One Economist Calls Another Overvalued ~ The Risk Averse Alert

Monday, January 11, 2010

One Economist Calls Another Overvalued

Tonight, over at Barry Ritholtz's Big Picture blog I came across his post highlighting the cover on this week's Economist magazine. Pictured above Manhattan are translucent spheres, and the headline reads, "Bubble warning: Why assets are overvalued."

Barry asks, "Is this a contrarian signal?"

To which I replied...
"Given the crowd the Economist appeals to I suspect this is a cover delivering a message most everyone reading it believes themselves smart enough to avoid, and because THAT is the consensus, most probably will fail to get out of the way once the Government Finance Bubble bursts. Indeed, I fear it is rather likely this period of “recovery” effected by the lender of last resort was in fact the last chance to batten down the hatches before all hell breaks loose (and woefully few probably have done so)."

Turning to Yves Smith's excellent naked capitalism blog, I was intrigued by a guest post titled, "We've Never Seen this Before — Such a Huge Rally, and the Little Guy is Out."

It seems everyone these days is scratching their head wondering who is behind the market's rally. Well, you know my sense of the matter. I believe the bear camp is in complete control.

I elaborated this in comments...
"It is my contention the short side of the trade more or less is in control of the market, presently working to build positions, and at the same time shake out weak hands.

"If you consider that, the multi-month trend in the CBOE Put/Call ratio is heavily leaning to the call side, and consider this in the context of the phantom economic recovery backed by much hot air and absolutely nothing of meaningful substance, then you simply must come to the conclusion that, short positions are being hedged with the preponderance of these call options whose relative excess over the past year is plain to see.

"Of course, an additional likelihood is that, in conjunction with short position hedging, long positions in such strong hands as probably effected the market’s rescue early last year are averaging up sales of their long positions via [covered] call options written and sold to institutional interests mentioned in the article ... which options then are being exercised by their purchasers following efforts to goose markets higher via the CME, allowing strong hands currently long equities seamless opportunity to trim their positions.

"Likewise, in the course of the market’s fits and starts higher those building short positions probably are simultaneously managing long positions whose trade on the way up helps offset the cost of hedging short positions. Naturally, these long positions will come in handy once weak-handed shorts are out of the way and it is time to detonate an explosion of sell orders intending to precipitate an avalanche.

"Think this unlikely? Well, then, ask Mary Shapiro about that uptick rule! It’s still AWOL and that is not cool if you are 'mother, apple pie and Chevrolet' when it comes to thinking about the stock market.

"So, here is my biggest concern. Although there is no way of knowing with certainty — indeed, we could see the next 12-24 months trading in the range established over the past year (which range, presently, we likely are very near the upper end) — there’s a risk we could see a brief period in which a collapse dwarfing autumn 2008 unfolds, featuring days on end when circuit breakers kick in and trading becomes very chaotic, allowing very few opportunities for the greater bulk of investors to get out. This is my greatest fear."

No doubt, we find ourselves amidst an extraordinary moment in modern financial history. Yet there is no reason to believe the stock market is operating any differently than it ever has.

I strongly doubt the Federal Reserve is at present directly acting to buoy stocks. Yet going into bottom last March, and for some time following the turn higher? Maybe. Having been behind the credit market "fix," odds of their being trapped long equities were slim, so buying near bottom would have been a fairly safe bet. However most, if not all, of their position (if there ever was one) probably has been sold back to the market by now.

And so we turn to the fact King Dollar Wrecker has yet to be confirmed for a new term as Fed Chairman. Holds on his nomination in the Senate have been placed, and there is concern the Monkey won't be confirmed by the end of the month when his current term expires. Indeed, sanguine expectations appear to be fading.

So, what if an outlier awaits? What if the Senate outright rejects Bernanke? Might Team Fraud quake? Has the President made a fatal mistake?

This could be an interesting January...

Fast Money
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