Maintaining a healthy perspective is about all you can do in volatile times. Keeping your long term plan in tack and trying to stave off a major meltdown is much easier said then done. Are we currently experiencing more growing pains or are we on the brink of another meltdown?
There are really two ways to look at any stock market: Short term and Long term. For most of us especially those that value our 401K, pension, kids college savings, etc. we really only care about the long term perspective. If you are looking at the market for a short term perspective you are most likely a trader or someone who loves to speculate. In general when markets experience extreme changes in volatility (meaning large up days or large down days) the market becomes a trader’s paradise.
Right now everything is broken: Oil is at or below $70. The VIX broke into the 40’s. Almost all indexes’ (DOW, S & P, NASDAQ) are below their 200 day moving averages, and my good friend copper is still way below it 200 day moving average. A new one I will talk about below – LIBOR is starting to tell us something also.
Why the technicals are important: Over 70% of the trading that happens on a daily basis is done by computers. These computers are unmanned and use a complex series of algorithms set against specific “trigger events” to trade the market. Some of these programs rely directly on technical analysis. Once a certain trigger is reached, example the (21 day moving average breaks the 200 day moving average) the computer changes it approach to making money and starts to sell on the up days and “maybe” buy on the down days….thus creating an overall down trend. Personally I hate the technical perspective but after the last meltdown I have forced myself to understand the hell out it!
Some will argue that from the US perspective (US economy) we are fine as we have just finished a very strong earnings session. Most companies have posted record profits (compared to last year) and all have posted very strong growth models in the months ahead. As a result the market is currently undervalued and we will soon see a much due bounce to bring us back to normal and further to continue our trend higher past our April highs.
-All this is true, we have come off a record earnings session, on paper we look well on our way to recovery…but none of the future growth models have taken in to account the current downturn Europe and China are about to head into. No one predicted the European problems would be this bad also most thought the problems in Europe would stay in Europe – this does not appear to be the case. With this conclusion we need to assume the current market highs in April reflected a much better global economic landscape then is the case today. It makes sense to think this new perspective could continue to fuel the market lower.
-I also maintain a stance that the current recovery is due in large part to the Government pumping billions of dollars into the system….again I mentioned last time the valve was turned off on March 31st. Look what has happened since then!
- Financial Regulation: Will the market as we know it is still be broken? Not until it is “fixed” will we be able to return to a world that will allow our retirement vehicles to survive and grow on what I consider a normal basis. When I say fixed, I mean – real laws passed by the Congress and Senate that put the entire derivatives market (600 to 700 trillion by the way) out in the open. This system needs to be completely transparent. If you want to gamble or take this much risk then guess what, rigging it in your favor and being bailed out when the bet goes bad can no longer happen. The current legislation contains an amendment called the “Lincoln Amendment” this amendment aims to extract government-backed financial firms from the derivatives market – basically what it says is if you want to participate in the derivatives market then you cannot be backed up by the US Federal Government. This is huge as I believe it may force all investment firms to separate from the banks they are attached too. Firms like Goldman Sachs, JPM, BAC, Citi and others will have to separate there proprietary trading platforms. Currently these trading platforms are backup by the “true” banking component of their firm and therefore also backed up by the Federal Reserve, oh and you and I - the taxpayers! The “Lincoln Amendment” if passed will be in the history books we read 20 years from now as the first real push to regulate the derivatives market. Goldman is so worried about this amendment they have 46 lobbyists currently running up and down the halls of congress trying the get the amendment removed. And for good reason - 70% of Goldman’s business comes from their prop trading desk. The transaction fees they make from the derivatives/credit default swap market business is in the billions. The amendment has passed the Senate and must still pass the House, personally I would like to see the Congressman that falls on his sword to attempt to remove the amendment and where he ends up working after he is voted out to his position! If only I could buy a credit default sway on him obtaining a position at a major wall street firm. I do believe however if the amendment is passed it will rattle the markets a bit to the downside, but still this is the kind of pain we need if we ever want to be on level playing field again.
- EUROPE: What a mess, think about for a second, they have this great unified system they call “United Europe” linked only by their “financial/economic” responsibilities, they appear to share one currency, one economic presence but oh by the way they all maintain very separate governments. Different from the United States we have 50 states that all fall under one umbrella - the Federal Government. The ECB (Euro Central Bank) can set economic policy but it then needs approval by each country – this makes it hard if not impossible for them to agree on anything particularly during hard times. They are unified but only to a point, example: On Tuesday of last week Germany alone banned “Naked Short Selling”, On Thursday Italy suspends mark to market account standard used to value its bonds. What this spells out is system of countries all trying to solve this crisis via their own way. Europe needs to be unified and on the same page or the volatility is going to continue to spiral out of control. As countries begin to adapt to their austerity requirements the potential for more scenarios like Greece will be greater. Throwing money at the problem has thus far not seemed to have a positive outcome. Since the 1 trillion was pledged, the Euro has sunk, gold has spiked, and European markets continue there downward trend. I still think something of significance needs to occur in Europe, something along the lines of “individual defaults” allowing some of these debt ridden countries to separate from the ECB, essentially declaring bankruptcy and going on their own. Just think of Europe’s economic picture without these troubled countries. At the very least we need a set of rules in place for Europe to deal with its problems, still we have nothing and the idea of throwing good money after bad – well that will buy you some time but not a cure!
- LIBOR rate: The LIBOR rate is the rate at which banks lend each other money. Specifically the 3 month rate seems to get the most attention. Basically it works like this, The Federal reserve will lend money to banks at a certain percentage and banks will then lend it to each other with a very small up tick on that percentage. Thus maintaining a necessary amount of liquidity in the system. The Federal Reserve has set the current rate (known as the federal funds rate) at 0 to .25 percent-basically free money. Thus in a normal environment banks would then lend it to each other at a maximum of .255 percent, again almost the same as the Federal rate. You may recall back during the last crash part of the reason was due to credit freezing up, banks where not lending each other money. Banks where so afraid to lend money to another bank thinking that is was going to pay for a mortgage write down or a credit default swap that the rates jumped as high as 300% above what the Fed was lending (back then the fed lending rate was around 1.5% and LIBOR rate was around 4.55%) Today the Libor rate is around .5% - already 100% above the lend rate. We need to watch this, in my opinion it is the closest way to see if the banks are working correctly. http://www.bloomberg.com/apps/quote?ticker=US0003M%3AIND
- Employment, what is the next growth engine: We need to discover our next “economic driver” and one that will create jobs. Is it healthcare, technology, alternative energy, higher education? Again as mentioned early we keep hearing about a recovery and companies seem to be reported stronger balance sheets…..but has anyone noticed the job market lately. Supposedly we have gone 4 months in a row with positive job growth, even last month we added 290,000 jobs, the most in 4 years. Here’s the catch, even though we added the 290,000 jobs our unemployment rate still jumped from 9.7% to 9.9%. In the words of Kenan Thompson from SNL “what’s up with that”. Sounds like some Enron Accounting at work here! Regardless, until this percentage begins to decline we cannot assume a full recovery is underway.
- The Road Ahead: What started to be a very strong year many portfolios up 10 to 15 percent has quickly turned. The technicals I like to watch seemed to turn in mid to late April, the story and background worsened in early may. Even now I still would rather watch then participate in the madness. Even a 4% up day scares the hell out of me - I hate volatility. I need the picture to improve, something dramatic to happen in Europe, the S&P and Copper to get back above their 200 day moving averages, the VIX to get in the low twenties again and LIBOR rate to be more in line with the Federal Lending Rate. I would love to see the unemployment rate start to go down – not up! I will admit some of these indicators have started to improve (over the past few days mind you) but I still need much more before I jump back on the train. I heard a great analogy the other day - Imagine the market is an airplane, for takeoff we had to boost the engines (March 2009 to March 2010), once airborne at a cursing altitude the engines need to throttle back, the question now becomes at cruising altitude is the plane starting to heading down or just experiencing some turbulence at it moves further?