Dead or Alive?

Rallies keep emerging out of potentially disastrous economic scenarios like a relentless zombie in a ' i thought it was dead' horror movie. The bulls look at the market this way.

Greeks will pass minimal legislation and a template for EU debt will emerge.

Stocks represent lean mean cash machines which are offered at a discount to future earnings.

All domestic government spending is going to decline which will please those who have jobs.

Those who have jobs represent a solid base from which further real declines are not likely and are enough to make the economy expand ever so slightly.

A drive out of government fixed income and into all corporate risk is about to take a giant leap.

Spreads between after debt service on rentals and the rents paid is widening which means the housing bust is over.


Bears on the other hand see it as a simple matter of jobs. They will give in when big job growth appears.

There is an interesting article in MarketWatch by Brett Arends reviewing data from Trim Tabs of corporate buying of their own stock to the tune of $124 billion in the first quarter. This money came from profits and a whopping increase in corporate borrowing by non financial firms of a $100 billion dollars, raising corporate non financial debt to a record $7.3 trillion.

Markets Ponder Several Problems

Equity markets have been nervous lately. Not just in terms of the current price retracement, but with a much greater degree of concern that the U.S., this time, is declining into an inevitable reckoning due to seemingly unsolvable governmental and private debt structures. Sovereign debt issues, QE2 cessation, and U.S. default fears, are all greasing the current slide. The markets also having an odd debate over the risks of inflation with, on the one hand, the belief there will be unavoidable repercussions of easy money, and on the other, the total lack of demand stemming from a stagnant and an increasingly jobless America. What with TARP being viewed correctly by the public as an entitlement program for the financial elite in this country, and the problem of two parties unable to provide hope for future job opportunities, traders are focusing on several primary realities.

(1) Job creation will be hard given that austerity means less growth and a slower economy. (2) China is a hype which has started to correct. (3) Over 25% of homes in the country are underwater and about 50% could not find a buyer for their market price if they tried. (4) Wall Street thinks Republicans are backing noble goals but are crazy to play with U.S. debt given the resulting negative play on world equity prices.

Number one. There is just no way around the negative impact of smaller government to the broader economy. Forget the economic debate. Cutting spending by cutting jobs will create a large whole which cannot be filled by the private sector. Traders are trying to determine whether the markets will have to cycle through a dominate Republican austerity reign of terror for several years or will have a milder not so austere compromise and split rule.

Number two. China has started a correction but who knows what an undemocratic monster economy correction will looks like. A hard correction would be unnerving since most strategic investment decisions by world economic giants would be altered.

Number three. Real estate is an orphan now with little hope. Practically ignored by the Obama Administration. It has always been the most important issue and for an Administration with a positive slogan as "Yes We Can", the reality became "Guess We Can't."

Number four. What can you say about tangling the possibility of the world largest economy defaulting for political gain. Now there's plan.

For traders, positive turns in any two of these four keeps this market moving higher.

View of Down

Disaster Not Averted
by Dean Baker, The New Republic

When the financial system was on the edge of melting down back in the fall of 2008, there was much talk in the punditocracy of a second Great Depression. The story was that we risked repeating the mistake at the onset of the first Great Depression: allowing a cascade of bank failures that both destroyed much of the country’s wealth and left the financial system badly crippled. Instead, however, we acted, and these days the accepted wisdom is that the TARP and other special lending facilities created by the Federal Reserve Board prevented a similar collapse that saved us from a second Great Depression. But this view badly misunderstands the nature of the first Great Depression—and may, in fact, result in the country suffering the second Great Depression that the pundits claim we have averted.

Allowing the cascade of financial collapses at the start of the first Great Depression was a mistake. However, there was nothing about this initial collapse that necessitated the decade of double-digit unemployment that was the central tragedy of the Great Depression. This was the result of the failure of the federal government to respond with sufficient vigor to mass unemployment. Indeed, the economy only broke out of the Depression when the federal government undertook massive deficit spending to fight World War II. Deficits peaked at more than 25 percent of GDP. This would be the equivalent, in today’s economy, of running annual deficits of $4 trillion.

Loss Aversion

Creating jobs and the psychological positives attached to growing employment numbers are apparently what markets are going to need in the months ahead. I can't get over the feeling however that this is about the old loss aversion theory; that people prefer avoiding losses to acquiring gains. I see it strategy choices all the time. Traders would rather choose a pattern of trading where the risk averse strategy limits there ability to participate in opportunities for gains. Bears choose the least up and Bulls pick the least down even when probabilities are equal. In the case of this market, participants do not want to be a party to the most anticipated Great Depression II on record. Ugly is going to get every opportunity to prove itself and whether it becomes self fulfilling or a sucker play, we will know soon.