Through the Looking Glass: Thursday in Wonderland

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 |  Includes: DIA, EWP, EWQ, FXE, QQQ, SPY, VGK
by: Philip Davis

"If you don’t know where you are going, any road will take you there." - The Cheshire Cat

I like to sit with my daughters (8 and 10) on the couch and look at news pictures on my laptop - it’s a good way of getting them involved with the day’s events, teaching them about my job and teaching them about the world (albeit from my twisted perspective). The USA Today is exellent for this, as is Reuters and the NY Times. As CSNY said:

Teach your children well and feed them on your dreams…

Can’t you see, you must be free to teach your children what you believe in, to make a world - that we can live in?

Since they are kids, I often simplify what’s happening - so we have a general classification of "protesters" to explain why the army or police are attacking people with no guns. Yesterday, my 8-year old had a "eureka" moment when she said to me "Why is everyone around the world protesting - it is because of the bad economy?" Well, she pretty much nailed it, didn’t she? As I’ve been warning for years, the poor (all of the bottom 90% at this point) have been pushed to the edge and they are now starting to push back - so much so that it’s obvious to an 8-year old that we are on the verge of a global revolution…

That led to a little photo project we did together, where I also got to teach my daughters one of my favorite songs: "We Won’t Get Fooled Again!" As the great and powerful Bush the 2nd once said: "Fool me once, shame on, shame on you. Fool me ya can’t get fooled again." That pretty much sums up my attitude on the markets right now - we cashed out at the top and, until we see some pretty DEFINITIVE proof that it was not a top, we’ll be sticking to mainly cash, thank you very much! While Alice’s Red Queen may have said "Sometimes I’ve believed as many as six impossible things before breakfast," we’re having a little trouble swallowing what’s being dished out by our government and the MSM. Richard Davis’s article on the lagging GDP is one example, as are many of the fine articles in our Phil’s Favorites section.

In "Through the Looking Glass" (you can tell I have kids!) Alice said "It’s no use going back to yesterday, because I was a different person then" and the Red Queen observes "It’s a poor sort of memory that only works backward… Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!" The Red Queen is very much like the MSM - they adjust their "facts" to fit what’s happening, no matter how ridiculous it sounds. Don’t like the economic reports? Just paint the white roses red! Up is down and black is white, which is all well and good until, as Douglas Adams observes, "you get killed at the next zebra crossing."

While it’s tempting to try to bottom fish on the dips (and boy have the little maze rats been trained to buy on the dips this past year!) I keep having to point out to Members that we don’t actually KNOW where the bottom is. I wrote up our major watch levels in our 5% Rule Post article (and there is more discussion on it in chat on that post). To simplify a long discussion, our key watch levels on the S&P are going to be 1,176 to the upside and 1,155 to the downside. If we can’t hold 1,155 then the markets are in for a world of hurt and we’ll be looking for a move all the way down to 1,100 at least.

Rather than rehash the reasons for this and blah, blah, blah the news, let’s contemplate what the major problem is at the moment - Europe! And Japan and the US but, right now, it’s Europe. I warned you last Thursday that "The Pain in Spain will Hardly be Contained" and you should know better than to bet against a clever title like that. Of course I’ve been warning for a year that all this incestuous bailing out of each other by the G20 could only end in tears, so Spain is simply the straw that breaks the camel’s back. Greece could have been solved anytime, but Spain?

Graphic: Web of DebtClick to enlarge

You see how ugly this all gets as things start unraveling. Look how totally screwed France is, with $912Bn on loan to JUST these 5 jokers. France’s entire GDP is "just" $2.7Tn (5th in the world) and they are themselves $5Tn in debt (the same as Germany, whose GDP is $3.3Tn) yet they have, as "assets," what could be almost $1Tn in bad loans. Wait, scratch that, of course they lend money to other nations besides the PIIGS, so France has OVER $1Tn in VERY questionable loans outstanding and, if the downgrade police are knocking on the doors of the PIIGS - how far away is France from a ratings downgrade?

And, if we keep downgrading everybody’s ratings, then rates are likely to go up and, if rates go up, then (and I hope this is obvious) debt service costs go up and the likelihood of defaults rise which would cause an honest ratings agency (sorry, laughed so hard I fell off my chair) to further downgrade the nations in question, which would lead to rising debts and further downgrades etc., etc.

As we expected, Japan came back from holiday and fell off a cliff, with the Nikkei diving 3.27% (361 points) all the way down to 10,695. The Shanghai reversed what I told you yesterday was BS action and fell 4.1% (117 points) to finish way down at 2,739 and the Hang Seng finished down "only" 194 points thanks to a 250-point stick save into the close. Oh yeah, like THIS is the kind of action you want to have your money on:

Click to enlarge

I would love to tell you there’s a great way to play this but there’s a reason we went to cash. As the great tradebot WHOPPER once said: "Sometimes the only winning move is not to play." Hopefully we’ll get a little more clarity over the weekend but, until then, we will stay on the sidelines until things make more sense. As Alice said: "It was much pleasanter at home, when one wasn’t always growing larger and smaller, and being ordered about by mice and rabbits."