No, no, don't worry. As a participant in the Credit markets and the infamous CDO, I have been developing a gloomy view on the Economy and the way this crisis will unfold for a while now, it began far before I started blogging. Today, I think I came to a scenario not that far from what we could call the Financial Armageddon or the Market Apocalypse (your choice... ). First a few arguments that have kept feeding my bearish view :
- Nothing is fixed on the Investment Banks side. To me, the subprime tox... oops... Legacy assets, that no one (to date) is able to value properly and still massively in banks balance sheets despite of government purchase programs, are just a first instance of the bad assets they loaded during the boom times driven by greed and more generally by, referring to Mayo's April 09 report, the 7 deadly sins of banking . The recent profits and the return to the high banking bonus days highlight that bankers have the upside letting the downside to the taxpayers, showing a strong lobby I'm not sure that is sustainable as Obama is starting to be criticized for using too much of the taxpayers money.
- The subprime crisis and the drop of residential property market can spread to commercial property market in a first step then to corporates, particularly the SMEs that are "too small to rescue". The recent case of CIT, a major lender to SMEs, is a good to illustrate the latter point. Despite their importance to the survival of a million of SME and the implied systemic risk, the government decided not to bail-out. They finally received a $3 Bio lifeline from the creditors, enough to meet a debt deadline but paying that funding 13% (more than the rate they can fund their customers at) and with a 7 times collateral. This lifeline that helps CIT to survive may not be enough to prevent their customers to bankrupt as the collateral posted for that new debt is taken from the flows they need to pay to their customers in the factoring process : CIT customers turned from debtors to creditors. Another point is the CDO of subprime ABS burst but not the synthetic CDO of corporate, that is the major parts of the CDO world, that brings us to the next point :
- The financial weapons of mass destruction... here they are. The "Derivatives Bubble" is yet to burst. The CDO and even all the CDS market could appear as a drop in the ocean compared to the current quadrillion exposure of derivatives. The derivatives have granted to investors a leverage level, a manifold of the total world actual wealth, we are not able to control anymore and any trader knows the outcome of a highly leveraged position when the market is going against you. An additional point is the pricing and the delta hedging of structured products use mathematics models that don't reflect properly the extreme market conditions. When such conditions occur : we're just blind and have no idea what is the value of those complex products!
Mmmmh, nothing good here... Now the real question is the timing all these will go burst.
Re-assessing my global view and strategies, the thing is as we all know, the market can stay irrational longer that you can stay solvent (Keynes) and in the current environment I would tend to go ... well ... long !!!
Long for the "short term" as in a few weeks to a few months
Back to my short stock index position after Goldman earnings announcement. I got burnt on that one in less than one week and that's a very strong signal for those who like me use volatility stops as it shows a very strong trend against your initial position. In most of the case, the good strategy in this situation is to reverse.
- Nothing is fixed on the Investment Banks side. To me, the subprime tox... oops... Legacy assets, that no one (to date) is able to value properly and still massively in banks balance sheets despite of government purchase programs, are just a first instance of the bad assets they loaded during the boom times driven by greed and more generally by, referring to Mayo's April 09 report, the 7 deadly sins of banking . The recent profits and the return to the high banking bonus days highlight that bankers have the upside letting the downside to the taxpayers, showing a strong lobby I'm not sure that is sustainable as Obama is starting to be criticized for using too much of the taxpayers money.
- The subprime crisis and the drop of residential property market can spread to commercial property market in a first step then to corporates, particularly the SMEs that are "too small to rescue". The recent case of CIT, a major lender to SMEs, is a good to illustrate the latter point. Despite their importance to the survival of a million of SME and the implied systemic risk, the government decided not to bail-out. They finally received a $3 Bio lifeline from the creditors, enough to meet a debt deadline but paying that funding 13% (more than the rate they can fund their customers at) and with a 7 times collateral. This lifeline that helps CIT to survive may not be enough to prevent their customers to bankrupt as the collateral posted for that new debt is taken from the flows they need to pay to their customers in the factoring process : CIT customers turned from debtors to creditors. Another point is the CDO of subprime ABS burst but not the synthetic CDO of corporate, that is the major parts of the CDO world, that brings us to the next point :
- The financial weapons of mass destruction... here they are. The "Derivatives Bubble" is yet to burst. The CDO and even all the CDS market could appear as a drop in the ocean compared to the current quadrillion exposure of derivatives. The derivatives have granted to investors a leverage level, a manifold of the total world actual wealth, we are not able to control anymore and any trader knows the outcome of a highly leveraged position when the market is going against you. An additional point is the pricing and the delta hedging of structured products use mathematics models that don't reflect properly the extreme market conditions. When such conditions occur : we're just blind and have no idea what is the value of those complex products!
Mmmmh, nothing good here... Now the real question is the timing all these will go burst.
Re-assessing my global view and strategies, the thing is as we all know, the market can stay irrational longer that you can stay solvent (Keynes) and in the current environment I would tend to go ... well ... long !!!
Long for the "short term" as in a few weeks to a few months
Back to my short stock index position after Goldman earnings announcement. I got burnt on that one in less than one week and that's a very strong signal for those who like me use volatility stops as it shows a very strong trend against your initial position. In most of the case, the good strategy in this situation is to reverse.
More on a technical analysis side we can see on the chart landscape several bull marubozu (big white candle with no shadow) candles each of them being one of the most significant sign of strength, of course it is even more powerful when you have several of them concentrated in a short number of periods, here I can count 3 and when they follow each other (that's the famous 3 white soldiers pattern). Mathematically, a white marubozu triggers a jump in the RSI and can bring it to an overbought status quickly. My experience with RSI is that once it went to a Overbought (or oversold) state, most of the time it comes back in that state shortly after its return to a "normal" state. I haven't not studied precisely the thing (nor read some research on it lately to be frank) but my feeling is white Marubozu and overbought RSI both reflect physics properties of the prices : once they occur, the price can not "physically" revert easily. That's a bit like a car launched at full speed, before changing direction, it will keep on going in the same direction and needs to decelerate, to brake, sometimes to stop before being able to go on the other direction.
To me, the range that began in April (880-950 for the S&P 500) broke on 20 July and the break was validated with the marubozu that occured on the 23rd. To me, this is clearly bullish for the next few weeks, albeit we could see in the very short term (a few days) a pull back that can test the 950-mark (old resistance that will probably act as a support).
Long for the "medium term" as in a few months to a few years ?
For this term, I have to confess that I have mixed feelings and no clear view. That's pretty new as the Bearish arguments I showed above used to be the foundation of my medium term bearish view.
The thing is I buy more and more the arguments of guys seeing a few bullish years before a deep recession and my Market Armageddon scenario like recently Roubini who predicted on July 23 that the global economy will begin recovering near the end of 2009, before possibly dropping back into a recession by late 2010 or 2011 because of rising government debt, higher oil prices and a lack of job growth or before him Russel Napier who forecast end of June a few years of stock market gains as the central bankers are engineering a return to inflation before the inflation "spirals out of control and foreign investors stop buying U.S. sovereign debt, sending the Standard & Poor’s 500 Index to an eventual bottom of about 400" (see the related discussion thread).
Inflation! That could the part I've missed since the beginning of this year while I was hit shorting the stock indices and the weakness of the USD can explain decently the rally we're currently in rather than earnings or other end-of-the-crisis arguments. How are the central bankers engineering the return of inflation ? Well that's the Quantitative Easing, Credit Easing or whatever-its-name thing : let's forget about all the technicalities around those concepts, in a few words : it's the FED printing massively USD. That leads to USD weakness, notably compared to the EUR and combined to inflation prospects, it drives stock and commodities markets up. That would mean that while the FED supports the weakness of the USD and the return of the inflation the markets will keep going up and Bernanke's testimony on 21 July seems to indicate that the QE mode will be on for a while.
I will keep you posted as my thoughts on all this develop as I need to see more how things happen to go further in this view.
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Finally, to translate the ideas developed in this looong post in terms of trading : I'm reluctant to go long stock indices as I'm naturally long stocks. But, further to my arguments above :
- I added last week to my long gold position (initiated at 688) at around 934, taking the risk to jump the gun before a stock correction as Gold is a bit less correlated to the stocks (there's a safe haven effect that drives it up when the things go bad), as it is a long term play and as I am protected by the consequent profits from the initial position.
- I cut a small remaining short EURUSD position at 1.4299 with a loss I had for a couple of month to partially hedge my Gold position playing a strong return of the risk aversion. I will wait for a significant pull back to start building a long EURUSD position that, if the medium term arguments above are true, could hold for years.
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1 comments:
I think I finally understand your arugement about QE and inflation. Just took some time to work out. Im finishing up the edited version. Ill forward it to you when Im done and follow up with some comments!
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