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With the last legs of this rally really more of a sideways trade on very light volume, we’re starting to see some signs that a rolling over process has begun.  While there is plenty of reasons to be a bear, the most compelling reason to be a bull was the notion that things were getting worse at a slower pace.  The idea was that we overcorrected to the downside in March, facing what appeared to be a depression, and having (at least temporarily) taken that off the table, we see very attractive valuations.

We’ve had a nice run already

After about 40% off the bottom, I think we can say the valuations have gotten ahead of themselves.  In addition, there are no signs of an earnings-led recovery or any real green shoots that indicate we’ll be seeing a pronounced rebound in the economy.  Most of the optimism is coming from China, which seems to be hoarding commodities for its own hedging game against the falling US dollar.  While hunger for raw materials is good for the markets, if it is not a genuine appetite that stems from growth, but rather a desire to build a materials portfolio for the Chinese government, then much of the optimism in energy, materials and other related sectors is overdone.

The biggest driver is not behind the wheel

The consumer is facing more foreclosures, credit card defaults and an increasingly tight employment picture.  This is not the atmosphere that is condusive towards a consumer-led recovery.  Consumers probably have 5-10 years before they can start to lever up again on their credit.  Other emerging markets are attempting to build consumer economies, and facing tremendous headwinds from populations who treasure thrift rather than spending.  The appetite for material possessions is not nearly as strong nor are earnings per capita elsewhere enough to sustain the vacuum left behind by the American and European economic implosion.

Greenflation not back, yet

Green energy is a promising sector when crude oil is above $100.  Right now the motivation is just not as strong with consumers or companies to make big moves in to more environmentally sustainable energy.  I believe that once inflation makes energy less affordable the appetite for green energy will increase.  This may be a while off depending on how fast the global economy can pick up the slack left behind from the last bubble.

Climb a plateau once its peaked…

So where is the catalyst for the next rally?  What could drive equities higher?  The only way we’re going to see a tremendous rally from here is if we see much more currency debasement and intentional inflation.  That kind of manipulation could continue to lead markets higher, but at the cost of the currency that equities are priced in therefore nullifying much of the gains.

Or fall right off?

I think the market is setting up to fall.  I’m not so sure we’ll retest the lows or not, but I do think we’ll see some more selling as fundamentals begin to play a center role in the stock market again.  On a technical note, we may be building a pretty significant head and shoulders pattern on the S&P 500.  Today’s action seems to confirm the right shoulder.  We could see a retest of 875 or lower if it continues to play out.

Global systemic risk is back in fashion, as Blackrock buys Barclays Global Investors, creating a combined $2.8T balance sheet, much larger than the US Federal Reserve.  If this newly formed titan ever had large its own liquidity problem it could threaten to once again bring down the world financial system.

Of course Blackrock has a number of curious aspects to it as well.  Merrill Lynch had a 50% stake which Bank of America gobbled up along with Merrill in a backroom deal with Uncle Sam.  Now Bank of America has a large (supposedly non-voting and non-influential) stake in this behemoth.  I believe this is cause for concern, because among other duties, Blackrock helps the Federal Reserve manage some of its assets and performs consulting as well.

How does Bank of America have a stake in a company that has some influence on the value of its assets in the eyes of what is supposed to be an independent central bank?  This question has come up in congressional hearings and been asked by pundits as well as traders.

Apparently there’s absolutely no rules to the game as long as the biggest banks survive.. at least for now.

Now that we’re off the 925 S&P 500 support area we see a rolling top forming on major indexes here and around the world.  A pullback in equities and commodities may occur as a result, providing opportunity to further short the market and gain more exposure to commodities during buying opportunities.

I believe the short term target could be as low as 900 on the S&P and interim if we see a large correction we could retest the 875 area.  The main determinant factors here will be the news flow, economic data and hunger for raw materials.

The correction could also remove the possibility of the 50 day moving average crossing above the 200 day moving average, which fund managers are looking for as further indication that the market is worth buying in to at these levels.

Bulls continue to cling on the notion of green shoots, but the green shoots look more like poison ivy according to many traders who are closely tuned in to the technicals and fundamentals.

The flight from US treasuries, equities and the dollar is a category five hurricane against the once safe haven.  Is it fear of hyperinflation or just a ripple of the recession?

Speculation is increasing that the US will not be able to pay off its mounting debt and it is showing in the markets.  Most currencies, especially commodity driven ones like the Australian and Canadian dollar, are rallying.  The US treasury bonds are selling off at an alarming rate.  The stock market is starting to either consolidate or make a larger move down.

If the hyperinflation hits and creates a panic, this type of activity will increase markedly.  If instead this is a ripple from the recession tarnishing the confidence of other markets it is still a negative because it shows that central banks around the world are not supporting US debt to the degree that they did in the past during a time when the US is creating more debt than ever before.

The implications are vast and will have an effect on purchasing power, employment, wages and the types of jobs available moving forward.

What do silver, the Australian and Canadian dollars all have in common? They should all be considered good inflation hedges for US dollar-based portfolios.  The Australian and Canadian dollar are commodity-based currencies, because their underlying economies are very much driven by the production of commodities such as gold, silver, oil, industrial metals, etc.  Silver itself is very undervalued against ever increasing real world demand for coinage, jewelry, electrical and chemical applications.  The combination of all three assets, in two different asset classes (foreign currencies and commodities) provide strong upside as the dollar weakens and world growth comes more from emerging economies than industrial economies.

The Australian dollar ETF can be bought through symbol FXA, the Canadian dollar ETF through FXC and silver through SLV.  I currently have holdings in all three assets and advise those concerned about inflation to consider what their long term investment goals are and how these assets may or may not fit in to their strategy.

The consumer confidence number bounced significantly.  This is generally  supposed to be positive to the currency, but because the US dollar has become a carry trade currency through the zero interest rate policy, now  good economic news has an inverse effect on the US dollar, moving it lower.

It’s hard to believe that consumers are spending more money when their 401ks, house values and wages are down significantly, unemployment is rising and even if they are spending money retailers have marked down items so low their margins are razor thin.

The problem is that when there is bad macro news, such as the rumor of the US losing its AAA rating, the US dollar sinks, too.  US equities can’t continue to rally if the currency continues to sink at this rate.  All of the consumers will lose their purchasing power

As the rally appears to be running on fumes at this point, I’d like to say that I was a little early saying to sell it before, but one never can trust a bear market rally.  That’s what it still seems like we’re dealing with, too.  The technicals were powerful during the 8 week surge, but we do not yet have a Dow theory buy signal (need a close above 9125) or a break above the 200 day moving average on the S&P 500.  Now the charts are beginning to look more exhausted as the overbought conditions are worked out.  Longer term the trend remains down as we seem to continue with the 10+ year double top formation playing out on the S&P 500.

Banks led the rally up and now they are beginning to give way as fundamentals point to a more pessimistic picture than the prior trading action of their equities might suggest.  While I do feel that the substantive cash injections, ZIRP cheap liquidity and stimulus have filled part of the vacuum left by the implosion of Lehman and the deleveraging process, there is simply too much enthusiasm around when this alleged recovery is due to transpire.

We are quite literally in the midst of a complete reinvention of how the world does business and in that process there likely will be further dislocations and market abberations before settling in to a U or L-shaped recovery — either economic destiny will be determined by the shape of fiscal policy and whether insolvent institutions are infact allowed to fail or continue indefinitely as “zombies”.  Unregulated derivatives markets must be brought in to the light and fully regulated in order to prevent credit default swaps and other leveraged contracts from contributing to widespread system disruptions.

This turning point has been marked by the downfall of the US as the financial capital of the world.  A slow unwinding process that in the decades to come will be much more apparent than it is now.  This is the unfortunate consequence of being the largest debt bearing nation in the world whose currency is quickly losing popularity as reserves for central bankers around the world.  The unraveling is going to degrade the quality of life for Americans and boost domestic inflation considerably.

If nothing can be done to restore confidence by regulating the shadow markets and unraveling the insolvent institutions, then this trying period shall last quite a while.  At this point I don’t feel the actions of the US government or the Federal Reserve have been constructive to that end.  That is why I feel the rally is largely unsustainable and right now we are in a frothy period where short positions in equities and long positions in foreign currencies may be appropriate to consider putting back on the table.

Disclosure: Short US equities, long foreign currencies

Much of the rally has been predicated on increased optimism because the recession may be slowing. Many recessions have double dip bottoms and most bull markets are not led by the same groups that led the last bull market.

In addition, the US still has a lot of problems with the deleveraging consumer, potentially insolvent banks and a financial system whose accounting has reverted back to off balance sheet trickery and mark to make believe models.

How can we believe the rally is real if it is within the context of one of the sharpest downturns the world has ever seen, where the fundamental macroeconomic picture has not improved and nor has there emerged a true cyclical leader for the next bull market?

For the past seven weeks there has been an impressive, rip roaring 30% bear market rally from the March lows.  There has been no fundamental reason or glimmer of hope that truly spells the end of this recession.  Instead what we have are bank earnings that no one in their right mind can trust with the amount of accounting trickery taking place.  Consumer credit card interest rates skyrocketing.  Record foreclosures in both residential and commercial real estate.  And a parade of uninspiring earnings and guidance from the S&P 500.

Room for gloom and doom

The market has been ignoring bearish news which  could be viewed as bullish, except it is also ignoring the fundamental macroeconomic picture.  Emerging markets in Eastern Europe and Asia are hard hit by the global economic crisis.  Some are on the brink of default with their sovereign debt, forcing them to seek loans from the IMF.  Others are rapidly devaluing their currencies.  Either  path demonstrates signs of extreme financial stress.

There is no end in sight to the problems with real estate, which led us in to this mess.  We have yet to see a meaningful bottom in housing and now commercial real estate is suffering.  GM is on the verge of bankruptcy with few alternatives and to top it off global GDP will likely shrink the first time in decades.

Froth at the top

On a technical basis the S&P 500 seems to be overextended.  It has been overbought too quickly for most of the momentum to be sustainable.  In the last week we’ve seen a lot of that momentum fall to the wayside.  While consolidation is normal, we can’t with any confidence declare this as more than a bear market rally to which an abrupt and painful end may be in sight.  The bank stress tests are expected to start being released to banks this Friday and to the public in early May.  The old adage “Sell in May” could be a very meaningful pronouncement for this Summer.

Keep your powder dry

I recommend using this rally as an opportunity to raise cash, sit on the sidelines and wait for a good buying opportunity for the long term.  Short term the best position is a short bias.  I don’t feel that being constructive after such a massive build up, especially when some of the larger gains have been on light volume, is warranted.  Possible support exists at 850, 830, 800 and 775.  At this point it is conceivable that we also retest the lows in the 660s over the Summer depending on how severe some of the interim problems become.

Washington is losing sight of the real crisis.  Incompetence, loose money and impulsive decision making are what brought us to near collapse.  Why are we repeating these same mistakes again?

Bonuses of the bailout

The $2B in Merril bonuses and the $187M in AIG bonuses when the government effectively saved these institutions from their own incompetence is far from acceptable.   There is no reason that people who created the systemic risk should be rewarded by the bail out money which is ultimately funded by tax payers facing higher taxation and a reduction in government services.

Having said that, the anger that swept the US House of Representatives to pass an unconstitutional bill that singles out individuals and retroactively taxes them at a 90% rate is equally an unacceptable reaction.  The bail out bill contained the provisions to allow these retention plans and bonuses.  How was this overlooked?  Because most lawmakers don’t read bills before signing them in to law.

Global righteous indignation grows

It’s an unbelievable situation we, as global citizens, find ourselves in.  The international banking conglomerates have failed us.  Our respective governments have failed us.  Yet they now want to claim to be the heroes and the saviours that will restore prosperity to the world.  Cutting interest rates, funding defunct institutions, floating trillions of dollars out to prop up bad debt all to relieve the liquidity vacuum the last bubble bursting left in its wake.

In the last two weeks there was a positive change of character, albeit short-lived, that boosted markets worldwide.  It was the prospect that the rules of the game had been set in the United States to favor a partnership between private capital and government loans that would allow an eventual transition away from the US Treasury and Federal Reserve propping up the every marketplace they can.

In an attempt to quell popular angst over the AIG bonuses, which were 90% less than the Merrill bonuses and 99.9% less than the total bail out AIG dished out to other banks, including non-US banks, the House of Representatives set out to destroy all the good faith that had been built.  Completely ignoring the bigger picture that AIG was simply a proxy for money that was siphoned all over the world, in the billions, not millions.

Who’s really in charge?

Let’s not forget the US Government is a majority stakeholder in AIG.  They own 80% of the shares and easily control any issue put to vote.  They can also demand the board and even CEO are replaced.  These types of extreme actions wouldn’t be positive, but they certainly seem more logical than passing a retroactive 90% tax.

The problem is the government keeps changing the rules in the middle of the game.   It’s very difficult to restore confidence when no one knows what the law will be tomorrow, let alone next week.  Every time there’s some level of complacency that the rules have been set, the rug gets pulled out again from under everyone.

Laws and lawmakers

The rule of law is a fundamental element of successful capitalism.  There is no confidence if laws  can be arbitrarily and retroactively changed or contracts can be freely broken without consequence.  I fear that more of this knee jerk legislation will completely reverse progress we’ve made toward restoring some level of confidence.

It’s unfortunate that we’ve propped up any of these institutions and in my prior entries I’ve always spoken out against bail outs and the corporate welfare environment it engenders.  No business that is unable to continue to sell products or services should be allowed to be given second, third or forth chances funded from the public trust.  Innovate entrepreneurs will create better, more profitable and functional replacements in time.

The problem is, Washington only realized this after the fact.  Only in retrospect do lawmakers seem to understand that most if not all of the effort was a waste of money.  Now, in order to not look foolish before the 2010 elections, lawmakers are putting on a big media circus to scapegoat everyone but themselves, who share in the blame just as much as the banks.  Let’s not forget as citizens that any lawmaker who voted for the TARP or the stimulus was complicit with bonuses and retention plans.

Even back when Fannie and Freddie were taken in to conservatorship, part of the contract with the US government was to guarantee the bonuses and retention plans remained.    The US Congress would have us believe that they were swindled and the bonuses flew under the radar.  Seriously?  Did you guys even bother to read the bill you signed?

Recently there’s been some discussion about regulation and improving oversight of our global markets.  Of course bankers and would be capitalists scoff at the notion.  Why would we want to regulate a free market?

In what seems to be a massive legal loophole being exploited for the gains of insiders with privileged information at publically traded companies, the existence of the JP Morgan PrISM program provides compelling reasons to closely examine the way banks and brokers handle securities and favor their biggest clients at the expense of everyone else.

The creation of a legally rigged market alienates and burns most average market participants, whether they are traders or long term investors.  If insiders are allowed to freely trade their company’s stock with privileged information, where is the incentive for any other person to participate?

Anyone who would knowingly lie, cheat and steal in this manner undermines the very system that allowed them to accumulate wealth and operate a business.   These individuals deserve to be held accountable for their actions, especially now that the world knows how disruptive this level of fraud can be.   What we’ve seen with AIG, Citigroup, Bernie Madoff and the rest of the firms and individuals is nothing short of a cataclysmic blow to free market capitalism.  To restore some level of trust we need to see a lot more folks than just Mr. Madoff going to prison, not passing go and paying BACK the $200 (or however much bailout/bonus/fraud money they received).

Just how many banks have a PrISM-like insider trading system much like JP Morgan?  With cockroaches you know that there’s always more than one.  I feel this scenario plays out much in the same manner.  More banks will have whistleblowers reveal that they also have insider trading and other very unethical programs.

Just how many money managers try to avoid doing their homework and try to cheat the system by getting insider information?  How many will be investigated by the SEC and actually be arrested?  Will the SEC reinvigorate itself to return as the sheriff of Wall Street or will this administration create a new, larger and more overbearing regulatory apparatus?  More importantly, will the crooks go to jail?

Or will we keep the status quo?   A revolving door between the SEC and Wall Street where former officials are given cushy jobs as legal counselors or advisors.  This massive conflict of interest includes members of the Madoff family working for the SEC and Bernie himself being a paid advisor for several years, helping to shape policy for the agency that was supposed to watch out for people like him!

I say we close all the loopholes and start prosecuting the crooks post haste.  No one deserves another breath of fresh air or moment of freedom if they are directly responsible for lying, cheating and stealing our system in to near collapse.

Where is the stimulus for the people that need a first chance?  Why is it all focused on those that need their second chance?  Whether it’s a company or an individual that’s financially distressed, there are many more that are not and just need a push in the right direction to ensure success.

Read more at chamandy.org.

I’m afraid that there’s no easy way to stop the debt avalanche now that it has begun.  Trillions have been committed, tens of trillions more of entitlements and other debts stand to hit us during the years to come.  We’re entering a deep, protracted global recession and deficit spending on pork barrel legislation will not have any tangible stimulative effect.  Instead it creates the potential for a depression when US Treasury bonds suffer from a lack of confidence and the government is no longer able to borrow to pay the interest on its ever growing debt.

I’ve done everything I can, writing the media, my elected representatives and trying to stir the minds of those I know with economic discipline.  There is no quick fix for this crisis, it will be difficult for every single hard working American.  Mortgaging the next generation’s future to prop up the corrupt edifice of insolvent banks and bail out home buyers who never should have gambled is a terrible approach to the underlying problem.

Capitalism is not dead, but any company, individual or even government that cannot sustain itself must be allowed to fail.  That is one of the most important and fundamental underpinnings of American capitalism.  Socialism will not be an effective stick save.  It engenders an environment where the most innovative are allowed to fail in favor of those who cannot compete.

America is still a great country and our dollar is still the reserve currency of the world.  In order to keep our economy the global leader we cannot spiral out of control with debt, but instead must reign in spending on all fronts and embrace an era of thrift while we recover our bearings and wealth.

According to CNBC, the White House has claimed Obama will give more details on the mortgage rescue plan in a speech on Wednesday.  This has provided a confidence boost and provided a bid to stocks.  Treasury bonds, however, continue to sell off in a significant way.

Yesterday at about 340pm, the US government, through Geithner’s treasury department, leaked a plan that will allegedly help distressed mortgage borrowers lower payments.  The plan boosted the mood, forcing end of day short covering, raising the S&P 500 back to a key resistance level around 835.

Today is the last trading day before a three day weekend.  We could certainly see an increase in volatility as a result.  Mr. Geithner’s department leak seems to have been strategically delivered to stave off another leg down.  Yesterday we were testing the 813 level of support, which looked to be giving up as the S&P traded as low as 810.  After 813, the last major support is 800 before we look at the November ‘08 lows in the face again.

Nonetheless, significant technical damage is being done.  The Dow Jones industrial average made a new multiyear low yesterday, the transports continue to sag and the only index with promise, the Nasdaq, seems to be finding less buyers lately.

We may be seeing an interim top on the US dollar index, which is no doubt expected to see pressure from the stimulus plan and the Obama administration’s bank bailout 2.0 that is expected to be revealed in the weeks to come.  The US dollar index appears to be making a descending series of highs.  If the pattern continues this could signal the next wave down.

Watch the foreign exchange markets, as the US dollar could be bound for a correction soon.  Possible trades include going long Canadian dollars, Australian dollars, Swiss francs, Gold, Silver and hedging by shorting the GBP Sterling.

In the downdraft of oil prices and the global recession taking full grip, a once bustling city in the United Arab Emirates is collapsing at an alarming rate. Dubai’s foreign workers are leaving in droves, their investments are drying up and new problems seem to be arising on a daily basis.

Recent incidents have highlighted the deterioration of competence.  Only a few weeks ago, raw sewage was discovered on tourist beaches.  Apparently being pumped in to the ocean by poorly run industry.  Just a few days ago a tanker collided with a freighter offshore creating a lot of debris and a necessitating more clean ups.

Above: The planned Dubai Towers project.  On hold.

I remember only a few years ago I would read that record breaking skyscrapers were being planned and even erected on a seemingly never ending basis. Now that the local economy is collapsing the government has passed a law that forbids talking badly about the city and fines those that would dare to about $250,000.

Tourism has been dropping as other destinations or staycations (staying home on vacation) become more desirable. Certainly many of the lofty projects will be put on hold if not outright abandoned as income dries up in energy and tourism. Many speculate this may be the end of a city that never really reached its planned potential.

Overnight the tone of futures markets has been pretty negative, pushing the major indexes to levels that could retest the trend line support at open if we stay this low.  The S&P has been flirting with 820, a very key level that if significantly violated to the downside, 813 and 800 remain as important support levels.  After 800, we have a vacuum that could reach the November lows.  Of course a violation of 820 on the downside will be seen as a breakdown of the modest uptrend and that could catalyse a wave of selling.

One discouraging sign is since the small rally in early January, every time the S&P 500 has bumped the 50 day moving average we’ve seen a wave of selling.   Market participants are not commiting to long term positions, but range / trend trading short term and this action is increasing volatility.

The US market had its worst day in 2009 on account of the Treasury’s lack of direction and specifics in their plan to assist ailing financial institutions.  The Dow shrugged off 8000 and the S&P lost the key area of 850.  The only encouraging signs are some end of day short covering in to the oversold condition that was created and that the S&P 500 is still hugging its uptrend line from the Nov ‘08 lows.  Other than that the picture looks quite bad.   Geithner had been expected to reveal details and even figures, but instead the market received more rhetoric and promises.

The action in precious metals lately has been impressive.  Silver and gold caught a bid amidst the chaos in currency markets and bank balance sheets.  The nervousness has created an atmosphere of fleeing away from equity in to safer havens.  With gold seemingly gaining steam to make another move to the upside, is $1000 within sight?

Looking ahead

Markets tend to discount the here and now and focus on the future.  Has gold already priced in potential inflation or is that a variable being gauged on a daily basis?  Options traders in GLD would suggest that $95 to $100 (or around 950-1000/oz) are reasonable price targets given their usually large call positions.

Charting the course

Right now $1000 is resistance long term, without some extraordinary volatility to the upside.  Below is a three year, weekly chart of GLD.  The bollinger bands are a great indication of potential support and resistance in price moves.  We’re using a longer term chart to get a very broad view of GLD’s price action over the last 150 weeks.

Past performance

While past performance is no indication of future gains, GLD has outperformed the SPY (S&P 500) consistently for quite some time.  Gold has always provided a safe haven for value.  For thousands of years, gold has had the same purchasing power.

It is wise for investors with long term objectives to have some precious metals exposure in any portfolio as a hedge against inflation, which is expected to increase significantly in time.  Traders may want to be more aggressive playing the rally depending on your strategy.