Saturday, May 2, 2009

May Day

All this talk of new bull markets and green shoots has been ferocious in recent weeks.

I wrote in March:

My gut tells me that this is the classic bear market rally that will suck in a lot of people before ultimately going lower. This rally could last a lot longer than six weeks, however, and a sucessful retest at some future point, could allow a rally (or the March lows) to hold for a long period. I suspect that we should be fine until mid/late April and we could test or break the January highs (which would take us to roughly break-even for 2009 YTD). Expect a lot of congratulations by the establishment on their fiscal and monetary tactics as the rally extends. You will hear that the interest rate cuts, the gas price "tax cut", the quantitative easy and the stimulus is working (and it may for a short period).

I don't plan on "believing the hype!". Bear market rallies are not "stabilization" but the natural ebb & flow. I remain very bearish long term but I could change my mind on all of this tomorrow. I plan on discussing the catalysts for the next downleg in a future post, but expect soaring long term interest rates to be part of the problem. At first, sinking bond prices will be welcomed but our overleveraged economy can not survive high interest rates.
At the time, I was long TBT (ultrashort the US long bond). Unfortunately I got stopped out a while back at a loss. Had I held on, I would have had a nice profit.

Here is my roadmap. As I write this, the world is giddy that the end of the recession is near (summer or Q4 at the latest is the current mainstream view). Dow 10,000 talk is back and few talk of retests of the March lows.

I believe that we are nearing an inflection point here. A downleg is starting that should take us to approximately S&P 777ish over the four weeks. From there, we can either start a nice summer rally (back to current levels of S&P 877 or higher to 900-1000) or we can go right to a retest of the March lows. The real move lower will probably start in August 2009, but I am still not sure when. Ultimately, I believe the stock market is going to go a lot lower.

All the congratulations and hype mentioned above back in March are now present, but I am not believing the hype.

The conditions still remain for a severe bear market that will last more than 1.5 years. While 2008 may have been the worst % year of the bear, I do not expect 2009 to wind up positive. There are many factors that need to happen, in my opinion, before a new bull market can truly start:

1) We need a lot more debt to be extinguished. Debt levels are still astronomical. Unfortunately, this means more bankruptcies (Chrysler) and more foreclosures. The process took about 20-25 years, and will likely take at least five years to complete.
2) We need savings to increase. This also will take years.
3) We need the banking system to heal itself. This process has started but there are more failures ahead, including in Canada, I believe.
4) We need the passage of time. It will take a few more false starts like this year's bear market rally to pave the way for a new bull.

There are many other factors (these are the ones that come to my head right now).

I also see a stronger economy in Q3 (contracting but not at -6% or -7%) but I would not rule out some ugly numbers for late 2009 or early 2010. Why? Interest rates. The world has never seen the type of debt issuance that governments are trying to foist on the bond market. There is going to be $4 trillion plus of debt issued by governments this year. Where is the money going to come from to buy this debt? It has to come from other asset classes. Even if I am wrong about interest rates, I don't see how $4 trillion can be floated without hitting other asset classes such as emerging markets. That $4 trillion is an annual figure. Chances are 2010 will require just as much.

I don't think that long term interest rates can be controlled as Bernanke & Geithner are attempting to do. For that matter, I don't think there is much that Bernanke & Geithner (or their successors) can do to prevent the massive debt deflation that is happening. The last thing the world needs is higher interest rates, given the crushing debt loads out there and given deflation.

All this deflation should ultimately lead to weaker currencies versus the US dollar (with the possible exception of the Yen). Again, another "last thing" the world needs is a stronger US dollar, as this will make debt repayment hard for many who have borrowed in US dollars. And finally, the weak financial system, overleveraged and underemployed consumer will hurt the economy and stock markets.

Instead of a double dip recession, how about a double dip depression?

Risk is very high once again.

Disclosure: Long US dollars, Long Yen, short and long various Canadian banks (with intent of being net short one day), short US banks and long SPY puts. I have started shorting again, but very small at this point. I need a move below 850-870 to have me convinced that the top of this sucker rally is over.

1 comment:

BBC said...

Once again great article! What do you think the 'closed 5yr' intrest rate for a mortgage will be in 5 years time? I have to renew and I have pre-approved for a 5yr closed rate for 3.95%.
Thanks for all the time you put into your blog.