Thursday, January 26, 2012

01-26-2012 comments

The Fed spoke yesterday and the message seems clear - things are not great and they don't see much improvement between now and 2014.  So interest rates will remain near zero for the next 2.5-3 years into 2014.  Make no mistake the Fed will do its best to protect its banker constituents as it screws Ma and Pa.  How are Ma and Pa supposed to survive on their Social Security and $200k in CDs producing little or no income.

So the Fed knows what we have told you here before - the worst is yet to come.  With major long term cycles set to bottom in 2014 they do not see rates going up for about 3 years.  They view deflation as a real possible outcome.  I cannot disagree.  So homeowners default, banks foreclose  and properties are written off 30-60% of the collateral represented by that foreclosed home.  When collateral gets written down/off then there has to be an adjustment on the asset side of the balance sheet.  This leaves less assets for the bank to make loans.  Less assets (fiat currency) results in deflation.  We have seen what happens to asset value when there is a problem in a sector too BIG for the government to bail out like in the housing market.  We got major deflation as housing prices tanked.

Now imagine defaults on a larger scale as sovereign nations default and the effect that will have on bank assets.  It will not be pretty and it is unlikely the Central Banks can print their way out of it as demand for credit and credit worthy buyers disappear.  This could lead to demand for goods and services to take major hits and lead to a rash of corporate defaults as the negative cycle feeds on its self.  Do you really believe people with tens of thousands of CC or student loan debt are like to pay it off?  Housing mortgages defaults are apt to remain high for some time.  I would expect personal bankruptcies to soar.

So you have sovereign nations, corporations, and individuals repudiating debt.  This will lead to a major reduction in assets available to stave off deflation.  And as we saw from the Great Depression this can lead to long periods of economic stagnation.  Or, if you prefer - "welcome to Japan".

Short term the market behaved irrationally and went up.  Don't fight the Fed - the market is responding to the short term that the FED will push liquidity.  Long term the problem will exceed the FED's capacity to manage.  So any pullback is temporarily halted.  Long term it means once we get a pullback it will be bigger and faster than it would have bee otherwise.



  1. When is the 1 year cycle do top?

  2. Hi Inlet, did you closed your shorts? I wonder where is your stop?

    1. I sold all my longs just over a week ago (too early maybe - as usual). I am still holding my shorts and feeling the pain. I generally set stops about 7-10% under the purchase price.

      Often though I will sell calls to reduce my cost on a position that does not behave as expected, so that level is somewhat dynamic. If we continue to climb I expect I will get stopped out soon. We will see. I was not as patient as I should have been.

      I don't as a rule promote individaul positions as I am often wrong and will trade around a losing position to try and improve my position. Somewhat risky and not for everyone.

  3. I think shorts might be good to 1260-1280 (until about March 22nd) and then we have one more turn around going into the Sell in May and Go Away period....which might put us just above where we just topped out at 1334-1360 area.

  4. Inlet - where are you? I hope all is well.....

  5. Shadow7 - I am fine, thanks for asking. New Year's resolution was to spend less time online following markets for a couple of months at least and pursue other interests (like finding land to buy).

    The 1 year cycle appears to top late January. We could use an extended sell down into March. Right now I am getting no clear indications of where the market is headed.

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