Central Banks: Between a Rock and a Hard Place

by: Bill Cara

Just when there appeared to be cracks in the prices of high-optic commodities like oil and gold, along comes Israeli Prime Minister Ehud Olmert to throw fuel on the fire.

Not that anybody has actually proven that the Iranian nuclear program is problematic, but Mr. Olmert says Israel or the US must stop that program “by all possible means”. Given that Iraq under Saddam Hussein was deemed to be an equal problem, although never proven in that case either, the Americans have in the past seven years put their entire economic health and social framework at risk over this issue. So it goes without saying that the Olmert threat is a real one.

So-called “speculators” are just calling it like they see it. Where there’s smoke, we have been conditioned to look for a fire.

On the macro-economics front, while there may be a few positive comparable metrics in recent weeks, the overall situation is worsening. The US economy is slowing, unemployment hit worrisome numbers last week, and commodity prices are soaring out of control. Interest rates cannot fall, or inflation will simply soar higher, so central banks are between a rock and a hard place.

The impact that lower house prices and credit market squeezing is having on the average American is worrisome to bankers too. In one breath, the bankers are saying, with bravado, that they have seen the worst, yet in the next breath they go hat in hand to the owners of Sovereign Wealth Funds, soliciting their investment capital. The worst is yet to come, I feel.

Friday last week was particularly hard on the Bulls. Traders are wondering now if they were set up on Thursday, right before more depressing economic data was to be released. Traders had been led to believe that stronger banks, lower energy costs, better-than-expected monthly retail sales, booming technology markets and so forth, were just cause for Thursday’s huge gain of +214 points in the Dow Jones Industrial Average. Not! It’s amazing how quickly this hype disappears under the pressure of selling waves.

On Friday, traders were hit with realities from Wall Street, macro-economics and commodity markets. That started the session off weak, growing more extreme as the day wore on, closing down just shy of -400 Dow points. A day to remember.

This equity market situation is not comparable to a rope-a-dope tactic of a young Mohammed Ali. The Dow index almost a year ago was 14022; it’s now at 12209. Investors who are bullish, including all pension funds and most hedge and mutual funds, have been beaten up. We’ve been laughing at the banks, but we should be thinking about ourselves.

By keeping the public hopeful and interested in buying stocks over this past year, can you imagine the huge positions these banks and other major market players have unloaded? It’s what I call a rolling Bear. Rather than take down all stocks at once, in a rotating market only a few groups are knocked down at any one time. This process is somewhat orchestrated by selective ratings downgrades and institutional sales calls. It’s a fact that banks are involved in front-running sales practices at such times.

At the conclusion, the point when the key inside players have offed the last of their over-priced positions, I believe they will stop supporting (i.e., promoting) the market. At that point in the Bear, the high-rise elevators will be moving swiftly non-stop to the basement, where independent traders ought to realize that the market savvy bankers, with control over lending and investment, expect to have virtually unrestricted access to the best values in the market. I have seen this in every cycle since the 1960’s.

But I think not this time around! Something is different. Independent traders have become savvy too. They have read Graham & Dodd, Edwards & McGee, Buffett, Pring, Murphy and that ilk. They now tune into informed blog commentaries. They are focused on the corporate and industry fundamentals, interest rates, commodity prices, technical indicators and similar metrics.

Just think how much more understanding that independent traders now have with respect to the nuances of RSI, Stochastics, MACD and short selling versus their general trading knowledge as recently as 2002.

The 2000-2002 Bear market smartened up independent traders to the process of what they thought was Wall Street analysis was actually just synthesis, i.e., good old story-telling—even in Congressional testimony I might add.

The humongous banks and brokers have been saying to themselves, if you can get away with it, hey why not try. Everybody else seems to be getting theirs. Game on!

Sadly, life has taken that turn. Still, it’s up to the rest of us to be ready to take advantage of a market blow-off. I think we’ll see it, but possibly not until after the summer.