Eagerly Awaiting Monday's Market Decision

[The following is excerpted from Bill Cara's Week-in-Review]

Very few of you it seems, and very few of the “gurus” as well, agree with my opinion that the 2007-2008 Bear market is over. You probably also won’t agree with my opinion that the next few years will be much like the period from 1974 through mid-1982. But that’s not the problem we face today. This emergency legislation in Washington is.

I think the crisis is not on Wall Street, but in the White House.

Kim sent us this news about what Treasury Secretary Henry Paulson is up to:

Mike Morgan's Quick Notes
- Behind Enemy Lines -
King Henry is now officially taking over. If you don't write your Senators and Congressman immediately, this one man will have complete control over everything we ever stood for or ever hoped to be. If you think I am being dramatic, just read what he asked Congress and the Senate to approve in the Bail Out Act . . .

This deals with what he can do and who can review his decisions of hold him accountable . . . No One. He is demanding complete, ultimate and absolute authority. This is directly from the draft he sent to Washington.
~~~~~~~~~~~~~~~~~~~~~~~~~~
Sec. 8. Review. Decisions by the Secretary pursuant to the authority of this Act are non-reviewable and committed to agency discretion, and may not be reviewed by any court of law or any administrative agency.
~~~~~~~~~~~~~~~~~~~~~~~~~~~
You had better start emailing and calling your Senators and Congressman. He already has enough votes to get this passed. If you don't act, King Henry rules.

Access to Senators

Access to Congressmen

I never imagined that I would witness a political coup in the U.S. in my lifetime. This situation and the draconian action being taken by Paulson and unnamed cronies makes writing the WIR extremely difficult. However, maybe sanity will prevail in Washington, and maybe Congress will rein in the Treasury Secretary.

In that case, I had better keep writing the usual stuff.

Some of you have asked for a clarification of the following paragraph that I wrote and re-used Thursday and Friday.

I continue to believe the equity market will split the financials from the non-financials, where the non-financials started a new Bull market on Thursday afternoon, but where the financial stocks will only rally for a time before falling again to test the sector bottom. In time, the financial sector will likely be seen to have missed the first leg of this new Bull because traders know: (i) the balance sheet liabilities of banks are understated and their assets over-stated, and (ii) the central banks that have been coordinating this emergency lending must recover those funds to then restore the health of their own banks and the confidence of government legislators… Home-owners are still beleaguered and consumers are still facing hugely inflated prices and have less purchasing means, so the financial services and consumer discretionary-spending companies will (ultimately prove to) lag.

The 2002-2007 Bull market is believed (by almost all people) to have started in 4Q02, but after an initial rally in the Financials (XLF), the sector failed and returned in the 1Q03 to re-test the previous low. Only in the second up-leg of the Bull market did the Financials catch fire. This link will show that.

What I am saying in the paragraph above is that I believe there will be a repeat of the 2002-2003 cycle bottom process with XLF.

Moreover, because inflation is so much higher and consumers much less well off at this point than they were in 4Q02, I also think that the Consumer Discretionary sector (XLY) will lag as well. However, those stocks in the Consumer Discretionaries that are most affected by oil prices, like the airlines and cruise lines, will lift first as fuel costs drop and fuel surcharges are better accepted in the future, which I expect.

The Financial sector still must resolve its problems with bad assets that have been kept on their balance sheets at overstated prices. This week the US Treasury devised a two-part plan to relieve the financial services companies of these problems so that they could return to their usual lending and borrowing practices in the credit market. The steps taken were: (i) for Treasury to set up a $800 billion fund to buy “bad” mortgages, so that these financial services companies would not have to write them off, causing the need for immediate new replacement reserves, and a $400 billion fund to return Money Market Funds to par, so that the banks could permit clients to redeem them without losses, and (ii) for the SEC to immediately prohibit the short-selling in 799 financial services companies for a period of up to 30 days.

A week ago, I referenced the problem:

If every financial services company that is presently holding supposedly asset-backed debt instruments in inventory were to value those holdings at real cash market prices, there would be devastation across the board. Maybe a trillion dollars around the world – half in the US apparently – would need writing down, and that would result in the immediate need for most of these companies to raise additional capital. The problem is that most of them could not raise capital – like Lehman (LEH) on Wednesday in the debt market -- without eliminating their existing shareholder equity.

This week, Lehman declared bankruptcy and lost over -98% of its market valuation, including -57% on Friday. Until this quarter, Lehman Brothers had not had a losing quarter in its storied 150 year history, or so it’s said.

The events happening this month in the financial services industry are simply astonishing. This week, the once greatest broker-dealer, Merrill Lynch (MER), was taken over by Bank of America (BAC), and this weekend, the second greatest, Morgan Stanley (MS) is in emergency amalgamation meetings with Wachovia Bank (WB). All four of these entities are in financial trouble, and the resultant combinations will still have to be saved by the US taxpayer, now that Treasury Secretary Paulson has gone down that slippery slope.

But right to the end, the managers who caused these bankruptcies or who were recruited to steady the ship have managed to make themselves rich off the backs of creditors, bondholders and shareholders. This story about John Thain and two friends is enough to make you sick—unless of course you were reading me all along about Thain. Thain and friends are now walking away from Merrill Lynch with a combined $200 million for less than a year’s “work”. There were reports he cried in front of his staff when he announced the deal with Bank of America. He cried alright, all the way to the next bank.

This world has lost common sense.

I am trying to say that in my experience it is unwise to bet against the central bankers of the world when they intend to build economies via reflation. Money buys bids and bids buy Bull markets. Traders go with the flow.

At this point I would like to recall the Bull market that started after the October 1987 Black Monday. I jumped on board the Bull from the beginning because I recognized the cathartic event that was Black Monday. Yet, some of the best analysts in the world, including my friends Ian Notley and Martin Pring, waited for over a year to finally buy into the fact the Bull started much earlier. At most major turning points in markets, both at the top and the bottom, you will find a purging of emotions. I think we had it this week.

I think there was actually a panic on Thursday at mid-day with the bankruptcy of Lehman Brothers, and then the central banks of the world convened to work out a $180 billion stopper package. Then they got together to agree to stop short-selling in the Financials, and to bail-out the banks in trouble. I figure the first relief package they put on the table cost $2 trillion at least. Another $2 trillion or $4 trillion will back it up.

Central banks have drawn a line in the sand. Banks and Broker-dealers will fall in line. Treasury Secretary Paulson is issuing the marching orders. Was this necessary? I think yes; but I also rail against the removal of rights of independent traders and the utter disregard for free capital markets. But it is what it is. We just have to hope that the US Congress and their counterparts in the G-20 nations are able to keep the global financial system under control, and out of the grasp of Henry Paulson and his friends.

Nobody has the answer to that on this Sunday morning, and I refuse to speculate. Traders don’t deal in hope; they watch prices and make decisions. Bigger people than us will be putting in their bids on Monday. This battle for control of America’s future will not take long to end in a visible result. So we eagerly await the market’s decision on Monday.

I protest the manner in which this action is being taken, but as a trader, I have to trade prices, and they have turned. Did you see the list on Buy Alerts on Thursday and Friday? If you can beat those prices (non-financials only please!), then your new positions will have a good risk:reward profile.

These days are very interesting, for all students of the market.

I received the following anon letter Sunday, which I answered.

Dear Bill,
You have a wonderful site that I share with my Grade 12 economics and business students. Very insightful and informative – I have my students read your blogs – much of the information is above them but I attempt to simplify it all – not an easy task. Your open letter to the SEC was exactly how I feel and mentioned this to my students two days ago. Here in Canada we have not had the abuses of the system that you have had stateside but they do exist as you know. I was happy when my students recognized that by printing too much money inflation is sure to follow. If I may be so bold as to ask you a question: yesterday on CNN Ali Velshi commented that when the government intervenes in the free market the taxpayer ultimately wins. I emailed him for clarification but have yet to hear back – I don’t suspect I will. How is this possible? Perhaps if the taxpayer buys shares in the company once the cheats and fraudsters are extricated from their corporate Lazy Boys. Once again, Bill a wonderful site for all of us. All the best!
Kind Regards/Anon

Thanks (anon) for your kind words. As for the students, I do hope they learn that with (i) a basic understanding of capital markets, (ii) the application of independent and objective thinking, (iii) the focus on risk management above all, (iv) the search for value, and (v) the study of price trends and cycles, they ought to do a good job at managing their portfolios. Of course, if they over-spend and don't save, they will have a very difficult time of acquiring the financial resources they will need to have a portfolio.

Government intervention in markets costs money, which means the taxpayers have to pay for it at some point. Government will not earn an income by going into debt unless they invest the money wisely in equities. That's no different than for any investor. What they are doing today, however, is buying bad mortgages, which will never pay a positive return. They have also guaranteed the $85 billion loan by the Fed to AIG (AIG) to help that insurance company stay in business, but the 80% share ownership taken back goes to the Fed, which if AIG survives and grows, as I think it will, the Fed (but not the government) will be the richer for it. The taxpayers are being taken advantage of. If I were the Treasury Secretary, I would have negotiated a very significant guarantor fee from the Fed for backstopping that $85 billion loan, and the other loans that the Fed has required the government to support.

The Fed is a public-private entity, which, like a broker-dealer, is conflicted to the core. Capitalism is a wonderful system, but to do its job it needs these pervasive conflicts of interest ended by new legislation. The Fed should be the government's banker, and the public's representatives to government should be elected to run our government like we have to run our households and businesses in the private sector. Because of conflict of interest, the most basic financial and economic concepts are being ignored, and taxpayers are being charged the costs. We need leadership in government that will put a stop to it.

Nothing I have written here is too complex to be understood by a secondary school student or by anybody in government. I hope your students agree.

Best regards,
/Bill

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Statements will be made by politicians that with higher prices, the market must be saying they endorse the actions being taken in Washington. That would be unadulterated hogwash. Traders see the writing on the wall and merely go with the flow at times like this. The fact is that independent traders are also taxpayers and they are furious at the boondoggle caused by the banks, regulators, and governments, which will end up costing them and their offspring trillions.

Remember that; just because a trader is making a defensive move, it can also be one that moves prices higher. They do it so as to not take a loss. This week many traders did it by covering shorts. There is nothing in these particular actions that is done in support of the Interventionists. In fact, we on the buy-side desperately want our freedom from these Interventionists. We want them to stop controlling our capital markets.

In wrapping up, what I truly enjoy in writing this blog is that I get to inform and educate and facilitate people who have less experience at trading than I. I do see that I make an impact and the bigger the impact, the bigger the responsibility. Sometimes that’s tough because this is after all a free blog. But, judging from your letters, it is important that I do it. All I can pledge to you is to remain true to my values, and hope things work out for all of us.

Comments

[Greg Pinelli:]

This moral outrage is precious. This isn't the first government bailout and intervention into the financial world..and won't be the last. The US was an incurable debt junkie well before last week...its actions this weekend (another $800 billion..give or take) only confirm once again what was evident 30 years ago..we have a credit and fiat driven system and its controlled by the powers that be..so what? The question is really..how do we turn a profit.
Before this little kabuki drama started my belief was that we would see whatver problems came down the road papered away...we have. It's clear what will move with the tide at this point..and build into a huge wave..
1. Gold will move MUCH higher..who has a bead on where the US$ (or any other currency) is going at this stage. The general consensus wil be that it's too risky to be in paper..any paper. Look to physical gold and silver and miners.
2. Oil is not done..in fact, it may begin to trade AS currency..not FOR currency. Domestic and safe haven producers are possibly BETTER than gold.
3. Invest in yourself...people had better start learning to make do and manage their lives with less..because that's what REAL inflation means..getting much less for much more.
Spare yourselves the futility of calling or writing your non-representatives. They work for others.

2008 Sep 21 12:23 PM

[whidbey:]

Your surmise the market decline is over is heroic but wrong. Missing in the hub bub you have raised in the issue of consumer solvency. The economy is 70% consumer spending (about 30% of this discretionary) Today consumers have lost purchasing power, cash flow and confidence; discretionary spending will fall for a time, and if the economy stabilizes at some point, spending may start to rise again. You seem to over look the impacts of inflation in this bail out, and immediate rise in stock buying will indicate that fear of the inflationary cycle is taking hold. In that case watch the Reits, rails, and other property intensive businesses. If they rise it will not be a good sign but fear pushing. And, you can watch PM to see just how concerned the buyers are. It is not over, it is in fact just starting. And by the way is not like any prior period so skip the silly period comparisons.

2008 Sep 21 01:59 PM

[User 266801:]

Spending for the general welfare?
Scope of the Power
[P. 164, add new paragraph at end of section:]

As with its other powers, Congress may enact legislation necessary and proper to effectuate its purposes and spending. It a crime who administer programs that receive federal funds, the Court declared that Congress has authority to see to it that taxpayer dollars are in fact spent for the general welfare, and not frittered away in graft or on projects undermined when funds are siphoned off or corrupt public officers are derelict about demanding value for dollars. Money is fungible, bribed officials are untrustworthy stewards of federal funds, and corrupt officials do not deliver dollar-for-dollar value.
[P. 165, add to n.603:]
This is not to say that Congress may police the effectiveness of its spending only
by means of attaching conditions to grants; Congress may also rely on criminal
sanctions to penalize graft and corruption that may impede its purposes in spending
programs. Sabri v. United States, 541 U.S. 600 (2004).
The Constitution of USA

John Smith

2008 Sep 21 03:33 PM

[andyn:]

Oh yes the market will go up until the elections (based on this govt-engineered boondongle).
But once that is done, get ready for the big FLOOD when the money and the govt holding the dyke crashes down on us.
How to profit from all of this... Buy Oct calls on the SPY and
buy lots and lots Nov and Dec PUTS.
And oh btw whoever wins, I am moving up north to Canada lock, stock and barrel. Either way, it looks like this is becoming the "United Socialist States of America" (USSA)

2008 Sep 21 04:12 PM

[Itsonlymoney:]

Hey Georealist you made some good points. I like the comments about managing our lives with less. Sometimes "less is more." I'm not suggesting that poverty is ever good, but simplicity and understanding value are virtues.

Am I the only guy out here that thinks Hank Paulson has turned the US Treasury into his own hedge fund? He is now obviously in the market for toxic debt and I hope he knows what he is doing. What was his record like at GS?

2008 Sep 21 08:27 PM

[bookman4:]

I agree with the article writer's sentiment that we have bottomed, and that as bad debt is rapidly unwound, confidence should return to the market. i don't think that will happen any time soon however.

i wholly agree with many of geo's points as well. my fundamental macro thesis is that the machinery is much too far beyond the average consumers control to even hope for anything other than a violent correction. oil/commodity shock will come, and when it does, let's hope we have an administration that has invested in renewable resources, rather than warfare and croneyism.

2008 Sep 21 08:39 PM

[Moon Kil Woong:]

www.nytimes.com/2008/0...

Please read it. Section 2 #3: All financial institutions will become agents of the state and employees are to act as such. Welcome to communism all bank employees please report anyone you think is a capitalist pig (short sellers to start then witches are allowed).

2008 Sep 22 03:13 AM

[PeteK:]

Sec. 8 is to keep the lawyers away. Do you want them after you all the time ? You probably know how it's like to deal with them. The cost will be billions if they involved.
Don't be nebulous over that.

2008 Sep 22 05:15 AM