Time And Price; There Is No Alternative
By Todd Harrison | 22 October 2008
NEW YORK (MarketWatch)— One of our favorite adages in Minyanville is to sell hope and buy despair, but the question remains whether we've seen enough fear this year. Last week, as the wheels wobbled on the financial wagon, we offered that the 2008 trading low was likely established the prior week (October 10), when the S&P (SPX) ticked at 840 and the Dow Jones Industrial Average (INDU) traded at 7880. Read MarketWatch column Following the fragile Friday retest, the market enjoyed a spirited sprint that added 150 S&P handles and 1400 Dow points in a matter of days. As psychology shifts and investors twist, we're left to wonder if the worst is behind us.
There is a massive distinction between a trading low and market bottom. All else being equal, it remains my view that the dollar must devalue or equities will decline— perhaps next year— as debt destruction manifests across the financial continuum. Read Minyanville column As traders, the destination we arrive at pales in comparison to the path that we take to get there. Therein lies the opportunity for those living in the nuts and guts trading the flickering ticks. The volatility is wicked, but disciplined risk managers are feasting on the emotional famine.
There are two sides in each trade and risk to every reward. As such, I wanted to explore five reasons why we could see lower prices still by the time we welcome 2009.
1. World, Hold On
Seeds of isolationism are sown as the going gets tough and the tough tend to their own interests. Derivatives may be financial weapons of mass destruction, but liquidity is the neutron bomb— pull the pin and it'll suck the life out of the global economy. Recently nationalized global central banks are being polarized as the dot-gov bubble bursts. Australia ruled out deposit guarantees for foreign banks and the Royal Bank of Scotland (RBS) cancelled its credit line to the National Petroleum Company of Venezuela. France's Nicolas Sarkozy proposed that each country launch sovereign wealth funds and take stakes in key industries to stop them from falling into foreign hands.
As countries fend for themselves, the risk of geopolitical turmoil is elevated. My single greatest concern is the potential for "something serious" to occur in the Middle East while the current administration is still in office.
2. Rampart
As a derivatives trader for 17 years, I understand the depth and complexity of our current conundrum. Stocks are the world's biggest thermometers, but credit is the backbone and you can't walk without your vertebrae. Classic capitulatory signs were present two weeks ago, but the credit cancer is bigger than the economic patient. There are upwards of $500 - $600 trillion 'notional' in outstanding derivative contracts and the nationalization of financial institutions transfers— but doesn't erase— that risk.
3. False Hope
Much has been written about the uptick in the credit markets being a precursor to an equity rally. While we've seen improvement in credit symptoms ranging from LIBOR to TED spreads, we've got a ways to go before conditions 'normalize'. The spread between three-month LIBOR and the targeted Fed Funds rate remains elevated at 2.33%, twice as high as it was a mere month ago. Further, credit Bears are building bets against Fannie Mae (FNM) and Freddie Mac (FRE) debt and that's disconcerting through a macro lens.
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4. Swingers
When global central banks banned short sales, it was the financial equivalent of messing with Mother Nature. The resulting volatility throughout the asset class spectrum can't be viewed as constructive regardless of your directional bias. Of the 36 times the S&P has rallied 6% in a single session over the last eighty years, 32 occurred between 1929 and 1933 [[when short selling was likewise banned or strongly curtailed: normxxx]]. History doesn't always repeat but we would be wise to remember the prevailing trend during those daunting years.
5. Pickers And Grinners
During the last few weeks, high-profile pundits have emerged to proclaim a 'positive' posture toward stocks. The cast of characters ranged from the Oracle of Omaha to several well-known bears in the financial space (present company included). To paraphrase Warren Buffett [[the J.P. Morgan of the 21st century(?): normxxx]], savvy investors sell when others are greedy and buy when they're panicked. The key to that approach, however, is having the staying power to ride out the storm. As John Maynard Keynes so famously said, "markets can stay irrational far longer than you can stay solvent".
Getting Stuck By The Landing
Let's take a step back for a moment. This problem has been percolating since the back of the tech bubble. The cumulative imbalances took a long time to cook and the unwind will be equally fierce. See Minyanville column
Time and price; there is no alternative.
Entering September, we warned that either a cancer or car crash was imminent as corporate debt came due. See MarketWatch column While one could argue we've conceivably seen both, the surreal script is written in real-time. The ramifications will be far-reaching. The 1929 stock market crash didn't cause the Great Depression; the Great Depression caused the stock market to crash. That's worth noting with mainstay averages down 40% year-over-year and once-venerable institutions having been laid to rest.
Social mood and risk appetites shape financial markets. The DNA of this market— a finance-based global economy levered to the hilt and laced with derivatives— is drastically different than anything we've ever seen. That's the other side of the trade, a toxic combination that consumes the world and turns us against each other. Stick with risk management instead of reward chasing as we find our way to better days.
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Normxxx
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