Double Journey

and at your own risk.  The market had a monster move just two days ago, and did its normal 2% correction the following day.  It was pretty predictable after such a huge move.  But the question is, what next?

I actually think we probably go up from here in the short term.  If you can get in and out quick, that might be something you look at doing. But if you are like me, and do not sit in front of a trading window all day, then you have to think long and hard about putting any cash into the game.   What is my big concern?  I have not figured out how to play the Fed’s one trillion dollar gamble.

Here are the undeniable realities.  We will have inflation in the next few years.  The value of the dollar will definitely drop in relation to other currencies, particularly the Chinese Yuan.  But the question is when will it happen.  If you have a long term horizon, your move is simple.  You need to short US treasuries and take an inflation play like gold.   The problem is determining where these are going to be in the short term and if you can stay in these plays long enough for them to play out.

I think Gold trades in this $900 range for some time.  I do think it will probably break out above $1000 and stay there over the next year or two.  Same can be said for the treasuries.  But it presents an even bigger problem.  Short term, I think treasury prices could actually go up.  But there is no way that investors are going to continue to stay there when yields are this low.  So do you get in now?  Can you wait two years for this to play itself out?

I need to spend some time thinking what the other side effects of this move will be.  This is a non-trivial shift in money.  There are going to be winners and losers and the trick is to be on the winning side of it.  The bad news for the rest of us?  Taxpayers will MOST DEFINITELY be the first loser if this plan goes south.

In a very expected move, the Fed decided to cut interest rates all the way to 0.25%.  They have essentially made it free to borrow money from the Federal Reserve.  Somehow, they have forgotten what got us here, cheap money.  Not only did they do that, but they pledged to buy all sorts of assets including Mortgage backed securities and U.S. Treasuries.  This now empties the gun of all the things the Fed has done, at least all the things that we can rationally expect.  God forbid if they come up with something more.

The saddest part of this all is that this is not going to work.  In fact, it will make the situation worse and prolong our problems.  Now, I have no doubt that we will see a small bump in the market.  In the short term, all this free money will have some positive effect on the economy.  But printing money never solved any problems and it will not solve this one.  How do I know?

The problem right now is not that there is not enough money out there.   The problem is that nobody trust the markets.  I am the Fed’s target.  They want people like me to start deploying the capital I have on the sidelines.  I have no skin in the game right now.   I do not own a house and I have lots of cash on the side.  It will not help to move the economy for people upside down in their house to just stay upside down in their house.  They need new demand to come to the market.  However, there is no chance that someone like me, someone who has had as much patience as I have till now, to come into the market anytime soon.

You see, I cannot get involved with a market that just wildly swings about.   The 5% move to the upside we saw today was just ludicrous.  Sane markets do not behave like this.  One of my larger positions in in UYG, the Double Long Financials.  It was up 20% today.  You would think I would be jumping up and down with joy but I am not.  As fast as it came today, it can go just as fast the other way, and there is no way for someone like me, someone who cannot sit in front of the computer all day, to safely get into this market.

All the Fed is doing is making it more difficult to trade.  They fired all their bullets early in the game and we still have a few innings left.  Now what happens when the next wave of bad news crosses the wires.  Believe me, there is more bad news coming, I have NO doubt about that.  There are more foreclosures and more job losses coming, more than most people expect.  The fed cannot cut rates anymore nor can they really buy any other asset class that will make any difference.  The dollar rally is now shot to hell and soon, foreign countries are going to lose interest in treasuries.  Then what?  Maybe the fed can just throw the gun.

I hate the Fed now.  It is ridiculous to think that a group of men think they are capable of picking an appropriate interest rate.  I could go on and on about all the things I hate about this, but it would just end up making me more upset.

I played this pretty well.  I followed the mantra of “buy on the rumor, sell on the news”.  It was widely rumored that the fed would cut the interest rate.  I was sure the fed wouldn’t disappoint and do the wrong thing.  I was still partially in my long position in the S&P, so I was looking for the right time to get out.  I decided the best time would be just a few minutes before the Fed announced because I figured there was probably only downside after the cut was actually announced since it was so widely believed that it would happen.

Now I would love to get short the market again.  I fully expect another leg down despite what the Fed is trying to do.  I really want to start looking at the banks right about now.  Seriously, as bad as these may look right now, the government is going out of its way to make sure banks are really profitable going forward.  They are literally giving them money, making money cheap for them to borrow, and essentially backstopping them to make sure they don’t go bankrupt.  When you add the fact that competition will be much less going forward, because so many banks are getting taken out, and you have it set up to be a great year next year for banks.

It is rumored that the Fed is considering lowering the Fed funds rate below 1%.  Really?

If you remember my post about what caused this financial crisis you will remember that one of the main factors was the cheap money the Fed flooded the world with shortly after 9/11.   Did we really learn nothing from the last time?  Do these people really think that even though we got here by making available cheap money, we can fix it by making money even cheaper than we did before?

I wasn’t sure about it before, but I’m very sure now, we have got to change the mandate of the Federal Reserve.  They should not be trying to manage the economy because they will screw it up.  Look at what Alan Greenspan just admitted, he didn’t know what they hell he was doing.   Giving anyone the power to manipulate interest rates and the money supply is just wrong.  Now people will look at the failure of his policies and conclude that the free market doesn’t work.  Of course this is very flawed thinking because the fact remains we never had free markets and still don’t today.

The Fed should get back to what it needs to do which is to make regulations that enable better transparency and accountability in the markets and then ENFORCE it.  If they would have done that job, rather than continually worrying about where the Fed Funds rate needs to be, we seriously might not have gotten into this mess.  If they simply did this, three out of the four causes in this financial crisis probably never happen.

But I’m sure that won’t happen.  I’m sure Bernanke and the rest of the Fed thinks it can out think the markets, even though time and again, they have shown that they can’t.  They will keep doing what they think they need to do, even though it was already proved that they don’t know what the hell they are doing.

So I’m still long the market right now, even if I don’t want to be.  If the market gaps much lower, I will probably try and get out even though I still believe the short term direction of the market is up.  Our government will do something to make sure that happens, even if it is a bad long term deal.

Today, the Fed announced yet another move to try and unfreeze the credit markets.  They have announced that they will start buying Commercial Paper.

While I’m not a huge fan of the Fed coming in and doing things like this, I much prefer this strategy over the strategy of throwing good taxpayer money at bad assets.  I even talked about this exact strategy in my post about what the government should consider doing. Why do I prefer this plan?  Unlike the bailout, this plan attempts to get to the root of the problem.  The problem isn’t with these mortgages going bad.  The problems we are facing now is that people are not able to find other parties which will extend credit.

The commercial paper market’s purpose is exactly this; it is a market created for business and government to obtain short-term debt.  This is vitally important for some businesses and governments because their cash flow is not sufficient to run their day to day operations.   This is the essence of the credit crunch going on right now.  The bad mortgages on the books of the banks is just one of the causes but it is not the problem that needs to be addressed.  If we really want to unstick the credit markets, this is the right approach.  The fed now truly becomes the lender of last resort, a role it has always historically had.   So long as this plan has a limited time frame, and it does, then this will have  the desired effect of providing liquidity in the markets and calming the panic that is now going on.

This won’t fix all the issues, so let’s not start popping the champagne.  But this is a much better step than anything that preceded it.  However, me being the skeptic I am, I am sure that the Fed wills somehow screw this up.  In all likelihood they will do this by dropping the fed funds rate.  They will of course have gotten amnesia and forgotten that the reason we got into this problem was that money was WAY too cheap for too long.

So how the heck did the Fed come to its senses?  Are they reading my blog? Are they going to screw it up again?

The fed, as expected, cut the rate 0.75%.  This was slightly less than a lot of people were betting on as the fed funds future rate actually seemed to imply a 1% expectation.

That being said, the market celebrated with a gigantic day with the major indexes up over 3%.  So it’s time to celebrate, pop the champagne, and go running into the market right? The economy is saved! Not so fast.

The feds action definitely helps the banks who got themselves into a mess by taking the easy money and making some bad loans.  The Fed’s actions are squarely to ease the credit crunch which is hammering the financial markets. However, the fed has no control over what the banks do with the easy money.  And by all indications the banks aren’t passing on the money to their customers.

Despite the Fed rate cuts, the cost of mortgages are actually going up.  The
average 30 year fixed mortgage is just under 6%.   This despite the fact that the 10 year note currently stands at 3.5%.  For those that don’t see the significance, this 2.5% difference (referred to as the spreads) is normally only 1.5%.  The spread represents the risk a bank is willing to take and the widening of the spread shows that they aren’t willing to take very much.  Add that to the fact that they are owning willing to lend to those with high credit scores, and you can see how this isn’t helping the average American very much.

So what are the banks doing with the easy money?  There is actually an arbitrage opportunity here since they can borrow the money and invest it in higher yielding government bonds.  Of course, you can’t do this since you can’t borrow from the Fed.  Sucks huh?

But at least the Fed cut isn’t hurting you right?  Saving the banks is a good thing isn’t it?  Sure if you don’t mind higher inflation and a weaker dollar (causing the price of imports and commodities like oil to rise).   If you don’t mind taxpayer dollars being used to bail out billion dollar banks.  If you believe that the way to fix the problems caused by easy money is to throw more easy money than the fed is doing the exact right thing.

Stocks had a better day than I expected.  The Dow was actually up while the Nasdaq came off its lows of the day.  This is probably in reaction to what is perceived to be a sure thing, the Fed cutting the rate very deeply.  Most are predicting a 0.75% cut.  Some even believe the Fed will cut as much as 1%.

But it is my belief that this is too little too late.  I really don’t think it matters what the Fed does at this point.  The Fed Funds rate is a blunt instrument and the economy is way to far in its downward trajectory for something like this to rescue things.

While I think the market will continue to go down, it is about the time you need to create a shopping list and start thinking hard about the companies you want to own 5 or 10 years from now.  My shopping list needs to be updated but I still think its a good list.  Actually, if you take a look at the list, all my stocks are doing well comparatively to where the market was at the time.  Some of them are doing great like Potash.

Talk about the bottom falling out. Today, it was announced that JP Morgan Chase will acquire Bear Stearns for $2 a share. This is seemingly a bargain basement price because Bear closed Friday at $30. It traded as high as $170 a little over a year ago. You couple this with the unusual move by the Fed to cut a key interest rate on Sunday, and you have some very serious developments.

This portends very bad news for the markets tomorrow. While the market has been down this year, their always seems to be a rally that quickly follows it. This tends to demonstrate indecision on the markets part as people keep looking for the bottom.

What these two events demonstrates is that, despite all the doom and gloom surrounding the market these days, the problems facing the markets are even more serious than previously thought. JP Morgan would not be able to Buy Bear Stearns at such a low price if things were not dire for that company. The Fed would not step in on a SUNDAY if they didn’t think something really bad was about to happen on Monday.

So what to do? I still am going to do nothing because I’ve been setting up for this eventuality for a while. I will have some stocks that get beaten up, I’ll probably even lose a lot of money in the next few days, but I’m not one to panic even if I think the market could easily go down another 10-15% if not more.

For those without the same stomach that I have, get out while you can. As some of my readers have commented, it has been an up and down ride, but it’s about to go straight down for a while.

The Dow had an up 400 day, mostly on the news that the Fed was going to inject $200 billion of liquidity into the market.   This gave hope to many investors that the worse might be behind us and that it was time to get back into the market.

I kept my money on the sidelines.  I’m not sure how this Fed action at all solves the fundamental problems that caused the market to tank in the last few months.  We are heading into a period where we need to pay for the excesses of the last few years.  We can delay it, and that is what the Fed seems to be trying to accomplish, but in the end, someone is going to have to pay up.

The market reacted to relatively weak news, and this stimulated others to jump in not to miss the boat.  But when the smoke clears people are going to realize that the fundamentals just aren’t there.

Take this opportunity to get rid of any stocks that you have been wanting to get rid of for a while.  Days like this don’t come by too often and you have to take advantage of them when you can.

Will you please stop with the rate cutting? You already made the mistake of cutting rates, and you are going to do it again?  You can’t save the economy now.  You can’t make housing prices go back up.  There is only so much the fed can actually do.  Cutting rates is not the panacea you are making it out to be.

For years, the Fed provided cheap money.  That cheap money caused the problems you are now seeing.  And the solution is to throw more cheap money at it.  It’s like paying off your credit card with more credit cards.  It just won’t work.  Let the economy feel some pain and lets move on.