Boing, Boing, Boing... And So It Goes

What we saw today is yet another example of the "dead cat bounce."  And I believe this baby is going to be bouncing for a little while, after which in all likelihood the rally will cease, fear will return and the market will continue its march downward in the face of massive de-leveraging. There is no choice; it is the case of the irresistible force (investors hoping and wishing for the bad times to be over, courtesy of the Fed) meeting the immovable object (the disastrous fiscal and financial market realities facing the U.S.). The Fed can lower rates to 0% - but that in and of itself doesn't create jobs, make banks more willing to lend and stimulate economic activity. What it will do, of course, is cause a massive capital flight out of the U.S. and its debased currency, fueling a downward spiral of economic activity in tandem with upward pressure on prices that will hit with devastating effect. Not a scenario I am looking forward to.

Remember what I said back on November 28th, in my post Did I Just See a Dead Cat Bounce?

The Fed is scared, that's for sure. They see the dislocation in the credit market persisting, and perhaps getting worse. All we need is the failure of a single monoline insurer or (another) 10-figure write-down by a major bank to toss the financial markets into a complete panic, which would be good for precisely nobody (except perhaps Bill Ackman, Jim Chanos and a few others). So in light of these risks, they may well tilt towards an accomodative stance. However, if they do this, will this really stimulate growth in the real economy and meaningfully loosen up tight credit markets? Debatable. There are likely more direct steps they could take to provide banks and other financial intermediaries with the liquidity to bridge the gap and to address the tightness in the mortgage markets, steps that maybe wouldn't have such an adverse effect upon the dollar. And what if they continue to push down short term rates, and the real economy doesn't react as hoped? In the absence of real growth and in light of lower rates, the dollar will fall further, only exacerbating an already difficult situation. This could have the effect of causing foreign capital to flee and long rates to rise, making it more costly for firms to raise stable, long-term capital (not to mention the US Government).

I could have written this yesterday; I believe my words are as applicable now as they were then. For those who are playing, the SPY closed at 147.13 on that day, after having rallied from 140.95 on November 26th. It bounced as high as 150.94, reached on December 10th, after which it dropped all the way down to 130.72 on January 22nd. Today we sit at 133.63, down from the October 9th high of 156.48. For a non-economist I think I nailed the situation pretty well.

So my point isn't that rallies can't happen, but that one needs to take a big step back from the headlines and ask: how is this going to change the fundamental outlook for the real economy, consumer confidence, purchasing power, the health of our financial institutions and the vitality of the credit markets? Oh yes, and trivial matters like the dollar, inflation and profligate spending on non-value creating activities like wars. As it stands today, I am not convinced the Fed, the U.S. Treasury or our President have the answers. What I do know is that a lot of investors who are breathing a sigh of relief today are going to be shedding tears of disappointment in the not-too-distant future. Because I just saw a dead cat bounce. Again.

Comments

[fabian siegel]

Great post.

With many market players having followed the market for less than 10 -15 years makes me think there might be an overall wrong expectation of a longterm uptrend in the markets. Given the fundamental situation (deficit spending, interest rates, currency exchange) the markets might be trending sideways for some time to come.

[Yaser Anwar]

You're right. If one looks at the rally today by short interest, the ones with the highest SI had the biggest uptick and the ones w/ the least SI had the lowest comparable uptick.

My favorite short is GFIG (increasing contract values which are being failed to deliver- 30%, the highest %, of their brokerage revs are from credit + exposed to lots of counterparty risk).

Yaser

FD: I do have a short position in GFIG (day/active-trading perspective).

[howard lindzon]

awesome. or just watch the all-time high lists. nada cooking on it.