Capitulation + Stabilization + Nationalization = The Creation of the US Sovereign Wealth Fund

Shawn Baldwin from CMG in Chicago discusses capital management and capital markets

Capitulation + Stabilization + Nationalization = The Creation of the US Sovereign Wealth Fund
Market Commentary October 16th 2008
Frightening. Unnerving. Scary...all of the things that October is supposed to be. Who needs Halloween when we have the US and Global Stock markets? Astoundingly we saw another terrifying 700pt plus drop in a single day. The readers of this commentary weren't surprised because you were well informed and knew that the credit markets hadn't responded since they were out on Holiday. 
The resulting wrath of that response was the decimated wasteland called the U.S Stock Market. Of the S+P 500, 495 stocks were down. I hope you got out of JPM, GS, MS and GOOG as I suggested.
When I released the market commentary on October 14th, it was with slight trepidation, the commentary was more jocular than usual and a lot lengthier. The reason for that extended diatribe being-- I was trying to convey a very serious message and very dour news. A Dramatic and brutal reversal, that would result in a very bloody market. The market went up dramatically and then began it's nosedive in the afternoon as we stated in volatile spasms. Yesterday I received 
a few email on the last line:"..squeamish buyers give up the ghost trying to buy and run for the hills."
Some of you guys thought that was funny and apropos....others...not so much.
I expected to hear from the PhD who wrote me about my recklessness and he did not disappoint. I assumed I would receive a verbal tongue lashing about the longer than usual commentary and lengthy pedestrian beginning. On that point I was wrong, he wanted to let me know that he thought that I did a great job of being predictive and he was impressed with my timing (he also told me to kill or "greatly reduce" the "frivolous" commentary). With that, Professor...
We now have to begin to look at this market with an emotionless disposition…the market is clearly oversold. Yes, America is being re-priced and yes, we have to get a final price on real estate and housing before we can have the exact valuation. However a significant amount of variables have been plugged into the polynomial equation and we can arrive at a very good estimation of present and future values. One of my favorite phrases for building wealth is "…that you buy 
when the blood runs in the streets" Clearly the blood is running, the next questions are: When to buy? What to buy? Let's examine the factors for the best trading decisions.
 From a technical standpoint there are several factors to consider when 
approaching the question of size and magnitude.
1. From a macroeconomic perspective there is a flood of cash management bills coming to the market approximately $45b of them to be precise. In the 90's when I spent lots of time in Chicago and London with Treasury and Currency Traders they had a simple saying "Don't fight the Fed." That amount of Bills being brought to the table is demand driven and a harbinger of more fear induced 
parking into cash, these instruments offer miniscule returns and in this market the effective return is zero. Remember: the reason that we are seeing so much selling is that there is still a lot of hedge fund redemption occurring. Some funds were levered 15, 18, 20 times--that has created a lot of selling. That selling isn't being matched by buying because of the fear in the marketplace and this is driving the market down. That is being accelerated by some well capitalized hedge funds who will capitalize on the fear and then ride it up again. Volatility is a traders best friend. You make money going up and down, 
however there is far too much downward pressure.
2. LIBOR (London Inter Bank Offering Rate-the rate that banks charge each other for loans)is in complete disarray and it effectively shows a 100 basis point discount. Remember: a large part of the problem is that short term lending was stymied and when that was compounded with the systemic risk of failure uncertainty-our debt markets ceased to work. The price dislocation outlines the irrational movement of the market and is an indicator that the system is over-wound.
Negative factors causing more fear:
1. Job loss numbers-this is to be expected because 25% of the job growth came from two formerly booming areas: housing and finance. Given the current economic situation these jobs won't be back but their loss should have been anticipated (and welcomed!) A reduction in workforce is what will be needed in a lower returns, sideways market.
2. Retail was down 1.3%-two thirds of the US economy is based on consumer spending. That data definitely deters confidence and creates fear induced irrational selling.
3. PPI (Price Producer Index)-this indicator tracks pricing through 
processing(price transmission) from raw goods, to intermediate goods to finished goods. Short story: raw goods in decline more than intermediate goods, intermediate in more decline than finished goods.
Additional harbingers were the Beige Book (the region by region report), which showed that economic activity was through all 12 reporting districts with decreased consumer spending and inflationary pressures on the horizon. Most predictions say that we should expect continued contractions in the 4th quarter.
The strategy now should be to cautiously play the market broadly. The market is poised for a 120 to 150pt swing tomorrow. Going long the S+P will return handsomely--gage your risk tolerance. I estimate today or tomorrow downward pressure initially in the morning followed by strong buying and upward pressure. I would not advise staying in the position long--as I have said since September 24th--expect extreme volatility. Do not expect 2 up days in a row at this point-there will be too many opportunities for negative news to shake uncommitted buying. This is the time for speculators-not investors. This market has had tremendous range and that won't stop yet.
Tomorrow's upside could go as much as 200pts because the sophisticated traders know that the market is way oversold, the treasury has effectively spring loaded 
the system along with all of the other G-7 nations for sustainable equity growth. Believe it. Attempts to short this market will end up with disastrous results if you don't sit on a trading desk and have a IPC or BT trading turret system with a direct connection to your executing broker--you will be toast. The indicators are down, the market is oversold and the herd is stampeding—the market goes back up. Bet on it.
The contagion caused by Lehman has caused an astounding $3.1T of wealth to be erased. This dramatic wealth destruction caused the first global coordinated rate cut (wow) and the effective nationalization of markets by every civilized country in the world tied into the global financial system due to counter-party risk. This effectively created Sovereign Funds everywhere--even in the democracy of the United States of America, where we believe in free markets. That is something historical and has not been reported or opined on. 
There will be two sides of this fundamental shift in ideology, the first benefit is seemingly stable markets. This will translate into less dynamic markets due to government control and regulation which says that rapid is scary so they will want slow. Next the compensation will be capped, that tends to scare the talent away--those guys usually want to make lots of money (exactly how many innovative producers do you know that go for that stable, secure government job?). Finally, 
if a company that the government has invested in wants to increase it's 
dividend--they will have to clear it with the government. Uh-oh. I can only imagine what wonderful impact that will have on dynamic earnings. Gads. I would rather have a scary market and I offer the following analogy: In Disneyworld they have an attraction for the kiddies called SmallWorld. It’s filled with very, safe rides that don't have high pitches, don't go very fast and don't lurch or jerk you around. They are very safe.
There is another section of Disney where you have to be taller than the wood frame cut-outs of the animated characters to get on the rides. These rides are very fast, have high pitches, rise and fall rapidly and they also lurch back and forth unexpectedly. These are exciting and fun. Enjoy the fun while it lasts--given the new Sovereign Fund world order it may not last too much longer.

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