Tuesday, February 9, 2010

Feb Update - Ok, that was nice - now what??

Ok, we had a nice rebound of a couple of percent today on the back of Friday's pretty strong reversal. I went back tonight and re-read my February update and let me tell you I sound pretty bullish. The funny thing is that I don't actually feel that way at all.

I am writing this evening simply to remind you to be on your guard. The reality is that things are very dicey in the credit markets right now and the sovereign debt of countries like Greece, Italy, Spain, and Portugal are all in question right now.

As I wrote last week, the bailout of Greece could be the catalyst for a move up..... which it was. But I also cautioned that the moral hazard of bailing out Greece would almost obligate the EU to move to assist Spain and Portugal which are much larger and frankly even bigger disasters.

Remember how our Federal government and congress was all too willing to spend your money to help the banks and stimulate to their hearts content? Why would they do this? Well of course it was all in the name of helping ourselves at taxpayer expense. We (they) were going to receive a benefit when we saved the banks, housing, auto manufacturers, and AIG. Remember, we needed to do these things to save us ourselves from the abyss. Self preservation is a strong motivator for going along with things we know are bad, or in this case - outright wrong.

While we often view the EU as something akin to the Federal government, the EU is not the US Federal government, and is only a binding body made up of willing participants. The reality is that the stronger independent countries like Germany will have a strong hesitation about helping the Greeks, Spanish, or Portuguese at their own expense. In other words, helping them hurts Germany. In addition, a prudent person questions spending their own money on a poor cause when they know that they will only need to throw more money in later. In other words, this game is real and Germans may think twice about this bailout when they know that it won't do anything but push the problem out a month or two and not change the final outcome.

Here's the take away about the EU problem. If a bailout is not announced we could see some serious selling as players move to the sidelines. There will be a flight to the dollar. Hedgefunds used today as a way to load up on their shorts of the Euro, so they were not scared off by the drop in the USD today. Their accumulation of dollars vs the Euro has me concerned that this is not over.

We may see continued movement up in the market over the next several weeks or months, but I will stick with my original thoughts about this year in that in April we will start a slide down again. I also believe that we'll see periods of sustained ups and downs within ranges and if you are not prepared to move in and out of the market you may end up absolutely nowhere - but with a few more ulcers than when you started the year.

I will leave you with this picture of the market, but concentrate more on the left side in March, June, and July of 2007. If you recall in credit conditions began deteriorating in February of 2007 when sub-prime mortgages were not being paid back. In April of 2007, UBS' own hedge fund was shut down after suffering big losses, and then in June and July Bear Stearns own funds were in crisis due to margin calls. Through the next several months credit issues increased (not abated). Finally in August, the Federal Reserve stepped in and lowered the Fed Funds rate and also expanded the types of collateral it would accept at the Fed window. This seemed to do the trick as the market thrust higher, more confident that things were better. Note from August to October how the S&P 500 moved up almost 200 points or another 12% or so.

In 2007 we pushed higher despite many warnings.

I've discussed this period previously, stating that I am absolutely on guard for something similar to this event unfolding. The Greece scenario seems familiar to me in that even if everything turns out perfect I believe it would mesh well with my timetable for a push higher for a month or two fueled by the euphoria that the all clear has been sounded. Unfortunately as in 2007, we may simply find that the troubled waters run extremely deep and all government intervention did was to muddy the waters at the top so we couldn't see the sharks below.

As I mentioned the range of this market has now been expanded and I believe that the downside of this move could substantial, with the upside at 1150 (not higher than before). Be watchful. Yes, if the rally looks like it has momentum - play it, but don't load the boat.