It is hard to reconcile the sunny optimism of CNBC with the grinding reality of the stock market. Where will earnings and growth come from in 2008? What sector? If inflation is out of control, are shares the best refuge? The stock market looks more and more nervous as investors try to sort all these things out.

The grim news Stateside is that the board of directors of Wachovia, the fourth largest bank in America, fired its CEO Ken Thompson. Wachovia lost US$708 million in the first quarter of 2008. It didn’t help Thompson that he engineered the acquisition of mortgage lender Golden West Financial in 2006—right at the peak of the mortgage lending bubble.

Thompson joins a long list of CEOs falling on their sword for thinking a credit boom would never end. It has. It’s still ending, in fact. Ratings agency Standard and Poor’s lowered the credit ratings of three big Wall Street firms earlier today. JP Morgan, Lehman Brothers, and Merrill Lynch were all downgraded because the S&P reckons the firms will have to take further asset write downs this year.

What did you expect? It’s a bear market in credit. The story comes straight from the department of news so obvious a rock would know it. What does it mean?

Well, a bear market in credit is bad for firms with heavily leveraged balance sheets. That includes most financial stocks. Why any investor would go bottom fishing in the financials when we still have a bear market in credit is beyond our feeble Tuesday-morning reckoning capabilities (still jet lagged).

Turning to our adopted homeland, we notice that other people are starting to get really worried about inflation. “Inflation rising at record rate,” reads a headline. “Inflation is rising at its swiftest pace on record,” according to a survey by TD Securities and the Melbourne Institute. You don’t say?

The RBA reckons inflation is running about 4.5% a year. It’s probably even higher than that, especially for people that eat, drive, get sick, and wear clothes. Hunger striking nudists who commute to work on bicycles are probably doing just fine. If there were only more of them.

There are comments by the usual morons on TV that the U.S. dollar is headed for a rally against the euro and the yen. This, the morons reckon, should lead to some “easing” in commodity prices. Oil eased itself up US$1.48 in early us trading, getting back on the north side of US$128. Gold eased itself up US$7 to just shy of US$900.

What if the dollar goes up against other currencies, but down against tangible assets? Is that even possible? Well of course it is!

The greenback weakened even more against oil and gold in the last few years than it did against the euro and the yen. Beware the false prophets of a dollar resurrection. They are looking at an incomplete picture because it’s more comforting.

How will shares behave if the global inflation bush fire becomes an inferno? Well, resource shares could melt up. The weak dollar is responsible for a lot of the nominal gains in commodity prices. But it's not responsible for all those gains. Demand is too; especially demand from the 3.2 billion new industrial consumers in India and China, and the billion more in the next wave of industrializing countries.

We’d better be careful though. If people begin to think the central bank fight against inflation is lost, they will modify their behaviour accordingly. This includes demanding higher wages to keep up with spiralling prices. And it includes trading cash for things before things get more expensive.

You’d be surprised how quickly the shelves of a supermarket can be picked to the bone when people become convinced (and afraid) that prices are going inevitably higher. There is proably not that much difference between the human genome and the locust genome.

Buy extra toilet paper.

And here’s a note we’ve been waiting to see. “Deal nears on iron ore price rise of BHP, Rio,” reports Jamie Freed in the Age. It looks like the Aussie miners are going to get something like a 95% increase from last year’s contract price. The Chinese steel makers won’t be happy about that. But if they don’t agree to a deal before June 30th, both Aussie ore titans are free to sell ore in the spot market, where prices are double the current contract price.

You can find more share market news from our pals over at Money Morning, who are all over the coal-seam-methane story. Until tomorrow…

Dan Denning
The Daily Reckoning Australia

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• Bear Market Actually Began in 2000
• A Trader’s Market or an Investor’s Market?