Well for all the assumed volatility we would have yesterday, it was kind of a let-down – the stars did NOT align – GDP broke any hopes of that happening coupled with more depressing housing data. I will be the first to admit that I was rather shocked (and wrong) not to see that kind of volatility I was expecting. I think a couple of forces created a tug-a-war on the volatility which reduced same-side momentum, meaning that between the 50bps cut and the bad GDP that there was enough bears and bulls to keep the market from making a dramatic move in one direction or another.
However, the 50bps cut could not get this market off the mat – and that is very troubling. We are now at rates at or below (depending on what numbers you wish to use) the rate of inflation. That means that if you put your money in a US bond or CD you will actually be losing money by maturity – since the rate of inflation is out pacing the return-on-investment (ROI) on the CD / Bond. This creates a conundrum, where bonds are usually referred to a “flight to safety” they are now not as safe since they are a wasting asset. Where then to invest money for those that don’t have the propensity for market risk? That is a good question. I seriously think we are a very similar road Japan’s economy faced in the 80s, the dreaded triple down-turn, the market dropped, their interest rates went to zero, the currency weakened severally – even real estate values dropped fast. There was no place in Japan at the time to invest money that was safe from depreciation. The answer is diversify overseas and into inflation fighting assets.
The confidence in the Fed’s ability is severely lacking and as predicted the dollar is slipping further – inflation is real and is rising faster. WATCH the EURO, if it breaks 1.50 we could see a quick smack-down on the dollar.
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US Dollar – facing a serious problem
The rate cut is putting serious pressure on the dollar and that is a very serious problem to the economy and therefore the market. Here is the 1,000 foot simple view of the problem.
1. This country (the entire economy) is based on credit lines that are extended to us via the purchasers of US treasuries. The largest purchasers of these treasuries are foreign nations, banks, sovereign funds, etc.
2. The purchasers of treasuries look at the interest rate return vs. the underlying asset risk (the strength or weakness of the dollar) to determine if it is a good investment. Just because a bond pays interest does not mean the investor WILL make any money. Example: A European Bank converts Euros to Dollars to purchase the treasury bond. At the end of the year the treasury bond 5%, but if the US dollar falls 10% to the Euro, when the bank repatriates their money (from dollars to Euros) they have actually lost money.
3. Interest rates are traditionally INCREASED to offset underlying risk (in this case the dollar).
4. When Bernanke (the FED) cuts rates there is less incentive for foreign funds, banks, and firms to purchase US treasuries because the interest rate return is less and the underlying asset (the dollar) is dropping in value.
This is a circular problem, the more they cut rates the less foreign money (which we rely on) are willing to purchase treasuries, the lower the dollar drops, and the cycle continues – pushing the dollar further and further down.
We do have many domestic people purchasing treasuries – but domestic investments in treasuries pale in comparison to the amount of money foreign nations invest.
The problem becomes even bigger on a global stage as the world (except a couple nations) has dropped the gold standard and the US dollar has replaced it as the stable asset which everyone relies on. The US dollar IS the world’s reserve currency, almost every nation in the world holds vast sums of dollars to secure their own currency and economy. However over the last 6 months several nations have openly commented on their lack of faith in the dollar and have been shedding dollars rapidly to look for something more secure. This is also putting tremendous stress in the dollar – and also a factor in inflation. The MASSIVE cuts in the interest rates by the FED is certainty not giving ANY foreign nation confidence in the US dollar – thus forcing these nations to further quickly exit the dollar as a reserve. If the US loses its status as a world reserve currency (which is starting to accelerate – specially in China) we could see a very big problem happen in this country. We are currently in very uncertain times and uncertainty brings volatility and volatility brings more risk.
Watch currencies very closely – it could bring serious pressure the equity markets.
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Bond Insurers
MBIA, one of the largest bond insurers, still has a AAA credit rating. The ONLY reason it does it to keep a domino effect from happening that could cause losses to US pension funds that are already looking at losses that could exceed $100 billion nationwide. MBIA reported record losses and SHOULD be losing their AAA status – but has not because of its serious repercussions. MBIA is scrambling and meeting with credit rating agencies as to not loose it’s very important rating. Additionally they need to shore up losses and raise money fast – as the “favor” can be only extended so long.
S&P credit rating agency cut or put on review over $500 billion in bonds and CDOs (held by state pension funds, financial firms, and other investment related firms) additionally they publicly stated that mortgage-related write-downs will exceed $265 billion.
The stop gap insurance companies of these SIVs, CDOs, and bonds are in serious jeopardy. Collectively they insure $2 trillion in US financial related instruments. The two largest are on the brink of bankruptcy and are looking for money.
This has caused concerned both for state governments where a majority of their state pension funds are invested in bonds and CDOs that are insured by these companies. Additionally foreign investment funds, banks, and governments rely on the credit rating of these products as well.
This could be the next shoe to drop that could cause an even bigger problem.
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Futures Pre-open
The futures are front running the cash and the spreads are fluctuating. ARB traders slip-risk is fairly big on the opening if they leg from the long side (buy futures) to short the cash at the opening (or pre-open). Expect pressure on the opening. The jobless claims that just came out is putting more pressure on the futures in the pre-open.
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Support / Resistance
We did see some intra-day volatility with the INDU swinging about 400 points over the day. However the close saw some negative pressure.
INDU 12,000 / 13,000 (It looks like the intra-day high of 12,600 range was it. We are heading lower – the jobless claims are not helping.)
NDX 1700 / 1900 (We closed to almost unchanged after a 40 point pop intra-day. The pressure seems to be to the downside.)
SPX 1300 / 1400 (The S&P could not get off the mat – and it looks like we are probably heading lower – the intra-day pop might have been the last up move before heading lower)
RUT 650 / 750 (We couldn’t stay above 700 and the RUT took the biggest % hit yesterday – this is not good for the market as a whole)
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Conclusion
I thought the stars would of aligned and all the economic data combined with the 50bps cut could of given the market a very SHORT term rally over the next 3 days. But the GDP and now Jobless numbers have screwed that up. Talking Heads are still talking about whether we are going to have a recession – that story is getting old – we might as well be in one now.
The rate cut is not helping after 125 bps in a week – that is a VERY scary thought, since the FED KNEW the risk of the pressure it will put on the dollar and inflation – which on the backside will put even MORE pressure on the market.
I think we are going to visit the recent bottom sooner than later, I did think we would have a short-term (3-5 day) pop to retest the resistances – but that is not happening.
The next shoe to drop is even more alarming than the write-downs of the banks – it’s the write-downs of the insurance companies that these banks rely on. Additionally the losses to state pension funds is already expected to exceed $100 billion nationwide and S&P is stating that over $250 billion of write-downs from financial firms is coming – that is over $150 billion MORE in write-downs to come.
Hedge positions!!!
Traders – look to take advantage of the skew!
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