At the outset of a new quarter, market signals remain mixed, making it difficult to find a reliable trading edge. Just to reiterate my longer-term thesis, I think talk of economic recovery is premature. We still have a number of shoes left to drop, including consumer deleveraging, commercial real estate woes, economic calamity in California, falling state tax revenue across the board, still-expanding toxic debt issues with banks, and a financial sector that retains most of the essential systematic problems that caused the crisis in the first place. As the architects of the disaster (e.g., Larry Summers) seek a solution, too-big-to-fail institutions continue to speculate heavily in risky investments, meanwhile lobbying in Washington with your tax dollars to further rig the system to their benefit.
Of course, the redistribution of our collective wealth to the bankers may push equity prices still higher in the short term. Meanwhile, at some point financial realities will manifest themselves. For instance,
AIG, Ready to Blow Up Again:
"American International Group Inc., the insurer bailed out by the U.S., said that valuation declines on credit-default swaps sold to European banks could have a “material adverse effect” on the company’s results.
The risk of losses on the derivatives may last “longer than anticipated,” the New York-based insurer said late yesterday in a regulatory filing updating the “risk factors” in its 2008 annual report. The firm had $192.6 billion in swaps allowing lenders to reduce the funds they had to hold in reserve as of March 31, AIG said.
“They’re guaranteeing close to $200 billion in assets in probably the riskiest environment in our lifetimes,” said David Havens, managing director at investment bank Hexagon Securities LLC. “It’s a huge number -- if there was any surprise, it’s that this hasn’t been flagged before.”
Now, I don't know why the US government doesn't simply nationalize or break up an insolvent institution like Citigroup, but instead chooses to guarantee its bad assets and allow it to continue business as usual. Maybe admitting these large institutions are insolvent would trigger massive CDS losses at places like AIG. Not sure. But the worst-case stress test scenario is already a reality, and we can expect bank losses to grow further as the economy and the real estate market continue to struggle.
As of the premarket on Wednesday morning, the bulls look like they want the party to continue, so there is no reason to trade counter to their delusional fantasies of green shoots. As we look at the chart for SPY, we can see that price need to get below 87.50 for bears to truly gain the upper hand. The bulls don't have far to go to move the market to a new high, and given high bearish sentiment, we could see a hefty short squeeze over the 95.50 level.
I have no idea which way it will go.
