Extend and Pretend Only Works for So Long

by: The Housing Time Bomb

Wow this is one tough market.

"Doom and gloom" one day and "happy days are here again" the next. I bet the traders on Wall St are happy today is Friday.

It is also a key day for the market. We now sit just below S&P 1100 which has been a very strong resistance for the bulls. If we manage to break through then I believe the market could run higher for a bit.

If we fail to break through then my guess is we continue to trade in a range until we get more economic data.

The move yesterday was all about earnings and Europe. Microsoft's (NASDAQ:MSFT) numbers were very strong. Amazon (NASDAQ:AMZN) however missed badly. They earned .45 vs. the .54 estimate. The stock is down 11% after hours. It will be interesting to see if the market can shake this off today. Futes are up so far.

One note here is the fact that Amazon relies heavily on the consumer. This miss shouldn't have been a surprise considering the consumer confidence data that's been rolling in.

Other companies like Microsoft have the benefit of selling to business as well as the consumer. As corporations recovered during the past year they started spending more money(although they continue to cut jobs).

As I have said before: The US consumer is toast and the 2nd half of the year will no doubt be dominated by much slower growth. If you dig into Microsoft's earnings the consumer areas of the company like X-box were much less robust.

Corporate profits have been strong because they have become much more productive. The corporate CEO's out there do not drink the Wall St Kool-Aid. They see the storm coming.

They are slashing payrolls and hoarding cash as a result in order to prepare. The balance sheets look strong for many of the corporate giants and there will be some historic values once the market bottoms.

The problem is Dow 10,000 does not mark the bottom although it might mark the top. Many questions need to be answered before we see any sustainable rally(more on this later).

Basically we flew through the first part of this financial hurricane in 2008. We now sit in the eye of the storm as we prepare for the second wave.

The second wave will begin when the Fed is forced to withdraw their stimulus in order to stay solvent.

For now they are content to "extend and pretend" as they piss away our tax dollars at a record pace.

This game can only go on for so long though before someone pulls the plug. That being said, we will see a lot of volatility before we eventually reach this point.

Until then expect a lot of volatility: One day the market will rise as signs of a recovery are evident. Then the next day it will break down as panicky investors sell when it looks like the world is going to end.

We saw a lot of market action like this in the 1970's. My father (a Wall St vet) tells me about the stories from Wall St during that period. Gold would move up or down $50 a day as the market feared an inflationary collapse.

Every day the desks would be filled with traders who thought the market wouldn't make it. It did, but not before we saw double digits rates and a deep recession in the early 1980's.

This go-around the fear is deflation versus inflation. Nonetheless, that doesn't mean that people won't act in the same fearful way.

I am starting to wonder if the market might act in a similar way due to all of the fear. As you can see below (), the Dow in the 1970's basically flatlined at 1000.

I can't help but ask myself this question as we continue to break down once we get a tad above 10,000 on the Dow: Could Dow 10,000/S&P 1100 be the top of the range for the next 10 years? Only history will tell us. However, the longer we keep failing to march past it the stronger the resistance will become.

The Bottom Line

The next few weeks are going to be very interesting. We get the European stress test results today. I am sure those will be a joke. The way Europe has been rallying this week you know the news will likely be positive. You have to also assume that the numbers have been leaked.

I suspect you may see 1 or 2 banks that play the role of being the sacrificial lamb. Another Ponzi style buying spree is very possible today after the press release.

The bottom line here is the market thinks all is well now. Europe has stabilized and earnings have been strong. It's the perfect setup for a short move higher.

The problem longer term is there are too many questions that have no answers:

  • How long can the Fed replace the consumer?
  • How long can we continue to sell $189 billion in treasuries like we are about to do next week?
  • How long will unemployment continue to rise?
  • Where are the new jobs going to come from?
  • How are we going to pay down the deficit?
  • How are the states going to stay solvent?
  • How do we continue to fund Social Security and Medicare?

I will stop there but the questions are endless and I have yet to hear one reasonable solution. The only solution thats viable is to slash spending.

If we don't do it now then the market is going to do it for us. We can't grow out of this depression like we did during our minor recessions the past 25 years. Wall St and the Fed keep talking themselves into thinking that we can.

The issue here is losses are too large. If they could have been taken then we would have setup a resolutions trust like we did in the 1990's. We couldn't do it this time because the losses were too overwhelming for the system.

When these losses are finally realized we will be right back in the soup except this time there will be no money left for bailouts. There will be no recovery until these losses are recognized.

It's just a matter of time until they are exposed. Fraudelent accounting and the Fed's balance sheet can only last for so long before the bubble bursts. Enron learned this the hard way and I am afraid we will end up being forced to learn the same lesson.

I hope everyone takes advantage of this "extend and pretend" market by paying off debt and saving money. You are going to need it as the "sugar high" from the stimulus eventually gets pried out of the governments hands.

Disclosure: No new positions taken at the time of publication.