US Government Recreating Leverage, Offering New Trading Windows
Fox News anchor Megan Kelly was visibly amused by two of her guest who predicted on this past week that the S&P 500 would fall below 600, but only after it rose by 30% from current levels during the course of this year. And, without doubt, many Fox viewers must have concluded that the bare assertions of the two asset managers border on insanity. But the Treasury and the Fed are on the verge of creating another leverage bubble and, as a result, the 700-to-900-to-600 scenario for the S&P 500 may not be as crazy as it sounds in the first instance.
The Obama Administration’s programmes to immediately engage the securitization market for a variety of consumer and small-business loans, and to force the restructuring of mortgages, are obviously designed to ensure that “credit flows through the system”. But in a climate where declining share prices and home values have caused a $13 trillion destruction in household wealth and where the jobless rate is severely curtailing family surpluses, the availability of additional (easy) credit, or the extension of contracts in default, is bound to generate new systemic risks within the American financial matrix. Credit apart, what the $1 trillion-plus which the government plans to inject into the consumer and housing market will certainly result in the flow of systemic risks right through the business spectrum.
American consumers are already leveraged. What is desperately needed now is a deliberate and structured de-leveraging, and a recognition that the state of the global economy is calling for a broad contraction in consumer demand. But, that said, this flow of credit may well support widespread upward revisions in corporate earnings in forthcoming weeks, and the predictions of the two Fox guests, as ridiculous as they sound when contextualized in fundamental terms, could start to gain currency. Another credit bubble is in the works, there is ample money sitting on the sidelines, stimulus spending is on the way and there are ample Wall Street analysts who are ready to advance the value-investing proposition with renewed vigour at the earliest opportunity.
From this writer’s perspective, a 30% increase in the major market indices (DIA, QQQQ, SPY) is almost unimaginable at this juncture, given that it is more than apparent that nobody in authority has been able to acquire a thorough grip on the banking crisis and given that neither Ben Bernanke nor Timothy Geithner displayed any grasp of the global nature of the problems confronting them at yesterday’s hearings on Capitol Hill. But the stage is indeed being set for some type of rally in the very foreseeable future, and the challenge will be to time both shorts and longs.
There is simply too much negative news still to unfold, both on the domestic and international front; so no rally can be sustained. The tension between the fundamentals on one hand and the short-term impact of government intervention on the other is offering new trading windows, not grounds for medium-term positioning by any measure. For example, gains in excess of 10% need to be sold into with the intention of covering shorts on periodic pullbacks. Gains in excess of 15% need to be sold into aggressively. Moderate longs are warranted if the indices drop by more than 10% from Friday’s closing levels.
What is important is discipline. In view of the fact that investors generally are unaware, and largely unprepared, for what lies in store in the months ahead, bouts of panic selling on bad news are inevitable; such bouts are going to be for limited periods and they must be used to cover shorts.
Arguably, the definition of “bad” is a relative one today. Investors are becoming almost immune to adverse economic data on the domestic economy and they will only rush for the exits in the face of substantive and significant events, e.g. Ukraine and Hungary defaulting on IMF commitments, a zero GDP growth confirmation from India or China, or a breakdown (for all practical purposes) of the European Union.
The writer’s bearish bias is intact, due to a number of well-founded reasons detailed in earlier articles posted by this writer However, the facts as they present themselves today are telling us that there is much more money to be made by trading the market from both sides in comparison to any medium or longer term strategy.
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