This Island Earth
May 10, 2010
Good morning. Wild and down market last week, with the SPY closing down 7.55 (or 6.4%) to close at 111.26. The VIX spiked up 85% to close at 40.95, signifying that the cost to protect positions had risen dramatically, and actually closed Friday night very close to the high. In addition the market had a nightmare day on Thursday, with the markets spiking down and coming virtually unglued for a brief time in the afternoon. Investigations are abounding, and should show that the entire market structure needs to be looked at very strongly and honestly, but I am not holding out any hope for real reform.
In addition, last night the European Community came up with an “all-encompassing” plan to bail out all the troubled countries, fix the Eurodollar, bail out banks long sovereign debt, and bail out the markets (in essence, really stick it to the short speculators). It was actually published in several media outlets last night that the Ministers meeting to formulate this “plan” had a stated goal of completion before Asian markets opened to catch the market “wolves” off guard.
So here we stand, with it Monday morning and the S&P Futures up almost 50 points in the pre-session. On the one hand it is surely a strong rally, and feels even more so if you piled on to the short side Friday night. The non-believer (or cynic if you prefer) might say that these European Ministers have essentially fired their last broadside and the Futures only indicate that we are back to the levels of last Wednesday. How do we judge (or trade) this move, at a time when the details are scarce and it is really unclear how much direct intervention (meaning buying) the central banks are doing? The believers either actually like the plan or are in the “They could not just stand by without doing something after last week” crowd. For the governments of Europe to just stand idly by and watch the Eurodollar decline rapidly by the day, and watch their Banks sink into the abyss almost hourly as the long sovereign debt on their books becomes worth less and less was simply not acceptable. It clearly makes somewhat more sense to construct an overall plan for the region instead of a plan for Greece, then Portugal, then Spain, and then whoever. It also would seem smarter to have an overall economic regional goal to lower deficits together to shared goals, versus last weeks plan which had Greece making draconian cuts while others remained expansive fiscally.
Several things about this type of a “rescue” bother me. The first is the obvious attempt to “get” the “wolves” or speculators that have positioned themselves against the Euro or some Bank stocks, or the market as a whole. In my memory it seems like most attempts by a Central Bank to “protect” or “save” a currency or market were largely unsuccessful. Those that moved their money from Euros to Dollars last week were doing so to protect themselves or their businesses from any further decline in the value of their money balances, not to “get” the European governments. The long-term value of the Euro vs. the Dollar is a complicated algorithm involving relative growth rates, relative governmental solvency, relative interest rates, etc. and in a floating system those relative value decisions are made by literally thousands of traders on a daily basis. The large majority of these decisions are totally innocuous, and could be as simple as someone in Europe buying his or her dollars a week early for an upcoming trip to the US, because it was on TV that the Euro is sliding. For a government, or group of governments to come together and devise a plan to correct non-working policies and address reasons why people are thinking the currency in question will sink further in value is one thing and probably a long-term positive. To target those people doing their valuation decisions on an ongoing basis as “evil” and target them shows a total lack of understanding of the phenomenon they are trying to alleviate.
No one is going to give these “Ministers” the three-year grace period to fix things that some seem to think they just bought themselves. None of the real questions have changed. For Spain, the question, among others, is whether their 20% unemployment rate (45% under 25) is 16% next year at this time and 12% the year after. If the answer to that question (and all the other like it) is yes, then the Central Bankers can take their bows three years from now. If no, then they have just pushed off the inevitable and made it even worse when it eventually does happen, as the debt levels will be close to $1 Trillion higher than if the default happened now.
What about the US? I have never been a proponent of increased Congressional involvement in the workings of the Fed or Treasury. After all, independent for the Fed means independent (forgetting if you can for even a second how political Alan Greenspan was and the current Fed Chairman Bernanke is). However (and I wonder if every belief I used to hold will change by the time I leave space ship Earth) how does anyone in this supposedly elected government commit us to the $100-300 B that someone seems to have committed on our behalf? I see where the Congress, the guys in charge of the Budget last time I checked the Constitution, spend a few weeks of hard work arguing over the $6 B for “Cash for Caulkers” only to show up on a Monday to find out that the President and two dubious assistants (Geithner and Bernanke) have committed maybe as much as sixty times that without so much as a word. I wonder if they really have the authority and really question whether they have the experience and smarts to be making these types of commitments (a mere $3,000 for every household in the US, probably less than the average family of four actually pays in federal taxes). Is anyone asking that question in Washington today, or are we momentarily giddy that the market is up 400 points, so everything is ok? Did we want to go along and participate in a massive European give away, which had as a stated goal to shock the markets? I say no in general, and certainly not to that degree.
Why do I feel so uncertain regarding the economic policy of an Administration that I voted for, and am trying hard to find a reason to still support? I (not to confuse myself with the soaring intellects of the likes of Ben Bernanke, Larry Summers, and other economists of the new round table), along with my readers and listeners, have been known occasionally to read a book without pictures, and maybe have picked up a few lessons along the way at regular jobs. Maybe it is the relative little practical experience of the Inner Circle that is the actual cause of my and other’s concerns. In any case, many of us are well aware of some of the Economic discussion of the Great Depression, and the conclusions in many studies that Roosevelt should have primed the pump more aggressively than he actually did. I could comfortably argue that New Deal Programs should have been increased by fifty percent, or doubled. I do not agree, however, and can find no solid theoretical evidence or example, that Roosevelt’s programs should have been increased tenfold or something, or that we should have not cared how much Hoover Dam, the Golden Gate Bridge, or the Holland Tunnel cost. We are acting like waste or fraud is actually part of the plan, since we can get money out there faster by giving it away than actually building something with a real budget. I do not know where this economic “theory” comes from, except from maybe the person who is the beneficiary of the largess. I can find no real example of where dumping another trillion in debt onto an over leveraged European economy, without addressing anything fundamental, is a stone cold winner. How did the European group talk President Obama and Secretary Giethner into taking a big share of that sum of money over a weekend? Cooperation on some level I will roll with, but this? Or did it really happen totally over the weekend? Or were there hints about on Friday at the Fed level that something this large was in the works? Was there time Friday for the usual in the know hangers on to get wind of what was going to happen, and the level of US involvement? Was anyone other than me a little suspicious Friday afternoon when the US market did not collapse on the close when all the European markets had done just that? Did our willingness to seriously “help” leak? Events are shoving me, almost daily, further into the conspiracy group.
Now the big question, how do we trade this market? I think for sure you need to stay hedged, and need to be careful about trading in those crazy periods when you may be tempted to go without the hedge for even a little while. If you were not listening to the show this morning you may have missed the critical email regarding my inability, or whatever, to get some clients money invested as we cascaded below 1080 in the S&P last Thursday. The truth was that the markets were totally inaccessible during that period, and there was no way that I could have completed the put side of the transaction as the current iteration of Exchanges was essentially shut down. Although I may have thought that, maybe in retrospect, the purchase of the SPY in the $107 range might have been a good idea, I will not make that purchase without the protection at the same time. I do not enjoy sitting by when the market hits a price I find attractive, and will write more about the market’s problems last Thursday next week, but I will not take any significant risk with client money in a non-functioning market. Maybe this week we may sneak back down some to levels that seem interesting, like maybe the XLE under $55. If that happens and the price of the puts come in a little it might be a good time to get a little more invested. I think we can expect an interesting week.