Fox News anchor Megan Kelly was visibly amused by two of her market guests who predicted on Monday that the S&P 500 would fall below 600, but only after it rose by 30% from current levels during the course of this year. And, without doubt, many Fox viewers must have concluded that the bare assertions of the two asset managers bordered on insanity. But the Treasury and the Fed are on the verge of creating another leverage bubble and, as a result, the 700-to-900-to-600 scenario for the S&P 500 may not be as crazy as it sounds in the first instance.
The Obama Administration’s programmes to immediately engage the securitization market for a variety of consumer and small-business loans, and to force the restructuring of mortgages, are obviously designed to ensure that “credit flows through the system”. But in a climate where declining share prices and home values have caused a $13 trillion destruction in household wealth and where the jobless rate is severely curtailing family surpluses, the availability of additional (easy) credit, or the extension of contracts already in default, pumping money is bound to generate new systemic risks. Credit apart, what the $1 trillion-plus which the government plans to inject into the consumer and housing market will certainly cause is the flow of systemic risks right through the American business spectrum.
American consumers are already leveraged. What is desperately needed is a deliberate and structured de-leveraging, and a recognition that the state of the global economy is calling for a broad contraction in consumer demand. But, that said, this imminent flow of credit may well support widespread upward revisions in corporate earnings in forthcoming weeks, and the predictions of the two Fox guests, as ridiculous as they sound when contextualized in fundamental terms, could start to gain currency. Another credit bubble is in the works, there is ample money sitting on the sidelines, stimulus spending is on the way and there are any number of Wall Street analysts and fund managers who are ready to advance the value-investing proposition with renewed vigour at the earliest opportunity.
From this writer’s perspective, a 30% increase in the major market indices (DIA, QQQQ, SPY) is almost unimaginable at this juncture, given that it is more than apparent that nobody in authority has been able to show a thorough grip on the banking crisis and given that neither Ben Bernanke nor Timothy Geithner displayed any grasp of the global nature of the problems confronting them at yesterday’s hearings on Capitol Hill. But the stage is indeed being set for some type of rally in the very foreseeable future, and the challenge will be to time both shorts and longs.
There is simply too much negative news still to unfold, both on the domestic and international front; so no rally can be sustained. The tension between highly persuasive fundamentals on one hand and the short-term impact of government monetary and fiscal intervention on the other is offering new trading windows. For example, gains in excess of 10% from Tuesday’s closing levels need to be sold into with the intention of covering shorts on periodic pullbacks. Gains in excess of 15% need to be sold into aggressively. Moderate longs are warranted if the indices drop by more than 5%, as long as one retains the capacity to average down.
What is important is discipline. In view of the fact that investors generally are unaware, and largely unprepared, for what lies in store in the months ahead, bouts of panic selling on bad news are inevitable; such bouts are going to be for limited periods only and they must be used to cover shorts, and to reinstate longs.
Arguably, the definition of “bad” is a relative one today. Investors are becoming almost immune to adverse economic data on the domestic economy and they will only rush for the exits in the face of substantive and significant events, e.g. Ukraine and Hungary defaulting on IMF commitments, a zero GDP growth confirmation from India or China, or a breakdown (for all practical purposes) of the European Union.
The writer’s bearish bias is intact, due to a number of well-founded reasons detailed in earlier articles posted on Seeking Alpha. However, the facts as they present themselves today are telling us that there is much more money to be made by trading the market from both sides in comparison to any medium or longer term strategy.