“Let me tell you something my friend. Hope is a dangerous thing. Hope can drive a man insane.” --Ellis Boyd ‘Red’ Redding, The Shawshank Redemption
Someone once said we should hope for the best but prepare for the worst. In the financial system, hope isn’t a viable investment strategy but risk management will save you from the worst-case scenario.
Over the weekend—yet another abbreviated respite that screeched to a halt when Asia and U.S. equity futures opened on Sunday—the world digested the latest proposed solution to one of—if not the—worst financial crisis in history.
The IMF started the procession by offering what Minyans have long known.
"Intensifying solvency concerns about a number of the largest U.S.-based and European financial institutions have pushed the global financial system to the brink of systemic meltdown," said Dominique Strauss-Kahn, IMF managing director.
The brink of systematic meltdown, you ask? Credit has crashed, equities had their worst week ever and the contagion has spread to every conceivable corner of the earth.
As horrific as the last six weeks—no, the last twelve months—have been, it can indeed get worse. If, how and when remain to be seen but as the big picture is made up of many smaller pictures, I’ll share my current trading posture later on in this article.
What is clear is that cumulative imbalances have been building since the turn of the century and we’re in the throes of the “prolonged period of socioeconomic malaise entirely more depressing than a recession” that we warned of in 2006.
Social mood and risk appetites shape financial markets and both seismically shifted when faith in the system and the credibility of our leaders evaporated. The denial-migration-panic continuum is coming full circle and that is perhaps a reason for optimism, if only for a trade.
To get through this, we needed to go through this and we’re going through it now.
Minyanville mapped this script for many years. As some pundits—many of whom never saw this coming—scream fire in the crowded theater, we’ve shifted our lens to identifying potential solutions, providing insight along the journey and encouraging lucidity and perspective as we digest the necessary, albeit painful, medicine.
One year ago, as the Dow Jones Industrial Average probed all-time highs, we offered the following thoughts:
“The structural imbalances, hidden risks, counter-party collateral exposure and embedded insecurities aren’t one-and-done write-downs. That’s not how the knitting is weaved with $500 trillion dollars of derivatives in play. In fact, one could argue that the inherent learning curve needed to unwind these interdependencies will allow the issues themselves to manifest.
The frightening part of these modern day sequels is that the same greed and reward-chasing behavior that was responsible for the universal acceptance of risk has again been so readily embraced. It is that story itself—the twisted tale of misguided agendas—that is the common thread of these seemingly disparate plots.
Trick or treat, my friends, and be wary of the bad apples. For when we bite into the forbidden fruit, we’re liable to find the pin that pricks collective psychology and leaves us all howling at the moon.”
Where Wolf? There Wolf!
We all know the monsters now. They look like derivatives, they smell like debt and they act like profiting is a privilege rather than a right. Admitting you have a problem is the first step towards recovery and the world has received the wake-up call.
Steps must be taken to stabilize the patient as the progression of debt destruction runs its natural course. Once this happens—make no mistake, it will—there will be profound opportunities for those who persevered the process and prepared in kind.
To be sure, the derivative and credit disease is bigger than the actual patient at this point. That leveraged volcano has been rumbling under the seemingly calm surface for years. Now that it erupted, we’ll need to toss in some maidens to appease the Trading Gods and sacrifice a few for the greater good.
The professors have mused about what we would like to see (as well as the flaws of such an approach).
At the top of the list is the protection of all consumer deposits. If we’re going to rebuild a sustainable foundation of recovery, it must start with credibility in the system and confidence that savers will be rewarded for doing the right thing.
There also needs to be culpability, which should be shouldered by those over-extended on credit, institutions responsible for financial engineering and policy makers complicit by acceptance. Existing equity in most financial institutions could conceivably be wiped out (replaced with taxpayer owned equity or warrants) but the pound of flesh must come from somewhere.
There are several other alternatives, game changers if you will, although none of them are particularly pleasant to discuss. They include dollar debasement (maximum pain for savers), Operation CDS Clean Sweep (wiping out speculators), shifting the rules of mark-to-market accounting, a comprehensive global nationalization process and programs to guarantee interbank lending.
We the people must remain calm as we chew through this process. None of this is something one would wish for but it’s where we are and we must forge ahead. It will take tenacity, resolve and profound patience but if we’re not part of the solution, we’re part of the future problem. Therein lies the greatest risk to this entire dynamic. The Blame Game is good and thick and societal acrimony could potentially shift into social unrest stateside and abroad.
And that's not something anybody wants to see happen. Not for us, not for our children and most certainly not as we attempt to defend the foundational elements of our U.S. Constitution. This is where we'll earn our stripes and earn them we will.
Some Random Thoughts:
- I wrote a column a few weeks ago called The Age of Austerity.
- Minyan Peter offered an insightful adaptation called The Age of Self-Preservation.
- To his point, it’s worth noting that several states—most notably California and New York—are already beating a path to
- George Soros on where we are and where we're going.
- The onus is on each of us to sync our time horizons and risk profiles and play within our particular comfort margin.
- With that said and given my cash hoarding for the better part of this year, I began putting money to work last week for a counter-trend upside trade.
- I entered Friday with two legs in my metaphorical bull costume (50% upside conviction), added an arm into the abyss (75%) and humbly slipped that appendage out after catching a 70 handle rally in the S&P. As a result, I enter Monday with both legs in the bull costume and the positions to prove it.
- They are centered in the energy space—Weatherford (WFT), Transocean (RIG), the OSX (oil service index)—with some Ultra QQQ ProShares (QLD) tossed in for good measure. While my initial entry points are higher, I’ve aggressively traded them around two outsized Snappers last week.
- I will again share that this is with the trading bucket of my book as my long-term nest egg remains 100% in cash backed by T-bills. I now have to ascertain if capital preservation will shift to capital conversion and, along those lines, the Japanese Yen (FXY) and Gold are viable vehicles at the right price.
- The “easy” trade today could very well be the first probe lower. That, of course, depends on where we start.
- I also plan on doing work on China and India as they’ll be the primary winners of the inside-out recovery that brings the Golden Age of Globalization back to mainstream vernacular.
- So we’re clear, I’m looking for a sharp rally that shifts psychology and seemingly sounds an “all clear” before what might be the harshest wave lower. Will that happen? I’m taking it one step at a time and taking nothing for granted!
- Intel (INTC), Johnson & Johnson (JNJ), JP Morgan (JPM), Coca Cola (KO), eBay (EBAY) and Wells Fargo (WFC) will report earnings this week. While nobody is expecting good news—and fundamentals pale in comparison to structural and psychological metrics—I’ll remind ye faithful that field position matters.
- Good news that’s not great is sold in overbought markets while bad news that’s not horrific are typically bought in oversold tapes.
- If you want some historical perspective, check out a chart of the DJIA since 1900.
- There have been a lot of technical prognostications of late. Remember, given the outsized derivative machination and debt dependency in a finance-based economy, historical perspective need not apply.
- With that noted, please “see’ that the banks have thus far held a double bottom at BKX 47.
- The rush to disassociate from Wall Street is in full effect. That will last for quite some time and should be recognized by those in the industry.
- When we first offered that there was an invisible hand in the market, people giggled behind our back. Ditto the Depression vibe, which was beyond collective comprehension at the time. I’m not saying that we’re always right—nobody is smarter than the market—but I will ask you to consider things you otherwise might disregard.
- David Owen, who was foreign secretary from 1977-1979, wrote a weekend column opining that Israel could strike Iran before the elections. That would seemingly sync with a scary sense I offered last year that began to crystallize anew last week.
- Hey Sam—Chill, I need Alice for some housekeeping items. They are as follows:
- Minyanland continues to grow in leaps and bounds, with 230,000 critter kids learning how to earn, spend, save and give. I know the world is tough—but it's never too tough to prepare the next generation for what’s to come in a fun way!
- There are 53 more days—count ‘em—until our annual Festivus soiree that will make you smile so hard your face hurts. Good grub, great friends, kickin’ music and—yes, it’s all for the kids—so if you haven’t locked your spot for our holiday trot, get involved! It’s the easiest trade of the year!
- Good luck, Minyans, and remember that profitability begins within.
Positions in WFT, RIG, OSX, QLD