Monday Morning Meltdown

Is it time to get real?

We went into the weekend mainly in cash but with a few speculative bearish bets (see Weekend Wrap-Up) even though the Wall Street Journal is screaming at us in today's headline (huge type, above the fold): "World Regains Tast for Risk – Stocks, Currencies in Emerging Markets Soar; China's Stimulus Spending Kicks In."  Gosh Uncle Rupert, that is good news for the masses.  Why is it though, that the on-line readers are greeted with "Stocks are No Longer a Steal – By Most Measures, Stocks No Longer Look Cheap?"

"The market is a little bit extended," says stock-market strategist Subodh Kumar, of Subodh Kumar & Associates. "Where it goes from here is going to depend on how quickly things really improve as opposed to getting less bad."  Getting worse more slowly was our theme of the past two weeks.  Now that we've pushed that party to the limit, it's time to take a more realistic assessment of where we are.  While earnings beat very low expectations, many companies did so by slashing costs and reducing inventories.  This led to a draw in inventories which economists have been calling a positive but – what if the 2M people who lost their jobs in Q1 in order to reduce the costs don't come running back to the stores to buy things in Q2?  What if their families don't?  Now we're talking 6M less consumers, 2% of the US population, that may not WANT the inventories you are planning to replenish. 

Economic modeling is a tricky thing but the model on which the bank stress-tests was based in is rose-colored, to say the least.  As I pointed out last week, many Financial stocks are already over-extended with forward earnings expectations priced in that anticipate a return to earnings they had in 2007 by next year.  This is RIDICULOUS.  First of all, the lending environment has changed so considerably that there's virtually no chance at all we'll get back to those levels for many, many years.  Second of all, even in 2007 the financials never earned what they claimed to earn in 2007 – the earnings turned out to be bogus – based on fantasy valuations that led to TRILLIONS in losses and write-downs yet, somehow, people are giving GS et al money as if those highs are just around the corner and the losses never happened.  Insane, irrational, stupefying…. it's hard to decide how to describe the action going by investors and the massively irresponsible MSM jackals (cough, Cramer, cough, cough) who are herding the sheeple back in for the slaughter.

Are we really, REALLY so stupid as an investor class that we are going to get all excited about a rally that is led by energy companies that are rising on the back of near-$60 oil which, if sustainable, will cost the American people $416Bn this year and will negatively impact our trade balance by $240Bn, Dollars which we will ship overseas, many of which end up in countries that are on the US list of sponsors of terrorism.  Globally, $2Tn a year is spent on oil at $60 a barrel and every $3 per barrel higher rips $100Bn out of the wallets of global consumers.  That is without taking into account the mark-ups by refiners and the chain costs of food and other base commodities that use oil and gas in production as well as manufactured goods inflation so it's more like $100Bn per $1 that oil goes up.  $100Bn that won't go for movies and restaurants and TV's and IPhones.  How do we bet on a global recovery that once again robs from the poor to give to the rich?

Do we celebrate the return of profits for GS, MS and their other ICE partners as they once again steer us down this destructive path that destroyed the global economy just 18 months ago?  Not only are the energy traders at ICE still circumventing US regulations and manipulating the price of commodities, jacking oil up 20% in less than a month and running food costs up 10% during April but now THEY ARE TRADING CREDIT DERIVATIVES.  That's right, the same things that Warren Buffett called "weapons of mass financial destruction" that very few people would not blame for a good portion of the Trillions of dollars of damage done to the global economy last year are already dropping $36M to ICE's bottom line (10% of profits) and the CME is trading them as well so Woo Hoo to the new Wall Street – same as the old Wall Street and it looks like we will get screwed again!

The big question brewing in Asia is will China be willing to get screwed again as that nation sits on close to $2Tn in US paper and is essentially forced to buy almost $100Bn more of it each month (despite the US buying 30% less Chinese goods than we did last year) in order not to destroy the value of the $2,000Bn they already have.   This is no different than a bank lending a business another 5% every month as they sink 60% deeper into debt each year in the hopes that the business turns around before you have to write off the asset.  There IS a point at which the lender finally gives up and takes a hit before throwing more good money after bad.

China has already put almost $1Tn of stimulus to work but most of the efforts have been centered on boosting exports, a strategy that will fail miserably if the US and EU can't turn their economies around and we, in turn, are counting on China to turn their economy around to save ours.  Sounds silly?  Only to rational people so don't worry about it as there are few of them in this market.  China needs an alternative to strong exports if it is to keep growing robustly. "Asia's export-led growth strategy may no longer pay the same dividends as in the past," the International Monetary Fund warned last week.   "The stimulus is a stopgap, not a solution," says Arthur Kroeber, managing director of Dragonomics, a research firm in Beijing.

The Hang Seng fell 301 points this morning but that certainly doesn't tell the whole story as the drop was actually a very dramatic 600-point collapse that hit the markets in the afternoon.  "The market is grossly overbought," said Andrew To, head of research at Tai Fook Securities in Hong Kong, referring to the Hang Seng Index. He noted shares had advanced in seven consecutive sessions. "I think the market is not supported by fundamentals, but rather supported by fund flows and a squeeze on short positions."  China's CPI fell 1.5% in April despite the massive stimulus, worse than the 1.2% decline in March.  If China were not stockpiling copper, buying 33% more than last year, global copper demand would be down, not up and that's been the indicator many economists have pointed to to signal a turnaround in commodities that has boosted both gold and copper miners as well as steel companies, very possibly under false pretenses.  TM dropped 5% and continued to be a drag on the Nikkei, who finished flat after recovering 100 points after their lunch break (why don't we get a lunch break?). 

Shares in Europe are off about 1.5% ahead of the US open (9am) as the dollar takes a small bounce off the 200 dma aided by a massive intervention by the BOJ as the Dollar plunged to 97.5 yen (from 99.5 on Friday).  We had a terrible 30-year auction last week and rates jumped almost 10% in a single day AND STAYED THERE but Cramer told us that only wimps worry about what it costs to borrow money so we'll pretend he's not a complete idiot and I'll diplomatically say that we are somewhat concerned despite Mr. Cramer's reassurances.  Auto makers don't like rising interest rates and car stocks dragged Europe down as well.  Nonetheless, they are pumping oil off the pre-market floor of $57, looking to give oil a near flat open over $58 before people realize what a farce it all is.

Our put plays will pay off this morning but, like last week we're not going to be greedy.  As I often say to members, I'm don't intend to be a day trader but I'm not adverse to taking profits in a day.  We have some very choppy waters around these levels with tons of resistance points clustered together.  It would be impressive if we can get through it and nice if we can get a retest in around 8,200 and hold that but better to watch mainly from the sidelines at the beginning of what is likely to be an exciting options expiration week.