Long term outlook for 2009

Just when a collective sigh of relief was breathed about 2008 ending and a fresh year beginning, 2009 was ushered in by the worst ever index performance in the S&P 500 and Dow Jones 30 for a January.  This was certainly not encouraging for those that believe in the adage, “So goes January, so goes the year”.

Outlook not so good

2009 promises investors and traders one thing.  Uncertainty.  While the market has declined nearly 50% peak to trough, the deleveraging process has not been completed.  Banks still have far too much common stock equity vs. assets on book.   Usually recoveries in any stock market are led by financials, so this turn around prospect seems bleak until the equity to assets ratio improves.

Inflation prospects seem to be rearing their ugly head again, as precious metals are catching a strong bid.  Oil seems to have bottomed.  Gas prices are on the rise again for consumers.  Treasury bonds are selling off.  The baltic dryships index has been recovering based on Asian demand for raw materials.  Certainly ZIRP (zero interest rate policy) has created the possibility of a new carry trade.

Recovery, what recovery?

Most predict that the US markets will tread through a slow, “L-shaped” recovery because of the serious damage to credit and stock markets, and most importantly, confidence.  Nearly $9 trillion is sitting on the sidelines in virtually zero yield short term treasuries and money markets.  That cash has yet to be deployed, and was originally retracted from equities, because of a flight to safety from confidence being lost.

The smart money is watching China and Taiwan, as the markets there have enjoyed a significant recovery from their lows and forming a bottoming pattern.  With the US dollar nearly free to borrow for currency traders, the possibility of the dollar becoming a carry trade currency is quite real.  Long term prospects for the dollar are weak so traders would not feel as though their principle loan is going to increase from dollar strength.

History in the making or repeating itself?

The possibility is striking because when Japan suffered a similar crisis in the early 90s, their currency suffered this very fate.  The carry trade in Japan caused most financial institutions to move money outside of Japan rather than invest in the country and assist its recovery.  Infact, Japanese equity markets have never recovered and still thrash around making significant lower highs and lower lows in recent months.

In my opinion, this is indicative of a significant risk to recovery in the US markets.  Already gold is more valuable per ounce than the S&P index.  Other stock markets are outperforming the US market on their recoveries.  Will the trend continue?

Where are we now in the bear market recession?

So, Fannie smells like its namesake and Freddie is more like Frauddie.

What has inspired this recent massive confidence boost?  Wait, who said it was confidence?

The SEC says, “Thou shalt not short”, and the blood that flowed in the streets retreated back in to the respective institutions in which it had spouted from.

The Treasury says, “We will buy the risk on the taxpayer’s dollar”, and somehow gold and silver decrease in value and the dollar holds its ground against other currencies.

The Fed says, “We have to raise rates” out of one side of it’s mouth while also saying, “The risks have markedly increased” from the other.  And yet the markets accelerate up in leaps and bounds.

What really happened?  Why are financial stocks rallying?  Because you can’t short them as easily if you’re a market maker or institution.  Any short positions that don’t have shares borrowed must be unwound.  Is this a magical cure-all for the financial markets?

Is Paulson’s plan for a blank check of nearly $1 trillion dollars to Mac and Mae a way to say, “Everything is OK”?

We have to examine the core underlying message here carefully to paint a more accurate picture of what’s going on behind the scenes.

Paulson needs lots of cheap money and fast to bail out a cataclysmic decline in Fannie and Freddie’s paper.  Meanwhile, Fannie and Freddie already out diluting their share holders with new issuances.  Why is that good for share holders?  They’re effectively seeing their shares watered down.  Oh wait, it’s harder to short during the next 27 days because of the SEC, so these stocks aren’t really rallying, they’re just floating on ether.  Ultimately the Fannie and Freddie share holders will see the equities go to 0.  Only the debt holders, particularly Japan, China, Russia and other governments, will come out with any cash.

Plosser of the Fed says, “We must raise rates sooner than later”, yet the financial system is still in peril.  Raising rates would boost the dollar slightly, but the fundamentals are weak because of a spiraling out-of-control current account deficit that may rise to $12T by 2010.  That would be a near treble from 2000’s level, which suggests the fundamental value of the dollar is being cut down by 66% (or a by two thirds) to 33% of its original value in 2000.  Wait, WHAT?  That’s correct, we aren’t even near the end of this fun ride yet.

In fact, it’s likely about to become much worse as savvy hedge funds and institutions find other ways to short weak companies, using options, derivatives and shares listed in other countries with more lax regulations.

At the same time the US government fancies itself the regulator of all markets now.  They’d like to tell speculators how many crude contracts they’re allowed to hold, after being told by the Federal Reserve, CFTC, independant researchers and many brokers that this will simply create more problems.  If there are less speculators, the markets will become less liquid, volatility will increase and the fundamental supply demand story isn’t over.  We may or may not be at peak oil, but one thing is certain, oil’s uptrend since $1 a barrel in the 1900s is far from over and Boone Pickins’ prediction of $300 oil by 2012 seems more than reasonable.

Where does that leave us?  We are in an area of extreme uncertainty.  Every rally is questionable.  Every dollar we hold in our bank accounts, retirement accounts and wallets are declining in value significantly.  Stagflationary pressures are now globalizing and the world economy seems poised for a marked slowdown.  We can hope and pray that this will pass and everything will be just fine, but after the second biggest bank failure in FDIC history (and more to come), we are nowhere near out of the woods, yet.

The new golden market

  Gold is outperforming the market by a large gap now. This is expected to keep up until gold potentially reaches $800/oz levels based on increasing US dollar weakness, fear driving traders in to safe assets (gold, bonds, etc) and away from stocks.

Gold outperforms

With the housing recession potentially spreading to other sensitive sectors, we see the potential for an economic slowdown being exacerbated by the ever weakening US dollar. Gold, which is a traditional safe haven in times of crisis and fear, is gaining strength. December 2007 futures are trading over $710/oz up from a low of $655/oz only several weeks ago. Traders that were short gold futures have covered or reversed positions and investors have been buying gold in large volume.

I would recommend buying gold on any weakness going in to the end of the year. We’ll see the dollar continue to weaken further, especially if the Federal Reserve cuts interest rates. This will cause traders to reprice gold higher accordingly.

Good luck trading!

Shorting home builders

Home builders have had a very rough run lately. It’s probably not over by a long shot either. Those engaged in the industry generally understood that residential real estate was overbought and inventories would eventually grow very large if building kept on pace. These same builders kept building at the same pace, all the while creating an astronomical number of unsold developed properties in their portfolio.

 

With the credit crisis stifling mortgages and home sales, these builders are in a very risky position with portfolio’s full of unsold homes that are now depreciating in value by the day. Without substantial rate cuts, the housing market will likely not rebound for a few years. This will force many home builders to sell their inventory at a discount and others to declare bankruptcy. It may be a good time to watch ITB (see below chart vs. CFC) and consider shorting it.

builder-recession.png

I’ve charted ITB against CFC because I believe they follow a very similar downward trend without support. CFC is guiding even lower and ITB is likely to follow as the situation worsens throughout 2007. Traders may want to short ITB and go long gold, US treasury bonds or Euros for a potential recession hedge. Good luck!

Brief: Gold rallies on weak dollar

Today, as the dollar weakened, gold rallied in response by 2%. Traders also speculate that this rally in gold is in response to the anticipated US Federal Reserve rate cut on September 18th. AUY along with other gold miners also rallied in response.

  Gold 9-6-07

The world optimistically waits for the Fed

This morning, with tremendous support from the US futures, European markets and gold, the world optimistically awaits the Federal Reserve’s speech during the conference on housing and monetary policy in Jackson Hole, Wyo. at 10 a.m. EDT.

Currently S&P futures are up about 1%, gold is up about 1.5% and the German DAX is up 1% all in anticipation of good news.

Why is the world optimistic about this? Let me present a few views:

1) President Bush has stated he will expand the government’s role to deal with the subprime mortgage credit crisis.

2) Ben Bernanke is expected to at least give traders and investors clarity about his views on the economy. There is also (somewhat irrational) speculation that Dr. Bernanke will give indications on his Federal funds rate policy decision at this speech.

3) Bond rates indicate traders expect a rate cut in the short term.

4) A lack of volume because of the upcoming holiday makes the US market very volatile.

5) The weakness of the Yen has lent strength to US markets as the carry trade may be winding up again.

All of this is important to consider today. What does it mean?

If the Fed speech gives no clear indication of policy or interest rates we may see market weakness. That market weakness may be exaggerated to the downside because of the low volume. This weakness may be temporary, as President Bush will be speaking around 11AM EDT regarding the subprime mortgage credit crisis. It will be very important to watch bond yields and the Yen today for signals.

Alternatively, if Mr. Bernanke gives the market a high degree of transparency in his speech, and it gives markets the indications it wants to hear about a rate cut, we will absolutely see an unprecedented rally.

My advice? Watch and wait. If you are an experienced trader you may want to trade the speech.