Endless Drama.

As far as drama goes, it cannot be any better. Nail biting, thrilling, turn at every hour. You name it we have it. Dems are blaming the Reps and vice versa. Who is to blame on this debt drama? Who bought Americans to the sacrificing alter? Look at the following chart.

You have the debts as a percentage of GDP by the Presidents of both colours. You decide which party is to be blamed more. I am in neither party. However, it seems to me that when Bush II got to drive the car, the ratio was below 60% and when he handed it over, it was well over 80%. Hmmm. Interesting to say the least.

Who is winning the debt debate? After all, this is all about the next year election and winning the hearts and minds of the voters. Again, I do not carry any favour from any party and I am sure things will remain the same whichever party wins next Presidency. But from what I read and hear, I do not think Reps have conquered too many hearts of the independents. As everyone knows, independents are the key to the White-house.

The current president was elected on Democratic Party ticket, but he has turned out to be George Bush II.  All his policies have been directed at maintaining the status quo and giving more freebies to the super rich and big business as well as to Wall St. To his credit, he is a great reader from teleprompter and says the right words for the poor people.   

But I know who are not winning. The average Americans are not winning. And Chinese must be worried sick that all their hard-earned money may soon be worthless. I wrote few days back that American can never repay its debt and it is a sucker’s game. I never expected that it will be proved right so soon.

http://bbfinance.blogspot.com/2011/07/americas-un-repayable-debt-and-suckers.html

In any event, the economy is going down and what will trigger a black swan event is not known. I feel that Spain and Italy will implode soon and that will trigger the dominoes to fall.

I still think, they will get past this debt debate in the last possible minute.  Some readers have asked why I am not more bearish at such uncertain time. Reason being, there is not much uncertainty about the outcome.  Chances are 99% that the limit will be raised. The credit rating is another matter altogether. The uncertainty is about time.

I think we are still in a Bull market, although it is coming to an end.  The following picture explains the bull market.

If you see the DOW, it has so far made higher lows and higher highs and is well above the 200 DMA.

I have underlined the lows in the chart. I expect it to make one last high before the turn.  The resolution of debt ceiling drama may be the trigger for that. So I was not ready to go short at this point. The market is fuelled by, amongst other things, liquidity. And there are enough liquidity in the market right now.  See the Mutual Fund Cash/Asset ratio.

It is still bullish.

From 2010, we have heard so many times that the sky is falling. Double dip panic, Greek panic, Japan Earthquake panic, China panic, Muni panic. At each state, they have scared us to sell cheap only to buy  back at higher level. They would shout boo and we would jump.  But the point is, from Feb.2011 we are moving in 5% band and we have not broken that band in any direction yet.

Today, the McClellan Oscillator is deeply oversold.

VIX has crossed BB twice in a row.

Yesterday VIX jumped 35% over it’s previous close. As far as panics go that was huge.

The market may go down one more day before finally bouncing back hard. Tomorrow the QE2 GDP will come out and it may miss expectations. Coupled with uncertainty, this may trigger the SPX to dip below 1300 level. But as soon as we have a resolution of this drama, we should have a huge relief rally. There is a 1% chance that things get blown away by the collective death wish and then we have that black swan event now.  But the odds for that is less.

God bless America.

Which Way Thursday?

Phil Davis of PhilStockWorld has an excellent article out this morning, as always.

In his unimitable style, Phil points out to the McClellan Oscillator, which is also one of my favourite technical indicator.

Phil shows that the Boyzs have been manipulating the market on a regular basis every month. They panic us to sell stocks to that they can buy cheap and then pump it up so that they can sell high. Isn’t it the same argument I have been making all along? This is happening like clockwork quarter after quarter.

Apart from various TA, which I am sure are great for trading, market is always ruled by greed and fear. Greed builds up slowly and price increase leads to more price increase. Fear acts all of a sudden. Imagine you are alone in a room, reading a thriller and engrossed in it. Now imagine your partner entering the room silently and screams the hell out of you. What will you do? You will be startled, panicked and throw the book and jump out of the chair. After a minute or so, everything is cool and OK.

Today’s situation is similar. The Boyzs are trying to panic us.They have panicked us. And we are looking for information wherever we can find them.  What is a regular housekeeping matter has been turned in a power grab by the Republican Party and they will pay heavily for this. We deserve the politicians we elect and the misery they bring along with them.

I have been in this situation before and only thing I can tell is what I would do. Just close eyes and stop thinking. If the market goes up big time, I will sell. If the market goes down more, I will buy.

I do not think the world is going to end on 2^nd August, I think it is one month down the line.

Roller Coaster Wednesday.

Today‘s market action was a warning shot to Congress.

It was a great day for day-traders and bears alike. SPX fell 2% and it was a sea of red. Today bears are rejoicing and bulls are fearful but just a few days ago it was just the opposite and we were talking of SPX 1370 +. So is it the beginning of the bear market? I doubt it. On 1^st of June also the market fell 30 points. Once again let me invoke the bigger picture. But sure there are more churning ahead.

1^st the Bull side of the story.

·         See the SPX daily chart.  

All the churning is in-between those two lines. And there is lots of money still waiting in the sideline. As I noted yesterday, in fact lots of money is coming in from Europe and other parts of the world, who still consider USA to be a safer place and they don’t believe that USA will default.

·         Today was a major distribution day. The next day is usually green.  The VXO (old VIX) actually touched the upper limit of the BB and went through it. Most likely it will also churn in the two bands that I have drawn.

·         The 10 year yield still did not break 3% line.

·         Gold fell.

·         And Seasonality induced rally is right around the corner.

Even Bloomberg says Banks don’t see any panic.  In fact S&P itself does not believe that US will default.

http://www.reuters.com/article/2011/07/27/us-usa-debt-sp-idUSTRE76Q4VF20110727?feedType=RSS&feedName=politicsNews&dlvrit=60468

Reuters says: “Top Republicans and Democrats worked behind the scenes on Wednesday on a compromise to avert a crippling U.S. default, looking to salvage a last-minute deal from rival debt plans that have little chance of winning broad congressional approval on their own.”

And now the bear side.

·         One concern I have is that the SPX broke below the 50 DMA.

·          $NASI gave sell signal.

·         One of the best TA is Cobra and he also thinks that lower low ahead. You can visit Cobra’s web site at  http://cobrasmarketview.blogspot.com/ . It is treasure trove.

So now you have both the view to take decision. If you remember my earlier posts, my original plan was to "sell the news". That is, be market neutral on 1^st of August after the deal is announced at the last moment.

I am consistent with the theme that all these are part of forming the top and we shall be seeing the mother of all shorts soon. So far the Cassandras have cried fear, panic and despair from May and yet the market is a tight range. Can the good times go on forever? Sure they cannot but they can last longer than most people think. Perma bears like Rosenberg have called out for double dip recession and immediate collapse of US $ and stock markets so many times that I have lost count. I have also lost money listening to them. Bear markets never start on televised real-time bad news.

 I see the whole thing a good trading opportunity and absolutely bad for investors. So once again, be very nimble. I am still holding to my longs and watching. As I said yesterday, I do not mind being wrong because nobody can be right all the time, but I would hate to be wrong for a long time.

Be safe out there.

Discounting Details

This post offers some further details in connection with an essay I've written for Bloomberg Views. It will be was published tomorrow, 28 July 2011. The topic is economic discounting, which I've posted on before. I naturally didn't get into any mathematical details in the Bloomberg essay, but some readers may find that looking at a little of the mathematics may help to clarify the key point of the argument. So here goes (in a sketch; I encourage everyone to read the original paper):

Suppose that the true discount rate for next year is r₁, for the year after is r₂, and so on, the rate for the i^th year being r_i. No one knows what these will be; the rates will fluctuate from year to year. To calculate the total discount factor over a string of N years, you should multiply the individual factors associated with each year as follows,

where δt = 1 year.

But because the future isn't known, Farmer and Geanakoplos point out, determining the correct discount factor to use over the coming N years means averaging over all possible future paths, i.e. all possible sequences of values r₁, r₂, ... up through r_N. Hence, we need to calculate the value of an "effective" discount factor given by the formula,

[Note: This sum, of course, should be divided by the total number of paths to give the average, effective discount.]

Now, it is tempting to think that when you go through the details of calculating this average, summing up the contributions for all possible paths, and dividing by the number of paths, you will find some kind of simple result in which D_eff(T) will be equal to a single exponential factor with an average discount rate for the N years, r_avg. In others words, you might think -- and most peoples' intuition would tend this way -- that you would find an equation such as

That is, the effective discount rate over N years takes an exponential form with some constant r_avg.

Seems sensible, but turns out to be totally wrong. If you demand the equality reflected in the previous equation, then, to make it work as T gets large, it turns out that in many cases r_avg will not be a constant in time, but will take on smaller and smaller values as T gets larger. This is what Farmer and Geanakoplos have shown using computer simulations to do the calculation. They used a so-called geometric random walk for the fluctuating rate r, this being the most common mathematical process used in finance to model interest rate fluctuations (i.e. this isn't a crazy or weird model, but a highly plausible one).

Their simulations show that, as a result, the effective discount factor D_eff(T) doesn't have an exponential form at all, but rather a very different "power law" form,

where α and β are constants. This falls off with increasing T much slower than an exponential. In other words, it makes discounting much weaker than the incorrect exponential form would suggest it should be.

In the earlier post I discussed some of the implications of this result and a table indicating just how rapidly, after 200 years or so, the exponential and power law forms give wildly different results, with the exponential discounting the value of the future millions or billions of times too strong.

It's rather frightening that a subtle error could make us mis-value the future so profoundly, but this indeed seems to be what we are currently doing. The incorrect exponential form is in wide and standard use by economists doing cost-benefit analyses of everything.

Afraid Of The Debtmageddon?

I borrowed the word from Lee Adler.

Right now it is easy to be afraid and difficult to be objective.  So let’s review the market actions in that light.

SPX came down about 5 points today. Big deal! If there is going to be Debtmageddon , there should be mad selling. What the smart money is doing? Why are they not selling out yet? Once again, let us look at things with objectivity.

Below is the SPX daily chart.

We are above than where we were one month back.

Shouldn’t there be a sell-off of Bonds, pushing the yields higher?  After all, the AAA ratings are about to go. Look at TNX, the 10 year bond yield indicator.

Nope. The yield is still below 3% whereas the 10 year average is 4 %.

I am not a big fan of TA. I think when you torture the data for long; you can make it confess anything. So for each bull case in TA, there is a bear case, all from the same chart. However, let us look at the following hourly chart.

It looks like we have kind of a bottom or base.

For me more important is the money flow and I will borrow a chart from Lea Adler of The Wall Street Examiner. This is one indicator I follow amongst many other.

As you can see,  cumulative net money flow is still positive and well above the SPX.  Lee’s chart is “based upon the theory that as cash moves between money market funds and the banking system, there's a relationship between that movement and the movement of stock prices. As you can see, it has correlated well with stock prices over the past couple of years.”

In his latest email newsletter Lee writes as follows:

“It seemed that virtually every market observer expected that event to have a bearish impact. My expectation was that it would not be felt until mid July due to technical factors having to do with the Treasury supply settlement schedule. But over the past month, the indicator shown above began to surge, boosting support for the market just as the Fed was ready to step away.

Hysterical media pundits have been loudly proclaiming that the sky is falling as a result of the approaching US Debtmageddon. The markets, however, are revealing them as the know nothing clowns that they are. In fact, the opposite of their dire predictions has been occurring, with both stocks and bonds remaining resilient. The Treasury market is even rallying today after the uber depressing N'Obama Boner show last night. You gotta laugh.

The chart above makes clear the reason for this market resiliency. Money has been flooding into the US banking system over the past month. The source is apparently capital flight out of the Eurozone. While I don't track the data at the source of those flows, we know from anecdotal reports that there's been capital flight out of parts of Europe. Other US banking system indicators suggest that this is the source of the surge of cash into US bank accounts. The cash account balances of  US based foreign banks have been surging in recent weeks. So have their trading accounts. Deposits in domestically chartered banks have also surged, but their trading accounts have not. It would appear that that the resiliency in the US equity market has been driven by foreign private buying. The Fed's data shows that foreign central banks have not been a factor. This is coming from the private sector”

For some reason private capital all over the world considers US to be safer than Europe and I suppose they know more than I do. But this is one reason I have not gone short yet.

But I am not blindly long and I may switch sides all of a sudden inter-day and shout “let’s get out”. Follow me on Twitter to get my latest calls.

Once again, make no mistake; these are all part of forming the top. But we do not want to short when the market is still going up. That is not smart. I talked about 27^th July before and we are almost there. For me the most crucial dates  are between 27^th of July to 5^th of  August. And I willl be watching the market activities closely to see if my calls are still valid. You see, I do not mind bring wrong, but I do not want to be wrong for a long time.

If you like what you are reading, please forward it to your friends. http://bbfinance.blogspot.com/

Fear Mongering Tuesday.

Last night I read an interesting theory.

If the debt ceiling is not raised, then bonds get downgraded. People sell bonds and move the money to equity. If the debt fiasco is sorted out, then we have a rally in any case because of higher asset allocation in shares. It seems stocks and bonds are going to move in tandem. 

Not sure I buy into this theory.

However, one thing I am sure, USA cannot afford higher interest rate on its bonds. So the moment 10 year rate crossing 4%, we can be sure of a market crash. So that people panic and go back to bonds. In any case, we are getting closer to a major crash when the rich Banksters will shout QE 3.

For now, month end asset allocation is coming up. I think 27^th July to 2^nd of August will be quite interesting period of the stock market.

Market is assuming that the real showdown is next year and so it is not yet that much worried about the debt ceiling issue. Assuming the worst, in the short run, where will all the money go? In stocks or bonds of other countries?  Not a chance by long shot. Perhaps the yields will go up, but then life continues. At least in the short run.

From Bloomberg : The U.S. government can avoid a default for at least a month after the Aug. 2 deadline to lift the debt ceiling set by the Treasury Department, said John Silvia, chief economist at Wells Fargo Securities LLC.

“The Federal Reserve and the Treasury can work together to generate enough cash probably for the next two or three months to avoid any kind of automatic default on the Treasury debt,”

Greater-than-forecast tax revenue might give the Treasury until Aug. 10 before it runs out of cash, Barclays Capital said in a report last week.

So you see, August 2, is just a self imposed deadline by the politicians for the game.

More from Bloomberg: “It’s very unlikely that we’re going to default,” Silvia said. The Treasury already has “cash flow that’s available” to last two weeks after Aug. 2, before resorting to any special measures.

Even if the two parties fail to reach an agreement to raise the debt ceiling in time, officials will still be able to stave off a default for at least a month, Silvia said. Bond investors have realized they will probably still get paid in the event the impasse goes past the deadline.”

Michael Feroli, chief U.S. economist for JPMorgan Chase & Co., said a Fed contingency plan could allow banks and other financial institutions to temporarily lend their Treasury securities to the Fed in exchange for cash. Such a move would be aimed at easing any credit strains caused by a default, he said.

“In general, I think they’d want to temporarily substitute the Fed’s credit in place of the Treasury’s credit,” Feroli said.

The long and short of it, what you hear is not the complete truth. There are many shades of gray which we don’t see or know. But the people with serious money have already thought about it. If they have not panicked yet, why would you? I am not saying that you do not have serious money, but I am sure your investment advisor has already told you what I am telling here.

As I keep telling people, this is not an investor’s market. We have to be nimble to get out at a short notice. Things can turn ugly very quickly. But bear markets are not televised in real-time. Therefore I am still long and will remain long for a while more.

I wrote last night, I do not expect much of fireworks today. Perhaps from tomorrow onward. In the mean time just sit tight and let the fear pushers do their daily job. The US $ is down and Euro is up. Can I say, I told you so!

If you are enjoying this commentary, please send this link around to your friends. Also, I am in Twitter, you can follow my updates and calls in real time.

Be safe out there.

Banking Corruption Update

Just in case you're not sufficiently demoralized by the failure of authorities to punish almost anyone in the financial industry for their actions leading up to the crisis, read Joe Nocera on the recent fine handed down by the Federal Reserve to Wells Fargo Bank. The Fed fined the bank $85 million (much less than 1% of its revenues for the last quarter alone). No one will be prosecuted, this despite apparent evidence that multiple bank employees "falsified income information on mortgage applications."

Nocera's comments hit the nail on the head:

What’s more, this practice appears to have been quite widespread — “fostered,” as the Fed puts it, “by Wells Fargo Financial’s incentive compensation and sales quota programs.” Matthew R. Lee, the executive director of Inner City Press/Community on the Move and Fair Finance Watch, spent years bringing Wells’ subprime abuses to the attention of the Federal Reserve. “The way the compensation was designed ensured that abuses would take place,” he says. “It was a predatory system."

These are exactly the kind of loans — built on illegal practices — that gave us the financial crisis. Brokers working for subprime mortgage companies routinely doctored incomes to hand out subprime loans they knew the borrowers could never repay — and then, after taking their fat fees, shoveled the loans to Wall Street, which bundled them into subprime securities. This was the kindling that lit the inferno of September 2008. So again, I ask: Why is there no criminal investigation into what went on at Wells Fargo Financial?

I'm not sure whether Justice Department officials have capitulated entirely to economists' arguments about financial incentives and the inefficiencies of good old fashioned legal punishments (i.e. jail time), but I can't see the culture on Wall St. changing one tiny bit until the law shows some real teeth. The dearth of prosecutions suggests that few people in power really want it to change. 

Various organizations such as the World Audit Organization and the Internet Center for Corruption Research try to estimate the level of corruption in different nations, and have been doing it since 1995. It's hardly an exact science and depends a lot on perceptions. But I'm not surprised that the United States in these estimates has fallen from 14th globally in the year 2000 to 22nd in 2010. Hardly surprising.