I hope everything is finding you well.
With this market taking a steep 4% drop today across the board, I decided it was time to share my market view today.
First, I want to start off by stating my positions as follows:
US Equities: Bearish
-Caveat: Market is quite oversold; I would not take big short positions if any at all.
--US Equities are headed for 5000 Dow and S&P 500 to 500. I view this as a conservative forecast that does not take into consideration any sovereign credit defaults or other major events, such as massive global nationalization programs.
International Equities: Bearish
-Caveat: Likely markets are more oversold than US markets.
US Treasuries: Bullish Short-Term Maturities, Neutral Long-Term Maturities
-Prefer to be short-term, which is either 3-month or less TBills. Longer term maturities, such as 5-, 10-, and 30-year, will likely perform well if there is a significant rally due to deflation. The deflation/inflation dynamic is clearly favoring deflation, but the unequivocally massive fiscal stimulus plan and aggressive expansion of monetary policy the Federal Reserve have put in place a ticking inflation time bomb. High-yield savings account and certificate of deposits of 1 year or less may eke out a better return than treasuries. However, keep in mind FDIC insurance limits, etc.
Foreign Exchange Spot:
-Extreme Bearish: Russian Ruble
-Bearish: EUR, GBP, NZD, and AUD
-Bullish: USD, CHF, and JPY
-Neutral: CAD
--Currencies on my bearish list are quite oversold, however, non-leverage to mildly leveraged positions in EUR and GBP are worthwhile, because they will likely go parity. The EUR also has a possibility of breaking up due to weak economies pushing the currency hard against the wall. A break-up of the EUR would also contain major downside event risk that would domino into other markets.
--Currencies on my bullish list, specifically CHF and JPY, are better buys now than before as they have sold off making them 2 great currencies to create a basket with the USD when shorting weaker currencies.
--CAD has the ability to be a stronger currency due to it's banking sector being one of the strongest in the world due to its relatively ultra conservative balance sheet. However, commodity prices are likely hampering its ability to appreciate.
Commodities:
-Oil: Bearish (Short-Term); Bullish (Long-Term)
-Gold: Bearish (See 400 dlrs/ounce)
-Softs: Bullish (Long-Term)
--Long-term bullish as it may be the best inflation hedge down the road. Shorting US Treasuries may be fruitless if they are artificially kept down by the Federal Reserve. However, there are two ways to play this one. One is to very slowly build a position, or the other is to wait and buy later in the year. Commodity prices still are being pulled down to deflation and struggling economies.
A couple of interesting market movements that I witnessed.
1.) VIX- an index that measures the cost of using options as insurance against declines in the S&P 500 -jumped 14% percent to 52.65. For historical perspective, I recall that VIX was in the low 10s when I was trading options in 2006-2007. We have seen the 80s last year, and it's quite possible we will continue to have levels in the range of 40 to 60. This quite simply means that buying put options to protect against further losses is no longer cheap. And, if people cannot afford to buy them economically, selling their shares may be the next best thing, which will likely further the sell off that began today.
2.) Twelve (12)-Month US Treasury Bills ticked down about 0.06% to 0.64%. Why care about short-term cash rates? These last couple of weeks we saw the market start to show some improvements. Typically, these improvements have been due to short-sellers closing positions, which drives the prices up. In this particular case, the 12-month Treasury Bill started to improve its interest rate to 0.70% from 0.60%, which indicates money is coming off the sidelines to buy cheap stocks. However, the reversal is illustrating that buyers were burned by their eagerness to come in too early. In order to really consider buying stocks, one would have to see cash rates rise in yield to over 1% on a 12-month maturity, and it would have to come with economic improvements.
3.) There are number of fundamental stories that have hit the wire.
A.) AIG, the big insurance conglomerate, is proving itself a thorn in the side of the Fed and Treasury. $30 billion dollars of more financial aid is going to be required to float this sinking ship as it took one of the biggest losses in history ($.42/share).
B.) Citigroup is still fighting off nationalization rumors as its shares continue to plunge (1.20/share).
C.) Fannie Mae, now under conservatorship, continue to eke out major losses like $25 billion.
D.) About 5 to 6 banks in the Federal Home Loan Bank system, a government agency setup to provide discount loans to commercial banks, have taken steep losses. As a system, they have collectively lost about $300 million in the 4th quarter. See Friday's Wall Street Journal for more details. Most of these losses stem from private label mortgage securities that are now being classed as impaired assets. These losses potentially make it a target for conservatorship like Fannie Mae and Freddie Mac and impair its ability to issue debt cheaply in order to provide discount loans. The banks hit hardest are those loaning in districts like California, Florida, and other hard hit states. What's important in this story is that so many lending institutions rely fairly heavily on this system for liquidity at cheaper rates. However, it's important to note that the Federal Reserve has stepped in quite a bit as a competitor. Does the story matter? Only, if it's bailed out to tune of tax payer dough and more debt issuance.
E.) "Consumers put aside 2.9 percent of their disposable income in 2008’s fourth quarter, the most since early 2002, the Bureau of Economic Analysis says. Deutsche Bank AG economists led by Peter Hooper say savings may reach 9 percent within two years after falling to zero in the third quarter of 2006" (Bloomberg). This is important, because the US has fueled its growth through the consumer. For the US to snap out of a recession, a new driver of growth will have to show up at the door, or consumers will have to regain their confidence. Until then, this could be the biggest problem for the US Economy. So getting long the stock market really requires a thesis that can explain how this economy turns itself around. The major deleveraging at work here, the inability to get good credit terms, etc. will also impede a fast snap back in the markets.
More importantly to think about, China has grown through the US consumer buying its cheap products. China has bought massive amounts of US Treasuries in this exchange. Note, Hillary Clinton is literally begging China to continue buying our debt. A sudden reluctance could cause sharp increases in US Treasury rates, which is why being in short-term maturities is a much safer play. We could see 22% interest like the late 70s and early 80s out of the Carter administration.
F.) Why short the EURO and Pound? The EURO suffers from not acting fast enough on its monetary policy front, that is they did not lower rates as fast as the US did, and they may have to take much more drastic actions as a consequence. They also have a number of weak countries within the union that require bailouts. And, there is risk the currency could fail in its efforts to be a unionized currency. Deutsche Marks anyone? There are also eastern european countries that are interwoven into the European economies. A sovereign default can spark a cascading event.
The Pound has suffered losses on its late to the rate decrease party. British Central Bankers are poised to lower their overnight lending rates to 0.5%- nearly matching US Central Bank's 0.25% rate -as well as engage in quantitative easing. As a smaller economy, the perceived vulnerabilities have lent the US Dollar as the reserve currency and flight to quality currency of choice. British has suffered just as catastrophic bank losses, bank runs, and threats of bank nationalization semi and full.
G.) Pay caps and government bailouts. Catch-22! While banks that take money should be required to cap excessive pay, the top producers will take their relationships else where. And, the bank falls flat. What do you do? If the bank's going to fall flat, why bail it out in the first place. And, this is fundamentally the problem in the marketplace. Investors are fearful of the current administration attempting bank nationalization. There is no investor confident in the banking sector as long as this remains in the air. Even Ben Bernanke does not have the ability to put the kibosh on this one, i.e. he might just fall in line like a good soldier. And without a proper banking system that is efficient and savvy, business becomes just a little bit more expensive. And, if it is politicized, more confidence will be zapped.
---Bottomline: The fundamental condition is still weak. And, this recent stock market drop is more evidence investors are losing confidence in the market. And, it is my contention that the broad market indices will have pared off at least 40% by late in the year if not sooner. I would look to the 4th quarter of 2009 to re-assess where the market is and where it can go. At the moment, cheap stocks are just getting cheaper.
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