Is This Melt Up Coming to an End? Is It Time to Sell?

by: Ray

I am a bear and that should not surprise anyone at this stage of the game, but I have long positions and individual holdings. Just because I think the market is going to tank does not mean I am opposed to being long. However, I am long very specific items and not, generally, long U.S. stocks except for a few biotechs, tobacco and some defensive names. I am long fixed income and have been for some time, high yield and emerging market debt has been very good so far with about a 5% blended return YTD, not bad for bonds, but my real winning positions are Russia, Africa-Middle East and Poland, up between 8 and 11% YTD.

I guess I am saying that even a bear can be long and in my case I had sought international, yield and strong dividends. One might say my positions are boring, but boring means consistent and low standard deviation. Investors should be embrace boring yet they are not as they pile into AIG (that was, evidently, a short squeeze yesterday) and other very low quality stocks. Typically, when you see crap catching a strong bid that should signal a top to the market, but we are in a continued melt up still so I just take the dash for trash stocks as a warning sign that things are probably about to change. I think the change is not going to be triggered by the Fed either.

What is interesting, even though I think he is bluffing, is that Great Hoenig from the Fed has “put the market on notice” about excessive risk. What that means will be realized soon enough, but I am convinced that interest rates are not going to be raised anytime soon. What Fed Chairman would raise rates with prices falling and unemployment pushing 10%? It is not going to happen. There is zero money velocity, no wage inflation, no significant rise in the PPI or CPI, and deflation is written all over the place, credit contracted again (!), which is very deflationary. All of that means rates are staying right where they are. Although they may raise the discount rate again, big deal.

The risk is not from the Fed at all. A simply look at the front page of any newspaper in the finance world will tell you were the risk is coming from, Europe. Greece to be precise, but I see Greece as one simple cog in a very broken machine known as the EU. Greece may have significant funding issues starting right about now as Germany is giving them a cold shoulder and, supposedly, are cutting them off from easy liquidity, as they should. In response to this lack of liquidity Greece’s bond yields spiked above 7% which will guarantee a default if they cannot get cheap money to borrow. The other broken cogs in the wheel are Italy, Spain, Portugal and Ireland. If Greece falls so will the rest of the PIGS and that will bring the euro down and could trigger a run on the currency, we saw this story before in 1997 in Asia I believe.

The very reason the euro is selling off is why I own and have advocated owning gold, silver, palladium and platinum as currency uncertainty means the value of these commodities will rise. Look at yesterday as the dollar gained value, gold and silver continued to break higher. That is not supposed to happen. The reason for the rise in metal prices is because of Greece and that issue seems to have some people concerned enough to run to hard assets. Can a European default really be a problem for the U.S? You bet. Consider that French, German and every other European bank owns some form of PIGS debt and U.S. banks hold European bank debt as well. Just remember, sub-prime brought down the mortgage market and sub-prime was tiny in comparison to the overall mortgage market, the same lessons apply here.

On top of the new debt problems involving foreign banks if the PIGS default, U.S. banks are still holding all the same toxic assets as before. Another shock from bad debt could be the straw that breaks the camel’s back and as I said Tuesday, the government and the Fed are out of ammo. On top of the European issues, California was downgraded and about $1T in more sub-prime debt was downgraded. As hard as I tried yesterday I could not find any good news out there. You also have to remember that the credit (bond) market is where all the smart money is so when they see trouble that means bad news could be just around the corner for stocks.

The bottom line is that earnings might be good for 1Q10 although I think top line revenue will be weak, but that might be meaningless as sovereign debt is rearing its ugly head again. There is no harm in going long equities, but with such a huge rally and shaky fundamentals I do not think it is wise to marry this market or have zero shorts. This melt up could very well be coming to an end as stocks cannot go up forever and there are serious problems out there that are completely unresolved and are not priced into this market. If these problems get priced into the market I can assure you the Dow will not even be close to 11,000.