Well you can’t deny the market is fairly resilient, even when one of the top investment banks in the world melted down over the weekend and the dollar slipped heavily against the Euro and Yen. We can spend lots of time on who or what kept the market from sliding down, maybe it was the cut at the Discount window over the weekend, maybe it was KNOWING that the FED will rush in a bailout any large financial institution and make guarantees ($30 billion in Bear’s instance). However, there is no denying at this juncture how serious the market turmoil is. We have recently seen the world’s largest lending company (Countrywide) which without the buy-out by BofA would of gone bankrupt, the world’s largest bond insurers at the edge of insolvency, the dollar sliding, oil rallying, and one of the world’s top investment banks fail.
Even Crammer didn’t have a clue (but then again I don’t give him too much creditability – although no denying he is entertaining to watch – just waiting for his head to explode), anyway he had it wrong last week – just look http://www.liveleak.com/view?i=2b7_1205751955 – another reason to watch him for entertainment value ONLY – not investment advice!
What is alarming is that there is still NO BLOOD running in the street, the “faith” that these financial firms have got a handle on risk is still status quo. That is rather alarming, especially when you see Bear Stearns (note they forgot to update their website) http://gawker.com/368637/bear-stearns-forgets-to-update-its-web-site tout their awards on the website: Best Risk Analytics (which failed), Best Buy Side Innovation (you mean buying without care), and then there is the tag-line “Never an unprofitable year”. So with all these financial accolades they still failed – fast and massively – to an extent that the Federal Reserve and a very low ante by JP Morgan ($2 a share = about $250 million, not billion). So who is next, Citigroup (which their large investors – the Dubai Investment Group already concerned), Lehman (the rumors are circling the water coolers), who knows.
However, the “talking heads” – which had recently (as of last week) said that Bear would NEVER fail (see Crammer’s link above) – have moved on and continue to say – Well the Bear Stearns thing was an anomaly it would happen to a “REAL” financial firm like Lehman or Citigroup. Maybe they have optimistic marching orders from the parent company (many of which are involved in the financial sub-prime mess) or maybe they just want to stay positive? Regardless – we are NOT OUT OF THE WOODS YET! You may be asking “Where was the SEC when all this was going on with Bear Stearns?” not that I am for MORE government oversight – but you have to admit they fell asleep at their post!
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The largest rate cut since Volcker?
The Fed Fund Futures are looking for a 100 bps cut (in both the Target and Discount rate) – thoughts are that they could even take the Discount rate to parity. The recession argument is still going strong – but the side that says we will not have one are losing ground fast. The meltdown of Bear Stearns has raised the bar on the serious factor of this problem. If the futures are right – this would bring down Target rates to 2% - the irony is that mortgage rates are UP! So the cuts are not flowing through to the homeowners.
Last week the CPI (read http://marketpreview.blogspot.com/2008/01/governments-modest-proposal.html ) would have us believe that inflation was in check and that while Bernanke was free to cut rates (believing that his cuts was NOT causing any or only a little impact on inflation) ----- then the weekend massive collapse happened, the emergency discount rate cut and now those futures are pricing in a 100bps cut for today.
Now here is the larger concern – while the market (futures in the pre-market 7am ET – yeah I am writing this early) – that the currency market is having the inverse relationship and the Euro is back to the 1.58 level. The inflation pressure and weakening dollar is only going to mount. The global stage is watching and waiting – between the weekend emergency discount rate cut and now the predicted 100bps cut – they global market doesn’t care about the knee jerk rally in the stock market – they have bigger concerns - they are watching that dollar very closely.
Expect another day of HUGE intra-day volatility!
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A forgotten story…..did it foretell of this coming?
Early last year there was a small story that no one gave that much attention too, it was China mentioning that they would NOT be renewing over 1 trillion dollars in US treasuries as they came due, they even mentioned that they would be selling to some extent. I made a big issue out of it because it is China and group of other countries that really keep the credit lines open by buying trillions in US treasuries. Of course we are a very arrogant country, a country that throughout history is more about muscle flexing, that many “taking heads” didn’t give that little news story the time of day. I was even on a conference call with UBS – and when asked they didn’t give it too much concern either – having “faith” in the US Dollar. Many people I talked to in the industry have argued that China relies on the US to purchase goods as reflected in the trade balance. However, I would argue that is not necessarily true – we rely on them to keep our credit lines OPEN and keeping the dollar strong.
In a very simple way of looking at it, we live in a very massive circle of debt, which other countries fuel by purchasing treasuries. When we spend on credit (mortgages, etc.) – if you follow the money – it all leads back to the Fed, not the banks as one would think. Almost every bank is fully leveraged on capital, meaning their positions (and their clients) exceed the amount of capital on deposit by very excessive amounts. The banks usually borrow from each other overnight to stay solvent – which is monitor and controlled (by the Federal Reserve).
Now the Fed has their beloved Discount Window in which you can actually borrow money from the government overnight. The Fed traditionally likes to punish those that do by charging higher interest rates – they would rather have the banks borrow from each other’s reserves. Now toss in the fact that the US government is in massive debt and deficit spending and now you can start seeing the BIG PICTURE. The US dollar is massively leveraged out. There is not enough printed US currency in the entire world to pay down all the debts in the US, even more alarming the net leveraged positions exceed issued currency by over 100:1 according to some. In order to keep the printing presses (not literally) going – the US NEEDS to sell treasuries – to avoid inflation (printing too much money – which makes the money worthless).
Now if we step back to take this all in – we quickly see that the largest group of treasury purchasers are floating the credit lines of the US. Those very large purchasers of treasuries are a foreign nations, China, Japan, S. Korea, Saudi Arabia, UK, etc. Many small nations also purchase US treasuries. Now their reason is several fold.
First, since almost all nations have dropped the gold standard (following our lead) – they are reliant upon SOMETHING to set the standard by De Facto – well that became OIL (and ostensively the US dollar since Oil was priced in it) – all nations need oil and need to purchase oil – so if it is priced in dollars then they should probably own dollars.
Second, since the world’s life blood is priced in dollars – then the dollar becomes the new “gold” standard. By owning large reserves of dollars – these nations are able to bring stability to their own currency.
Third, is more of a self for filling event, since they all hold dollars and oil is priced in it, well the dollar becomes the world’s reserve currency and everyone begins pricing and trading in that currency.
Now here is the very interesting irony, all these countries purchase huge reserves of dollars (and buys US treasuries) for the above mentioned reason, what they all had failed to realize is that it was THEM (the foreign countries) the propped up and supported the dollar by purchasing the treasuries. They have believed “faith” in the US dollar was their currencies protection, their “gold” standard, their security blanket. They didn’t realize that it was years of every increasing investments in the dollars that made that belief a reality. Then, it was as if a light bulb turned on one morning in some Central Bankers head in China – he probably said – we have Trillion in US dollars to purchase oil and to secure are own currency – but is the US dollar supporting our currency or are we supporting the dollar by purchasing US treasuries? What would happen if we stopped purchasing trillions of treasuries? Maybe we should look at the US Government’s Balance Sheets! How safe is the dollar, if we don’t own it? As you can see now all these countries are all wondering WHO is really the “hidden” gold standard – that is keeping the dollar propped up? Some believe the Euro and other’s the Chinese Yuan.
That answer will come in time – right now there is a scramble out of the dollar but to where? Gold just topped $1000 an ounce and other metals are rallying. Until nations have faith in SOME currency – expect to see commodities continue to rally.
For the first time in the US dollar’s history – the World’s Central Banks “FAITH” in our currency has SERIOUSLY shaken to a point where many countries have completely lost faith. They see the massive debt the government, corporations, and the US consumers are in and they don’t want to own it anymore. When the world starts pulling out of the dollar – the credit lines disappear – since they are no longer fueling those purchases. You can see it in the rapid drop in the dollar.
You could say, that small news story which I touched on at the beginning of last year, was the questioning of “faith” in our dollar and ostensively our economy. It may very well be the straw that broke the back of the economy. For if China and other nations had faith in the US dollar and our economy they may have continued to purchase dollars and support this economy during the housing sub-prime mess. But they were already heading for the doors – even before the sub-prime mess was fully realized – we could no longer rely on them – their bags were packed!
It is now the World’s Stage that will determine the future of the dollar and our credit lines. There is nothing that Bernanke can do, other than slap on some more band-aids. His current policies is keeping the World from buying dollars. Between cutting rates (no incentive for them to invest in dollars – getting paid LOWER interest rates for a depreciating asset?), putting the government further into debt from bailing out more companies, to opening up the money spigots at the discount window. The rest of the world is saying NO THANKS – we are not interested in your dollars!
We need to build confidence in the world stage – to get them to purchase dollars – because without the global support, the dollar will continue to fall. Rumors are that Bernanke has already begun calling upon his brethren at the ECB and other foreign central banks to get them to start purchasing dollars to stop the slide. Wonder what incentives he has to make to get them to purchase dollars?
I will leave you with this quote “No nation in the history of civilization has devalued themselves to prosperity!” that is the road we are currently on.
If you want to know what is happening and what WILL happen read the following two books, it will make sense out of it. If you are reading this Market Preview and give an ounce of care to what is going on – you need to read these books. Of course you don’t have too – and that means you either have “faith” in Bernanke and the dollar or you just don’t really care enough about what is going on. Sorry for pounding on this issue – but these are times that define the future of our country.
Tug of War (by Paul Erdman)
Vandal’s Crown (by Millman)
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Inflation?!?!
If you are a reader of the US Government’s reports on inflation (CPI) and listen to Bernanke (and his beloved Core) we didn’t see any measurable increase in inflation in the last month. However, the rest of the world is seeing it and what is even more ironic – THEIR currency is UP. So if their currency is up and they are seeing steady rise in inflation, simple math would clearly indicate we are seeing way more inflation than those across the pond. However, inflation and cutting rates don’t go well together (like oil and water). Bernanke was very happy to see the CPI showing no(or only little signs) of inflation – because it means he can continue his massive axe cutting assault on interest rates with OUT affecting inflation. Yeah Right!
China is seeing increased inflation and is looking to defend their currency, Europe has NOT cut rates to keep inflation at bay – because they too are seeing it. However, Bernanke has taken a different tack – he doesn’t care about inflation (or actually believes the government reporting). What’s so alarming is that if you ask ANYONE (even yourself) we are all FEELING and SEEING inflation – food prices are going up fast, gas prices are going up, energy bills are up, etc.
May be the government’s reporting and all its changes and adjustments are finally coming back to haunt them? http://marketpreview.blogspot.com/2008/01/governments-modest-proposal.html
The world is watching the interest rate cuts and the dollar closely. Keep an eye on it today.
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Futures Pre-Open
The futures are getting a good boost in the pre-market (7:30 am ET) are front running the cash by as much as 10 points. Expect to see the ARB traders short futures into the opening and buy the cash basket. The basket buying will create upside pressure on the market – how short lived it will be is anyone’s guess. The futures are rallying on a 100bps rate cut expectation. Of course things could change in the next hour – but it seems that we will have a positive opening.
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Support / Resistance
Yesterday looked as if the market supports were not going to hold and also indicated we could get a solid covering rally into the close. The INDU closed UP on the day (even though it’s only 30 stocks). It did show some resilience.
INDU 11750 / 12250 (This is a fairly tight range and we will probably stay in it today – but with lots of volatility. If we break 12250 expect a HUGE short covering rally up to 12500. It could happen today another big upside 300-400 point move. Now remember this rally is NOT because of the 100bps cut, but rather short-covering. Do NOT be surprised if it happens. Start flattening out positions at 12150, get fully flat at 12250 – and start leaning short – fully hedged (over buy some OTM calls) in case we rip. To the down side play it the inverse at 11750. Cover all shorts at this level and start getting long fully hedged (over buy some OTM puts) in case we break down.)
NDX 1675 / 1725 (We will probably see some action in here today – both up and down. We don’t look that strong at 1675 – so long have to over hedge at this point in case of a break to the downside. Which I think has a higher likelihood of happening if we test. 1725 is NOT a place to get short because of the short-covering risk – however flatten hard delta and get some OTM gamma on your sheets at this level.)
SPX 1275 / 1300 (1275 is KEY support – get flat but ONLY take long SOFT deltas – 1275 is a great gamma point cause we will either rally off it and maybe catch some short-covering or breakdown hard and fast. The futures are showing a 1290-1300 opening right now. If we get through that and catch some short-covering – look for a 1325 area to get short. I would flatten all deltas at 1300!)
RUT 650 / 675 (650 – another area to be fully hedged on long positions. If we crack then it will continue to slide fast and hard. It WILL pull the rest of the market with it. If we hold and bounce off 650 – and get through 657 – we could see short covering massive rallies in some sectors. WATCH 650 – that is the “tell” for the whole market – if it can’t not get off that mat here – the market as a whole will begin to fail their supports.)
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Conclusion
We will look back on these times as defining the economic and political turning points. I predict the history books will write the Bill Clinton/George Bush era as the zenith of the American Empire and our nation will pass the torch to China and/or India as the next big Super Power. Not that anything is wrong with that, but we can only be king of the hill for so long. The Sun DID set on the English Empire 100 years ago and they are still a great nation and doing fine. It might be nice to have our nation out of the lime light. However, the process of passing the torch is and will be a painful one. We are fighting with everything we got to stay on top of this hill, but I don’t think we have the economic war chest to keep us up there.
The political landscape is changing and socialism is sweeping through the nation as the middle class disappears (becoming poor or rich). The Dot.Com and Housing Bubble have wiped billions away and is accelerating that need for a government that is more reflective of Mommy than what our founding fathers had intended. The Womb-to-Tomb nation has been born and hopefully we as a society can stand up and take accountability and responsibility – to shed any feeling that we want the government to be our mother. The fingers are starting to point at everyone but themselves. There will be a demand for MORE government oversight, MORE taxes, MORE government knows best, MORE social programs, etc. For those that have not read The Road to Serfdom – it should be mandatory reading for every high school student!
The economic landscape and 100 years of the John Maynard Keynes has shown its massive failure. I only wish that they would of given Hayek more consideration. What is left of the Bretton Woods accord is a few threads (which shows how successful that idea was) as Bernanke changes the rules daily. It’s interesting to note the a very young Greenspan wrote a paper of the possible problems of becoming a Fiat Currency (off the gold standard). And now as Hayek, Freidman, and (a very young pre-Fed chairman) Greenspan all predicted those problems have reached our shores. Bernanke, while a great study of the Great Depression, is facing a different time. Those were the days of a “CLOSED SOCIETY” and not the current Fiat Currency. His scrambling, rate cuts, and injections have done nothing to save a bank from failing, lending firm from failing, bond insurers from failing, shoring up the credit problems, or at the very least LOWER mortgage rates – which are up! His recent scrambling however does have an effect on the dollar and inflation – both of which are having a national dramatic affect – but his CORE CPI would have him (and us fools) believe that inflation is in check.
So I continue to predict a very volatile year – and only time will tell. Our dollar and economic future is now in the hands of other nations and what they feel is the best course of action. It is THEIR faith in a NEW security (gold, silver, oil, Euro, Yuan, etc.) that will set the bar and as that slowly happens the dollar will continue to slid. It may take years to pass the torch to the next nation – but from what we are seeing it could happen sooner and it may be painful.
These are great times for traders – the action, volatility, and positions (both short and long Vega holders) are enjoying the ride.
However for investors it’s hair pulling time. What to do? What bank to trust? Where should I put my money?
I will continue to say HEDGE your positions and speak with a trusted, knowledgeable, and seasoned Financial Advisor. Don’t let them tell you we are in this for the long haul and stay the course. Demand alternative strategies and investments. Ask about hedging and insuring positions. You can’t afford not to.
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