Greeks (And Goldman) Bearing Presents: Trojan Horse

Includes: EZU, FAZ, FXE, GS, IEV, XLF
by: Serge Hagopian

In Homer’s Epic, the Greeks devastated Troy despite valiant Trojan efforts. Call it optimism, call it poor “risk management”, but the Trojans saw victory (the Trojan Horse) rather than guard against danger. The rest is history.

In an irony of epic-proportions, the recent sovereign-debt “developments” may be a sign of a devastating blow awaiting an otherwise complacent world hiding behind the secure walls of its panacea: “coordinated government bailout”.

Meanwhile, could the DOW head toward 6000, or 5000, or…?

Goldman: Den of Thieves?

It’s difficult enough for traders and investors to separate noise from information, and analyze facts correctly. Now stories surface that the facts are misleading because Goldman (NYSE:GS) helped Greece “hide” its debt via various financial instruments or vehicles (here and here). To borrow from the movie Sabrina, Goldman Sachs thinks “scruples are money in Russia”. Leaving Goldman’s ethics aside, if the scale is biased how can anyone (bull or bear) “measure” the facts correctly?

This is a valid risk-management concern, not perma-bear pessimism. To wit: how many millions did Greece’s bond-holders loose because of “off the book” issues they were not aware of prior to investing? Just as before with “toxic-assets”, now the sovereign-risk may be what else is out there (not just with Greece, but with others)!

Facts, Not Opinion

The problem is not Greece or Spain. Sadly, the problem of indebted government is much larger. Looking at our own economy, after all that government borrowing, what has changed for the BETTER in a fundamental, sustainable way? Statistical shenanigans notwithstanding, let’s be honest and itemize:

  1. Banks? Existing problems are papered-over (e.g., by changing “market to market” rules, etc). New problems are creeping up and things may get worse (commercial real estate, resetting mortgages in 2010-2012 on mass-scale, etc). Whether banks are now in as bad a shape as in 2008/2009 is another issue, but we know they’re weak, and up against a treacherous future.
  2. Credit? Its true credit is not abysmal compared to a year ago; but it’s still tight and choking off growth prospects. Some argue “tight credit” is a good-thing for a society leveraged to historical-levels, and not a bad-thing to de-leverage to levels that are sustainable in the long-term. Good or bad, it’s plain to all to see that one of the instruments of modern economic growth is on life-support.
  3. Industry? Still swimming in excess capacity, corporations are not planning new factories, facilities, or capital investment at any meaningful-macroeconomic-level.
  4. Consumers? The engine that’s 70% of US economy is still deleveraging.
  5. Unemployment? Not improving, just statistical shenanigans (“improving” numbers reflect seasonal hiring, and/or the unemployed dropping-off the statistical-count).
  6. GDP? It improved, “yes but”. The growth came from replenishing bare-inventories, and temporary government stimulus, which helps-- but it does not make a self-reliant recovery. In the context of other negative economic events, it’s a step forward, and two steps back.
  7. Leading Indicators? More statistical mirage; they’re capturing government-assisted stimulus not private-sector (and sustainable) growth.
  8. Local Government? Even for the optimist, this is a mixed-bag because liabilities of some U.S. States may make Greece look “good” by comparison!
  9. Exports? Good, but for how long? China is clamping down on its banks to rein in its “bubble”, and EU has its hands full with Greece & Co.
  10. The Markets”? I must be wrong, because the markets (Dow, S&P) are UP? Markets are up, so what? DOW was at 14,000 back a few years ago while “pricing in” a robust GDP…where did that get traders and investors?

Sovereign Shenanigans

It was a Greek philosopher who warned “those who do not study the lessons of the past are condemned to repeat it”. Now then, how do you resolve a leveraged-based, credit-lead “great recession”…with even more monumental borrowing, this time by government?

What happens when (1) government expenditures around the world increase to unsustainable levels (think Greece, Portugal, Spain, and yes even US, UK, et al); (2) the private sector stubbornly faces extraordinary headwinds; and (3) the only difference between now and a year ago is this: governments themselves are drowning in debt?

I am not suggesting that a year ago governments should have stood by, arms-crossed, watching economic Armageddon unfold. Rather, I’m focusing on two subtle points: (1) did governments focus on solving the correct problems, and go about doing it in the right way or did they spend precious time and limited resources rescuing the likes of Goldman Sachs?; and (2) was it even possible for governments to succeed when markets failed, or was the global leverage dilemma too big-and-complex to resolve even with the best of intentions and 20-20 hindsight?

Lessons Learned

  1. Only the Cubans, North Koreans, and “V Shaped” recovery crowd believe government solves everything. After 80 years, even the Russians came around. For this recovery to begin; the markets must function (not propped up, but actually function) on their own…we’re not there yet, not by a long shot. For proof, look at the Fed. If the private sector was self-reliant, the Fed would be withdrawing accommodative monetary policy. The “good” news is the private sector is propped up and unable to stand on its own!
  2. The “bad news” is a year of unprecedented government expenditures world-wide, and we’re still debating the necessity of bailouts (substitute Greece for GM, Spain for sub-prime mortgages). Maybe governments have not succeeded, maybe they coordinated their efforts (like lemmings) to merely kick-the-can down the road (helping no one, and only making matters worse). The mainstream media point to this, and call it recovery!
  3. All-mighty “markets” are not infallible and over the last several years “the markets” got it spectacularly wrong. These failures were not of amateur dot com startups with flimsy business plans, but seasoned marquee firms like AIG & Lehman, in the financial “bulge bracket”. After so much private-sector miscalculations by prestigious firms, would it be fair to ask if governments can also make spectacular miscalculations? If so, then not only are we not out of the woods, but maybe the worst is yet to come.
  4. Hope is not a strategy: After so much sacrifice the exhausted Trojans desperately wanted a happy-ending because it’s was so temping to believe the “pain is finally over” and because its was so agonizing to imagine the vicious alternative…Troy saw victory rather then guard against danger. Today’s traders and investors equally brutalized on the financial battlefield may be making a similar mistake in believing “the pain” is finally over. Remember the Trojan horse and never accept a gift from your adversary…neither, for that matter, from Goldman and those selling the “V Shaped” recovery fairytale. Guarding against danger means realizing that things were ugly in 2009, but that does not mean they cannot get worse…just like a stock price might go down a lot, it does not mean it cannot go even lower (e.g., Lehman, Enron, et. al.).

Actionable Advice…Trader-Alert

In context of everything presented, when (not if) markets correct there will be no psychosocial life-line left to calm market sentiment and hysteria because they’ll be no potential of government bailouts right around the corner…Been there, done that. This time, the floor for prices may be much lower than March lows of DOW 6000. Traders are encouraged to consider the following actionable recommendations:

  1. Prudent Risk-Management: Now more then ever, it’s critical to be even more defensive and use upward price-action for profit taking.
  2. Value Advice: Close long equity positions and go into cash…wait for the correction (when, not if) and when liquidity is vaporized, when cash-is-king, buy great companies at prices-of-a-lifetime discount. This is when fortunes are made.
  3. Contrarian Advice: Aggressive traders can open short positions and profit during the correction. Even with the recent market rally I’ve made approximately 12.83% since shorting the market in mid-January (I purchased 3x bear FAZ at $16.7496, and it closed today at $18.90 for a profit of $2.15). Not a bad return for 1 month.

I encourage and welcome honest and respectful dialogue, pro and con, for everyone’s benefit, Bull and Bear.

Disclosure: Author holds long position in FAZ, TZA