Thursday, September 22, 2011

CLOSED FOREVER - (UNMET EXPECTATIONS MEET REALITY)

We were hungry and cold and we absolutely needed a warm meal.  Yesterday was special, we had reservations at our favorite eatery called the FOMC Diner.  Everyone had been so excited about our afternoon meal and the anticipation had simply been unbearable.  As we parked and walked across the street we were startled to see a sign that rocked us to the core, we were speechless, and worst of all we had the realization that our hope for free desserts to go along with our stimulating meal would be unmet.  Somehow, the FOMC Diner had closed its doors......forever.



OUR DINER OWNER, BEN TELLS US HE IS OUT OF BUSINESS
The much anticipated Federal Reserve meeting decision was made yesterday and within an hour the market finally acknowledged what we've stated for almost two years; that the Fed is out of bullets.  After two and a half years of getting pounded by a false market fueled by hope and trust that unlimited printed money could fix the world debt and solvency crisis, we have been been conditioned to expect the impossible from Ben Bernanke and his friends, but alas we have finally seen that he is a hollow man, simply a shell with little or no substance.

Rather than assault the Chairman with paragraph after paragraph of text describing how he has misled investors and damaged the average senior citizen in favor of banks and the financial elite I will simply highlight the implications of this moment where the world awakened to the impotency of the Fed.  The significant troubles we face are global and cannot be solved with easy fixes or more electronic dollars.  Financial pain is going to be delivered, the question is, who will suffer and how much.

A TWIST OF THE KNIFE
When the Fed released their statement and plan yesterday they essentially told us that they would begin selling treasuries that were short dated (2 to 5 years) and they would buy in the market about $120 Billion in treasuries that were long dated (20+ years).  (The total program is $400 Billion) The impact of this action will actually be that the yield curve should rise on the front end and longer term rates should fall.  The Fed tells us that they are doing this in hopes of stimulating the mortgage market and reviving the housing sector.  I don't buy that and in fact, I strongly believe that this action (the purchase of long dated bonds) was to meet the funding needs of the US Treasury to ensure that we can sell treasuries to someone.  The Fed is essentially budgeting these purchases.  Thus, the Fed and Treasury's coordination helps to fund the government and also put a cap on interest expenses for US debt.  So much for an independent Fed right?!  The situation could get much worse for the Treasury as well since effectively the US government has already spent all of the funds from the last budget battle and is in need of another tranche of money.  I haven't discerned any new love and cooperation between the two political parties over the last couple of months and therefore anticipate that we could actually have a government shut down and perhaps more rating agency downgrades. 

US BANK DESTRUCTION
Banks have been suffering in the last couple of weeks and that fall has accelerated over the last few days.  Since banks borrow "short" and then lend "long", the impact of Operation Twist is that banks will need to pay more for their money and then they will receive less if they actually lend it out to borrowers because longer dated rates should begin to fall.  This movement in rates is making the yield curve flatter, this is exactly what banks hate as they make lots of money when the curve is steep.  In the last several years we have seen the Fed act in the markets with the goal of sustaining and supporting banks and financial institutions no matter how badly it would impact the overall economy or the US financial position.  The key metric that makes the Fed unable to preform more QE is simply that these actions have been strongly correlated to price increases in food, energy, and other commodities (and gold).  Essentially the Fed's hands are tied and Operation Twist was more about meeting government needs for interest rate control and funding than helping anyone else out.  Actually if you think about the implications here, this action further damages retirees and pension funds as their investments are further crushed since most are using long dated bonds for a large portion of their portfolios and they benefit from higher longer term interest rates.

US RECESSION
Many of the metrics I report monthly have shown that our economy has been slowing down and has probably already been in recession for months.  If you felt strongly that this wasn't the case, you might as well throw in the towel as the last vestige of hope was destroyed as asset prices have fallen and we'll see a failure of confidence drive the final nail in the coffin for the economy.  If the Fed is right (and they are always right) then asset prices are the key to recovery AND asset prices are the key to misery and deflation.  Since the maneuvers of the last two years of Fed intervention have produced no tangible lasting economic results then we must assume that the collapse of prices since May 1st will seal the deal and confirm that the US is or will be contracting significantly with no turnaround in sight.  In otherwords, the asset collapse will kill the remains of the business confidence and therefore kill the potential growth that might be in the works.

GREEK DEFAULT AND EURO CHANGE ON TAP
Remember that little area of the world that we would forget every other week when the ECB proclaims that everything is fixed or when the Fed would come out and promise they would do something next month?  Oh yes, that little area.  Unfortunately, Europe is still there and they still have their little issue called Greece.  The Fed whiff yesterday coupled with the complete mess of the Eurozone has heightened the problems and perhaps made the dire straights the world is in more clear.  While the Fed has made USD swaps available to the ECB and foreign banks, the entire area is beginning to fall apart.  The Greeks need another slug of money to stay afloat for a few months and they have been forced to promise that they are really really serious about austerity this time!  Unfortunately for them, the Germans are getting tired of these never-ending bail outs and are realizing that they are going to be on the hook for a larger and larger share of inevitible losses.  Senior German officials are dropping out of the ECB, IMF, and Eurozone leadership and this could signal that they are making subtle moves to extract themselves from this nasty financial disaster called the Euro. 

In recent developments we have seen the contaigen of sovereign insolvency get a bit more serious as several major corporations have removed their excess Euro reserves from French banks and moved them directly to the ECB.  As stewards of these reserves can you blame the corporate executives of these firms?  No, of course not, however this "bank run" demonstrates just how fragile these banks are and how capital impaired they will be in the event of a Greek exit (default).

As I suggested the other day, the ECB and IMF continue to pressure Greece into tougher and deeper cuts which have a circular and negative effect on their economy.  As Greek leaders lay off government workers they harm the economy and as the economy is hurt as more businesses close and exit the nation.  As businesses fail, tax revenues decrease, and more cuts are required.  At some point, Greece will wake up and realize that it is better to pull the scab off at one horrible moment (default and exit the Euro) and reemerge with its own currency rather than destory everything and sell (give away) all of its assets to lenders over years.  I give this 6 to 9 months more at most before Greeks take these actions.

SO NOW WHAT?  TRADING UPDATE
I wrote yesterday that the markets were in no man's land and that investors should wait for clarity before taking a short or long position.  With one more day behind us we've witnessed a -283 point drop on the DJIA and also today's beating of -391 points to end the session at 10,733.  At the cross below 11,250 we essentially got the green light to short with abandon and today's bloodbath was a confirmation of that.  I would not be shocked to see some rallying as the sellers take a breather, so personally, I will add some shorts as we rally higher.

SHOW ME THE MONEY!
Why do I have this kind of conviction despite the 750 point drop in markets?  The reason is simple, show me where the catalyst is for buying?  We have an impotent Fed, we have a disintegrating Euro, we have a slowing economy, we have a broken political system that argues over additional spending when  we should be cutting, and we have US banks that are about to blow up again (see BAC).  I'll be clear, we will probably get a pop here as we bounce off the 200 week moving average in my Weekly 4 Yr Chart, but I will be using that as an opportunity to bet on a further decline.  My hope would be that we rally up to the 11,000 area, I'm just not sure we'll get there.   

$DJI -
Overhead Resistance - 11,000
A convincing break down through 10,700 will mean we will add to shorts with target of 9,750.




If you are absolutely committed to being long the market you must look to the relative value trades we have been highlighting for several months.  Those are the utilities, healthcare, consumer staples, and defense stocks.  (XLU, XLV, XLP, and PPA).  Even these conservative plays could be troublesome in this environment because healthcare and defense should be on the chopping block for reductions in government spending.  Portfolio managers will be looking to buy dividend producing stocks like McDonald's, Coke, and others and hide out in these safer areas.  They will simply look to outperform the overall index and proclaim that they "beat" the market.  Personally I don't like that approach, but there are folks that feel like they must be in, and if that is you, this is where the safer water will be.

ALL of those charts are resting on support.  If we have another rough and negative day, all of those positions are sells in my opinion.

If the downward trend continues for another few weeks we will see a coalacing of politicians that begin to find common ground to make headway and restore confidence.  There will be calls to the Federal Reserve to provide stability and leadership in the wayward markets.  At that moment we will see a final coordinated effort from central banks around the world to step in and halt the financial destruction with loan and debt guarantees and never-ending liquidity.  Ultimately these efforts will fail, but it may provide the last boost before everything simply falls apart.  This could be the point at which gold blows through $2,000 as confidence in the existing global monetary system is utterly destroyed once and for all.

WEEKEND EMERGENCY MEETING
You need to know there is a meeting of the IMF this weekend in Washington D.C. and we could see some emergence of a plan, however I don't think this will be the "Stimulus That Ends All Stimulus" quite yet.  The US markets need to endure a bit more pain to achieve the mobilization of the Treasury, Fed, the White House, and both sides of the aisle.  When they are all acting in tandem, then we will see the last attempt at shoring up the collapsing ponzi scheme.  Till then, this weekend may provide a small bit of fuel to give sellers higher prices to unload.  Europeans are hurting and as an example the EWI (the Italian ETF) is down 50% since May, if the USA was in the same neighborhood, I would guarantee action.

Let me sum this all up for you.  The economy in the US is getting worse.  The economies in the emerging markets are slowing down, the economies in Europe are a disaster, the banks in Europe are about to implode, US banks are under attack and Bank of America may use the nuclear option on its Countrywide purchase, and now the facade of a powerful and helpful Fed has been destroyed.  If we are lucky markets will stay range bound and simply idle along, but at this point I anticipate troubling stories about Greece and Europe's banks to continue to drive markets much lower.  Be careful!

GOATMUG


Goatmug is an investor that cares about you and your family. Goatmug's Blog - Financial Perspectives From The Mountain Top is a collection of thoughts on our economy and how it impacts the lives of investors and average people. While several specific investments are named in many of his posts, these articles are simply invitations for you to do your own research and reference to these securities does not constitute financial advice. Your situation is complex and unique and you should seek professional assistance with your trading and investing. Please visit Goatmug and share your comments at http://www.goatmug.blogspot.com/