3SOF

DK Report again:
Liquidity injections can smooth out the wrinkles in financial markets, but the effects are both mildly disfiguring and very temporary.

In less than 48 hours this week, the central banks of the US, Europe, Canada, Japan, Switzerland, Australia, Singapore, Malaysia, the Philippines and Indonesia injected over $293 billion of liquidity into the global financial markets. A whopping 72% of this infusion -- $213 billion -- occurred not in the US system, but in Europe.

This was the largest global liquidity injection in history, and it's ironic that the US pump was a paltry $62 billion, one-fourth the size of Europe's.

There was also a jargon injection, with "statistical arbitration" and "quantitative funds" added to a growing list of arcane credit terminology popping up in the mainstream press.

The market also saw a volume injection, as this marked the heaviest week of trading in US stock market history. The kicker is that even though volatility reached record highs, the stock market paradoxically edged higher as well.

What's going on here?

Hard to say for sure, but below are eight observations:

1. The Stock Market
The financial markets have become more irrational than they've been in years. The source of the problem is that mortgage-backed securities -- a huge asset class -- have become difficult to value. Wall Street hates uncertainty anyway, and when it extends to the value of an entire asset class, it's a big problem. Massive positions are being liquidated for reasons other than fundamentals or technicals, making this an unusually risky time to own stocks. Because so little has been resolved, it's going to get worse before it gets better, probably much worse.

2. Statistical Arbitration and Quantitative Funds
Stat-arb is the latest variation of black box strategies in use for decades (LTCM was brought down by a variation of these). Really smart guys with computers exploit tiny, statistical abnormalities in the relationships between various securities. The spreads are so small that enormous leverage -- 3 to 10 times -- is used to make them profitable. The problem is that in an emergency, it can take 3 to 10 times as long to exit a position. When the emergency is in an illiquid asset class -- like mortgage securities -- it can really get out of hand. Perfectly good stocks get sold en masse to raise cash, which in turn triggers stops at other firms, and so on. The irrationality can accelerate rapidly.

3. Liquidity Injections vs. Rate Cuts
Because the FOMC didn't cut rates on Tuesday, Fed critics feel vindicated by this week's liquidity pump. However, liquidity injections and rate cuts are very different tools. Liquidity can be highly targeted (the Fed bought high-quality mortgage paper this week) and is very short-lived. Rate cuts are a blunt instrument capable of producing unintended consequences. The effects are also much more long-lasting.

4. Bail-Outs
There's widespread disgust at the thought that the peddlers of shameless credit products are getting "bailed out" in some way. The truth is that the peddlers are paying dearly for the Fed's help. The Fed is holding the market's best mortgage paper for just 3 days. After 3 days, the peddlers have to buy the paper back plus a Soprano-style vig that's roughly 5-19% higher than on the open market. The bad news? This caper doesn't solve the original problem of the subprime toilet paper they still can't sell.

5. Greenspan vs. Bernanke
Thanks to the bias of Greenspan's 20-year reign, an entire generation of Wall Street pros believes that the main function of the Federal Reserve is to be "accommodative". This isn't true of course, and Bernanke's data-driven approach has proved a genuine shock to the system. Despite consistent policy language and behavior, Wall Street refuses to take Bernanke at his word. You can see this doubt in Fed fund futures and the bond market, which after 1 1/2-years still resemble more of a Greenspan handicap than Bernanke's approach. Bernanke will continue to provide liquidity, but will be slow to cut rates. If things really fall apart, he will of course. But short of that, he'll continue adjust policy to the incoming data.

6. Frozen Markets
The biggest reason Bernanke will be slow to cut rates is because in the end, lower rates won't solve the problem. Illiquidity has hit the mortgage market because the value of the assets is unclear. In absolute terms, rates are low, and making them lower (a) isn't going to create valuation epiphanies, and (b) will open a can of worms in other asset classes and global economies. Transparency, not cheap rates, is the only true solution.

7. "Malt Liquor Mortgages"
The unspoken secret about the subprime mess is that these products were designed for and marketed to low-income minorities, mostly African-Americans and Hispanics. Comedian Jon Stewart had a great subprime bit on The Daily Show this week. Guest Larry Wilmore called subprime the "menthol cigarettes of loans", adding "we knew these loans were unfair, that's why we stopped paying them back!" In a twist on Black Power, Wilmore contends that Blacks are getting back at The Man by using $100 billion in leverage to strip him of power, status and wealth. Protests, voting and violence are dead ends -- using Wall Street against itself is the ultimate diss.

8. The Silver Lining
When the stat-arb boys are forced to raise cash, they sell the market's best companies, and cover shorts on the worst. This crushes hedges with a vice, yet it's why the worst stocks did so well this week, and a troubled, heavily-shorted market closed higher. The silver lining is that this irrational behavior is creating a large value inefficiency in the market. The economy is in decent shape, yet some of the most best stocks in America are being dramatically mis-priced. There's a bundle to be made when this is over.

Keep some powder dry.


http://dkreport.blogspot.com/

lol



Disclaimer: Not suitable for children under the age of 3, Ron Paul, or Conspiracy Therorists. May contain parts easily swallowed that may present a choking hazard. May not fly in some situations. Not sanctioned or authorized by the Federal Reserve Board, Ben Bernanke, Shadow Governments or the Plunge Protection Team ™

DK Again with nice links included:

Monday, August 13, 2007
The Day After

After a promising start, stocks faded to unchanged on Monday as the market nursed a wicked hangover.

Volume started out heavy, but faded dramatically as the day wore on. By the close, NASDAQ trade was off 31%, and leading stocks put in a similar bleary-eyed performance. The IBD100 edged up 0.2%, but 94 of 100 stocks traded on lower volume. Strong open or not, institutional investors remain cautious.

Volatility has been so wild recently that it may come as a surprise to learn that stocks have actually traded in narrow range for the past 13 sessions. Also, price losses for the broader market are still relatively minor, with the Dow off just 5.6% from its high. The indexes are all consolidating at their 200-day, except for the Dow and NDX which are hovering at their 50-day. The market just experienced its heaviest trading week in history and stocks still aren't in an official correction yet.

In the face of all of the uncertainties surrounding the credit markets, this sideways action has produced a growing sense of bullishness among some experts. Below is a random sample of this and other bullish indicators, and there's much more of it out there:

--- Bill Cara is one of many who believe that the liquidity injection will lift stock prices.

--- KingCAMBO makes an interesting Camtasia presentation on the XLF that suggests The Fix is In, and big money is flowing back into financials.

--- Bill Rempel uses a variety of Predictive Models, and his 20-day versions remain positive for stocks. He notes that regression models are offering good odds, and that his fav EMA-based trend is still up.

--- Carl Futia offers a contrarian observation: while stocks have gone nowhere, the media has grown more bearish. Barron's, the New York Times, Chicago Tribune and Business Week Online have all published bearish front page stories.

--- In another contrarian bullish take, Mark Hulbert notes($) that the HSNSI has fallen off a cliff and is now down at a shocking 5.4%. Just four weeks ago, it was at 50.9%! While the Dow fell 5.5%, HSNSI slid 45 percentage points, a move contrarians would suggest is a tad overdone.

--- Goldman is making a bullish move from the belly of the beast, pouring $3 billion back into the deeply wounded Global Equity Opportunities quant fund.

--- There's definitely no signs that the US or global economy are rolling over, and Q2 earnings season both beat expectations and offered decent guidance.

--- Finally, there's a hodgepodge of various technical bottom finders and volatility metrics nearing extremes common at important IT bottoms.

So, are we near a bottom?

It would certainly make things simpler, but very weird clouds remain on the horizon.

--- On Thursday, both the Dow and NDX undercut their previous low, killing the new IBD rally on Day 8. The "Current Outlook" of Investor's Business Daily has returned to "Market in correction".

--- VIX and More notes that the commercials are heavily long VIX calls. This is the "smart money", and it points to continued equity downside ahead.

--- In an interesting twist, one of Bill Luby's readers noticed the purchase of 30,000 Aug 25 VIX calls on Monday. This is a $7.5 million bet that the VIX will close above 27.5 by Friday -- a big negative for the stock market. Such a large, professional move led Bill and others to wonder if another fund is about to liquidate on a massive scale.

--- Speaking of options, Jim Kingsland notes in his CNBC Options Report that despite Goldman's $3 billion GEO ante, options players aren't bullish on XLF, with puts swamping calls 2.5 to 1 on Monday. Is this another tip that more liquidation is ahead?

--- The current index consolidation at 200-day support looks like a bottom. However, it could easily be a setup for a fresh leg down. Numerous technical indicators give this possibility above-average odds.

--- In a troubling sentiment note, the AAII Sentiment Survey shows that individual investors are surprisingly sanguine about the current pullback. At 46% bullish, this group has a long way down before it reaches historic bottom territory.

-------------------------------

Strong arguments for both the bullish and bearish case are being made by experienced professionals. However, this fact alone suggests that the pullback may not be over. Historically, a sentiment extreme needs to be reached before corrective behavior is complete, and this is clearly not the case. Also, despite last week's heavy volume, an exhaustive price extreme was never reached either. Lastly, it seems very unlikely that the financial sector has given up all of the skeletons in its closet.

In the end, a strategy is perhaps most influenced by one's time horizon. With your time frame in mind, adjust risk to taste.

And get ready for another ride 'round the track.

http://dkreport.blogspot.com/

cheers
O.

The following poll results tells me we're near the bottom for the stock market:




CNNfn poll

I guess your a contrarian Dave. I personally am also with the "no way" crowd. Unfortunate but necessary we are in the beginning of a recession. Time to start saving. Opinions welcome.

uc.

Quote from: usedcasting on August 15, 2007, 09:13:20 AM
I guess your a contrarian Dave. I personally am also with the "no way" crowd. Unfortunate but necessary we are in the beginning of a recession. Time to start saving. Opinions welcome.

I totally agree.  I am going all gold.  This credit-housing-dollar bubble will make the tech bubble look like a blip.  The signs indicate to me that US is not just in the beginning of a recession but a large scale depression like the 1920s.  Bankruptcy for the US government is a matter of when not if.

This is all just my opinion.

buddjas1: what are the signs? thanks. Berloga.

Not sure about longer term, but I think we should see a bounce on the Dow around 12700 to 12800.  Tech should be OK till end of year.

Hi All
Long time no write.
I have been following John Mauldin and tend to agree with him that things will be flat to mild recession.
He's got a free newsletter you can check out at:
http://www.investorsinsight.com/

I like this guy who is pro gold as well.
http://investmentpostcards.wordpress.com/

Cesar - Keep up the good work!
I'm still with ya!

Is anybody in PLYFF? - Tungsten play (I am)

All the Best
G Man

Quote from: berloga on August 15, 2007, 09:36:35 AM
buddjas1: what are the signs? thanks. Berloga.

The sign is history repeating itself.  While there are many theories to the cause of the Great Depression, the one that makes sense to me is the "Austrian School" idea--a credit driven market expansion is a false expansion.  So when the credit dries, the bubble bursts.  There is a wealth of information on this issue, but a good place to start is:

http://www.independent.org/pdf/tir/tir_08_1_garrison.pdf

See page 115 and the following excerpt:

"In recent years, Bernanke (1983) has resurrected the old debt-deflation view of
the Great Depression. Investors who are seriously in debt when a price deflation
occurs are in big trouble. If there are enough such people and they all have to tighten
their belts, then spending falls precipitously, and the whole economy is in big
trouble—especially the banks. In the face of bad loans and hard times, banks become
more conservative. They build up their reserves, which intensifies the deflationary
pressures. The big trouble gets bigger. This kind of self-aggravating process can turn
a 1930 into a 1933. Parker describes the depression-inducing dynamics of debt cum
deflation as the "Nonmonetary/Financial hypothesis" (p. 14). He recognizes, however,
that this hypothesis is built on Friedman and Schwartz's monetary hypothesis.
Clearly, the monetary aspect is crucial because otherwise there would be no accounting
for the initial deflation. The debt, accumulated in the 1920s with little or no
regard for the deflation that lay ahead, just helps to explain how a change in a nominal
magnitude (the money supply) can have real consequences (reduced spending all
around and hence reduced employment and output levels)."

Sound familiar?  Keep in mind that hedge funds, which are primarily credit funded, account for half of NYSE volume.

http://www.taipeitimes.com/News/biz/archives/2007/08/05/2003372840

The Fed will act to lower rates. There will be some pain in the interim but when that happens the inflation cycle will continue to power higher. We are locked into inflation for the next few years, lower rates etc...

This will all pass, it's noise people. The time to buy fear is now.

Quote from: buddjas1 on August 15, 2007, 10:17:47 AM

Quote from: berloga on August 15, 2007, 09:36:35 AM
buddjas1: what are the signs? thanks. Berloga.

The sign is history repeating itself.  While there are many theories to the cause of the Great Depression, the one that makes sense to me is the "Austrian School" idea--a credit driven market expansion is a false expansion.  So when the credit dries, the bubble bursts.  There is a wealth of information on this issue, but a good place to start is:

http://www.independent.org/pdf/tir/tir_08_1_garrison.pdf

See page 115 and the following excerpt:

"In recent years, Bernanke (1983) has resurrected the old debt-deflation view of
the Great Depression. Investors who are seriously in debt when a price deflation
occurs are in big trouble. If there are enough such people and they all have to tighten
their belts, then spending falls precipitously, and the whole economy is in big
trouble—especially the banks. In the face of bad loans and hard times, banks become
more conservative. They build up their reserves, which intensifies the deflationary
pressures. The big trouble gets bigger. This kind of self-aggravating process can turn
a 1930 into a 1933. Parker describes the depression-inducing dynamics of debt cum
deflation as the "Nonmonetary/Financial hypothesis" (p. 14). He recognizes, however,
that this hypothesis is built on Friedman and Schwartz's monetary hypothesis.
Clearly, the monetary aspect is crucial because otherwise there would be no accounting
for the initial deflation. The debt, accumulated in the 1920s with little or no
regard for the deflation that lay ahead, just helps to explain how a change in a nominal
magnitude (the money supply) can have real consequences (reduced spending all
around and hence reduced employment and output levels)."

Sound familiar?

That all makes sense in general, and I cant provide a good argument to say it wont happen. 

My only contrarian indicator on that is that Fast Money reported last night that Warren Buffet just anounced yesterday a new position in Bank of America (among a LOT of other new or increased positions like NKE, WLP, UNH, DJ, BNI, etc.).  The caveat is that the announcement is as of June 30th, but its rare he would put on a position and sell it quickly.  He isnt infallible, but its worth noting.

Then, right as they were reporting that, they got in real time news that Eddie Lampert boosted his position in Citigroup by 65%.  Two of the big time billionaire investors getting into banks/financials.

If there are enough such people and they all have to tighten
their belts, then spending falls precipitously, and the whole economy is in big
trouble?especially the banks.

That is the key-if there are enough people. Right now no one really knows the scope and impact of the subprime mess and valuations of mortgage debt securities is a crap shoot and certainly the dust hasn't settled yet. If a large lender such as Countrywide report more bad news as they dig deeper into their losses then that may be the catalyst for the market to tank in a big way. I'm betting that the losses will be spread out and the crisis we see now will be looked upon as a great buying opportunity for equities that have gone through the ringer for the last several weeks.

Quote from: capricho on August 15, 2007, 10:55:32 AM
If there are enough such people and they all have to tighten
their belts, then spending falls precipitously, and the whole economy is in big
trouble?especially the banks.

That is the key-if there are enough people.

Keep in mind that consumer's total household debt now equals the GDP and household debt is 134% of income.  Consumers have to tighten their belts, as credit tightens.

http://bigpicture.typepad.com/comments/2007/04/capital_commerc.html

Thank God I can pay my credit cards in full each month and have the pink slip to my 10 year old car. Those numbers are rather sobering.