The anniversary is the collapse of Lehman Brothers on September 15th 2008. It was like a financial "big bang," the end of one financial universe as we know it. But could there be more meteor strikes on the way for Planet Leveraged Earth? More on that issue below.

Slipping quietly under the radar in the build up to the Lehman anniversary is the fact that the All Ordinaries closed Friday at an 11-month high. Even a mediocre Friday session in New York will have to work to depress local shares. But it could happen.

In fact, our resident technical analyst and chartist Gabriel Andre told us last week that the S&P ASX 200 index had cleared (on the upside) the technically important 4,550 level. But he called this a "false breakout." The reason? None of his technical indicators have confirmed that there is any more momentum to the upside.

Of course, that doesn't mean the rally won't coast higher. We read from some analysts that there are still a lot of investors who are "underinvested" in stocks. But that hardly seems to be the problem at all. It's more like people are overinvested in an earnings growth story that's been fabricated from a mix of optimism and sleight of hand.

It will be a good test of Gabriel's new trading methodology. You may have seen last week that he's finally gone live with his "black box" method for finding trading patterns on ASX stocks. It's not a "black box" system, actually. Gabriel is simply testing the idea that you can capture price swings in blue chip prices using a combination of technical analysis and charting.

We will see if he's correct. It's an interesting proposition because it ignores things like the positive industrial output data from China that cheered Aussie investors last week. In fact, we reckon most technicians would be happy to chuck everything but a chart out the window when deciding to buy or sell. You don't eve n need a ticker symbol.

You just need a chart and some tools to analyse it in order to find the trading opportunity (long or short). We'll keep you posted on how it goes. We reckon there are a lot more opportunities on the short side than the long side. But they are opportunities none the less.

"Some day this war is gonna end," said Lt. Kilgore on the beach in Apocalypse Now. He was almost wistful about it, in the same way you read a lot of investment professionals talk about the collapse of Lehman Brothers last year. They're discussing it as it if were ancient history.

Not Joseph Stiglitz. The economist told Bloomberg that, "In the U.S. and many other countries, the too-big-to-fail banks have become even bigger...The problems are worse than they were in 2007 before the crisis." That does not sound promising. It sounds ominous, especially for banks and other financial stocks.

There certainly were a lot of casualties that resulted from Lehman's loss. Here in Australia the roll call of fallen firms includes Allco, Centro, Tricom, and ABC Learning. Some were killed in battle. Others were wounded and taken from the field. But is the war really over?

The press coverage would suggest that the war on the financial crisis-fought with unwieldy weapons like interest rates and fiscal policy by besuited warriors like Ben Bernanke and Wayne Swann - is not over, but not critical any longer either. It's as if the Germans have been pushed back east across the Rhine. Berlin hasn't been taken. But the beaches have been stormed and the Hun beaten back.

Yet if you examine the lessons of Lehman, you wonder if we have really learned anything. The collapse in global trade and output was the worse since World War Two, following the fall of Lehman. You can see it in quite shocking fashion from the chart below, courtesy of High Frequency Economics. But what does the chart actually mean?

The chart shows the first real and large fall in global trade since the 1970s. But we think it also shows that global output and trade have grown with the globalisation of fiat money. The entire global economy expanded at a furious pace because of the amount of credit and leverage in the global system.

When you take away this leverage - a process that began like hitting the proverbial brick wall with the Lehman collapse - you find that a lot of economic activity disappears once credit vanishes. The huge slump in output persists. But what's crazy is that stock prices began to recover once the free fall in output seemed to end in March.

Stocks seem to be repricing a return to growth rates, pre credit crisis. But as we've argued here before, most of the first and second quarter earnings outperformance for publicly listed stocks was driven by cost cutting and inventory destocking, not any fundamental improvement in business conditions.

Another lesson from Lehman was that asset prices (across all asset classes) were much more heavily supported by leverage than anyone suspected. This was true for commercial and residential real estate. It was true for stocks. It was true for commodities. And it was true for bonds.

In fact, we'd argue that it's only government-backed leverage that is supporting the U.S. bond market. You could even argue the rally in stocks was made possible by Fed-created liquidity, which banks and brokerages took advantage of to engineer a massive stock market rally which is now ending.

It's a mistake to think that letting Lehman collapse was only a mistake because Lehman proved to be so interconnected to the rest of the financial system. It wasn't just that Lehman was one of a handful of firms "too big to fail." This is the most under-appreciated point about the last two years.

The most important lesson from Lehman's collapse is that when you combine massive leverage with securitisation and derivitisation, you get a financial world that is inherently less stable. Statistically speaking, it's far more prone to volatility and collapse. The interconnectivity of the global economy showed how quickly instability could be transmitted across borders.

If you're a student of networks, this may seem counter intuitive. You might think that increasing the number of nodes in a network decreases instability. The more nodes and interconnections there are, the easier you'd think it would be for problem nodes (Lehman) to be bypassed or isolated before they can destabilise the whole system.

Yet it seems like the more complex the global financial system has become, the less stable it has become. hy is that? Maybe it's because there are several important connections we're talking about. For example, the fact that information and prices are communicated swiftly around the globe does not make the world economy less stable.

It may make trading more volatile as people try to figure out what news really matters. But the interconnectivity of the world has just upped the pace of business. It's forced everyone to have faster OODA loops (observe, orient, decide, act). So if sheer connectivity isn't to blame for instability, what is?

One likely culprit is complexity. We simply don't know how things are inter-related in the global economy. And by "things" we mean cross ownership of assets and obligations. What's made the system so unstable is that the asset side of the global balance sheet has become opaque. It's become derivative. It's become relative.

In the meantime, the liability side of the balance sheet grew and grew, setting up an inevitable "complexity catastrophe," to use Eric Beinhocker's term. As far as we can see, the complexity catastrophe is still unfolding as the value of bank collateral continues to deteriorate. Government's are trying to arrest the rate of decline to prevent massive unemployment, and meeting with some success.

But one year after Lehman, we feel confident in saying that someday this war is gonna end. But it's not today. And it won't be today for quite some time.

Dan Denning
for The Daily Reckoning Australia

• Technical Analysts see the Market 80% Psychological and 20% Logical
• Lehman Brothers on the Verge of Liquidation
• Lehman Brothers (NYSE: LEH) Is Not Dead Yet
• Prices of Gold in the Top 10 World Currencies
• Financial World Has Every Reason to Encourage Government Stimulus

First things first. The budget comes out tomorrow. Blah blah blah. What is really left to say? The Treasurer predicts collapsing revenues from the GFC and has cut spending in some places while increasing it in others. The annual deficit could be around $70 billion (we expect it to be lower so it's 'not as bad as we expected') and the government predicts more deficits for years to come until the relationship between falling revenues and rising spending becomes "more sustainable."

How Australia chooses its social spending priorities is a political question. And who wants to get into the sewer and debate politics on a Monday morning? The effect of financing those priorities/promises, however, is an economic question. And for that we'd say watch out for a steepening Aussie yield curve. This indicates rising long-term interest rates. In other words, big government borrowing to financing deficit spending is going to make borrowing more expensive for ALL Australians. More on the bubble in government bonds below.

What about the stock market though? Australia reported its second-best ever trade surplus last week. Chinese purchases of Aussie exports have surged 80% in the last four months, according to government statistics. China purchased a record $4.4 billion in Aussie goods in March.

Surely that must be the kind of national income that boosts corporate earnings? But whose income? Well, farm exports were up 10%, with wheat exports up about 40%. Imports were down three percent. That would begin to explain some of the surplus. But what about minerals and metals?

Coal and other mineral exports were actually down five and six percent, respectively. But metal ore and mineral exports were up 8% to $354 million. Iron ore exports were up 9%, although in volume terms, exports were up 19% while prices were down 8%.

So wheat and coal held up the trade figures in March, along with a decline imports. That makes sense doesn't it? Australia has a fair bit of wheat and coal. But we have to confess we find the iron ore export data perplexing. If Chinese demand is being driven by the government stimulus, that might explain it.

But remember, iron ore and coal prices are going to be a lot lower this year than they were last year, once contract negotiations are settled (this also means export values are going to value). Why, then, would the Chinese government pay a higher price for ore now when it could have it at a lower price in the spot market or in a new contract price in just a few months?

Who knows? One possibility is that the surge in ore exports to China is being driven by speculators who are stockpiling. It could be steel-makers could rebuilding inventory. Or it could be what some people seem to think it is: a new boom! We'll see.

For now, the simplest explanation for the market rally is this: inflation. All over the worlds, fiscal and monetary stimulus packages are kicking into the gear. Their effect in the real economy is dubious. Their effect in the stock market is obvious. Rally! A huge amount of money is being pumped into the global financial system. Stocks are surfing it.

By the way, lest you think we're against the idea of making money in these rallies, we're not. The two investment newsletters we publish, Australian Small Cap Investigator and Diggers and Drillers, have each recommended resource and small cap stocks that we think will do well in an inflationary boom.

In fact, that's probably the simplest way to make big returns in an enormous inflationary boom: owning small and micro cap stocks, especially natural resource stocks. Mind you that is pure speculation. That's the only caveat we'd add. Can you do it? Yes you can! Is it risky? Yes it is!

What the current rally is NOT is a new bull market rising from the ashes of reasonable valuations and an economic recovery. The boom in government debt issuance is driving investors out of the bond market and into the stock market. The consequences are going to be...not good.

"The government is reinflating the financial bubble," MIT professor Simon Johnson told the Wall Street Journal this weekend. "The over subsidizing by the government in the financial sector will get us stuck in the same kind of financial bubble that got us into the mess in the first place. Last year, what we saw was a private-sector financial bubble."

Johnson says this government debt bubble is what directly precedes inflation. "We should look out for inflation as early as the end of the year. The government credit put in the banks makes inflation almost inevitable. It's a recipe for going to hyper-inflation. Within the next one-to-two years, the government will have to cut back to prevent it from happening...Reality will hit roughly in the next two to five years. What we should watch is the interest rate of 10-year Treasury note. When it approaches 5%, the strategy is in trouble."

Do you think the government is going to cut back its borrowing?

Meanwhile, 5% on the ten-year note may get here even sooner than Johnson reckons. On Friday, the U.S. Treasury endured what fixed income trader Mary Anne Hurley called a "horrible bond auction." Uncle Sam's debt dealer was trying to hawk US$18 billion in 30-year bonds. The auction did not go well, and yields on the 30-year climbed to over 4.25%.

What does it mean for Australia? Well, yields on ten-year Aussie government notes are back over 5%, according to data from Bloomberg. On Friday Bloomberg wrote that, "Australian government bonds fell four days this week with the yield on 10-year notes rising 29 basis points, or 0.29 percentage point, to 4.96 percent." At the start of the trading week, yields had climbed even higher.

Obviously investors don't like the idea that Aussie government debt could rise to 15% of GDP by 2012, given the government's budget projections. So bond investors are demanding higher yields to provide credit to profligate borrowers. The IMF reckons that the four biggest government bond issuers will float nearly $4 trillion in new debt this year.

That is a lot of supply for private investors to absorb. And private investors have a clear choice. They can hitch a ride on the market rally or flee to the perceived safety of the government bond market. But if inflation is really on the way as Simon Johnson suggests, you'd expect falling bond prices and rising yields. You'd expect the bond bubble to pop with a resounding thwack.

That means money flows could pump stocks even higher as equities inflate faster than cash depreciates. We wouldn't exactly call that a recovery from the bubble excesses of the previous fifteen years. But if you're a trader, then profiting from an inflationary boom means dipping your toe in the speculative end of the resource market. If you're an investor? More on that tomorrow.

Dan Denning
for The Daily Reckoning Australia

• Central Bankers Encourage Debt Booms That Become Debt Bombs
• The Very Large Bubble of Government Debt
• Now in Post-bubble Era as Financial Industry Bombs Out
• Australian Trade Deficit Grows for 75th Consecutive Month
• Terms of Trade Driving Runaway Australian Inflation

Then, shares rallied nearly 5.7% for the rest of the day. The All Ords closed up 54 points on the day. But from the intraday low to the close, it was more like 186 points. Now that's what we call a bounce back!

Maybe Mr. Market had a few martinis for lunch and came back in a reckless mood. We know the feeling. Or maybe he just needed a stiff drink to give him the courage to say that scariest of words these days, "buy."

Source: www.yahoo.com

Others too courage too. At much-maligned, forever-falling Oz Minerals (ASX:OZL), new CEO Andrew Michelmore told the market he was buying $30k worth of shares. Director Barry Cusack said he was in for $100k. The insider buying was enough to engineer a 25% turnaround on the day, with the stock closing up nearly 13%.

Whatever the cause was, we came in the control room at the Old Hat Factory this morning around 7am and found Swarm Trader Gabriel Andre already at work. It looks like the rally triggered a host of signals. But will it continue?

It's been a tough market to trade. There's no real momentum. No one really knows what's going on. One day, you're up three percent. The next, down four.

The Dow started its Friday bounce back work a little later than the ASX did. It didn't begin its late-afternoon run until 1pm in New York. But when it finished, it had climbed 494 points above the open, for a daily gain of 6.54%.

The Dow Bounces Back

Who knows why these things happen? The story making the rounds in the papers is that traders "cheered" the news that Tim Geithner, President of the New York Fed, would be Barrack Obama's new Treasury Secretary. He'd replace "Bazooka" Hank Paulson.

No word on Geithner is as good for Goldman as Paulson. But he has been one of the three big wheels behind the various bailout plans engineered by the Wall Street/Treasury Axis. He's a known known, as Donald Rumsfeld might say. And since we're going with the Roman metaphor, we'd say Geithner has been Caesar to Ben Bernanke's Pompey and Paulson's Crassus.

Of course the first Triumvirate coincided with the beginning of the end of the Roman Republic. It was never official. Just three men calling the shots from behind the scenes.

But it certainly marked the beginning of the Empire and dictatorship. Crassus was one of Rome's richest men. He'd put down the slave rebellion led by Spartacus in 74 BC (still one of Kirk Douglass' best performances, if you ask us). But he died fighting the Parthians at the edge of Empire at the Battle of Carrahae in 53 BC.

Pompey lasted longer. He gained fame in Rome after defeating pirates in the Mediterranean in 67 BC. He formed an alliance with Julius Caesar in 59 BC and cemented in by marrying Caesar's daughter Julia.

But when Caesar famously crossed the Rubicon in 49 BC and brought his armies into Italy for Civil War, he put Pompey on the run. Caesar chased Pompey all over Italy for a bit, eventually defeating him in battle and driving him to Egypt, where he was promptly assassinated by his own friends and beheaded.

Tough place, ancient Rome.

But back to the modern world. There are no financial Rubicons left to cross that we can see. They've all been crossed already. And we believe they all lead to inflation in 2009. The New York Times Reports that Senator Charles Schumer wants the new stimulus plan to be around US$700 billion. That would match the TARP, providing some classical symmetry.

Gold must've noticed. It was up forty three bucks on Sunday. In the spot market, gold's back over $800. By the way, Australian gold production fell by 8% in the third quarter, according to Bloomberg. Australia is the world's third largest gold producer. But high production costs are biting.

In the bigger picture, gold traders and investors realise that the Great Fiscal Stimulation of 2009 is being prepared as we speak. President-elect Obama is conversing with his fiscal and monetary generals. He is marshalling his armies of inflation to go forth and multiply the money supply.

If gold investors are right (and we think they are), the upcoming war on deflation should unleash the epic inflation we've all (except for Bob Prechter and Marty Weiss) expected.

Obama and his Consuls Geithner, Summers, and Bernanke are preparing the public for operation GFS 2009. "We now risk falling into a deflationary spiral that could increase our massive debt even further," the President-elect told Americans in a speech this weekend.

He's right. The rising value of cash (in a deflation) makes debt harder to pay back (especially when you plan on adding so much more). That's why all governments everywhere prefer the policy of soft, slow-motion inflation. Obama does not represent change here. Just more of the same borrowing and spending we've had for years.

Inflation gradually erodes the value of accumulated debts by allowing you to pay them off in an increasingly weaker currency. If you're having trouble with that idea, think about this way. Say you borrowed $1,000 twenty years ago. Twenty years ago, $1,000 had more purchasing power than it does today. If you inflate steadily enough, it gets easier to pay back your accumulated debts. $1,000 ain't what it used to be.

The United States also enjoys the luxury of paying off its debts in a currency it prints. So inflating the debt away is easier than, say, defaulting on it because you don't have enough of the currency in which the debt is denominated. There is no reason to default, in fact, when you can print the currency in which your debts are owed.

This is why we increasingly think inflation is coming. Up until now, the best laid plans of Paulson and his team have been focused on recapitalising banks and keeping the financial system from imploding. Deflating financial assets have chewed up that new capital, and prevented it from becoming new lending in the economy.

But the next step is the reflation of household balance sheets. Wall Street got its bailout. Now it's Main Street's turn.

Already, Obama's team has indicated it will let the Bush tax cuts expire naturally in 2011, rather than repealing them now. Expect an expanded foreclosure mitigation effort too. And eventually, a new government-backed refinancing plan will be floated to try and put a floor under U.S. house prices.

Yep. 2009 is shaping up to be quite the year if you love big spending government with big plans. Yet here in Australia, the government seems scared to follow Obama's lead and go into deficit to "get things going." The unemployment rate will have to go higher, or house prices will have to fall further, before the Australian public demands more rate cuts and deficit spending (rather than resisting the latter).

Here are a few problems to think about until tomorrow. First, if you're a large owner of U.S. dollars and a major creditor to the U.S. government, and you see that the U.S. won't default on its debt but instead, inflate it away, what do you? What policy levers can you pull to exert influence on your debtor?

Second, what happens to the world's stock of available savings when governments start hoovering it all up to be used as fiscal stimulus? Does it crowd out private investment, leading to fewer new jobs, and a prolonged crisis? In other words, is the big government push to "fight the crisis" actually setting it up to be much longer and more painful than it otherwise might? More on this tomorrow...

Dan Denning
for The Daily Reckoning Australia

• China’s Economy is Now Freer and More Competitive than the United States
• America’s Debt Woes
• American Family’s Share of Government Debt Now Over Half a Million Dollars
• Geithner and His Toxic Asset Bailout Plan
• Fannie and Freddie in a Free Market Economy

"Every single person," he said, illustrating his point, "who drinks milk...dies. There's a perfect correlation between drinking milk and kicking the bucket."

A couple of inattentive students looked worried. What our maths teacher meant, of course, was that milk isn't a significant cause of bucket-kicking. Unless you happen to be a particularly uncooperative cow.

But whether you're bovine or human, here's a correlation that should have a bit of meaning for you. There's some causation here. Take a look a look at the graph below, Crude Oil vs The All Ordinaries.

Yesterday we looked at the Dow Jones version. The All Ordinaries has fallen in much the same way as crude oil has risen. But since oil corrected, the bounce in shares hasn't taken off yet.

There are a couple of reasons that might be the case. The oil price might not be the cause of share price movements. Or a bounce in shares might be ahead.

We think it's somewhere in between. Crude oil certainly isn't the only cause of the downward slope in the All Ordinaries this year. Worries about inflation (more on that below) and earnings are right up there. But the oil price has been a bigger worry for shareholders.

Why? Well, the heart of Australia's economy runs on energy. The two big sectors in the market are financials and resources.

What happens to a resource company when you take energy away from it?

That. That sorry chart is the tale of nickel miner Minara Resources (ASX:MRE). It's been unable to run operations at full capacity since Apache Energy's gas plant at Varanus Island blew up. Nickel production will be around 4,000 tonnes lower at Minara this year. That's causation.

Its P/E ratio has tumbled from over 11 to under 4. The market would rather chew on glass than look at this company now.

But isn't this what's happening in the overall market itself ? Just on a slower time scale. An invisible hand is slowing removing oil from easy access. Energy is contracting. If oil prices rise in the long term, the mining and manufacturing sectors will eventually feel a general production slump.

We reckon that's the major reason the market was selling under 5000 points earlier this week. But there's a good chance the correction in oil will undo a lot of that negative sentiment. Oil fell 3.1% yesterday.

Incidentally, we think there is a way to make money out of nickel. It has nothing to do with Minara. What it does involve is a company that has devalued almost 40% this year. If you'd like to see a few solid reasons why it can undo that, take out a subscription to Diggers & Driller.

Inflation refused to go quietly into the night yesterday. Instead it stormed up to its room, plugged in its electric guitar, turned the volume up a little higher...and made a bit of a nuisance of itself.

The key consumer price figures for the June quarter came out yesterday. They amounted to further evidence that the RBA has little control over inflation any more. Economists expected consumer prices to rise 1.3% in the June quarter. They rose 1.5%.

Here's the breakdown, straight from the statistics bureau. The biggest movers are in red (inflation) and green (deflation).

Food prices fell largely thanks to a correction in grains prices. That's temporary. Transportation needs little explanation. The greatest oil spike of all time is responsible for the inflation there.

And here's our point: the cost of financial services rose by more than any other category. High interest rates may have something to do with that. The major banks raised their mortgage rates again this month. They're nearing 10% now.

So now, the RBA can leave interest rates up there and contribute to the inflating cost of the financial system. Or it can drop them and risk letting the economy overheat. It only has one lever to pull. Now it can pull the lever up and add to inflation. Or it can pull the lever down and add to inflation.

There's a chance this could throw the market comeback off-kilter. But investors certainly look ready to run with the good news.

Alan Robinson
The Daily Reckoning Australia

• Crude Oil Becoming Much Harder to Find
• All Ordinaries Reach 52 Week Low
• Inflation is an Artifice Caused by Government
• Australian Dairy Prices Up Due to Grain Prices
• Supply of Conventional Crude Oil is Very Close to its Peak

What about that data yesterday on the housing market and retail sales? Retail sales rose by 0.7% in May. Apparently that was stronger than analysts expected. Should it surprise anyone? People are good at spending money these days. We live in a spend at all costs society. Saving, not so much.

New building approvals fell 6.5% in May. There are two ways to read this (more probably, but two that we can think of). The first is that tight credit conditions are choking off demand. Investors and builders aren't interested in borrowing to build, especially if potential buyers are less likely to take loans out at higher rates.

The other way to read it is that builders don't see demand for housing so they're not building houses. Yes, yes. That must sound like utter nonsense if you believe there's a genuine housing crisis. But is there a crisis in Australia's stock of available housing? Or is it an affordability crisis? There's a huge difference.

Why are price signals not working in the Australian housing market? High prices tend to attract production. New production-more new houses- brings prices down. It's all text book stuff.

Price signals can be distorted by bad public policy or bad monetary policy. Are Aussie builders stymied from building new houses by rising input costs and a minefield of regulations? Is it just too expensive to borrow money right now? Or do the builders realise there are already plenty of houses? There just aren't any inexpensive ones in places people really want to live.

Oil traded up again on the NYMEX overnight. August light sweet crude traded at US$144.15 in after-hours trading. The U.S. Energy Information Administration said U.S. crude oil inventories fell by 2 million barrels. Everyone else expected them to rise. It was a disappointing result.

Here's the thing. High oil prices are going to cause even more economic pain. If investors think they can flock to oil and ride its rise as the global economy goes to hell, they should remember that if the global economy goes to hell, the oil price is going to fall.

Right now it's just the stock market that's falling to pieces. This is the markets way of telling us that the second half of 2008 is going to be bad for corporate earnings. High petrol prices, tight credit, more expensive imports...gloom, gloom, and more gloom. We're sticking with our call that oil is topping.

Dan Denning
The Daily Reckoning Australia

• The Mother of All Housing Booms
• Mortgage Crisis: Shark With an Appetite
• Homebuilding Goes Down While Economy Gathers Strength
• All Ordinaries Down 17%, Worst Showing in 30 Years
• Crude Oil vs The All Ordinaries… Who Will Win?

Investors open the week caught between two forces pulling them in opposite directions. Inflation is afoot globally. Higher commodity prices have been good for resource producer so far. But now everyone is worried that high raw materials prices will slow down industrial production. The world will pat its collective belly and say, "Sorry Australia, I'm full."

You also have the added worry of a lousy financial year for superannuation investors. That is, balanced funds with your basic exposure to Australian and global equities will have had a lousy year. You can blame the All Ordinaries for this. It's set to finish the financial year down around 17%. That would be its worst showing in nearly 30 years.

The financial year performance is what matters to super investors. But it doesn't really tell you the whole story, does it? Since June 30th, 2003, the ASX/200 is up 72%. That includes the 23% fall we've had from the early November high of 6,828.

It all depends on how you define your terms, doesn't it? A term, according the Latin definition, is a boundary or limit. But there are all sorts of terms. If you started investing in November of 2007, your time in the share market feels like a prison term. If you're a U.S. homeowner who bought a house in the first quarter of 2007, it feels like a life sentence.

In the long-term, the conventional wisdom goes, you won't do poorly investing in the broad market. You should ignore short-term volatility and focus on the long-term real returns above the rate of inflation, which you hope will be between 7-10%. And you know, if you look at a few charts, this long-term perspective is encouraging.

The RBA's latest chart pack has three interesting charts. First there's this little gem. It shows us that Australian stocks have clobbered the S&P 500 since the resource boom began. It also shows that while there could be more losses ahead, the long-term trend is still pretty bullish.

Then there's this little beauty. It's an even longer-term chart. It compares the ASX/200 to the S&P 500 going back to 1994. There's at least one bubble visible in this chart, and perhaps two, depending on how you view these things. The first is the S&P's boom that ended in 2000. The index did make a new high in October of last year at 1,565. But where will it go from here? An answer in a moment.

This last chart shows the leadership of the local market. Financials (the big four banks) have been the slow and steady winners for years. But the resource hare is lately clobbering the financial tortoise. Are banks a buy at these depressed levels? Are resources a sell?

You probably can guess what we are going to say. We say it nearly every day anyway. But we will clarify it again as we begin a new financial year. The world's financial system is full of an awful lot of rot. Slowly, reluctantly, but irresistibly, banks and brokers are being forced by shareholders and international capital rules to reduce exposure to risky assets.

Practically, this means financials will spend the rest of this year slimming down the balance sheet, selling assets and trying to stockpile cash. But just what assets will the hedge funds and Wall Street banks be selling? And who will they be selling to?

The first casualties of deleveraging will continue to be financial stocks themselves. These companies have massively bloated balance sheets with huge amounts of leverage. The big equity indexes were overweight financials and underweight energy for years. That's reversing. Eventually, they'll be overweight energy and underweight financials. But that is a few years off.

In the meantime, emerging markets had better watch out too. Brazil, Russia, India, China..the BRICs...will probably weather the storm. Each has something attractive about it that foreign capital will be reluctant to ignore. But the Pakistans, Vietnams, and Mexicos of the world had better watch out.

Is Australia an emerging market? Nope. But it depends on how you define your terms. Australia is thought of as a 'risky' market by some investors who see commodities as a speculation against a weaker U.S. dollar. If those investors see a greenback really in the second half of this year, they'll sell commodities and buy the U.S. (as insane as that sounds.)

What does Australia have going for it? Well, for one thing, there is the cash rate of 7.25%. As painful as this is for individual Aussies, it's a huge draw for foreign investors. The Reserve Bank will surely not cut rates when it meets in Sydney tomorrow. It should also give us a clue about the direction of rates for the rest of the year.

The Aussie economy looks strong. But you can tell that people are getting nervous. That's the trouble with inflation. It destabilizes people psychologically and economically. There's a lot of data due out this week that will show us what people are actually doing.

On Wednesday the retail trade figures come out as well as building approvals. We'll also find out what demand for credit is like. Thos things will probably tell us what we already know. The economy is roaring along in some respects, and looking a little tired in others. That's better than a lot of other places in the world.

The trouble with the long term is that it's getting shorter and shorter every year. In the age of the 24/7 media cycle, with the Internet and mobile Internet, people receive and attempt to process information faster than ever. There are tens of thousands of variables, and investors somehow try to figure out what it all means on the fly.

But most of what flies over the newswires everyday is irrelevant garbage. You can try and trade it. But it is doubtful that much of what passes for news will actually affect your long-term investment strategy (if you have one.) The interconnectivity of markets makes them more volatile. But it doesn't mean you shouldn't think about long-term trends.

In the long term, as Keynes said, we are all dead. But in the short term, we expect to see the indexes lower but the resource shares generally higher. Gold and precious metals are due to take the baton of leadership within the commodities market. We are avoiding the still-bloated corpses of the financial stocks, which will not survive the coming revaluation in their current incarnation. Geopolitically? More on that tomorrow.

Dan Denning
The Daily Reckoning Australia

• U.S. Dollar Index Showing All Sorts of Weakness
• Crude Oil vs The All Ordinaries… Who Will Win?
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