Monthly Archives: September 2008

The nature of money and politicians

With a second bailout of a Belgian bank in as many days, a guarantee from the Irish Government to underwrite their banking system for two years and the swirl of debate and interpretation of yesterday’s shock move in Congress reverberating around us, I have found myself pondering two key issues facing the market at the moment. The first concerns the nature of money and the second concerns the nature of politicians. The former must have changed, while the latter remains as obdurate as ever.The word “unprecedented” has been used so often this year, referring to Central Bank actions, that it has lost so much of its power that it is almost a cliché now. I don’t have the exact figures to hand (sorry not enough time to do proper research today!), but hundreds of billions worth of global currencies have been pumped into the financial system. One question which has been absent from a lot of commentary is exactly where has all this money come from?

How exactly is the Belgian Government suddenly able to bail out two banks? How can the Irish Government afford to underwrite banks, which have to be on thin ice (especially given the state of the Irish property market)? How can the British Government afford to take over Bradford and Bingley? Most critically how on Earth can the USA afford the $700 billion bailout, especially given the amount of Dollars they have already pumped in?!

Historically money was tied to some form of underlying base product or commodity. Traditional economic models state that increased money supply must lead to inflation. Governments’ primary source of revenue is through taxation. Printing money to “solve” economic problems has usually created even bigger problems, notably hyper-inflation. Hyper-inflation leads to destruction of currencies, which suppresses economic activity and usually ends in a violent correction.

OK so I am over-simplifying things, but have things changed so much that these basic principles do not hold true anymore?

No doubt there are those that will tell you that past performance only serves as a guide and future performance should not be judged on it. After all modern money is electronic. It can be whizzed around the World at the press of a button. It is a system of exchange, based on confidence that your counter-party in any transaction will honour the agreement and that Central Banks are there to underwrite the transaction.

While we have experienced massive, social, technological and economic change in the last 30 years, the confidence the system is based on is potentially its most serious structural flaw. What happens if confidence evaporates?

The simple answer is no-one knows.

If historical precedent is anything to go by then the implications are horrendous. We could see a total collapse of the financial system, which takes generations to overcome.

If, however, we have made a break with history then the outlook might actually be a lot more positive. While we could well see a short-term serious retrenchment, which will be painful, the modern economy might well be able to heal itself in an unprecedented (sorry!) manner. I actually have a lot of faith in modern people. We are better educated and informed than any generation that has lived before us. We have incredible technology at our disposal and live in generally liberal, positive, stable democracies. Power (military, political or economic) is not concentrated in ways it has been in the past. While the US is certainly the World Leader, in relative terms this position is not as significant as it has been in the past.

What I am less confident about is the inflationary outlook. I need more time to understand this, but intuitively a lot of what has been done this year to solve the Credit Crisis feels wrong.

So what does this mean for the rest of the week?

The more I think about it, the less in favour of the bailout I am. By letting banks, who deserve it, go to the wall the US Government will be taking a massive risk. However given the level of financial support they seem able to give the economy I believe that their energies could be better targeted elsewhere. Wall Street executives really do deserve what should be coming to them.

If the bailout does go through, I fear that it will be doomed to fail as it has got off to such a bad start. For a confidence raising initiative, it does not inspire much assurance such is the level of resistance to it.

However I still think it will pass, although it will be interesting to see what happens in the next two days. I need to see the re-worked version of the plan, but I think the shockwave of yesterday’s equity sell-off is bound to have had an impact. While this morning’s rally might have lessened the affect, it is still bound to be influencing the agenda. The dire state of money markets must also be playing very heavily on US lawmakers’ minds.

Of course there is one factor, which we do need to remain aware of. Throughout this period of great change, there will remain one constant – the self-interest of politicians. I caught one item on the radio this morning that said that out of roughly 145 US Congress seats, which are marginal, only 8 members voted for the bill! Given how unpopular the bailout seems to be with the US public and with an election looming we really shouldn’t discount political expedience halting the entire process.

I am staying out of the market today.

Bailout Monday is not being well received, especially in the UK

I went quite heavily long on Friday night in anticipation of a bailout driven surge in equities. When markets first opened last night, they were up slightly, but nowhere near what I expected. I was able to move my stops up and limit my exposure. I left the positions and went to bed.When I woke up this morning, absolutely everything had collapsed.

While I have taken a loss (albeit not that great), I was less bothered about that than I was about the initial market reaction.

At the moment my main feeling is that there is still some uncertainty about the bailout passing, but I am starting to wonder whether or not economic fundamentals are starting to have a stronger impact. After all, the outlook in the medium term is pretty dire. Even if the bailout goes through it is highly unlikely that this will immediately unclog money markets. We are at the end of credit driven boom and there has to be a rebalancing of economic forces in favour of what we can afford rather than what we would like.

In the UK things look especially bad. The only surprise that Bradford and Bingley has been nationalised is that it has taken so long to do. It will be interesting to see how the Tories perform at their Party Conference in comparison to Labour’s last week, but something needs to change in this country to change reverse the mood. Sadly Gordon Brown looks more and more isolated. I watched his keynote speech and didn’t think it was that well received in the conference hall. He is likely to hang on until the next election, but this is more by default than anything, thanks to the total lack of a credible challenger.

I am still going to go long this week, but am not sure when. I might trade very lightly today. If the US bailout is to pass through Congress, then it will surely happen today. Even if it does, it is not a certainty that this will provoke a rally. The evidence from Asian and European indices is not positive, nor are the US futures prices. As with last week, I would continue to urge caution in whatever you do…..

Washington Mutual fails and Republicans rebel

I went to bed last night really believing that I would wake up to the news that the bailout had been agreed.

Instead I woke to hear that WaMu had failed, JP Morgan had bought the remnants for next to nothing and that the Republicans in Congress were leading an open revolt against the Bush Administration. The longer this all drags on the more I despair of all our prospects.

To be honest I have a great deal of sympathy with the Congressional Republican position, but less so for the people pushing it. I definitely believe that market forces should in principle be allowed to play out. Bankers on Wall Street caused this mess; they should reap what they sowed. However the same people making now fighting this corner are the same people, who enabled the Bush Administration to push through the level of deregulation that allowed Wall Street to engage in such avaricious behaviour. They even lauded the Administration for doing this.

Where all this leaves us now is nigh-on impossible to say. The fact that Democrats are siding with Bush in trying to push the legislation through is the clearest sign of what an upside down World we now seem to live in. The failure of WaMu last night (and the timing of the regulators to move in is certainly questionable) is certain to put more pressure on a deal happening today. Given that Congress is meant to break for recess tonight, time really is of the essence.

For my money I am still long, as I think a deal has to happen. I really cannot see what other outcome can be reached. If the Republicans in Congress do manage to block it, then they might as well also hand over the keys of the White House to Obama at the same time.

If a deal does go through I can see some immediate short term relief for equity markets, but I believe this will be short-lived. If my Presidential Rally does occur I can’t see it lasting long. The mood and situation now is so dark as to be pitch-black. Whether or not the bailout is going to resolve the situation really remains to be seen, but if the inter-bank lending rates are anything to go by then the money markets certainly aren’t holding out much hope on a significant increase in liquidity. In some ways it is surprising that the major increases we have seen in these markets in the last couple of days haven’t translated into deeper falls in equity markets. Against the backdrop of a week of dreadful economic data somehow equities have just about held on. Although we did see the worst two day performance on the Dow in 6 years, this was on relatively light volume (relative to the carnage of the week before at least).

The only conclusion I can come to is that everyone, like me, is waiting with baited breath to see what happens on the Capitol in the next 72 hours……

Don’t bank on the bailout and Buffet buys into Goldman

I got the opportunity, yesterday, to watch most of the Congressional hearing on the bailout plan. Ben Bernanke, Hank Paulson and Christopher Cox, Chairman of the SEC, were grilled about their plan for the $700billion bailout of Wall Street. It was pretty intense and, at times, even smacked of desperation.My overriding impression was the level of anger the Congressmen and Congresswomen, from both sides, directed at the three in the hot seats. There was a definite bi-partisan expression of intense frustration on behalf of taxpayers at this plan, which could see the liability for every man, woman and child in the US reach $37,000 under this plan.

A particular bugbear concerned the level of executive remuneration for failed business models. At one point Bernanke was even asked if he felt that Wall Street should apologise to America (he fluffed the answer and was non-committal). Hank Paulson repeatedly said he shared these frustrations, but kept pointing out that US taxpayers are already so hideously exposed to this crisis that the only way to proceed is to be extremely pragmatic, focus on solving the major threats and dealing with such issues later on, in a new regulatory context.

On the subject of the level of oversight for this plan and Wall Street in general, Paulson conceded that the regulatory environment has simply not kept pace with financial innovation. He recognised and welcomed the need for careful monitoring of the bailout and also stressed the need for an overhaul of the Fed and SEC.

One particularly interesting exchange was when Bernanke was directly asked why this plan would work, when his others hadn’t. Bernanke tried to reply that there was no evidence yet that his other plans hadn’t work. This wasn’t convincing and his accuser eventually managed to force him to concede that he simply didn’t know if this plan would work. This answer seemed to agitate Paulson, who very shortly after interjected that so far the actions that had been taken had each been in response to the specific circumstances at that time and that today’s plan was so big it would end all the problems.

Throughout the hearing Bernanke and Paulson pointed out that credit markets has now effectively ground to a halt. The implications of this for the wider economy are horrendous. They kept making reference to the lack of car loans and painted a very vivid picture of 6million fewer auto-sales if Americans could not get access to car loans.

I thought Paulson did extremely well. He was extremely consistent and didn’t get riled by some pretty aggressive questioning. He shared a lot of his personal anger at the current situation, but tried valiantly to keep the focus on the wider problem. I was a lot less convinced by Bernanke (Paulson had to expand on several of his answers to give them more punch) and Cox’s role was something of a bit-part, although he did make some very good points about the need for further regulation and an explanation of how the SEC had come to the decision to limit short-selling (a decision he said, which was not taken lightly).

In terms of the standard of the Congressional questions, I was extremely impressed with these. If I look back nearly a year, when Parliament held a similar event to assess the wreckage of Northern Rock, British MPs were simply clueless and asked a series of irrelevant or, dare I say it, stupid questions.

It is difficult to see where things stand now. I am not convinced that Congress are going to pass this bailout plan that quickly. Even if they do, it could come with so many clauses that it is not flexible enough to implement effectively. For example one issue, which I can see scuppering things concerns executive pay.

As much as I really hate to admit this, I agree with Paulson. Any move to limit current executive remuneration is likely to damage the overall impact of the plan. After all Wall Street vultures have consistently shown themselves not to care what happens in the wider economy. Sadly their support is vital if this plan is to work. What incentive would they have to help push it through if they not only faced the prospect of losing out financially but also being pursued by criminal or civil lawsuits? The alternative is to bypass them, but to do this will take a lot of time, which is something the market and economy simply do not have.

A second critical issue concerns the price the RTC pays for the “assets” from Wall Street. Given the sheer size of this scheme, it is certainly open to abuse and profiteering. While Paulson acknowledged the need to effective oversight several Congressmen and Congresswomen pointed out that there wasn’t enough time to get this into place. Paulson recognised that this was a risk. This matter wasn’t really dealt with satisfactorily and I expect to hear much more about it today.

Overall I think that Congress have to support the bailout and I am long in expectation of this, but I would urge caution.

I am not taking a lot of exposure at the moment as this is such a complicated situation and has only begrudging Congressional support. It also remains to be seen exactly what the plan will look like or how long it will take to pass. Given how skittish the market is, we could see a substantial move down, if things drag out for the rest of the week.

One possible reason to feel bullish is Buffet’s $5billion injection into Goldman Sachs. Buffet is a legend when it comes to snapping up fantastic bargains at distressed levels. His timing also tends to be spot on. However he is not infallible. He must have figured that now is the time to act as Congress breaks at the end of this week, meaning that the bailout is likely to happen in the next couple of days.

Given what I saw yesterday, he might be wrong about this.

The end of US Investment Banking… (well not quite)

The news yesterday that Goldman Sachs and Morgan Stanley were being allowed to change their statuses to “government-approved holding companies” was widely greeted as the end of the US investment banking industry.This is complete rubbish. While it is certainly true that we have seen a seismic change in the US financial services sector in the last ten days, it is nonsense to suggest that this activity won’t continue beyond the current market travails.

While MS and GS will now be able to take customer deposits, I found it laughable suggestions that they are seriously going to engage in less risky activity. Equally Bank of America’s takeover of Merrill and Barclays’ capture of the remnants of Lehman simply means that the majority of the same activity will go on, under different names.

If US regulators are not very careful, all that will happen is as soon as Wall Street executives feel they are under less scrutiny they will fall back into old habits.

I understand that there are larger concerns to deal with in the short-term, not least finalising the creation of this giant cesspool of debt, the Resolution Trust Corporation. However this situation on Wall Street cannot be left as is. Allowing the predatory vultures to gain access to commercial deposits has the potential to be diastrous in the long run. I wrote last week that I hoped banking executives would learn the lessons of the Credit Crisis, but this is highly unlikely.

Investment banking and commercial banking were separated long ago, for very good reasons. Re-uniting them, will be in nobody’s interests.

What happens next? Some of the long term issues we all face…

There are a lot of unanswered questions this weekend. For the most part the market will be focusing on those that surround the unprecedented bailout of the US financial sector by the Government.

In the short term the majority of these questions concern the precise make-up of this package. I am holding some long positions over the weekend, in anticipation of a positive short term-reaction. As I said yesterday, it would be a spectacular own goal for the package to do anything but meet expectations at the very least, if not surpass them.

Beyond the next week all other commentary seems to be focusing on what this means for the financial sector in the longer term. As is being pointed out ad infinitum this is truly unchartered territory. We could be on the verge of a Thirties style decade long depression, but the simple fact is no-one knows. This speculation is likely to continue for a very long time. Whatever the case the longer the uncertainty continues the greater the corrosive effect will be on confidence. Given that the whole system is predicated on this fickle commodity this has brutal consequences for all of us.

However it is not these questions which are bothering me. I am far more concerned about what the Fed will do next.

The Fed cannot leave things as they stand. Their whole strategy has so far been built on underpinning financial markets to stop the credit crisis spreading to other areas of the economy. It remains to be seen whether or not this has worked, but even if it has this can only be the first stage.

In the coming months and years US regulators have an almighty mess to sort out.

First they somehow need to reduce the Government’s exposure to all this debt. Some figures I have seen could put this exposure as high as $10 trillion. Failure to do this and we really could see the unimaginable happen – a default to US treasury debt. If we thought the reaction was bad to the failure of Lehman, this will be nothing compared to the destruction we will see if a Western Government defaults on any of its debt. One certainty I can see coming out of this crisis is that the next President will be forced to press ahead with offshore drilling and drilling in Alaska. The national budget is desperately going to need the extra Dollars generated by increased oil revenue.

The next major issue that the Fed will need to deal with is decoupling investment banks from the commercial banks. With the takeover Merrill by Bank of America, the possible Morgan Stanley/Wachovia and JP Morgan/Washington Mutual tie ups and the acquisition of a large chunk of the remnants of Lehman by Barclays Capital we find ourselves in an extremely dangerous situation. Investment banks are there to provide risk capital (although they clearly took their risk taking too far) and commercial banks are meant to provide a safe depository for consumers’ savings. Combining the two is simply insane. While such moves have been borne out of the madness of recent times, they simply cannot be left unchecked. When things eventually sort themselves out again investment bankers will inevitably become embroiled in other greedy/borderline corrupt practices, which will lead to another crisis of some description. If this threatens the security of depositors’ savings then the implications will be dire. Things are bad enough now, without this having happened.

Third the Fed is going to have to take some hard decisions about interest rate policy. The longer rates stay at such low levels, the stronger the inflationary impact will be. While a positive side effect of the defaults in the housing market and on Wall Street will be to remove some liquidity from the system, this will be short-lived. Commodities are likely to resume their upward momentum. The population pressures of China and India certainly haven’t gone away. While there might be less economic activity in the West, these countries are still on course to grow at elevated rates. Part of the Fed’s strategy is almost certainly to allow for some inflation to help alleviate the pressure on the housing market, but this is risky. Their logic will be that if prices rise relative to house valuations then this will help the market form a bottom. The problem is that history has shown us that inflation has a habit of being an untamable beast, when unleashed. The last thing that the Global Economy can handle is a runaway inflationary cycle.

Finally the Fed urgently needs to resurrect confidence in the financial services sector. The banks must start lending to each other again. If they don’t then they threaten to unravel absolutely everything. Sensible borrowing and lending underpins the whole economy. So far the banks have been bailed out by the Government and it is their responsibility to reciprocate this. To be honest my greatest fear of all the threats facing the system, is this last one. Apparently morality has no place in business, but if we learn anything from this crisis it is that this is patently not the case. Remorseless and unfettered pursuit of personal gain has caused this calamity. Ultimately it should be up to the people who caused this to do their best to minimise the impact on the rest of society.

I fear this will be a vain hope….

I love Hank Paulson….

….. and Hank Paulson clearly loves me!

Having faced my own personal financial meltdown at about 5pm yesterday afternoon, I went to the gym to commit suicide on a running machine.

By the time I got home the mother of all rallies was well under way. This morning I had erased all my losses and was well up on the week. For the record I banked big profits in Barclays, the Nikkei, the Dow and the FTSE100. I am still long the Dow, but with relatively light exposure.

The news that the US Government is going to set up a Resolution Trust Corporation to take the toxic debts off Wall Street’s balance sheets was compounded by news that short-selling has been seriously curtailed. In one stroke US policy makers have removed the two greatest weights on the market. Before I get too carried away, we need to see what happens this weekend and next week, but the rally looks well and truly back on.

I can still see some near term weakness, but to be honest I am likely to use this as a buying opportunity.

Overall I think this week is going to be viewed as a master stroke by the Fed. Earlier in the week I was questioning how they could possibly unravel their strategy from the last twelve months in letting Lehman go to the wire. What is clear now is that this was part of a wider plan. The basic psychological slight of hand they have played this week is extremely impressive. Letting markets sink to the depths of despair by Thursday afternoon only to announce the most incredible news 2 hours before the close was clearly designed to have maximum impact. Reports of wild cheering around the world at dealing desks are unlikely to be exaggerated.

Of course there is still the rest of the US session to go, before the weekend, but if Wall Street extends its gains then the scene is set for a strong rally next week.

We still need to see the detail of the RTC, but it would have to be a spectacular own goal for the Fed to get this wrong now.

What a wonderful day to be alive J

Blood on Wall Street

One thing that is certainly going to come out of this year (and week especially!), is that there are going to be some fascinating books about all that has happened. With all the bail-outs, write-downs, corporate failures and panic selling, these are perfect ingredients for an exhilarating read. You can just imagine the titles – “Blood on Wall Street: How the US investment banking was brought to its knees” etc…This week has been exceptional and there are still two full trading days to go!!

This morning we heard news of the coordinated efforts of 5 central banks to inject $180 billion more liquidity into the market. Whether or not this stems the tide of selling remains to be seen, but I do see this as another positive step.

If you are in cash at the moment, I would seriously urge you to start buying stock. While prices certainly have capacity to fall further this is an excellent time to average into the market. Purely looking at the value of stocks buying companies, with a long term view has to be a good idea. Although there is a great deal of doom and gloom out there at the moment, the outlook has to be much better than it has been at any point this year.

It is important to remember that 6 months ago, we were faced with an implosion in the investment banking market. Well this has happened now.

We also had the prospect of rampant inflation, caused by a commodity boom and the excess liquidity pumped into the system by the Fed. Well commodities are now 40% off their highs and one positive side-effect of the destruction in value by the collapse of Lehman and others and also housing prices is that this has taken a great deal of liquidity out of the system. I am sure these will actually have a balancing effect and we will see inflation start to come down. I wrote about wage inflation as a concern facing the economy, but in the current climate, with the pervasive, horrendous headlines how many employees are seriously going to ask for more money, when faced with the prospect of losing their jobs?!

We are now entering earnings season. I actually expect results will not be that bad. However what is likely to have a negative effect is that companies are likely to use this period as an opportunity to get any and all bad news out there. From a PR perspective this has to make sense.

Finally there are two critical points to remember about the market.

First it is a giant discounting system. In other words it looks at the outlook and prices in likely risks and rewards. Part of the reason I have remained positive this week, is that the “news” that has come out, while it has been pretty spectacular, it can’t have been a surprise to anyone who has picked up a financial newspaper or read a financial website in the last 9 months.

Second the market has a remarkable capacity to heal itself. While this week has been dreadful and it looks likely that there will be further selling we are not facing the end of the World. It is arguable whether or not things were worse in 2001-2002, but I would suggest they were. I will write more about this, this weekend.

And I thought the US won the cold war?!

Is the US Government going to nationalise the whole finance industry? Less than two decades after Communism was allegedly defeated, who would have thought that the bastion of capitalism, the US financial services sector, would succumb to national ownership? These really are unparalleled times.For all intents and purposes AIG was nationalised yesterday, a week after Fannie and Freddie. Although Lehman was allowed to go to the wall and the Fed didn’t cut rates further, US tax payers now collectively own the world’s largest concentration of complex financial companies, products and commercial arrangements. In spite of this the market reacted positively to this news and we saw a day of record volume on the New York Stock Exchange and a +100 point rally on the Dow. Given the intraday lows, this was actually an encouraging move. Then came the news that Morgan Stanley beat estimates.

While there was speculation that even the mighty Goldman Sachs might have to consider merging after its poor results pre-market, I wonder whether or not the rampant rumour mongering is going to come to an end soon. This week really does have the feeling of a bottom. So much has happened and it is only Wednesday. If we see a rally into the end of the week, then stocks could well move +15% up. Of course if there is a sell-off today, then Dow 10,000 could be on the horizon.

I am only long Barclays at the moment, taking profits in the FTSE and the Dow last night. I am waiting for the building stats at 1.30pm GMT, before making any further moves. Whatever happens I am going to tred carefully.

Things get worse, but my outlook is brightening

I have spent some time this morning looking back at market crashes in the last 20 years. 1987 and 1998 were the last two occasions when we saw action similar to that seen yesterday, but there are some critical differences.

First yesterday’s severe sell-off in markets occurred, when markets were already in or at the border of bear market territory. In previous crashes markets have been at the top or near the top.

Second the only real surprise yesterday was that the Fed did not provide a bailout for Lehman. Although this wrong-footed me quite severely, I have woken up this morning thinking that this was actually the right thing to do. If the Fed follows up with more of a package to help underpin the rest of the market, then we could well be approaching a bottom. This has been coming for a long time and the key market participants have had time prepare.

Third, while volume was extremely heavy yesterday and was one of the highest volume days on record, comparatively it did not stand out against relative 1987 or 1998 crash volumes. This for me is quite critical, as we have already seen so much selling in this market in the last year that the economy would really have to nose-dive for things to get much worse. While there is a possibility of that, there is also the chance that things could start to improve.

Fourth yesterday’s sell-off was not followed through in a mass ditching of the Dollar. Again one might have expected such an event as yesterday to see substantial declines in the Greenback. There are some rumours that this is partly explained by an implosion of hedge funds and they are desperately trying to unwind positions, but it remains to be seen if these have any substance.

In terms of what is to come it is still difficult to predict. The market is so emotional right now that we really could see a total collapse. Equally the Fed might step in with a package to end all packages. We might even so all of those who got out at the top of the commodities boom start to pile back into stocks.

Whatever happens today is certainly not going to be for the faint of heart. For my money I am still going to go long, although I must take care not to burn myself further. I have also taken this morning’s pullback to go long Barclays.

Don’t forget the Fed is due to announce at 7.15pm GMT.

P.S. Thank you to all of you who wrote to me yesterday to point out my “deliberate” mistake. Last night’s close on the Dow was actually below the July 15th level – mea culpa, I am sorry!

After all that money, finally the Fed’s strategy unravels, but I am not panicking…….. yet

Well I got burned today and I wasn’t alone. I really thought that the Fed would have to stick to their strategy of underpinning the markets. They haven’t and today the market’s back was broken in the last 2 hours of trading.It is going to take something pretty spectacular to save this situation now. I just cannot understand how after all of their actions this year, they decided that now was the time to stop. I know it will eventually come out, but for the time being it does not look good. The collapse of Lehman is cataclysmic. In a year of unimaginable events this one really takes some beating.

If the selling continues from here, the Dow could seriously fall below 10,000. About 2 hours before today’s close there was actually a decent rally. This failed and the selling intensified in the final hour. As bearish signals go this couldn’t be much worse. Taking into account the extreme volume and the sheer number of stocks that declined, the outlook is dire.

However…………. while the S&P 500 broke the July 15th low, the Dow just about clung on. If it manages to stay above 11,000 tomorrow and the S&P makes it back over 1,200, the rally could still be on.

I know that this view is ultra-contrarian, but the reasons I wrote about last week are still valid. Lehman’s failure and the takeover of Merrill by Bank of America mean that a lot of capacity has been taken out of the US financial system. For the survivors this is a good thing. It also means that the two largest toxic portfolios have been cut out of the market in one day. In many ways today feels like the beginning of the end of the Credit Crisis. Time will tell about this, but, seriously, just how much worse can things get?!

I also don’t believe we have yet heard the last from the Fed. If they don’t do anything tomorrow, then things are going to get far worse. Rates are surely going to fall tomorrow and watch out for yet another spectacular announcement. Anything other than this and could the last person to leave the markets please turn out the lights.

Now for some real nastiness and Betting on Barclays

For the 3rd Sunday night on the trot I find myself awaiting the open of the futures market with baited breath.Unsurprisingly markets plummeted in the first seconds of opening as it really does look like Lehman are going to fail. The prospect of this is actually unimaginable. What happens next is simply anyone’s guess. This is America’s 4th largest bank. Bear Stearns was the 5th largest.

This time however the Fed is saying that they are not going to underwrite any bailout. I cannot understand this position, even though I agree with it. My problem is that so far this year the entire Fed strategy has been built around underpinning the US banking system. I have always thought that ignoring the basic principal of moral hazard was going to be a strategic mistake. In their actions this year, the Fed has simply said that it will bailout US banks, no matter what they have done. The fact that the Credit Crisis is purely self-inflicted hasn’t seemed to matter at all. Letting Lehman fail is surely going to bring this whole strategy crashing down, further amplifying the affects of a crippled banking system and seriously increasing the overall risk of the vast positions they have taken on, at the risk of US tax payers.

Just think about the huge range of financial transactions Lehman will be involved in. These are suddenly going to have to be unraveled. In all likelihood they will be forced to default and the lion’s share of them. I can’t begin to comprehend, let alone explain what a mess this is.

The Fed is due to meet on Tuesday, for their next statement on monetary policy. I wouldn’t be at all surprised to see them cut rates. They might even do it in the next 24 hours.

In spite of all of this, I have actually just gone long again. The Dow’s decline tonight halted at its March 2003 Value Zone 11,163:11,179. I am fairly certain the Fed are going to have to act and the last 48 hours has been an almighty game of chicken between investment bankers and the policy makers. The policy makers have the weaker hand, so I cannot see what else they can do.

My positions from Friday got stopped out, but I did bank most of the profit as they were on tight stops. I have used this to go long the FTSE and the Dow, again with tight stops. This is an extremely risky trade, but the upside is massive, in the event of a bailout. If there is no bailout, then watch out for Armageddon.

If we do see a collapse tomorrow, I am going to stay out of the market for a while, but one long term play I am going to look at closely is Barclays. I have written about Barclays in the last 6 months and it has been a stock I have a positive long term view on. This has been heightened this weekend, by the news that they were one of the potential firms being touted as a saviour of the carrion of the carcass of Lehman. I was really surprised by this, but the fact they were seriously in the frame for this, must have meant that the Fed have confidence in their long-term prospects. While this is not the most ringing of endorsements, in light of all that has happened, it surely has to be a long term bullish signal. Barclays P/E, based on Friday’s close, is 6.1. By any estimation this is cheap. If it falls tomorrow I am likely to buy more.

I spoke too soon about AIG

AIG fell 30% and Merrill Lynch fell 12%, in what was otherwise a reasonable day for the markets, even though they ended slightly down.

The falls in AIG and MER seemed to be based more on fears that they would be next in the Credit Crisis. I am not yet advocating buying either stock as I want to do more research, but if you are familiar with either company, yesterday’s drops look suspiciously like a buying opportunity. My logic behind this, is that moves driven by such widespread fear can lead to a condition where an embattled stock gets oversold. While I don’t know enough about either company to comment with any conviction, I am going to consider going long this weekend.

I am now long the S&P 500 and the Dow. If there is a Lehman bailout this weekend, then this should be good for stocks. There is serious talk of an LTCM-style rescue package and you get the feeling something has to happen by the time Asian markets open.

How the market will react is simply anyone’s guess at the moment. Judging by the moves in AIG and MER, we will need to see something pretty special to help the market find its feet, but I am still reasonably happy being long at the moment. As it turned out last week, I did pretty well. While I would have like to have seen a stronger positive move, after the Fannie and Freddie bailout, the fact that the market did move forward, even with the financial uncertainty is encouraging. On Thursday we saw a fantastic one day reversal and yesterday we nearly saw the same. Both of these moves were on large volume.

Is there anything beyond Washington Mutual and Lehman?

This week started so well!Of course things have turned really rather nasty since. The collapse in financials, triggered by Lehman Brothers and Washington Mutual has really put a real damper on the market. My rally is looking increasingly unlikely, but I am not giving up on it just yet. While the news flow is increasingly negative I find myself wondering how much more is there to come.

Lehman and WaMu have been in and out of the headlines for a long time now. Given their share performance in the last few days, the writing is clearly on the wall for both. It is looking likely that both businesses might even fail this week. With WaMu on the Fed’s watchlist and Lehman about to be downgrade by Standard and Poor’s the immediate future is looking pretty bleak for both. There are arguments that support both banks, but the market is exceptionally unforgiving at the moment and this kind of action is rarely reversed.

I just wish both of these two would get out of the way!!!

If they did, then it is hard to see exactly what the next major problem will be in the coming months. The long-term structural issues will still take some time to manifest, but whilst this is happening stocks could well breakout to the upside.

There have been increasing numbers of articles surrounding problems in the insurance market, with AIG looking particularly weak, but so far this coverage has been fairly muted.

I have been writing this blog piecemeal today. The way things are looking we could well see a decent one-day positive reversal on large volume. Such a bullish pattern at these levels will be encouraging.

The Dow’s March 2003 Value Zone is 11,168:11,183. The resilience of the index not to drop too far below this level is also a good sign, but other indicators are looking increasingly bearish. Just go away Lehman and WaMu!!!!

Divergence converges and the US collapses

There are no two ways about it today’s action on Wall Street was horrendous. Financials and energies fell a massive 6% each on extremely heavy volume. Unsurprisingly the Dow tanked. As commodity prices collapse further and the oil price falls below $100, energy stocks look like they can head only one way. Equally as the dust settles on the bailout of Fannie and Freddie, realisation has set in that the Credit Crisis is by no means over. Further weak data from the housing sector helped push stocks even further lower.Even against this backdrop I am going to stick to my guns for the time being. While we are still in the throws of a nasty bear market, I think there is a lot that can still lift this market in the short term. It would be a huge help if the Lehmann board would just give up and sell the seemingly doomed company (or whatever remains of it), but even in this case the board is standing by their prediction that there is good news to come on their September 18th earnings announcement. Time will tell on this one, but if anyone fancies a pure gamble, a 40% daily drop in a company like Lehman could represent a buying opportunity (though be warned I did initially say that about Bear Stearns!!!!!). Of course we are in an archetypal outlier market at the moment, where the improbable has become extremely probable and no-one seems safe, so any move is high risk.

Even so, the move by the Fed at the weekend is yet another unprecedented move, which is simply huge. Normally I would expect this move to be trend changing. In that respect there is an interesting parallel between today and yesterday’s trading and the trading in the two days after the Bear Stearns bailout. The day after Bear Stearns was announced, the Dow rallied extremely strongly on high volume. It then fell back the next day, almost as much on nearly the same volume. We have seen exactly the same yesterday and today.

I am especially hopeful that today’s drop did not completely erase yesterday’s gains. Given where the market closed and the slight rally in after-hours trading, I have taken the opportunity to take on more long Dow positions. I have relatively tight stops, as a further move below the March 2003 Value Zone (11,165:11,178), could provoke a more severe sell-off. Equally a rally tomorrow could see the start of a break-out through 11,750. If I do get stopped out this week, I will probably buy again at the start of next week. If that plan fails then I am going to re-assess my view on the likelihood of a rally between now and November.

Once again it is back to Asia and I expect more selling tonight, as markets there seem to be particularly responsive to financial market turmoil and bad news.

And now over to Asia….

The rally in Europe today was fantastic, but the in the US it was jittery to say the least. I banked some profit, but am still long Wall Street, but we really do need to see a decent follow through now.

I am sure that part of the problem today, is based on the complexity of the Fannie and Freddie deal. As both companies were battered down to valuations a little above zero, the rest of the market was trying to digest how this mess would be sorted out. Looking back I really should have shorted these, especially after I called this outcome a while ago.

Looking through available announcements about the deal, I am struggling to see exactly how it is going to work. Hopefully things will become much clearer in the next few days and this will give the market succour.

While today’s session in the US was extremely volatile, volume was huge. A decent performance from Asia tonight and hopefully we will see some more of the same tomorrow…..

The rally has to start now

Unless you have been stranded in a desert you could not have failed to hear the news that the US Government is effectively nationalising Fannie and Freddie. This is Northern Rock on steroids.I am so glad I went long on Friday. I have pretty much reversed last week’s losses as of writing as the Dow has jumped +200 points already. If this isn’t the beginning of a decent rally in the market, then nothing is going to move it higher. I was fairly positive for all the reasons I spelled out yesterday. I didn’t factor in the Fannie and Freddie bailout, but this is something which I have been covering in the last 6 weeks. As I said before this was certainly having a negative effect on equities, but now that the US Government has acted decisively this weight has been removed.

The Bear Stearns bailout in March was the catalyst for a significant bear rally and I now expect more of the same.

Before I get too carried away, though, I do want to drop in one note of caution. While we could well see the Dow move to 13,000 the long-term structural problems in credit markets and the Global Economy still need to be solved. While the Northern Rock experience in the UK has been relatively benign so far, things are far worse in the US housing market. The Federal Government is taking on huge exposure to one of the worst housing markets in several generations. As we heard on Friday, 9% of US homeowners are struggling and repossessions are hitting record rates.

This bailout is going to cost US taxpayers billions. If the housing market gets much worse, their exposure could grow exponentially. This view is obviously held in currency markets as there has been a broad sell-off of the Dollar as of writing.

Time will tell whether or not this move will help solve the US housing market woes, but if the Dow breaks through 11,800 enjoy the ride while it lasts!

A feeling of utter bemusement….

Yesterday left me feeling quite lost, when it comes to the markets. Somehow the Dow finished higher on the day, whilst the FTSE 100 rallied +75 points in after-hours trading.The US Payrolls data was dire. Not only were more jobs lost during August than forecast, but there were several substantial downward revisions for previous months. June saw 100,000 jobs lost. Against this backdrop the US unemployment rate leapt to 6.1%. This news was compounded by a report from the Mortgage Bankers Association, which claimed that 9% of American homeowners are now behind with mortgage payments or are facing repossession. (NB. This is all against an apparent upwards revision of GDP for the quarter!!!!)

Given Thursday’s massive sell-off, one might have expected markets to plough through the July 15th lows yesterday, yet they didn’t. In fact we even saw a one day reversal with stocks ending higher on the day led by financials. In the last few weeks there have been a series of bullish patterns emerging in one day charts, interspersed with the occasional extreme bearish pattern.

If stocks rally next week, then we could see the beginning of a double bottom. So long the Dow does not reach the intraday low of 10,731, then the Presidential Rally could well and truly be on. As I wrote yesterday, the March 2003 value zone stands at 11,168:11,177. On the face of it, this represents real value in stocks. At this level investors should start to buy again. From July 14th to July 17th, this year we saw a great deal of volume at around this level. If there is a decent rally on Monday, backed up by high volume, then this is a good sign.

However is this likely in the current climate?

Although I took a severe beating in the market last week, this was largely self-inflicted and I am going to take some time to regain my objectivity. At the moment there are several key reasons why I believe a rally off these levels is likely in the US. These are:

We are reaching the climax of the US Presidential election. The country is in desperate need of regime change. The Bush Administration has generally been a disaster and America feels like a country in need of rediscovering its self confidence. Both Obama and McCain are offering change. So long as one wins with a clear mandate, this should help shift the mood of the country

  1. Commodity prices are in freefall. While this isn’t good for commodity stocks, the effects in the wider economy should be felt through lower inflation. If inflation appears to be coming under control naturally, then the Fed are less likely to raise rates in the next two quarters.
  2. Wage inflation doesn’t yet seem to be creeping up. I wrote a while ago, how this was likely to be the next threat facing policy makers. I don’t believe this problem has gone away yet, but in a climate of job losses, workers are less likely to ask for more money. Although there have been increased levels of industrial unrest (most recently at Boeing), this is by no means out of control – for now at least.
  3. US companies substantially revised their forecasts lower over the course of this year. In all likelihood they erred on the side of negative caution. If this is the case, then the next earnings season could hold some pleasant surprises. Given this starts in 2 weeks, the timing to support a rally off current levels couldn’t be much better.
  4. While the news out of the housing market is dire at the moment, somewhat perversely this might be a good thing. Quite simply how much worse can things get? We are already at record levels of households in trouble. 9% is a huge figure. For it to rise much further we would surely be facing total economic collapse. The situation is bad, but I do not believe we are facing the end of known civilization.
  5. Financial stocks have been highly resilient at current levels. There has been a lot of buying of this sector in recent weeks. Although it would be nice to see more volume on the up days, it has been noticeable how these stocks haven’t been punished on bad economic news. While the Credit Crisis is still rumbling on, investors clearly have appetite for risk in this area, which is a positive sign.
  6. We are at the March 2003 value zone. From the perspective of trading using the system, this is a critical level, not to be taken lightly. While the reversals have been bearish signals, a rally from here could well form the basis of a technical double bottom bounce. This is an extremely bullish pattern. So long as the Dow breaks through 11,800, the next move will likely surpass 13,000.

I went long the Dow on a December contract at the close of play last night.

I am still going to take tomorrow to look at reasons as to why I might be wrong in my opinion of a strong rally for the rest of the year. Above all I am conscious that the relief from most of the reasons above is likely to be short-lived as there are still major structural problems, which need to be fixed in the economy.

Dow back to March 2003 value zone

I have opened two sets of Dow positions this week, with tight stops ahead of data, only to watch both close. I anticipated a pullback from 11,750, but I certainly didn’t think it would be this severe.

Yesterday’s drop is very worrying for indices. It was on very large volume and prompted a massive sell off in Asia overnight.

Once again the Dow has stopped overnight at its March 2003 value zone (11,168:11,177). For today I am sticking to my Presidential rally expectation, but I might be forced to change that over the weekend. Given the price of the Dow, its valuations is extremely tempting to go long. However the fact it has twice reversed off the 11,765:11,782 retraction zone is a very bearish signal.

Payrolls data comes out at 1.30pm GMT. If there is any hint of a negative shock there, in the number itself or the unemployment rate then markets are likely to tank today.

One way or another this has been a pretty damaging week for me and I am not prepared to chase another negative move. There are still some reasonably bullish signals out there and yesterday’s sell-off seemed to me to be an extreme over-reaction. The retail sales numbers and initial claims data, while not good, can’t have been that much of a surprise.

I really don’t think the outlook has worsened sufficiently to justify the kind of selling we have seen this week. However the market is rarely rational. Panic selling is exceptionally infectious. If the Dow breaches its current levels, then we could really see the next move being to 10,000 rather than 13,000.

Yet again we are facing a critical day for the markets (how many of those have there been this year?!), so I will be watching closely with bated breath!!!

– As a final aside to this note, for the long term buy and hold crowd, today is a good day to average into the market.

A nasty, but not unsurprising pullback from retraction zones

Yesterday got off to a flying start on Wall Street. Stocks surged 200 points on the Dow, pulling up indices all over the world in their wake.

However by the end of the day, this rally had collapsed and we saw quite a nasty one day reversal on reasonably high volume. This is quite a bearish signal, but I was not unduly shocked by it. As I have written recently, the Dow has a retraction zone at 11737:11749 and the FTSE 100 at 5632:5644.

I was already out of the FTSE (as I wrote yesterday) and I tightened my stops during the first hour of trading in the US. I did get stopped out of all my Dow positions, but I did bank a substantial profit (which lessened some of Monday’s pain!!!).

So what next?

I am still bullish for the next few months. We have the Presidential election to move stocks higher, but there is one other factor I haven’t really discussed. In the first two quarters’ of this year, corporate earnings have missed targets and outlooks have been revised substantially lower. There is an argument, that the outlook has been moved to far to the low side, giving companies a real chance of surpassing expectations at the next earnings season in a month.

We have found in the past that using the system for buying individual stocks has worked best roughly 6 weeks before earnings. By worked best I mean, that we have seen the fastest profits, trading in this sort of time period.

There is a lot of data still to come this week, so my plan is to trade ahead of each announcement, until I catch a rally. I intend to use quite tight stops as this is a fairly risky strategy I wouldn’t normally advocate. However in this instance I think positive economic news, will have a substantial impact on stocks. Given the Dow’s proximity to its retraction zone, if it breaks through this, we could well see it move back to 13,000. Equally if there is bad news, then this could hammer stocks and I do not want to get caught on the wrong side of a substantial drop.

For the time being I am going to focus exclusively on the Dow, but I am also going to spend some time looking for individual stocks in the S&P 500. That index has been doggedly low now for quite a while, so my feeling is there will be some good value out there to buy into.

Wrong footed by Gustav; Closed UK positions; Japanese political uncertainty; Long Wall Street, but watching GDP carefully

The last few days have not been good for me on the market. I made the critical error of convincing myself something would happen, when all evidence pointed the other way. I compounded this error chasing my losses and ended up burning myself quite badly.I am talking about Hurricane Gustav of course. When I saw the projected path on Friday I was certain it would wreak havoc on the Gulf of Mexico. On Sunday the futures markets jumped massively and I thought I was due to make a really decent profit. However by Monday morning my positions had stopped out. I went long again, got stopped out, went long again, got stopped out and finally walked away. I am extremely disappointed with my performance in the last 24 hours.Quite simply I know better than this, but there is no point anchoring myself on this nasty loss. The signs were all there to warn me and I have only done this to myself. What I should have done yesterday morning was to go the other way!! It is a very simple rule, but when you know you are on the wrong side of a move, reversing your position can often be the profitable way to come out of a loss making trade. The challenge of following this rule is the psychology of it. Had I been more objective yesterday I would have paid more attention to the movement of the charts and (possibly more importantly) have noticed further Dollar strength, which was bound to weigh on oil.

For the record Oil’s August 2007 Value Zone is 10579:10596. I am definitely going to sit this out for the time being. Apart from anything else I need to learn more about the technical aspects of this market.

UK

Moving on to the UK, I read Alastair Darling’s infamous interview with the Guardian on Saturday. If you haven’t read it, you really should http://www.guardian.co.uk/politics/2008/aug/30/alistairdarling.economy

I had heard the headlines surrounding this controversy, but this was nothing compared to the tone of the article itself. I have promised to try and steer clear of politics, so I am going to stop myself here, but before I do ask yourself how much confidence you have in this man to show the kind of economic leadership we desperately need in this country at the moment, when you read this article. Could you imagine Hank Paulson enlightening us with insightful analysis such as “Becoming chancellor is completely different from any other appointment. Completely different. Even when times are easy, it’s important, because you’re dealing with money, and money affects how everything works”.

I think not. What worried me most in this article, was the extent to which the Government seemed to have no clue what was brewing in financial markets. It is simply not true to say that no-one could have predicted this. Anyone who read the Hugo Bouleau book I recommended at the start of the year will know this http://www.amazon.co.uk/Final-Crash-Addictive-Deformation-Economy/dp/095552170X/ref=wl_it_dp?ie=UTF8&coliid=I3SMYMJH5INMOU&colid=2UV97FN9N2XOB

Given the FTSE’s proximity to a retraction zone, which is likely to provide resistance I decided to close out the FTSE positions and bank profits. Before I did this, I did take a look through the components of the index and was hard pressed to find anything that looked like it was worth buying. I am already long a couple of stocks in the index, so have decided to limit my exposure to those.

If the FTSE breaks through 5700, then I might be tempted in again. I accept that a substantial weight of FTSE 100 profits are generated abroad, but given the Global outlook, this doesn’t fill me with much hope either.

Japan

Yesterday saw the surprise resignation of the Japanese Prime Minister. I haven’t really had a chance to look into this yet, but did last night saw a big drop in the Nikkei. I am out of this now and didn’t take the opportunity to get back in. While the valuation is extremely tempting now, political uncertainty is never good for markets. Until I am able to get to grips with what is happening in Japan I am going to stay out of the Nikkei.

I am still medium term bullish on Japan, but want to understand better what is happening there.

Wall Street

I bought more of the Dow yesterday. Friday saw a big drop on small volume. On Friday we get the next payrolls number. I am still looking for a rally in the next two months, but there are still massive problems lurking out there.

I did cast doubt on the GDP upwards revision last week. Over the weekend I found some commentary explaining this as being down to a rise in food and oil prices. The US is a major exported of agricultural products and refines a lot of oil, which it exports. Given the inflationary characteristics of these two markets, they are bound to have contributed to GDP, but not in that meaningful a manner. If the US were sending out more goods-laden merchant ships, then the GDP figures would have a firmer foundation. Since they are not, then a large chunk of this GDP figure looks to be something of a mirage.

Even if this is the case, I still expect a good run-up in US indices between now and November