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Why You Need To Be Cautious


Reasons include IndyMac and the Fed.


Greetings from the Cascades mountains of Oregon, where for the first time in a long while I've been able to put the markets behind me and have focused on having fun like a kid on a majestic playground. Not that I'm ignoring what's happening on the Street, it's just that for now I'm finding myself able to say "Who cares!".

It seems healthy for my previously fried psyche, and good for my P/L, as a clearer head and self-executing, out-of-sight Good 'Till Canceled orders seem to be playing out much better than my hyper-trading fingers.

Not all my positions are working of course, with my short shot at gold being Exhibit A. My thesis was that central banks would not allow the dollar to completely unravel just yet, and/or that the bond vigilantes would not ignore inflation and would drive long term rates higher. I'm wrong on both counts so far, and the chart of gold is not one I want to continue fighting. I've used yesterday's weakness to cover some and I'll use any lower prices to cover more.

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Meanwhile, my foray on the dark side of REITs has been far more rewarding. Furthermore, the action in the REITs equities is entirely consistent with mounting anecdotal evidence of troubles in commercial real estate, as well as renewed bad vibes from the Commercial Mortgage Backed Securities market. I continue to use the Proshares UltraShort Real Estate (SRS) as my vehicle of choice, despite some obvious signs of exuberant excesses in the near term.

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At the root of the REITs' slide, of course, is the ongoing meltdown in financials, about which I will mince no words: In my opinion, the U.S. financial system as we know it is going away, and there are no safety nets left to prevent that. The only things that remain to be seen are the precise timing and process for its liquidation, and whether it will go out with a bang or a whimper. But gone it will be, because -- for all practical purposes -- gone it already is.

As reasons for my wishy-washy position I offer you the following:

  • Indymac Bancorp (IMB) looks to be taking the ribbon for the first major bank to drop on the lap of the FDIC after failing to find additional capita. Despite the sure-to-come reassurances that this will be a relatively isolated case, I believe twelve months from now we'll look back and realize that IMB's failure was all but isolated.

  • As Pepe noted, Fannie Mae (FNM) and Freddie Mac (FRE), the ETs of structured finance, will soon "Go Home" to Boom Boom and the Feds, in a headline making event which will raise choirs of "this must be the bottom" and "brilliant move by the government to remove uncertainty from the mortgage markets." Sorry choir boys, wrong again in my opinion, because...

  • Shortly after the rush of this "credit crack" mainline wears off, the reality of adding the GSE's balance sheets to the imbalances already crushing the U.S. currency will cause historic upheaval. Note: I am intentionally avoiding any predictions of whether the upheaval will result in deflation or hyper-inflation because I'm on vacation and I really don't feel like dealing with this debate.

  • If the overly rigorous analysis behind my call for the end-of-the-world-as-we-know-it does not convince you, this chart of the Banking Index (BKX) might. This is not the picture of leverage exiting the system. It's the picture of the system exiting the leverage.

    Click to enlarge

  • And lastly, should I be wrong in my cataclysmic prediction, keep in mind that Minyanville's mission in not only to educate, but also to entertain.

Is it time for me to go leveraged short? Hardly. I fully expect that the markets in the near term will look like the EKG of a heart attack patient before he flatlines.

Not to mention that we know the sharpest, most vicious up moves occur in bear markets, and, as uber-Minyan Jeff Saut suggests, one such move may well be lurking. I remain net short with the bulk of my short exposure through long-dated at/out-of the money index puts. As Mr. Practical would say, I view risk as extremely high.

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No positions in stocks mentioned.
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