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The Ultimate Bull Trap?


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Bull Trap: A false signal indicating that a declining trend in a stock or index has reversed and is heading upwards when, in fact, the security will continue to decline.

Is the Ultimate Bull Trap Being Set?

Longtime students of the market will tell you that the crowd is usually wrong at extremes. Judging by what I see, hear and read in the media, the current consensus is:

  • Stocks bottomed on November 20th-21st;

  • An economic recovery will begin in the second half of 2009;

  • Corporate bonds are a buy;

  • Stocks are cheap;

  • The stock market is now discounting all the bad news - which is surely a sign that the worst is likely behind us.

Even though I was looking for a low in the S&P 500 around 750 (it bottomed around 740 on November 21st, only to close at 800 the same day), I continue to believe that was a low point, but not the low point for this bear market.

My firm was a large buyer of mortgage-backed securities during the Wall Street de-leveraging, and we've been rewarded with handsome gains - although we began to take some profits on Friday, where appropriate.

Stocks have rallied even more (S&P at 931) and could possibly make a run at 1,000- 1,100 - particularly if "performance anxiety" sets in among those portfolio managers afraid to miss the rally. As an absolute-return investor, I am not afraid: I have the luxury of having missed the big move down from nearly 1,600. The managers subject to performance anxiety are the same ones who managed to get to a market benchmark - only to get tattooed.

Corporate bond spreads have tightened during a slow holiday season, as have spreads in CMBS (commercial mortgage-backed securities). Corporate spreads may or may not tighten further; I believe there will be a wave of issuance at every level - government, emerging markets, corporations, municipalities, etc.

Treasury yields have also crashed, as the Fed has taken the federal funds target rate to a range of 0-0.25%. By manipulating interest rates to zero, the Fed is badly punishing savers. You can sit in cash and earn zero - or you can be forced out onto the risk spectrum, just so you can keep up with inflation or your benchmark.

Forcing money into risky assets is perhaps the most dangerous experiment ever, and we have no idea how it will end. I expect it to end poorly - with hyper-inflation. The funneling of assets into risk is masking the deteriorating fundamentals and giving the appearance of a market that's already bottomed. But this is sleight of hand - an illusion.

The Fed is setting up the ultimate bull trap - a trap that, when sprung, will leave only sellers standing. And we could see that happen by the end of the first quarter, or the beginning of the second.

Click Here to Purchase "Bond Basics: A Q&A with Bennet Sedacca"

No positions in stocks mentioned.

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