The Liquidity Rally
October 13th, 2008
If for some reason you decided to go long at the end of last week after the S&P 500 suffered its worst week since 1933, you saw that pay off pretty handsomely today as the market bounced back strongly. I personally believe it was likely due to an ever increasing amount of bottom calls and signs that the virtually unprecedented steps towards unified worldwide liquidity were finally starting to have an impact. People were really panicking last week that potentially the only thing that could unfreeze credit markets would be a 0 basis point target by central banks, since the TED spread (the difference between the Libor rate and the Federal Reserve Bank target rate) continued to remain very high. Now it’s starting to look like things aren’t going to turn apocalyptic in the near term.
I Disagree Strongly With the Bottom Calls
I think we might see a little bit of a rally, or at the least some more sideways movement coming up here, and if you were in the mood for a bet, you could go long some financials. If lending rates keep falling and the credit markets start unfreezing, we’ll see some strong rallies in financials. If you did that, you would have to strongly hedge yourself, because regrettably I think that the downside risk is far too great to ignore.
When up and down 500 point days start to become common place, as they have recently, that to me indicates that there are some significant problems that still exist in the market. If we were really at a bottom, we would start to recover slowly, not with some giant bounce.
The direction of the market doesn’t change in a weekend, and we’ve seen bottom calls for the last 14 months. Frankly, you’re going to get burned if you step in for anything longer than 1-3 weeks.
Consumers Don’t Watch the Stock Market That Closely
It’s important to look at everyday consumers instead of the stock market analysts who are calling a bottom. I firmly expect spending for this Christmas season to be down pretty significantly. People have lost a lot of money and potentially their homes since this crisis first began in the summer of 2007, and to expect people to just flip on a dime at this point would be extremely foolish. I think we’re in a short term foolish rally, but as soon as consumer spending data starts getting released (a lot of Christmas shopping happens in November), I think we’ll be in store for another fall.
That’s also not to mention the fact that I believe we’ll likely see at least some sort of bankruptcy or last minute merger agreement in auto companies or airlines. Things have been relatively quiet in those industries, but the harsh reality still looms. An all out moratorium on large ticket spending (comparitively to past years) would send auto companies reeling, and an airline industry struggling to turn profits two years ago is going to face even tougher winds as credit becomes more scarce and people get tighter with their lending. I think this will likely force a few shotgun mergers, but as was discussed in a Bloomberg article today relating to a GM/Chrysler merger, the advantages to that deal are many years off in the distance, and the merger would not represent an overnight fix.
My Calls Remain the Same
I personally would use false rallies like this to try and exit losing long calls and enter in to precious metal calls like gold and silver. Ironically, precious metal miners tend to rally on days when the market is up, regardless of what gold and silver do.
I’m guessing this stems from some idea that they’ll better be able to find the credit that they need for daily operations when good news comes out of financials. In general, I think buying solid miners on market down days and broad precious metal etfs like SPDR Gold Shares (NYSE: GLD) and iShares Silver Trust (AMEX: SLV) on up days are some good bets. You can also check out my post from last Friday for more suggestions.
What We´re Reading Today (organized by most relevant and interesting going down):
World May Be Lucky to Get Worst Recession Since 1983 - Bloomberg
Why we picked it: if you’re looking for a simple article that gives you a cursory explanation of what all is going on right now, look no further. It talks about the risks we currently run, and the best case scenario we could be facing.
Treasury to Invest in `Healthy’ Banks, Kashkari Says - Bloomberg
Why we picked it: as the government first talked about making stakes in individual companies, many saw the idea as the only real way to stave off the collapse of financial institutions. However, there was also speculation that a direction investment from the Federal Government could raise serious doubts about a company’s financial strength, and could in turn result in further problems for the bank. This statement seems to be aimed at that, hinting that the government would let the good succeed and the bad fail. This of course raises the big question: if a bank is healthy, why the heck would they need a direct capital investment from the government?
Pelosi Says Congress to Consider Second Economic Stimulus Plan - Bloomberg
Why we picked it: as one of my reasons why today’s rally was a “fool’s rally”, in today’s post I cited my opinion that consumer spending, especially on big ticket items, will likely flat line this holiday season. A bill like this would be targeted at trying to help raise that negative perception. For most average Americans, the bailout bill is extremely obtuse as a concept, and they likely won’t receive any sort of direct benefit. A bill like this would help main street and potentially provide a life line for consumer spending. Look for consumer discretionary stocks to rally off of this news, however it might very well be possible that Americans will use this check to pay off credit card debts and other obligations, limiting the bills short term impact on the economy.
Across the Country, Fear About Savings, the Job Market and Retirement - New York Times
Why we picked it: continuing on the theme discussed in today’s post that you should be watching consumer confidence and not market analysts, this article does a great job of summing up the fears present right now. These are the things that a one day rally doesn’t fix, and as long as this negative perception persists, we will not see a bottom soon.
Bullion Shortage and Spot Prices Tell Two Different Gold Stories - Seeking Alpha
Why we picked it: if you’re someone like me long on gold and silver, stories like this provide an interesting dilemna, since according to most sources worldwide gold and silver have ballooned in demand, in many instances leading to physical scarcity. Ironically, the spot price for gold hase fallen today and Friday, leading many to think that there are some problems with the way that paper markets for commodities work, some claiming it’s an all out conspiracy. Although I don’t believe that it’s that complex, I do think that if there is a sudden correction in spot prices that this might lead to a bull market for precious metals.
GM-Chrysler Merger Won’t Fix Problems, May Add More - Bloomberg
Why we picked it: I talked about this article in today’s post, but I think points to the general problems of so called “shotgun wedding” mergers. The term essentially applies to failing companies that either quickly sell themselves to bigger or healthier institutions or when two failing companies mash themselves together. The article raising questions about whether the merger could actually allow the two to realize any sort of short term benefit.
Spanish Bank Said to Be Close to Buying Sovereign Bancorp - New York Times
Why we picked it: I’ve been thinking about Santander Rio a lot lately, mostly stemming from the fact that they more or less avoided most of the problems with the subprime mess in the United States. This article talks about their proposed buyout of American Soverign Bancorp, which would give them a larger presence in the United States. I frankly see them becoming one of the mega-banks coming out of their crisis if they play their cards right.
Disclosure: the author of this article is long GLD, DGP, SLV, SIL, FCX and trying to build a position in EDD
Questions? Comments? E-mail me at thesaneinvestor@yahoo.com
All material copyright
© 2008 Andrew Jarmon
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