The Debts of the Spenders: Explaining Bear Rallies

The equities market has gone through several "bear rallies" since the sub-prime news first hit the mainstream. First, was last August/early September when quant models failed and Bank CEOs rushed to assuage investors with soothing words. Second, was the Fed engineered bailout of Bear Sterns in Mid-March that petered out by May. Third, and current, is the SEC anti-short selling rule.

What does it mean? How can companies and government agencies release bad news and have the indices rally?

Simple. We look to Pakistan and the futures markets for the answer.

First, - In May, Pakistani regulators banned short selling and set price floors on stocks on the Karachi Stock Exchange. This had the short term effect of bolstering stocks but the longer term effect of causing foreign money to leave the country. The result? Nearly consecutive months of losses. The regulators finally wised up and abolished the rule - only to see the pent up market forces wreak further havoc on share prices.

Second, - Futures markets are heavily leveraged. Traditionally, the smart (aka institutional) money has been the dominant player. Many of these institutions are banks, have some sort of lending arm, or are otherwise exposed to CDOs, sub-prime, Alt-As, and other toxic crap. Fund managers are being forced under the SEC and Treasury's new capital adequacy requirements to further increase their free cash flow. Translation? Liquidate assets and reduce leveraged activities. This has resulted in lower liquidity and higher volatility in the futures markets.

But, what do these two things have in common? Simple, volatility. When regulators attempt to manipulate share prices, they are also manipulating 1) the bid and ask spreads which in turns leads to 2) lower liquidity. Since the US markets are deeper and more liquid than Pakistan's, we are unlikely to see index wide monthly consecutive losses. Instead, since the US markets are well capitalized and run by a network of casino bosses - I mean exchange officials and market makers - reactions are going to be a lot different. When I say well capitalized I mean there are more suck-...err ...retail investors and foreign funds involved.

Wider spreads lead to sharper market swings. The slightest bit of news - good or bad - can be enough to send markets into a 200+/- vector. While analyst expectations are already massively lowered in financials, they are being raised higher elsewhere in other sectors. Seemingly unrelated companies can be caught in a sector wide punishment - or benificence.

Don't believe me? Look at the market's reaction to Ford (-250 Dow) and US Steel (+260 Dow) in the past two weeks alone. When Ford plunged it took the steelmakers down with it. Now on the other hand, when US Steel rose, it carried financials up with it.

The element of human emotion is more present than ever before in this market environment. Fear - and greed - are apparent as never before.

My advice to predict a bull or bear market on a daily basis? (It is impossible to predict a weekly basis in this new environment)

1) Look at what macro-numbers are out 2) Listen to Gov official announcements and 3) Examine the Earnings Calendar for companies. This is old advice for veteran traders but take on increasing importance in today's market. Number one seems to have been largely discounted as manufactured numbers released to contain political damage. Number two is important with regards to certain trading behaviors.

Three is the most critical. A single company's performance ability to meet, miss, or beat analyst expectations can be enough to send the entire index up or down. There is increasingly no sideways action (thanks to the SEC, Fed, and Treasury).

The Debts of the World: Australian Bank Writes Off US Sub-Prime

Systemic risk is no longer a theory, it is a study - a study in cold, hard numbers.

http://www.news.com.au/couriermail/story/0,23739,24089154-5003501,00.html

The Debts of the Spenders: Quotes from a Lying CEO

Merrill Lynch's CEO, John Thain, recently insisted that his company's capital position was adequate - even in the face of a 20% shareholder dilution and missing the Street's already lowered estimates by a mile. Really? Here are a selection of quotes that he made to the same effect over a period of 18 months. You be the judge.

http://www.reuters.com/article/marketsNews/idINN2824127720080729?rpc=44

The Debts of the Spenders: The True Costs of Fannie and Freddie Bailout

Politics are notorious for including low balled financial figures to get bi-partisan approval. Today's Housing bill is no different. The CBO's figures are sickeningly rosy. Expect the true cost of the bailout to show itself by the end of the summer.

http://finance.yahoo.com/tech-ticker/article/41887/Housing-Bill-Better-Than-Nothing-But-No-Cure-for-Still-Ailing-Market?tickers=FNM,FRE,XLF,XHB

The Debts of the Spenders: FDIC Imposes New Rules to Avoid Bank Runs

http://www.bloomberg.com/apps/news?pid=20601087&sid=aoyCaK0Tc63A&refer=home

The Debts of the Spenders: Short Selling is Illegal...Unless you're a Market Maker

It's okay to ban naked shorting in just a few financial firms, but market makers are allowed to continue breaking the law and people can still use naked shorting on all other stocks. It's like a card game where someone decides they don't like their hand so they'll need new cards. Are you f$%&%&cking kidding me?

Apparently, their excuse is that banning EVERYONE from naked short selling of financials will affect liquidity (since there will be lower volume). This is what happened recently in Pakistan as foreign investors abandoned the exchange after authorities imposed a 2 month moratorium on short selling and limits on price drops. That doesn't stop this new exception of smacking of paternalism and favorites.

http://www.bloomberg.com/apps/news?pid=20601087&sid=a6vYdD7V5sB4&refer=home

The Debts of the Spenders: The Slow Death of Fannie and Freddie

Technically insolvent, the government sponsored enterprises of Fannie Mae and Freddie Mac are in deep trouble. Already on the hook for $billions in lost accounting revenue, Congressmen expect these 2 GSEs to prop up the ailing sub-prime sector. But at what cost? Traders reacted typically by dumping shares in each. Even rumors of a Federal Reserve bailout aren't as strong, with the combined debt loads of the two enough to turn the dollar firmly in the red and threaten America's AAA credit rating.

http://www.bloomberg.com/apps/news?pid=20601087&sid=apRAcM9YkI4s&refer=home

http://www.housingwire.com/2008/04/15/sp-gses-could-strip-us-of-top-credit-rating/

The Debts of a Nation: Americans Eat Dessert

America is a nation built on cheap everything - cheap virgin natural resources, cheap foreign energy, cheap immigrant labor, cheap food, cheap talk, and most of alll cheap money. Too bad that world is ending.

We have home equity lines and credit cards – but the easy credit is disappearing. We have McMansions in suburbs and 2-3 cars per family – but can no longer afford the energy required to run them.

Even our eating habits harken back to a different era. Families surrendered home meals in favor of restaurants. Everything was supersized – including our population.

For too long we ignored the perils of tomorrow for the indulgences of today. Now Americans are getting their supersized desserts.

As a nation we borrow almost $3-4 billion per day. Nearly half the national debt – about $5 trillion – is owed to foreigners, most of it in the form of treasuries.

The much heralded "services" sector led by finance is in danger of complete collapse. Historically, the financial industry provided only about 10% of U.S. corporate profits. In the credit bubble, the percentage rose to 40%...and is now headed back down.

It's going to be a hard landing.

The Debts of the Spenders: Wage Spiral Inflation Hits Western Europe

For the past 5-6 years, Western Europeans have enjoyed unprecedented purchasing power in the strength of their leading currencies - the British Pound and the Euro. However, that strength comes at a hideous cost.

As the ECB battles inflationary pressures by raising interest rates, it is igniting the flames of a wage spiral. Wage spiral inflation is the name given to the vicious effect of wages keeping in check with inflation. While this effect is largely absent from North America because of the slow death of organized labor, it is enjoying an unprecedented surge in Western Europe where unions remain strong.

These unions have wrested generous concessions from employers to match their wages in adverse times. Who can blame them? With the cost of goods rising it is only natural for shop stewards to heed the calls of their constituents. But at the same time, Europe's strength is also proving to be its Achille's heel.

Formidably high exchange rates have cramped exporter profits and increased pressures on management to cut costs. But due to agreements made 15, 20, even 30 years ago, companies remain locked in outdated, money losing contracts. This is a leading cause of inflation. There are other pressures to be sure, such as (take your pick) a falling dollar, surging oil prices, evil speculators, etc.