Three events, two related, one seemingly unrelated, shook the markets yesterday and brought the prospects of a global recession much closer to reality. The FOMC only did more damage to the markets as a sell on the expected news took down averages yesterday and today. And the EU bailout may not happen at all, or be significantly delayed, which may take the S&P to my 1,000 target sooner rather than later. Finally, Alpha Natural Resources (ANR) started the U.S. trading day off with the first real look at China's slowing demand. which became reality today wth HSBC/Markit's early look at their manufacturing activity.
Little old Slovenia, that old communist country, could be the fly in the ointment. The government fell last night and elections are not yet scheduled but the party that seems to be in favor of assuming power is apparently less benevolent than the outgoing politicians. Slovenia’s Democratic Party is also much less benevolent than U.S. Democrats but I guess the word “Democrat” has different definitions in former communist countries than here. They believe that countries like Greece should pay the piper themselves and that it shouldn’t fall on the Slovenians to give up their hard earned cash to profligate spenders. The issue with this is that the approval of the new ESFS proposal requires unanimous approval from all 17 members. If the Democratic Party does assume power, there is no guarantee the Slovenians vote to approve the bailout making for, at least, some suspense. The markets don’t need more uncertainty.
Alpha Natural Resources noted slowing demand in Asia for coal as one reason why they cut guidance yesterday. This is not a good sign. China was supposed to be a bastion of strength but in addition to this hint, China manufacturing is still contracting as reported last night. Copper and Freeport McMoRan (NYSE:FCX), at lows, transports getting smashed .... these are the front end of the recession. I’m short Consol Energy (NYSE:CNX) and Peabody Energy (BTU). The rails, which of course benefit from coal shipments, are feeling tremendous pain. CSX (NYSE:CSX) had already lowered guidance as did FedEx (NYSE:FDX) again today.
In 2002, Bernanke made a speech about Kennedy’s use of Operation Twist and it wasn’t so favorable (click here). Granted the speech referred to Japanese deflation issues but is nonetheless very telling. Quote is from footnote 11:
“An episode apparently less favorable to the view that the Fed can manipulate Treasury yields was the so-called Operation Twist of the 1960s, during which an attempt was made to raise short-term yields and lower long-term yields simultaneously by selling at the short end and buying at the long end. Academic opinion on the effectiveness of Operation Twist is divided. In any case, this episode was rather small in scale, did not involve explicit announcement of target rates, and occurred when interest rates were not close to zero.”
Like Chubby Checker, the inventor of the only twist that worked, this move will be for entertainment purposes only since it will have less of an affect on the economy than Chubby’s record sales. And it will hurt the banks.
In addition to Operation Twist harming the banks by crimping margins and doing nothing to increase lenders confidence in the economy, the Moody's downgrade is adding to the uncertainty for investors. Most troubling about the bank debt downgrades is the reason. It’s crazy logic. Does Moody’s see a need for the government to bail out the banks? If so, their debt won’t be worth anything so the downgrade should be to junk. If the Lehman deja vu isn’t an issue, then there shouldn’t be a downgrade.
Guess what? I’m still bearish. We will make new lows.
Disclosure: I am short BTU, CNX.
Additional disclosure: I may exit these positions or enter new ones mentioned in article. I am also long SDS, EUO.