Bear Market

The “RISK OFF” trade could deliver a huge flight to safety for Treasury bonds. Is shorting short dated bond puts the best play?

The most important piece of news announced last week was the Fed’s release of the schedule for its second round of QE 2 bond buying. All told, the Fed intends to buy $105 billion worth of bonds through January 11, 2011. The purchases will occur practically every other day and are broken down into $6-8 billion increments. Now, the Fed has made it clear that it intends to prop stocks up at ANY cost.

Timberrrrr. The market sold off today as a result of tech companies posting earnings that failed to titillate the street, China raising their interest rates to try to stave off an asset bubble that soon may be only a prick away from popping, and the rent still being too damn high.

Many skeptics enjoy pointing out that the fear and loathing toward stocks as exhibited by the seemingly endless mutual funds outflows, now in the 18th consecutive week, is nothing but a contrarian play, and when the masses are stepping out is when the smart money should invest. Under other circumstances we would totally agree. However, in this case, we make the argument that it is in fact these "contrarians" (with the assistance of the Fed, the Primary Dealers, and the HFT scalpers) who have ramped the market in advance of this move for many months now, anticipating an inflow which never comes. In other words, the true contrarian move is to fade the market here. Why? Because as the below chart from ICI shows, stocks have experienced the biggest short-term equity return upswing in history on the smallest net amount of positive inflows also in history. The argument would go that the entire upswing is nothing but an engineered push on nothing but momentum, and QE, and that fair values are far, far lower. Once GDP passes below zero, and once S&P EPS forecasts are revised to +/- 60, as the double dip unwinds, and applying an appropriate multiple of 10-12x, the market will be far more credible, and will see far more inflows when it is at 600-700. For now, however, nobody is foolish enough to enter. And those buying on hopes that Joe Sixpack will finally put in his two remaining cents in Amazon will continue to be disappointed, entrusting their entire risk capital to the like of the Federal Reserve, Goldman and Getco.

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The 21 day plunge into the May 25 low caused significant technical damage to the SP500. Specifically, it caused the quarterly moving average to roll over and slope down. The bearish slope indicates a potential shift in trend from bull to bear.

During the bear mkt of 2007-2009, dead cat bear mkt bounces typically lasted 18 to 34 days. That includes the 22 day rally into Dec 26 2007, the 18 day rally into Aug 11 2009, and the 32 day rally into Jan 6.

Now, in stock mkt bull cycles, bullish impulses “right translate” and left translate in bear markets. Let me explain. Cycles are measured from low to low. The last low to low cycle was 77 days ~ from Feb 5 to May 25. The final low to low into the March 6 2009 capitulation was 75 days. Using the last 77 day low to low cycle as our starting point, for this dead cat bounce to right translate, it would have to rally 39 days or more off the May 25 low. Now, as we noted in the typical dead cat bounces in the last bear mkt expire 18 to 34 days later.

Bob Prechter was on Teck Ticker today telling us to "stay in cash" because we entered the "second major wave of deflation". Before you go slicing your wrists, relax, it's just the big hedgies toying with your insecurities. I got one message for these big hedge fund swingers: BRING IT ON!

PIMCO's boss says the world's biggest bond fund remains underweight on Gilts, and to avoid the UK as the "bed of nitroglycerin must be delicately handled." Bill's three conditions for whether a country will be attacked by bond vigilantes:

1) Can a country issue its own currency and is it acceptable in global commerce?

2) Are a country's initial conditions (outstanding debt, structural deficit, growth rate, demographic balance) moderate and can it issue future public debt as a substitute for private credit?

3) Can a country's central bank be allowed to reflate via low or negative real interest rates without creating a currency crisis.

The conclusion is not pleasant for Greece. And some very troubling observations for the US, and how the just passed healthcare reform is one big deficit-reducing lie.

Federated Investors' David Tice has a thing or two to say about the rally - "We've been the beneficiary of a massive credit bubble that we've not yet worked off the excesses... This secular bear market will not bottom until we get back until we get back below book value." In a portion of the interview not caught by the Bloomberg clip below, Tice says that the decline potential for the market is "huge." Don't tell that to the algos whose one and only program for the past month and a half is Buy.The.Dips.

According to the latest Flow of Funds report, household net worth increased by $2.7 trillion, of which 85% was the result of an increase in "Equity Shares at Market Value." With the mortgage piggy bank shut down for years, the only capitalappreciation recourse for Americans has become the uber-manipulated stock market. Zero Hedge expects another TV appearance by Obama within 24 hours, in which, to great pomp and circumstance, he will announce this increase without highlighting what the actual reason (Liberty 33, wink, wink; vertical yield curve) for the increase is. In other not so shocking news, consumer deleveraging continues with $113 billion in debt wiped out from both mortgage and consumer credit in Q3. Who took its place? Why the US government, which borrowed more than enough: Federal government debt outstanding increased by 20.6%! Welcome Central Planning - we eagerly await Obama's announcement of the first five year plan in one of the 10 or so daily TV spots he has reserved until Christmas.

There are only two real precedents for the deleveraging cycle that the U.S. economy faces today: 1)
The Great Depression & 2) Japan in the 90’s (I am excluding Sweden from this exercise due to their
small size – “what’s wrong with a Swedish model” is always worth a read, however). I have said
that the current deleveraging cycle is actually not all that similar to the Great Depression –
primarily because our economy is much more mature and stable, and also because there are certain
safeguards in place that help prevent such an event from occurring again (the FDIC is a great
example). The similarities to Japan, however, are quite frightening. Goldman Sachs recently
wrote a piece noting the same thing with a few counterarguments. Just how similar to Japan is the
current deleveraging cycle in the United States? Let’s take a closer look.

"Tudor said the 47 percent gain in the Standard & Poor’s 500 Index of the largest U.S. companies since March 9, when it fell to a 12-year low, is a “bear-market rally.” The index topped 1,000 for the first time in nine months this week after companies reported better-than-expected profits."

[youtube=http://www.youtube.com/watch?v=iRzr1QU6K1o&hl=en&fs=1]

Weekend humor

The reason why so many investors have been skeptical about the recent rally in stocks has to do with the role of bank stocks, which have been at the heart of both the drop as well as subsequent 20% rebound. The question is whether this recent dramatic move up in financials is sustainable or is merely a temporary blip, as the market reevaluates the inherent risks. I present a good summary by Goldman, arguing that all signs point to the latter.