The S&P traded through the 1100 level twice last week, on Wednesday and Thursday but was pushed back at resistance. It’s probable that a close above that level could set up some very strong buying and maybe the Santa Clause rally will start early. I’m not convinced that breaking through that level is really that formidable, although optically and psychologically it’s an important round number, BUT there is nary a seller in this market; hasn’t been since 666.
It should an interesting week coming up and I think we will find closure and resolution, either way. The financials will have to jump back in the sandbox and play nice with the other longs to break us out, if not look for pressure.
So what about those bulls and bears?
First the Bull Case:
1- Low Rates– The Fed has corporate America convinced that they will be borrowing money at zero forever. Their language is vague but excruciatingly clear at the same time, the buzz phrase that they like to use is is “extended period”. The banks are having a bigger and better party than any other sector because they borrow from the FED at zero and loan to the Treasury at higher levels. I’ve heard of borrowing low and lending higher, but that is ridiculous. By the way, it’s great work if you can get it. The reality still seems to be though, they are still not lending, but hoarding, at least that’s what successful business people tell me and friends of mine that have high level banking jobs.
2–Liquidity and the Carry Trade– Mutual fund inflows have been lackluster, money is coming in, but at a drastically reduced rate. Joe Sixpack may have had enough, buying all those fake bottoms may have shattered his faith and his wallet. Some won’t EVER come back. But as I mentioned in a post the other day, who needs mutual fund liquidity when corporate issuance is exploding? That money has to go somewhere.
The carry trade is when institutions borrow relatively cheaply in the short-term financing markets, and then use the proceeds to buy, on a leveraged basis, longer-term and higher-yielding assets. Treasury bonds are the most common asset that banks purchase with the carry trade, but hedge funds will also purchase anything from corporate bonds to emerging market stocks with the proceeds.
This setup usually occurs after a crisis, as the Fed keeps short-term rates lower for a longer period of time than would naturally occur, thus allowing banks to earn back some of their losses by capturing the spread.
The Fed has been unusually clear in stating that conditions are “likely to warrant exceptionally low levels of the federal funds rate for an extended period.”
Despite this clarity investors have not believed the Fed and have been betting on higher yields. These bearish bets have actually hindered the carry trade; but have gotten crushed in the last few weeks as the Fed reinforced their message.
The crushing of those bear bets is likely to open the financing market further, which will likely intensify the carry trade. The carry trade is nothing new to us, but it could pick up steam.
3- The Dollar– This one could go either way, but if the greenback does cave and go lower, and by that I mean a break last months lows, the market should fly and the remaining shorts will be squeezed.
4- Disbelief Factor– No one can understand why we are where we are. The market seems to go higher everyday on lousy volume and bad news. Don’t kid yourself, that could last, again, to reiterate, there are NO sellers. Markets stay over bought and oversold longer than we ever think.
The Bear Case
Earnings– Bears think the current earnings reports were and are a joke. With the exception of some real organic growth numbers, they believe the bar has been lowered to the ground and “beats” are/were due strictly to the slashing of corporate spending and general poverty level spending.
GDP– Bears think it was a jacked up, hacked up number with more smoke and mirrors than a fun house.
Unemployment– We are at 10.2% and going higher, many astute economists say the real rate is closer to 18% when you take in to account the “under employed” and those that have just given up. I classify an M&A analyst at Lehman who now works at the DMV or the Fed as under employed.
The Dollar– Many bears will argue that the dollar is oversold and the short trade in that currency is way crowded. They hope for something, anything to set up a short squeeze in the greenback.
In that sense, every move upwards in US stocks or gold or the Aussie dollar or junk-bond indices is another step in exactly the wrong direction: it’s a step towards yet another massive crash. And it’s all being turbo-charged by Fed policy. If there’s a painless way out of this situation, they don’t see it.
Volume– Let’s face it, it’s anemic. I’ve needed epinephrine blasts just to stay awake the last few months. The bears don’t believe the market should go up or stay up with such light volume.
Interest Rates– The bears argue that when rates do go up, the economy and corporate America will not be able to handle the sugar shock wearing off. When I started in the business in the eighties a very smart guy told me “Son, remember one thing, it’s an interest rate sensitive market and never fight the FED”. I honestly never did forget that and it served me well over the years, but rates were 20% then, Carter was getting kicked to the curb and there was room to lower rates then. It’s hard to get excited by rates going to…..an 1/8th????????
The Japan analogy isn’t lost on the bears either.
At this juncture I truly find myself as a major league agnostic on the market. I will however have a hair trigger either way in the coming days and weeks. No one will convince me that we are in the midst of anything but a cyclical bull in a secular bear market. No one dammit!!!
It won’t take much for me to get real short.
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