gas. There are natural gas ETFs (UNG, GAZ), but costs are high. A better way is probably just to buy future contracts, or Pioneer Natural Resources (PXD) or the First Trust ISE Revere Natural Gas Index Fund (FCG).

Source: What to Buy…or Not Buy

According to a report in The Daily Telegraph today, Japan’s gross domestic product contracted at an annual rate of 2.4% in quarter that ended June 30, after expanding 3.2% in the first quarter.

The news sent Japan’s Nikkei 225 down the most in a month.

Taipan Publishing Group’s Adam Lass says it’s a good time to short iShares’ Japanese ETF, EWJ…

Five years ago, the legendary Japanese exporting machine dragged the country out of its recession by flooding the U.S. (among other markets) with relatively cheap, reasonably high-quality products.

Unfortunately, U.S. consumers are in a bit of a funk right about now, so Japanese exporting is down 2.3%, leaving such mighty manufacturers as Toyota (TM:NYSE) with rapidly diminishing profits. And speaking of consumers, internal consumer spending represents better than 50% of Japan’s economic action. Unfortunately, spending fell 0.5% in the second quarter.

How are they taking all this in the land of the rising sun? If Dai-Ichi Life Research Institutes’ Hideo Kumano is representative, “The numbers are awful. Things are going to be very tough in the second half of the year.”

Since time immemorial, the usual response to a slowdown like this would be to crack open the central piggy bank and pump a little specie into the system, just to grease the wheels of commerce a bit. Unfortunately (as I have pointed out ad nauseum) this whole international crisis stems from the rabid overuse of national printing presses.

In this particular case, the Bank of Japan has not raised its target rate above 0.5% since 1995. This has created an incredible thirst for borrowed yen on the part of arbitrageurs, who would cart them off to places like the U.S. and EU where they could buy bonds with interest rates of an order of magnitude higher.

Now, however, this obscenely low rate has left the BOJ with no wiggle room whatsoever, now that it actually needs to inject some additional liquidity. As the fine details of the horror sink in the great herd mind, Japanese shares have burned off some 29%.

Silent Panic Ripples Through the White House Could Hand You 511%As the U.S. government races to prevent food riots at home, a 210-year-old doomsday doctrine has ignited the next mega-trend bull market that could hand you 511% by February 1, 2009. Learn how you could collect your fivefold gain in just six short months.

And quite frankly, that only represents about half of what’s coming. An examination of the Nikkei 225’s chart reveals a Japanese market mired in both long-term, mid-term and short-term down cycles.

Overall this blue-chip index has been losing value since 1989. Drawing in a little closer, and one can see a double-top formation with an early high at 20,833 in April of 2000 and a lower high at 18,295 come July 2007.

Both of these highs were quickly followed by Comparative Average Sell Signals, with the seven-month average cutting under the 13-month average. The first instance was followed by a 41-month bear market. I see no reasons to presume that this cycle will be any different.

As I have mentioned repeatedly, bear markets are normal natural parts of the great economic ebb and flow. They are also an excellent opportunity for dramatic gains — if you are willing to stretch your minds a little.

At Taipan’s recent San Francisco conference, I pointed out that iShares’ Japanese ETF, known as the EWJ, mimics the Nikkei reasonably closely, allowing a trader so inclined to play put options against the broad Japanese decline without ever actually leaving the safety of the American marketplace.

Specifically, I recommended EWJ January 12 puts (EWJ ML), which have already gained some 22% in the few short days since the conference. Should the Japanese blue chips fall another 12% (the highest of my three predicated targets!) over the next few weeks, these calls stand to gain another 82%.

Source: Here’s How to Bank on Japan’s Recession 

That wiped out the gains from the June infusion of tax rebates and turned the key Personal Consumption Expenditure – which had risen a solid 0.6% in cash terms – into a feeble 0.2% drop in real terms.

It’s obvious that inflation is continuing its inexorable increase. It’s also obvious that the world’s monetary authorities – including the Federal Reserve – are going to have to get serious about this potentially ruinous trend.

For long-term investors, all of this leads to a single conclusion: It’s time to get prepared.

The policymaking Federal Open Market Committee meets today (Tuesday), and is expected to keep the Federal Funds target rate at its current level of 2.0%. Even if the FOMC surprises the market and raises the target to 2.25%, that would still leave short- term interest rates about 3% below the current (actual) level of inflation.

In short, this wasn’t a serious attempt to slay the inflationary dragon.

A real such attempt might, however, have a useful effect on global commodity prices. When you look at a graph of commodity prices over the past year, it becomes very clear that their vertical ascent was ignited at just about the time that Bernanke began cutting interest rates last September.

As the Federal Funds rate was cut from 5.25% to 2%, oil almost doubled in price and overall commodities prices shot up by about 40%. Since interest rates stopped dropping at the end of April, commodities prices have stabilized and indeed oil prices have backtracked from their record high of about $145 per barrel to about $120 per barrel.

Even the start of a monetary-tightening cycle would very likely cause a reversal in commodities markets, with speculators closing off their positions and prices dropping back toward their long-term-trend levels – even if the continued demand growth emanating from the emerging markets prevents them from dropping back all the way.

That, in turn, would be immensely helpful to the global economy; after all, even oil at a $100 a barrel – a level first reached in January, just months ago – still seems like a faint-and-withering dream.

High Inflation and Loose Monetary Policy

Of course, inflationary pressures and a need for tighter money are not exclusive to the United States. Even in Japan, which for a decade has worried about falling – not rising –prices, inflation has reached 2%. That’s above the 1.53% yield on Japan’s long-term government bonds, and is well above the Bank of Japan’s policy rate, which has been stuck at 0.5% for the last 18 months.

China and India both appear to have double-digit inflation – as well as interest rates well below the inflationary level.

China is not yet admitting its true level of inflation, since it wants to present a rosy picture for the Olympics, but the first statistics released after the Olympics conclude may be grim.

As for India, it is fighting inflation not by monetary means (The Reserve Bank’s interest rate is still only 8%, compared to inflation’s 12%), but by subsidizing the price of oil, food, and other basic goods. And those subsidies are causing the country’s budget deficit to spiral out of control – it almost equals 10% of India’s GDP.

In Europe, the European Central Bank (ECB) has made fighting inflation its top priority. At 4.1% in July, compared to the ECB’s policy interest rate of 4.25%, inflation is far above the ECB’s target of 2%. In Britain, the Retail Price Index (the one the government hasn’t fiddled with) is currently up 4.6% over the past year, although the Bank of England has managed to keep interest rates positive in real terms at 5%.

A few countries are fighting inflation vigorously. In Brazil, where retail price inflation is around 6%, the central bank interest rate is 13% – producing mouth-wateringly tight money that will allow the domestic economy to grow even after the commodities boom (from which Brazil generally benefits) has turned down.

However, countries with positive real interest rates, which allow them to fight inflation, are few and far between. At the other extreme, you have monetary basket cases like Dubai, where inflation is 22%, but you can get a home or a commercial real estate mortgage at a fixed rate of 7%. This has naturally led to a gigantic construction boom that could end cataclysmically.

Nevertheless, the global picture is clear. In the United States and worldwide, inflation is reaching levels at which policymakers are forced to pay attention. Their first steps will doubtless be inadequate, since rate-setters remain concerned about recessionary risks, and global interest rates will mostly remain negative in real terms. At some point, however, the gradual tightening of monetary policy will bring an end to the commodity price bubble.

Where to Be When the Fed Gets Serious

When policymakers finally start raising interest rates and the commodity cycle turns downward, stock markets will initially be adversely affected. The shares of oil companies and commodity producers will drop, and other shares will remain affected by the likelihood that higher interest rates will translate into lower profits. But there are two clear investment groups that are poised to benefit:

• First, to profit from rises in dollar interest rates, you might consider the Rydex Juno Fund (RYJCX), the price of which is inversely linked to T-bond prices (the fund shorts Treasury bond futures).

• Second, you should consider investing in countries that have few domestic energy and commodity resources, and that have been particularly hard hit by the price spikes as a result. Those would include Japan and Korea, both highly productive economies that are forced to rely on imports for most of their raw materials. In Japan, the iShares MSCI Japan Index ETF (EWJ) is currently trading at 16 times earnings, and features a yield of 1.6%, giving it a good market spread. In Korea, the iShares MSCI South Korea Index Fund ETF (EWY) trades at a lower Price/Earnings ratio of 12, though with a beefier yield of 1.9%

Source: What to do When the Federal Reserve Finally Gets Serious about Inflation

He was a great fan – he read all my columns and had done well over the years out of taking some of my advice. I glowed with pride. Then came the fall. But, he went on, he had also lost a small fortune as a result of buying into the Japanese market – again on my advice – in 2007.

What did I suggest he did now? I shifted uncomfortably from foot to foot and prayed for the speeches to begin while the editor of a rival publication, irritatingly standing right next to me at the time, tried not to smirk too obviously.

It’s always horrible to feel responsible for other people losing money, but when it comes to Japan I really feel the pain: my own Isa is stuffed with Japan-related investments. So the fact that the Nikkei 225 was one of the world’s worst performing markets last year hasn’t exactly brought forward my retirement date.

So what did I tell him? That I was buying more. Japan is cheap in a way that no other developed markets are. A good 50% of Japanese stocks trade at less than their book value (the accounting value of their assets), for example. Dividend payouts are also rising. They have always been stingy, when they have existed at all, but over the past three years, the dividends offered by the biggest companies have been rising at double-digit rates.

And the economy isn’t doing badly at all. In the fourth quarter of last year, Japan grew at an annualised rate of 3.5% and in the first quarter of this year the numbers are expected to show that it grew at around 2.5%. Given that the best the US can do is 0.6% (and that number is bound to be revised down over the next few months), that looks pretty good.

Japan is currently the world’s fastest growing developed economy and given its links to Asia (twice as many Japanese exports go to Asia than to the US), it is likely to stay so.

Even more interesting is that fact that, after well over a decade of falling prices, Japan appears to have finally banished deflation. Food prices are rising (McDonald’s has eased the price of a Big Mac up from ¥250 to ¥280) as are energy prices.

But these obvious elements aren’t the only things that drove core inflation up to 1.2% year-on-year in March. Strip them out, says Jonathan Allum of broker KBC Financial Products, and inflation is still “mildly positive”. Better still, wages appear to be rising: the average base salary turned positive in November last year.

This is a very big deal. For far too long falling prices have put the Japanese off spending money (why buy something now if it will be cheaper tomorrow?) but if prices are rising – and workers have more money in their pockets – perhaps they will finally start to loosen their grip on their left-over-from-the-1980s Louis Vuitton wallets.

Already, says Christopher Wood of CLSA, Japanese consumers are expecting inflation to be running at 3.1% in 12 months’ time. This should do wonders for corporate pricing power (you can’t put prices up when people are expecting prices to fall but you sure can when they are expecting them to rise anyway) and for profit margins.

The other thing that might work to cheer up the Japanese consumer is the state of the property market.

Those who have placed very heavy bets on the UK property market on the basis that “we are a small island and demand is greater than supply” don’t like anyone to mention Japan. There, the long and totally insane bubble of the 1980s was justified on identical grounds. Then prices fell for 15 agonising years.

The good news – for Japanese homeowners if not for our own buy-to-let investors – is that they aren’t falling any more: residential land prices rose for the first time in 16 years last March.

Still, a lot of this has been true for some time and, as my new banker friend reminded me, it didn’t do us any good last year. Why might it now?

The answer is sentiment. Today most people hate Japan. Jonathan Allum points out that the week leading up to March 14 saw the biggest wave of foreigner selling since October 1987.

This is good news in the sense that the total capitulation of foreign buyers often marks a turning point for Japan. And so it has again. The point is that sentiment is beginning to turn. Right now very few investors have a stake in Japan. Soon they’re all going to want one.

So it’s best to get in before the rush – and the easiest way to do so is via the iShares MSCI Japan ETF (NYSE:EWJ).

Source: Bucking the Trend Could Help You Make It Big in Japan

What we saw on Wednesday amounted to a surprising display of strength from the bulls. Just think about what they had to contend with: Oil futures hit a record $115 a barrel; the dollar continued to dive; gold picked up fresh strength; and JP Morgan and Wells Fargo delivered a grim-faced outlook for the rest of 2008.

And yet, in the face of all that, stocks powered higher. That’s resilience (or determination, or foolishness, or some such thing).

The technical picture has shifted, too. After Friday’s GE-inspired drubbing, stocks looked ready to head back down. The ceiling appeared to be too much. (Note how the Dow failed twice in Feb, in roughly the same area it hit last week.)

Yet now, like a tough old boxer who just caught his second wind, the market looks ready to fight again. Yesterday’s sharp turnaround, which fully erased Friday’s decline, was the equivalent of the bulls peeling themselves off the mat. That they did so in the headwind of bad news is all the more impressive. The same picture applies for the S&P, the Russell and the Nasdaq; index shorts put out on Monday and Tuesday may soon be quickly covered. (That is, if they haven’t been already).

A lot of technical analysis is mumbo jumbo. The part worth its salt applies mainly at pivot points, when there’s a clear battle being fought between the bulls and the bears. It’s hard to tell who will win in the early going… and so the longer the battle gets dragged out, the more important any big reversal becomes. This latest turn of fortunes could mean something.

All About Expectations

Wednesday’s action in JP Morgan (JPM:NYSE) highlights another key point: The market responds to investor expectations rather than straight-up news.

On the JP Morgan earnings call, CEO Jamie Dimon reported that profits were cut in half by the credit crunch. The results were ugly by any measure, and Dimon pulled no punches. But since those ugly results were expected — and because the news could have been worse — the stock went up, rather than down.

In contrast, the sin of poor General Electric was to catch investors unaware. No one expected GE to miss as badly as it did, which is why the stock got crushed.

Both JP Morgan and General Electric were hit hard by the credit crunch — Morgan arguably the harder — but the bad news was “priced in” for one and not the other.

Technology stocks helped buoy the market on Wednesday, too. Good news from IBM and Intel seemed to counter GE’s mojo. If the tech blue chips are okay, the rationale seemed to go, then maybe a global slowdown isn’t in the cards.

How the Mighty Have Fallen

The jury is still out on how much longer the credit crunch will last. Wall Street CEOs now talk of a long and difficult slog, rather than a quick recovery. That’s progress. At the same time, they are happy to imply that the worst has passed.

So is the low point already in? Optimists take the view that “it’s always darkest before the dawn.” To which the pessimists respond, “it’s always darkest before it goes pitch black.”

To get an idea of just how rough things have been, consider Citigroup (C:NYSE). About six weeks or so ago, Taipan Daily called Citi a “poster child” for the credit crunch. The big bank took beating after beating as the full scope of its folly was revealed.

As a result of those beatings — and the market value lost — Citi is now smaller than Apple (AAPL:Nasdaq). Imagine that… The company that makes iPhones and iPods has a larger market cap than the banking behemoth that was, at one time, the second-largest financial institution in the United States.

Thanks to the credit crunch, hundreds of billions in shareholder value has gone up the flue. Lumbering giants like Citi have been cut down to size, and calls for a breakup are getting louder. General Electric is hearing the breakup calls, too, after seeing $55 billion wiped off its market cap in one trading day. (The brokers and the banks have written off less than $250 billion in losses so far; if you add market cap shrinkage into the equation, the carnage is much, much greater.)

General Electric was one of the 12 original Dow components back in 1896. A breakup of such a venerable old stalwart is hard to imagine… but then so is the idea of Citigroup being worth less than Apple.