Where Will Markets Go from Here?

Macro Man has spent the weekend in Madrid, which is salubrious an environ as any other in which to digest the momentous developments of the past week. While things do seem to be changing at the speed of light, he does have a few thoughts about where markets go from here.

The first and perhaps most important of these is that global equities remain in a bear market. Global growth continues to slow and earnings expectations continue to look overambitious in many markets. One little note that flew around the market on Friday night highlighted that the stunning turnaround on Thursday and Friday simply took many assets back to their closing levels of the previous week.
While Macro Man has long thought that some sort of fiscal solution was necessary to end the current crisis, it is by no means a sufficient solution to kickstart a new bull run. Ultimately, the market needs that greatest of all healers, time, to do its thing before Macro Man will be ready to contemplate strategic longs in stocks.

Between now and then rests what is likely to be a hard slog of treacherous trading conditions. Fortunately, we're all get used to trading those kinds of markets, as "treacherous conditions" is a pretty apt description of the last year or so.

That having been said, there remains ample scope for a further tactical rally within the broader bear market. Whether such a rally actually materializes is, of course, another question; frankly, Macro Man isn't sure. His portfolio risk has been reduced accordingly, as he wouldn't be surprised to see equities end the coming week up five percent or down five percent.

Such short equity risk that he does retain remains concentrated in Europe. While the ECB's intransigence in the face of changing circumstances drew a surprising number of defenders in the comment section of Friday's post, Macro Man is frankly happy for it to continue; equity shorts are always easier to run in the face of unforgiving monetary policy.

To be sure, the rising tumult of regulatory backlash against short-sellers and hedge funds, which resembles nothing so much as a cartoon mob armed with torches and pitchforks, makes Macro Man glad that he does not deal in single name securities. The squeeze potential in single names, both from regulatory diktat and ongoing issues surrounding Lehman-facing trades, appears to be substantial.

It looks increasingly likely that the market will have another go at the dollar. It is pretty hard to construe the implosion of the US financial system and socialization of the associated costs as anything but a negative for the dollar. With central bank swap agreements in place, foreign banks may now be able to borrow dollars again, rather than being forced to purchase them in the open market. Moreover, the market may retain a desire to price in a small chance of additional Fed cuts, though if the SPX rallies another 100 points then hikes will likely re-emerge in short-end pricing.

You'd have to think that the Paulson Plan should eventually steepen the US yield curve, though perhaps not as much as in previous cycles. A steeper curve is clearly beneficial for banks, but if the US wants to kick-start prudent mortgage borrowing again, having long-term rates at too high a level will be a negative. In any event, Macro Man lives in hope that markets re-introduce a term premium into the US government and swap curves.

Ultimately, the market's mission is to get through the end of the year alive. While last week saw the price of many major financial indicators largely unchanged, Macro Man wouldn't be surprised if there was a large pile of money lost in the process. Although circumstances can obviously change, from Macro Man's perch the next few months are likely to be all about opportunistic trading, taking the other side of panicked pricing a la the RMB one year forwards last week. This naturally lends itself to a lower risk budget than normal; and hey, if last week is anything to judge by, you're likely to be taking more risk than you think when you put on a position.

Comments

[Smarty_Pants:]

Overlooking the blatant illegalities of the government's 'bailout', the net result will be the long term movement of the dollar toward its true value of zero.

Any comtemplated positions should bear this in mind and limit exposure to risk levels where large moves against you are tolerable as follow-on interventions seek to forestall the inevitable.

1) Long precious metals
2) Short T-Bonds
3) Short dollar vs. 'stable' currencies like Swiss Franc
4) Short US stock markets

Once again, low risk positions as there will likely be WILD swings with news of each additional intervention. Add a bit on dips, sell some on rallies and build your positions conservatively. Eventually the wheels will come off and you will be well paid for your trouble.

My two cents, for what it's worth. Use at your own risk. I am currently long gold, gdx, and in cash otherwise.

2008 Sep 22 10:44 AM

[carey_jim:]

Smarty_Pants:

It might be in the interest of the United States government to fix gold and silver prices again and to invade Switzerland to protect the dollar.

It would be a lot easier to occupy Switzerland than Iraq, except during the winter, of course.

The good news is that the Swiss will accept baseball cards as legal tender. If that turns out to be more than a rumor,
I might even join up myself.

Go National Guard.

2008 Sep 22 11:54 AM

[wpdragon:]

I believe the worst of the volatility will occur, and the most critical time to try to get through things alive, will not be the end of the year, but rather up until the election.

It is clear from looking at the charts and timelines since January, and particularly the unprecedented actions that the Fed took w/ regard to the investment bank access to the discount window during the Bear Stearns crisis (and their true motivations for doing so), that certain people are desperate to keep the DJIA above 11,000... that is the line in the sand below which they evidently believe there is great political risk for them, as it represents a 25% loss for its headline and most widely watched average, and a loss of support from their rank and file.

Every time the market has broken down below that major 11,000 number it has been met by immediate and violent buying at the same time as major Fed and Treasury intervention and manipulation engineers short squeezes in the Dow and SPX ( and it always occurs after-hours so as to leave the shorts powerless to react).

It started in mid March with Bear Stearns. Look at mid July. Look at last week. Look at the charts.

Coincidence? I think not.

There is a war going on at the 11,000 Maginot Line, and desperate people are doing desperate things to keep the markets above that line.

Can anyone tell me why else, with the extent of this world-wide financial and economic catastrophe, this Black Swan event, the US averages are down a "mere" 25%?

By all rights if you told me the Dow was at 8500, I would certainly not be in the least surprised.

The war for 11,000 will go on until election day.

My greatest fear is that there is another Black Swan event out there waiting in the wings... and it involves the election and our democracy.

2008 Sep 22 12:23 PM

[OldLimey:]

MM: another interesting post. I gather from earlier posts that you're sparing the FX market your attentions at the moment, but I'd be interested in your views on the NZD. With kiwi banks having to go offshore for around a third of their borrowing and paying a hefty premium for the privilege (despite being soundly run institutions), I'm wondering whether Bollard might be lining up some 'shock and awe' on the domestic interest rate front in order to average down their overall cost of funds more quickly than the market expects. I've got a bit of 'pocket money' in a kiwi bank left over from when I lived there. I asked for a 6-month rate last week and was quoted 7%; this morning an unsolicited email offered me 8%. Makes a bit of a mockery of that 50bp cut, methinks.

Smarty_Pants: I like your portfolio choices but can't help wondering who's going to stump up your bail bond. I mean - all that shorting.

carey_jim: suggest you invade Switzerland via Italy. The French and Germans might notice.

wpdragon: another interesting comment. The evidence suggests you're dead right about 11k on the Dow. Regarding another Black Swan before November, it seems utterly crazy - but I've used the 'coup' word already myself on a couple of SA comments. I hope I'll be looking back on that with embarassment by Christmas. It certainly does seem that the US political system is as stressed as the financial system.

2008 Sep 22 02:03 PM

[Smarty_Pants:]

OldLimey: You don't have to be a direct short for three of the four. It's still legal to short T-bonds and stock indices in the futures market. There are also ETFs for both those positions (TBT= short bonds and several for shorting the general market) which allows you to be 'long' while short. You can also buy/sell the USD/SWF in the interbank market if you trust the counterparty bank to still be there when you want to exit.

carey_jim: Good luck invading the Swiss. They're ready for it. It would be much easier to bake them a pie and drop in to say "Hi". They might let you convert all your dollars to francs and stay on a while.

wp_dragon: You're right. Desperate people will try desperate measures when backed into a corner. My cash position is waiting for an opportune moment to take a position in a short ETF. I haven't been in much of a rush though since AIG was "assimilated". I actually closed out a short ETF position about a week before that at a nice profit and I think all the recent political interference will make any position in stocks risky at this point. Gold will be pretty much all for me for the next month or two unless conditions changed markedly.

2008 Sep 22 02:45 PM

[wpdragon:]

OldLimey, see my response to your's on:

Treasury's Plan Is Breathtakingly Awful by Steve Waldman

we have to keep addressing it whether we want to or not.

2008 Sep 22 03:21 PM