Halloween Scares - Greek Referendum.

In my last post I mentioned that risks are high and we will see a correction soon. Sure enough we got one. The market killed the bears and when the MOMO lemmings joined the bulls, they got killed as well. I think the corrections will continue for a while before we reach a tradable bottom.

Confusion should be the other name for Europe. Here we have an empty box full of magic money. The magic number of Euro 1 Trillion is a figure made out of imagination and half truths. Europeans never had that money to start with and it was just a figment of imagination of the EU politicians. Why otherwise travel to China and beg for money if they have it? The Italian bond rate continues to soar higher and that itself undermines all the efforts to stop the contagion. The pink elephant is well and truly in the room. There was nothing in the EU plan from last week that would make investing in European sovereign or European Banks attractive for investors. If 50% hair-cut was voluntary, can you imagine what the coming 90% hair-cut will be? The hair-saloon is now open - who is the next customer? This not going to end well for Greece or for Europe. And now G-Pap has come up with the bright idea of referendum for the freshly proposed bail-out package! Talk about brinkmanship!

Closer to home, MF Global has now gone bust and have taken customer’s money along with it.  Millions of dollars have gone missing. Will anyone go to jail for what appears to be a clear case of fraud. Will anyone be held responsible for this mess or they will reward the person in charge with a golden handshake of $12-13 millions? Judging by what has happened since the sub-prime crisis of 2008, where nobody has been held responsible for the massive losses and collapse of the financial system, chances of anyone going to jail this time around appears to be remote. But for the next few days at least it is all “Risk-Off”. At this point, S&P futures are down about 25 handles and European markets are down almost 4%. Euro has given up most of the gains from last Friday.  With the lack of clarity in Europe and absence of clear information with MF Global, there is bound to be some panic in the market place.

The prudent course of action is not to take any action at all at this point of time.  Too many factors are in play and it seems that no one is in complete control of the events.  Even precious metals are down and if gold closes below $1700, it will see more selling pressure. That is why I am still waiting for a better entry point for gold. So far as Us bonds are concerned, I do not think selling pressure is over yet and again, I have advised not to take any position yet.

We shall review the position by the end of the week and I expect the corrections to get over by then. If not, we can kiss the year-end rally good bye.

Till then, keep all your fire power dry.

Why The Melt Up?

Last week I was travelling through parts of interior India and one thing lacking was decent internet connection. As a result I could not post my regular market comments for almost 10 days. I should have purchased and carried the portable internet connection from Mumbai but silly me.  Anyway, lessons learned.

Last week we saw melt up and SPX was almost touching 1300 level. Is this the beginning of a new Bull market?  I am waiting on the sideline for many months now, waiting to get a sense of direction. We were close to 1050 in SPX and while many were expecting a re-run of the 2008, I said many times that we are not going to fall though the crack as yet. We might see one more selling pressure next week before we can have a tradable bottom.

So what is the reason for this melt-up? Have Europe solved its problem for good? Are the PIIGS really flying?  We must be delusional to think so for even a moment. European Union faces a risk of tsunami of fiscal and banking crisis. EFSF cannot solve this problem.  The problem is of solvency of all Euro zone financial institutions and banks and ECB and the Governments are trying to cure it by injecting liquidity. Of course if you give free money to the insolvent banks, it might keep them alive for a longer period but in the process create some Zombie banks which will drag the economy down for ever. If you don’t believe me, ask Japan!

The Europeans agreed for 1Trillion Euro for EFSF but where this money will come from is not explained. And they will use leverage to reach this magic number. And even that number is not sufficient to shore up the fortunes of the PIIGS countries. We are told that the banks have agreed for a voluntary haircut of 50% on the Greek bond holding and yet there can never be a greater lie. Because team Merkozy told them that the other alternative is 100% haircut. There is nothing voluntary about this agreement. The banks have been forced to accept this 50% write down with great deal of arm twisting and the next question is whether they will get the protection from the CDS they purchased. If it is voluntary, then there is no compensation from the CDS they purchased and that will effectively kill the CDS market.  So what happens when Ireland comes calling next about its due 50% write down or when Portugal comes with its share of write down? Will it be a voluntary event as well? What happens when Spain or Italy goes down? Already the yield of Italian Bonds are close to 6 % vs 2.5% of German bond yields.

"Data released by the European Central Bank show that real M1 deposits in Portugal have fallen at an annualized rate of 21pc over the past six months, buckling violently in September.

" ‘Portugal appears to have entered a Grecian vortex and monetary trends have deteriorated sharply in Spain, with a decline of 8.4pc,' said Simon Ward, from Henderson Global Investors.

Given this situation, when things are far from normal why this massive stock market melt up? What gives?  Because they changed the rules of the game. As simple as that. Because the haircut was voluntary, it did not trigger the CDS payouts. That took away the risk factor the financials who wrote the CDS.  As there is no risk, it is time to cover for those who were short the markets.  The HFT algos saw the short covering and they joined the trade. So did the momentum traders. And the run up continues. This is a very simplified version or explanation of the run up.

Just remember nothing has changed and when other PIIGS come calling, there would not be enough money in the world for voluntary haircut. Not even China can save Europe.

Coming back to the stock market, what can we expect next? Because everything is so overbought for now, we can expect a pullback next week. For traders that will be an opportunity to go long. I think it will be safer now to buy the dip till December. For investors, it will be another opportunity to liquidate and go out of equities.

For precious metals, the Bull Run will continue for the next six to eight months. I plan to go long gold in the next two weeks time. But I am hoping for a lower entry point. If we close below $1700 in gold that would mean that the corrections in gold is not over yet.

The year 2011 will possibly end in positive territory but I am very skeptical about 2012. Combined with the solvency problem in the Euro Zone, we shall be facing a very nasty Presidential election in the USA. The end of the debt super cycle is upon us. We are just missing the woods for the trees. The risk is actually increasing.   

Back to Basics

The number one problem for the US and for Western Europe is job creation. There is no bigger problem. The politicians can focus on all sorts of other things: taxing rich people, subsidizing pet projects, bashing China, etc. But, anyone who thinks there is a bigger problem than unemployment is missing the forest for the trees.

How do we get more jobs? That is not a tough question. It is only tough because we are talking about labor. If we asked the identical question about anything else, the answer would be painfully obvious. For some reason, politicians and many economists become completely irrational when asked how to increase the demand for labor. If the same politicians and economists were asked about how to increase the demand for anything else the answer would be immediately forthcoming.

How do you increase the demand for something?

How about making that something more expensive? Would that help?

What about substantially increasing the taxes for people that use that something? Would that help?

What about passing new regulations that would apply to using that something? Would that help?

To increase the demand for apples, why not make apples more expensive, tax folks who eat apples, and make anyone who buys apples spend one month of every year filling out paperwork to satisfy the regulations required to consume apples. Would that increase the demand for apples?

Yet, politicians and economists (like Paul Krugman) think that this is exactly the prescription necessary to get to full employment of labor. They are wrong.

To get more jobs, you need to reduce the cost of labor, increase the economic incentives for those who employ labor and reduce the regulations that surround the employment of labor. That's how you would increase the demand for anything including labor.

The Anger of the Entitled

Wherever you look these days, there are people demonstrating for their "rights." These "rights" are the right to take money from other people so that the demonstrators can have free this and free that. If education and health care are to be free, who pays? The demonstrators could care less.

Look at Greece. There are daily and massive demonstrations demanding that their failed welfare state continue to support the "entitled." It is always someone else that should pay for all of the things that the "entitled" want. Everything is a fundamental "right" without obligations on the part of the entitled to fund anything. There are no obligations to be imposed on the entitled. After all, they are the entitled.

What about Italy and Spain? Who pays? Their answer is the same as the OWS (Occupy Wall Street) crowd. They payers are "the rich." As if the rich had enough assets to keep all of these entitled folks going on indefinitely. The move to "get the rich" has historical precedents and none of them are very attractive for average people.

The Russian and Cuban experiments were long playing disasters for the average person living through those experiments. It's worth noting that even those "leveling" societies had their privileged. The Castro family lives in a style that America's rich would love to aspire to.

People with responsibilities, kids to take care of, old folks to support and the like don't have time to camp out in make-shift camps around the US and the world and make posters with four letter words describing their hatred for capitalism.

When winter comes, the OWS gang will retreat to the warmth of their comfortable homes or back to their "entitled" college community.

The truly disadvantaged don't have time for this stuff. But the truly "entitled" can camp out for years on end before retreating to a more comfortable lifestyle that they are "entitled" to.

The rest of us have to work for a living.

Milton Friedman noted long ago that the only societies that have ever produced for the average person were capitalist societies. Such societies also produced rich people as a by product of raising the standard of living of the average person. You can see the fruits of capitalism today in China raising the standard of living of hundreds of millions of Chinese. Capitalism is what is needed if the average person is going to have a fair shake.

But, the entitled are not interested in capitalism. They are mainly interested in getting their "rights" at the expense of others.

Ho Hum

The European "deal" is mostly a mirage. The only "real" thing that takes place in the deal is the 50% write down of Greek sovereign debt and even that write down only applies to the 60 percent of the debt that is in "private" hands, meaning mainly in the hands of commercial banks.

Buried in this deal is the possibility that CDS (credit default swap) contracts will not be triggered. That is probably a sop to the banks who are on the hook for these contracts, which, among other things, insure Greek sovereign debt. No payoff for those who took out insurance. Who would have thought?

Europe is following the American pattern of reneging on past contracts to foster the illusion that they are solving today's problems. (America continues this pattern with debt forgiveness orchestrated by the White House, invalidating legitimate private sector contracts with the hope of securing more votes for Obama in 2012).

As for the EFSF (European Financial Stability Fund), the plan for that entity is ridiculous. Somehow, someway, someone is going to give the EFSF $ 1 Trillion and then that will be used to "insure" the first twenty percent of loss on newly issued debt, presumably debt issued by Greece, Spain and Italy. Who is going to come up with the $ 1 Trillion? The short answer is no one. The long answer involves numerous future headlines about the Chinese, the Saudis, and other targets, who will play nice, but, in the end, will donate nothing at all to this silly idea.

This "deal" now gives breathing space for a further expansion in sovereign debt by the weakest members of the EU so that a year from now, problems will be much, much worse than they are now. Meanwhile, Greece can go back to running the most inefficient economy on the planet without fearing a default (in the next few weeks).

So, why did the markets go up?

Because the US economy continues to grow, albeit slowly, and business is learning how to do without employees and still make money. So stocks will continue their upward march -- at least for a while yet. A sick Europe and an ever growing sovereign debt debacle is factored into market prices already. That's why the market is cheap (but getting less cheap).

Around the world in 8 charts

The charts tell the tale of the October rally. 

Since our last update on the global correction in stocks, shares have bottomed (at least in the short-term) and embarked on a powerful new rally. 

As noted in real-time on Twitter and StockTwits, the 1,250-1,260 levels were an important technical (and psychological?) level for the S&P 500 and US shares. The market busted through those levels this week amid a backdrop of hectic news concerning Europe's debt crisis. 

Here you'll find newly updated charts, from the SPX to the AWCI (MSCI World ETF), the Dow Industrials and Transports, the Nasdaq, the EEM (Emerging Markets ETF), the VIX, and TLT (long-bond ETF). 

This is still a very news-driven (some would say intervention-driven) market. Therefore, I want to either watch (or ignore) the action from the sidelines or keep a very tight reign on positions and risk. We'll see if the global share markets can continue higher on a stream of bad news, a sign of a potential bullish uptrend in the making.

Keep up with Finance Trends in real-time on Twitter and StockTwits. You can follow our RSS feed (full posts, always free) to catch all our posts.

Side Issues and Reality

You might wonder why all the talk about greed and Wall Street. Isn't the real issue that the American economy is moribund and that unemployment is at staggeringly high levels? Why is the national debt important? Because it threatens the economic vitality of the future. These are the real issues -- the economy. They are made more real by the simple fact that opportunities for those who are less fortunate always improve with economic growth and always decline with economic stagnation.

Case in point -- today. As much as the Obama folks crow that they support the economically less fortunate, the Obama policies are devastating the poor, minorities and the less fortunate among us. Folks cannot find work. That is the real problem.

It is clear that President Obama will never focus on the economy's real problem -- stagnation and unemployment. He doesn't understand such problems because he has never experienced them and knows no one who has ever experienced these problems. His olympian view is that politics can solve all ills.

Well, politics has devastated our economy and our economic future. Government policy, regulation, and taxes have brought the American economy to its knees. Europe and the US have made promises to their citizenry that cannot be kept. So, why not change the subject? Find someone else to blame. We've seen this political tactic before many times in world history.