Seeing the Forest for the Trees ~ The Risk Averse Alert

Tuesday, August 19, 2008

Seeing the Forest for the Trees

Back on July 23, 2008 I went Down on Cox Farms and reported what I saw...

"By no means should anyone assume the drama unfolding at the core of securities-based finance is near resolution," I said.

Today the former chief economist at the IMF, Kenneth Rogoff, agreed, saying, "[FNM and FRE] should have been closed down 10 years ago," adding, "They need to be nationalized." He also went on to predict, "The worst is yet to come in the U.S.," saying, "The financial sector needs to shrink; I don't think simply having a couple of medium-sized banks and a couple of small banks going under is going to do the job."

That last comment certainly indicates the kind of thinking necessary to become chief economist at the IMF. For years now this "august" institution has applied its nation-wrecking austerity formula to many a strapped, sovereign state. It was only a matter of time before the world's largest debtor nation received its due. Why they even made a movie to help jam unwelcome sacrifice down our throats!

Yet it's the push for nationalization that's of interest here. Not that I believe this will do any good to maintain the status quo of, say, the past thirty years or so. However, I suspect it could help Wall Street pick up the pieces and recapitalize for pennies on the dollar ... putting the masters of recklessness in better position to survive the financial storm likely to develop over the next several years.

This is what I was getting at when I wrote Jumpin' Jiminy Cramer Sachs Cox and said, "The feeding frenzy has begun and the chef's specialty is assets on the cheap." Momentum appears to be building.

I also see SEC Chairman Christopher Cox has let the financial markets know that, within the next few weeks a new rule on short selling will be announced. Ever the cynic, my guess is the world's hungry financial sharks will gain the means to prevent anything from gumming up the works. A disintegration unfolding too quickly is to be avoided if possible. Nevertheless, a disintegration — controlled — very much appears likely, indeed.

So, once again the news lends further weight to my market melt-up followed by Dow 3600 thesis...


The VIX provides an interesting study in the evolution of the credit market breakdown now targeting the core of securities-based finance ... and its impact on equities trading.

Trouble erupted in the sub-prime mortgage market early in '07 when New Century Financial, the second largest sub-prime lender next to Countrywide, went belly-up in March. Then in June '07 a couple hedge funds controlled by Bear Stearns, largely invested in CDOs backed by sub-prime mortgages, were forced into liquidation. Subsequently in August '07 the carnage went global and spread to other asset-backed credit markets unrelated to sub-prime mortgages.

These were the seeds of credit destruction whose sprouting came as no shock to many. Likewise, with all the leverage built atop a shrinking physical economy providing insufficient income it is little surprise troubles have spread.

Still, the stock market rocketed higher from late-March through July '07, then higher still into its peak in October '07. What up with that?

I think the simple answer begins with liquidity ... and ends with animal spirits highly geared to take advantage of opportunities as they appear ... no matter what underlying circumstances might otherwise suggest "ought" to happen.

This little exercise courtesy of the VIX — which, itself, has behaved rather tamely since its late-August '07 peak — is meant to suggest a stock market melt-up is, indeed, possible. Truth be known, sometimes I have trouble convincing even myself of this...

[5:00 p.m.]
Today saw more of the same as yesterday unfold. In the process positive RSI divergences took further form across both exchanges. Expect a bit more of the same as a short-term bottom is made and a resumption of the market's bounce off July's low ensues...

NYSE 5-min
NASDAQ 5-min

The Pump and Dump's relative outperformance of the Big Board continues ... suggesting the market's bounce off July lows is not over ... and further providing subtle evidence of there being underlying interest in owning undervalued stocks.

This latter point lends support to my pending melt-up thesis. The desire to seek out value might indicate some significant portion of sideline cash is not afraid of growing risks.

We will see whether NASDAQ's relative outperformance of the NYSE will persist as the final move lower to bottom of the market's multi-month correction unfolds...

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