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Prior Tuesday's monster 416-point Dow rally, the Global markets - not
just the US
- were panicked, possibly on the verge of a crash. US financial stocks were
the primary focus of the fear. On the Monday before the Fed's latest action,
bank & financial stocks were in the grips of mini-crashes of their own. The
XLF was down 4%, Citibank (C) down 6%, Leman Bros.
(LEH) down 7%, Bear
Stearns (BSC) down 11%, Freddie
Mac (FRE) and Fannie Mae (FNM) down 11.5% and 13%,
respectively. And these were just single day (3/10/2008) moves! Measured from
their 52-week highs to Monday's lows, the declines for these financials have
been bloody: XLF down 39%, C down 65%, LEH down 48%, BSC down 62%, FRE down
76%, and FNM down 74%. Clearly, the financials weren't anticipating a crash -
the crash has already occurred.
Furthermore, global markets had lost confidence in the Fed. The TIPS
market was indicating that the Fed had completely lost
control of inflation. The dollar was caught in a downward spiral. The opinion
was that the Fed was cornered - there was no way it could raise rates to
protect the dollar, but lowering rates further risked even more inflation.
The Fed Invents a New Trick
From this no-win situation, the Fed seemingly pulled a rabbit from a
hat. The news, as it is gushingly told, is that the Fed has acted decisively
to inject liquidity into the faltering financial system by loaning $200
billion worth of Treasuries - securities as good as cash - in exchange for
mortgage backed securities. The implication is that banks that are loaded
down with toxic, faltering, MBS's can just trade
them in for Tbills. That's basically how I heard
the news described on CNBC today, between the oohs
& aahs at the record-breaking stock market
rally.
Gushing and hype aside, the real news is this: Today the Fed announced
that it would loan Treasury securities to primary dealers for a period of 28
days, in exchange for AAA-rated mortgage securities, at a
discount. The first weekly auction will not take place until March 27th.
What does it mean? It means the Fed is expanding its role as a pawnbroker. Banks can bring
their crappy loans in to the Fed and exchange them for risk-free Treasuries
for a few weeks until they (the banks) can hopefully get back on their feet. But
like with all pawnbrokers, there are a few caveats: The exchange won't be
one-for-one; banks will have to take a haircut (discount) on their crappy
loans. How much? That part hasn't been worked out yet. Oh, and the loans
can't be that crappy. They've got to be AAA-rated paper. The banks
will have to leave the super crappy toxic stuff at home. The Fed doesn't want
that and that window isn't open, yet. Every 28 days the loan will have to be
renewed, and seeing that the Fed is a bank, fees will most certainly apply.
So what's the big deal?
The Fed is trying to lubricate credit markets that have become sticky
of late because trust has broken down. Banks don't even trust AAA rated
paper, By stepping as lender of last resort, the Fed is trying to ease fears
and get markets to act more "rationally" and "normally." (But
who's to say they're not acting rationally now?)
Will It Work?
Will the Fed's new plan work? Has crisis been averted? So far, so good
if that 416 point rally is any indication. Confidence has been restored, at
least for a day, spreads are coming down, and even the US dollar had a smart
rally. But will it work in the long run?
Hmmm... Oil just hit a new high near $110. It is said that the real
housing crisis - the one where people are getting thrown out of their
foreclosed homes - continues to worsen and is causing "a drop in cities'
revenues, a spike in crime, more homelessness and an increase in vacant
properties," according to this article. My local paper
had a front page headline today that screamed, "Many more going bankrupt." It begins,
"Bankruptcy filings have surged 22 percent in Massachusetts this year, as more people
are unable to afford their rising mortgage payments or refinance their homes
to pay bills, according to court filings and bankruptcy attorneys." And
is it ironic to anyone but me that the so-called "safest"
securities in the world, those that are considered "risk free" are
US Treasuries? Mind you, Treasuries are the debt of a nation that has not
properly balanced its budget in 40 years, is $9 trillion in debt, mired in unwinnable wars and is the issuer of a crashing currency?
If it were anyone but the US,
would these securities still be called "risk free?"
So, no I don't think the Fed's latest plan will "work." This
site isn't called Depression2 for nothing. The Fed's plan is a band-aid so
that the financial de-leveraging might take place in an orderly, rather than
disorderly fashion.
How the Fed Affects Our Market Plan
If you've been following along with our plan to short the Dow, you should
have sold the DOG position today when market traded back up into its range.
I cannot stress enough that markets are completely unpredictable and
traders must therefore limit risk and not get overextended. This is why we're
trading with the modest position and the tight stop. We had a good setup and
we swung at a pitch. It didn't work out. No big deal. We didn't lose much,
and we're regrouped, ready for the next opportunity. Now it is back to
watching how the market behaves within its new, expanded range.
 If you think that sucks, think of
it like this: In 2007, David Ortiz had 549 at bats, and struck out 103 times.
Each time he swung and missed, he simply accepted that it was part of the
game. He didn't let it bother him or hinder him from his true goal. If he got
bent out of shape with every strike, he never would have gotten 182 hits for
a .332 average.
I've just finished reading Michael Covel's
excellent book titled The Complete Turtle Trader which is a
fascinating account of Richard Dennis' Turtle Traders experiment in the
1980's. If you're serious about trading, you should read this book. I'll have
a review up later this week. If you'd like to be notified, please sign up here.
In the mean time, it wouldn't be a bad idea to take advantage of the
calm to prepare for the second great depression.
Michael
A. Nystrom
Editor, Bull not Bull
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