The Inger Letter

The Inger Letter: Daily Briefing

By Gene Inger | Monday, 4 February 2008

Good Evening;

Collusion or collision. Those may be real alternatives; with debates raging behind the scenes, as to whether the more substantive, than generally seen, catastrophic risk can be overcome in a sufficiently timely manner by the consortium of banks and other entities, aggressively scampering to assemble strategies with real substance as relates to 'rescuing' the situation (or preventing failures on rating downgrades and so on), while mitigating culpability issues that we've warned might take center-stage if this secondary 'surge to run-in shorts', interspersed by some selling squalls, ends— let us just say- 'poorly'. In the last couple of weeks, we clearly tempered our bearishness (it is known to ingerletter.com members as 'trading moves' and addressed via the newest Flash-based audio-video chart analysis), while harboring hopes (for the good of our Nation) that the Fed's moves would be merely initial phases, not the culmination, of rescue efforts.

At the same time that we don't want to 'fight the Fed', we are aware that what is at stake here is indeed more dangerous than the typical gentle 'step on the gas' (or typical 'tap on the brakes' kind of monetary shifts) which our generation's become all too accustomed to.

This is more of a crisis than the Fed's draconian move merely being engaged or well-received; after all if things are 'not so bad' as the optimists eternally proclaim, then for what possible reason is the Fed giving us the largest short-term rate cut in all history, as far as the total extent of 'ease' being initiated in a very compressed period of time.

For months I've suggested the Fed is looking at more than is superficially visible, and I have not changed my thinking on that subject. Chairman Bernanke has done super, in this crisis, considering what he inherited (a point we have consistently argued, unlike the majority who blamed the Fed, rather than the true perpetrators [[including Alan Greenspan: normxxx]] of the overall giant mess). Although the ego of some would contend otherwise, I suspect the Chairman hasn't simply 'buckled to pressure' from bankers or economic pundits; though they probably think they influenced matters. Rather I have felt since before July's top (of mostly Big-Cap indexes the public 'thinks' is the stock market), that there was an ongoing unwinding really dating to late 2006/early 2007 in small-cap stocks (generally exhausting sooner rather than later); with big-caps typically coming under pressure later-on in the game [[the 'smart money' has learned how to 'chow down' on the small caps without roiling their markets; they have been distributing over most of 2007: normxxx]].

The challenge is ascertaining how late we are. If the Dow and S&P alone were 'the market', I would be concerned that we could be many months from a conclusive trough, and it may be so anyway. However, the market internals were juxtapositioned to big Indices even as 2007 began. Furthermore, distributive patterns for the NASDAQ 100 (NDX) and even more so the Semiconductor Index (SOX) are more reminiscent of having concluded (we've denoted this for many months) rebounds within a super-cycle bear, or secular negative market, than having a mid-cycle correction in a bull market, which is the reality of 'price action' that you simply don't get from most mainstream analysts.

And yes, we who love technology (that is our focus other than the S&P and so on, of course while realizing we've dramatically expanded our coverage last year and this in economic and even arcane structured investment areas, like CMO's or CDO's, which generally aren't addressed (much less mortgage re-insurers); avoiding technology for the most part too (selling the last of our sizeable holdings earlier in 2007 and open to buying them back whenever it suits us, which I suspect is somewhere down the line a bit), in harmony with the concept all last year that there was no 'perfect' hiding place (yes others have said that more recently; but in a majority of investments, that's not helpful after a decline is no longer in its early stages and is already borderline mid-cycle downside).

Yes, we expect a rotational low may well create earlier buying opportunities in some of these than for most of the largest-caps; while many financial industry structural managers are sadly lacking in more areas than we care to probe. But somebody has to 'look at the big picture'; a growth area that is yet to hit its stride, we also suspect. As the impact on the markets can be gleaned (or lack of impact, should that be the case), we may have a better glimpse as to how the market puts in a low-point. If that implies that we think that the 'crowd' currently calling for a 'thousand Dow points' up from here without retrenchment is, in gentle terms, 'nuts', well yes, that would generally summarize our interpretation (may only happen if certain structures get cobbled-together— but needs to happen quickly).

Daily action . . . certainly doesn't have to adhere to our outlined advance pattern (or any other), but this past January generally did comply with our suggested outline for a 'brick wall' of resistance to greet the new year, then a drop, a rebound, another drop, and renewed pre & post Fed firming generally (allowing for the shock & awe trench warfare reaction to the actual cuts) into late January / early February action. If lucky, that would take us back to the 'neckline' of the S&P's breakdown, and some more 'chop' action, before renewed risk of substantial downside ramps up gradually.

For a long time (anyways, before it hit the front pages), we talked about re-insurance, pensions, and even municipality risks (various bond classes may or may not risk impaction; as some are only well-rated if insured, but others can stand on their own... such things vary widely and of course require individual due diligence); if this became wider and more systemic. As that is the risk; we have felt all along that what the Fed was doing related to such risk [[of total financial collapse: normxxx]], and not primarily to bailout of lenders, homeowners, or such; though that would sure be a welcome ancillary benefit. We felt the primary institutions were 'severely at risk'; therefore you couldn't even 'drill-down' to help the struggling average citizens, if that resulted in a loss of Fed/government influence, direction, and the stability of the core elements of our financial system.

As the various government and non-government entities collaborate with the Fed and Treasury (or foreign entities which we'll address again another time), there is an effort (we called it 'financial engineering', though it is NOT of the type that produced those 'toxic' products that the basic structured investment vehicles— SIVs— were investing in in the first place) to stabilize both a slew of banks and private insurers [[those designated as "Too Big To Fail": normxxx]]. And that collides with the retribution of the rating agencies [[as well as any short sellers: normxxx]], or a just fate; which has many at odds with the Feds, as everyone contemplates what happens if the raters were now suddenly to rate these banks and assets properly [[and, in the meantime, praying that the monetary and fiscal actions being taken actually have reduced risk: normxxx]]. Clearly, reclassifying such entities or assets properly could set-off a domino effect of defaults and bankruptcies, a 'once in a lifetime' waterfall, which we actually would prefer NOT TO SEE in our lifetime.

And that makes it hard to divine. Just as in medicine; common problems are seen as we all know, commonly. And rare maladies are encountered.. shall we say.. rarely. In this case the 'risk' is definitely still present; even though it has been eight months since we'd first started talking about the 'risk-off-loading' tactics among institutions or some holders. That the issue isn't even dented, much less resolved, in a sense hints at how humongous the challenge is.

While this goes on the pundits keep talking about buying (as if it was a sort of momentum market); keep telling us how 'powerful' the government moves are for the stock market (which is not the question anyway, as the problems relate primarily to debt, which impacts equities indirectly in a manner that is not readily apparent by merely looking at 'price'— it can severely constrain future profits, or even profitability); and misdirecting all talk of the actual challenges (or at least the dimensions of the challenges) from investor ears.

I'm actually not sure I blame them, as the industry does not want to put the kibosh on investing, and scare off their clients/livelihood. However, while they proclaim potent bullishness, in incredibly dangerous times, they are doing their adherents a great disservice if what's being attempted falls short. Ironically we would like them to be right; because we too do not want the Nation (especially in wartime and with other challenges) to go through something akin to another era before most of us were even born (in case you were around for the 1880's or 1907's panics, or the 1930's 'depression', good for you!). Remember what partly tipped-us off to how right we expected we'd be with our forecast of failing rally attempts in the Spring of 2007 and later: the collapse of a small brokerage in California. Net-capital requirements had the NASD force their liquidation, because their holdings were no-longer investment-grade or acceptable based on industry requirements.

While I can't be sure, I think this is what has the industry and the government partly freaked out, since the Nation— aside from real estate— doesn't yet seem in such horrible shape. Though, of course, many individual regions are. Something is forcing the Fed's and W's hands just a bit more than your typical recession fears [[how about a potential collapse of the entire international financial system, so carefully constructed post WWII? : normxxx]]. Might that be an only semi-controlled unwinding leading (potentially) to a 'waterfall' collapse, since broker/dealers, banks, certain money funds, pensions, and so on are vulnerable if they can't adequately meet their creditors' demands or their particular regulatory requirements?

The rating agencies must realize this (and who pressed them not to and who pays them well— we discussed that in the past); likely some think great political and financial pressures are being applied to stall them from coming clean. (Would you be shocked if a threat 'to' investigate (by the Feds or Congress) would be applied if they 'did' come clean, versus the opposite as may be seen as the propitious thing to do?) To wit, do they dare risk (a sudden, new-found) 'objectivity'?

As investors, we demand honesty and objectivity. Or do we? If it costs us? We are not invested in any such SIV or other impacted vehicles; never have been. This is really an academic query here because I'm thinking that many municipalities, even county, state, and pensions..etc. etc. ..might prefer not to see their holdings identified and rated appropriately; while wishing they had been a year or more ago. However, if the raters don't 'come clean', isn't that even more unsettling for future confidence? And will it open them up in terms of culpability, as opposed to continuing to game the system?

So far it seems that the tenet is to do everything mostly opposite prudent instincts, so as to avoid any tinge of recrimination based on even accidentally repeating anything that occurred in Hooveresque times (for good or ill); when 'cleaning house' was decided upon and, instead, everyone's 'clock was cleaned'. New York's plans to inject capital into monolines focused this thinking: it implied shifting to (the ever uncomplaining) taxpayers [[or our Chinese creditors?: normxxx]] the burden of far more than bailing out mortgagees, or even 'our' bankers. Meanwhile the pundits focus on 'investing sectors' and individual stocks. Is that too an effort to steer investor focus away from what they ought to worry about— back toward conventional thinking?

There is underlying fundamental concern that's structural and unresolved. It may be that stocks make bottoms before 'systemic corrections' are in-place, whether the burden is on the taxpayers, on upon the entities themselves. In such circumstance we have now seen many instances where accounting games cleverly distorted truth, and no investor angst was allowed to surface in terms of an oversight 'cure' (certainly, in this administration), because of the 'larger implications' and 'potential damage' to the economy and society [[in fact, this administration has been so kind to the perpetrators, that we are able to celebrate two crashes within years of each other, and not have to wait for another generation, to forget: normxxx]]. It can happen anyway; but only if enough pressure's brought upon regulators to do their job.

If we were to guess what 'should' happen, it might be at the margin slightly similar to perceived Hoover-era solutions: exact a toll on the perpetrators, not on the victims. It sounds responsible (and is), but it could backfire. Fining the connivers, not all citizens (a taxpayer bailout is a citizen 'fine') is ideal; so then why isn't there a consensus just to do it? Fear of the unknown. Instead they give big golden parachutes to the worst of the worst at some of the culprit marketers, banks, and other miscreant organizations.

But, what would happen if you exacted fines from the entities, and/or receivership beckoned? Applause from 'common people' initially; then realization they could get hurt 'on the flip' of it (taking blood from a stone tends to degrade the stone). Money could be taken (if any remained, or could be found) to pay the taxpayers rather than exploit them further; rather than have 'we the people' borrow more money stupidly to expend on Chinese goods we don't need; or lunch for the rest of us at the Capital Grill or someplace similar. Why is there such 'bipartisan cooperation' these days? Is it because they want to help us; or protect the 'bigger interests', whose failure would surely undermine us (unfortunately).

Isn't there a better way? That would liquidate at least the worst of those who unduly distorted their 'measures' and cajoled the rating agencies; it would channel the funds somewhere to do some good (at least the General Fund), and it would refresh honest oversight in Washington, to clean-up the Ponzi schemes (which have become the hallmarks of American finance) that we warned of throughout 2007, and even before, with respect to the real estate game.

Anyway, lest fervor let me rant further, there are challenges, and slowdown and adversity risks beyond anything you've seen in your lifetime; but it may yet be mitigated, if not averted. It's just that doing so, in the way the 'powers that be' are attempting it, will not punish the 'guilty' perpetrator types adequately [[leaving them to try worse another day: normxxx]]— that's just part of the moral dilemma everyone skirts the edges of, but fails to confront directly except for a few rare 'headliners' (to appease the mob), or when control is completely lost, as in the '30s (but even then, the saviest and less greedy of the lot managed to survive OK).

Summary: suspect this chaotic volatility will incredibly resume next week, led by the movement of Averages, to perpetuate logical rebounds.

This is all part of the 'ripple effect' on the broader financial markets we've outlined, say, since last Spring. Though many are only noting it now (even using our 'tsunami' term), it doesn't help much, because (as often is the case), the horse left the barn long ago. It's sad, because as we could identify this crisis almost a year ago; others should also have; especially since we used Government charts, real estate, and banking industry data to prove our contention (the bell curves; the CDOs/CMOs and other derivatives exposures).

I said when predicting last July's rally as having 'zero chance of sustainabilty' that all 'the magnitude' of this, would impact housing market values, future lending policies, fallacious perceptions of momentum, and of course reveal the truth about the much-vaunted 'massive liquidity' that didn't exist (for reasons documented; including Gold).

These Fed and 'market' [[Plunge Protection team : normxxx]]efforts are primarily intended to help stabilize the banking system's illiquidity [[or, better, insolvency?: normxxx]]; and that is not a typo. Only an intellectual buffoon would conclude these are all buys now; for investment; though some have bounced, which even we thought was reasonable.

But trying to tag onto new cyclical or secular advances are still highly risky. As long as cheerleaders keep looking at every rally as a buying opportunity versus a chance to lighten-up, prospects (especially given retrenching overall business) remain fairly onerous if not ominous. I expect that the rating agencies, seeking to redress their besmirched reputations, may finally start reviewing their ratings of large banks in the United States, before the litigation begins and before the Congressional (as always) oversight after-the-fact rounds of investigation commence. Many banks are thinly capitalized [[or already actually at least 'technically' insolvent: normxxx]]; hence just the opposite of the ratings being promulgated to the public, though we recognize the clear need to deflect 'a panic'. It's that need, we conclude, that quashes true justice here.

So sure; they're pulling out the stops, which did not happen prior to the 'crash of 1987' or the 'crash of 1929' or the 'panic of 1907' or the ante bellum panics: e.g., 'a railroad bond debacle'. Though just because some economic fundamentals are assisted, is not an assurance we'll get through this unscathed; and that this current upside isn't a desperate rebound try as was expected, or as also replicated in other historical 'hail Mary', failed tries. If that seems to mean, is the risk-quotient as relates to February ameliorated from our original (in late 2007) call for the first parts of 2008, I think not. I don't think that roadmap's changed much— if anything, it's gotten worse!

Bottom-line: for months, even before the peak, we suggested the irony might be that the magnitude of a post-peak decline (likely recessionary depth) might not be just 'average' U.S. post-war duration, but rather dwarf those typical contractions. All such periods were 'exclusive' of the kind of 'debt' we are encumbered with now; and the 'rescue' plan is basically a prescription to 'compound debt'; a ludicrous long-term solution (their logic is just 'bet' that they can effectively 'reflate' once more); and we hope they succeed if that is the determined route, even though we wouldn't suggest it as particularly wise; it is so dangerous it can result in outright collapse of the dollar and then the entire international financial system as cobbled together so carefully post WWII.

Note our 'rebound' calls are against backdrops of an S&P 1595 March 2008 call sold back last year and retained for some time now, reflecting belief that the macro pattern by no means has reversed. What happens as the analysts backtrack on their proclaimed bottom in-place (or repeated so-called bottoms), when the bottom isn't really in place.. (and will demonstrate that one fine day) will become interesting.

It's against what we called for since early 2007; clearly proclaiming that the 'rotational distribution' under cover of a strong Dow Jones and S&P was masked a broadening top. Rotational lows will occur in some sectors and individual stocks.

Because many made too much of a snapback, it enhances the mass-market potential disappointments when or if the lows fail to hold. Historically, penetrations of washout key-reversal lows lead to utter panic and a larger decline. And by the way, in history's major events this isn't unprecedented; it happens to be how it works when underlying fundamentals have shifted dramatically— as was our call for the end of a 'Gilded Age' in 2007; which became the 'Panic of '07' (per May's forecast) leading to..you know.

Do we get out of this? Sure; but how long is the question. The systematic approach; that the sober worry will lead to more excessive debt or leverage isn't precisely what is faced, because they can't peddle structured investment vehicles to investors again in the foreseeable future [[oh come now, Wall Street has nothing if not an inexhaustible bag of new tricks for the "sucker" that's born every minute! : normxxx]]. Therefore, we'll likely have more pressures; more pain, and longer-periods of introspection, reform, litigation; while trying to avoid introversion if you will; before the United States finally puts the broad mass of citizens of this Country first [[never happen! : normxxx]].

Signs as we interpret them, including (updated recently) the following bullet points:

The extreme conservatives ('hard right' neo-cons) are off-base; a centrist Republican Party is in the Nation's best interest;

Retired Fed-head Paul Volker endorsed Sen. Obama; means he's really ticked at AG's, BB's, and W's policies;

Americans like candidates who exercise judgment on ALL issues, not just those that most impact their 'base';

Global economic decline has started, inline with our ongoing forecast of economic contagion;

From the start, we said the world wouldn't be isolated from globalized 'U.S. credit pandemic'.

Normally, stocks offer better potential reward when rates are so low; but analysts for the most part continue to underestimate the debt burden (including credit card risks in the fullness of time); even though the bond market pricing has gone totally berserk. In most cases this is when one shifts to equities; but while on the lookout for sustainable lows, and not going to say 'this time is different' on the downside', these are not even normal bearish times; at least compared to what we've seen in our lifetime. (And the Fed's actions bears this out.)

Key credit or derivative issues are not ameliorated, as further Fed actions towards easing remain essential, even if morally questionable from the perspective of supporting bank or other perpetrators of the problems. Nevertheless, these moves continue for now in the mode of 'pushing on a string' as outlined from the start. It's a different issue then just stemming a tide. And, we're hardly out of the woods with respect to housing, debt or war issues. Notably: a Fed 'staying ahead of situations' won't necessarily prevent serious financial 'evolution', or even revolution.

Normxxx    
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