Trust is the operating word…

shawn baldwin from CMG in Chicago discusses capital management and capital markets

Trust is the operating word…

Market Commentary October 14th 2008
October 13th finished the day as one of the largest gains ever in the markets. An 11% gain in one day...where did that come from and did anyone see that coming? Well actually, yes I did and I said it on the October 10th commentary on the last line of the aptly named-Freefall on the Anniversary (it seemed catchy when I wrote it): "There will be a 10 point day and the Vixx and short interest will tell us when"--the Vixx had the biggest drop in history and we had our largest gain ever. There is a correlation. Believe it.
I actually took a lot of heat from a few of the recipients of this commentary for that statement. The recipients are an intellectually fearsome, market savvy group. There are over 300 market professionals who receive this commentary. That group is comprised of ivy league finance professors at 5 of the top schools on the planet, an assortment of PhD's, the largest plan sponsors in the U.S.,hedge funds, sovereign funds CEO and CIO's, investment bankers on both sides of the 
pond and finally news media in tv, print and cable...not exactly a forgiving bunch and they tend to be fairly well versed in market history. I was lambasted for that "reckless, salacious shock inducing statement"--In retrospect maybe it wasn't so reckless, it was based on a number of fundamentals and the theoretical basis was the velocity of trading through electronic platforms, program trading used by a number of large mutual funds to buy on value and the predication that 
a large segment of the baby boomers quite simply don't have anywhere else where they can invest their money and generate the returns sufficient to retire on—so it's back to the roulette table to bet on black!
I'm sorry for the additional diatribe but I had to take a moment to outline that because one of the persons I received that comment from has an IQ so much higher than mine that I actually questioned myself. It is fairly intimidating to send these comments to this group with the incendiary statements I make, such as saying on September 24th that " the market will fall of precipitously on September 30th". You can almost hear the lions gnashing their teeth when you write it. In truth, more often than not I receive very valuable insight and additional information which makes me a better trader--so it's more than worth 
the risk. You guys are smart.
Back to the regular format:Watching the crash was frightening to everyone (professionals included) as you could see the fear of "no buyers" and the market becoming completely unhinged on their faces. You could also hear it in the voices of the various phone calls and messages I received. More terrifyingly after our 2nd term "CEO President" spoke the market dropped another 400 pts. Its 
official--keep Bush away from the microphone--the market does not want to hear what he has to say. That statement serves to outline the fundamental problem in the market-complete lack of trust. Underlining that fact was the Lehman auction of Credit Default Spreads for an astounding 10 cents on the dollar. We now know where to value them unfortunately--in the toilet. This is however a valuation 
point and far better than a question mark and it, along with the multiple possible solutions for the clearing the instruments at the Intercontinental Exchange and the Chicago Mercantile Exchange/Citadel offer (my personal favorite) bring us closer to the fundamental problems being solved.
Does that mean the day has been won and we are off to new unprecedented highs? Not hardly and don't count on it. Once again, this is the time for traders so you should expect more volatility and market capitulation. If you remember in 1987 (I was an intern at EF Hutton making cold calls for brokers while in college) the Dow raced back in 12 months after the crash. However, what we experienced on Friday was the worst sell of since 1930, in which after the crash of 1929 it took the market 3 years to drop and it didn't fully recover until 1954. However they didn't have large pools of capital moving around in 
nanoseconds buying equities from every point around the world. We do.
Why did the Treasury force capital down all the banks whether they wanted it or not? The same reason that the G7 was front and center--most people need some form of guarantee whether implicit or stated that things were going to be alright. The Treasury wanted to make sure that they didn't induce bias and cause a potential shorting frenzy on banks who didn't receive capital. They also wanted to outline that there was going to be a bottom. That seemed to be the resounding question I was asked-"Where is the bottom?" To that question once again the mitigating factor is a combination of fundamentals, processes and trust. Remember the commercial paper market and inter-bank lending had to be repaired to get the system working again and no one was prepared to lend inter-bank because of failure uncertainty. The Treasury wanted to reassure the 
banks so that they could lend with each other without worrying about 
counter-party risk and send a message to the rest of investors that the markets were safe. For those of you lamenting that the U.S. has went to far--you should be aware that the Europeans put over $2.3T into their system, our Treasury only injected $250b--nearly one tenth less and hardly comparable. That still seems like a lot of money but when you think of it systemically and you bear in mind that the U.S and European economies are very similar in size and scope, you realize that it could be a lot more. Having said that we can definitely expect hearty times in 9 months to a year period from now--the government has all but 
insured that. The only action likely to derail that would be a zero interest rate policy similar to what stagnated Japan after a similar period of leverage and uncertainty of the value of bank assets. The key defining difference in this instance is that we were prepared to dispose of our "drek" while they weren't. The Treasury also wants to assure the retail buying public and the foreign investors that it's safe to invest in our market--one of the points Hernando DeSoto wrote about in his famous book "The Mystery of Capital-why capitalism 
triumphs in the west." Only one question still remains: true housing and real estate prices. Although it's only one question, it is a pretty big question since 65% of all U.S. bank lending is real estate based. That answer is still a year away.
We continue to see that we are in financial dysfunctional times although there is no hard data to suggest that is carried through in goods and services. Before 
you start to call me Phil Gramm, Jr. ask any economist (I hang out with a lot of them) and they will tell you that this is completely true.
The euphoria that the bull is back spread to all of the Asian markets and the Nikkei raced to an all time high. Please don't be fooled--make no mistake, this is the time for active traders and people who can discern magnitude, direction and pick a stock. The problem is that most people on Wall Street can't pick a stock to save there souls which is why there is always a "flight to quality". 
Fundamentals are contracting and we will begin earnings reporting which will not only give moments of jubilation and disappointment but events to trade on to both the up and downside. I have to admit--I am intra-day trading during the day and watching opportunities--that is why I haven't given anymore specific buys or shorts. I simply don't know and I wait on market cues. I do know what fundamentally is needed and I am trying to outline that completely. I can tell you that it is time to look extensively at tech and biotech. Next week I will have very specific recommendations along with some energy plays as well.
Remember: The credit markets weren't open on Monday due to the holiday, so I expect to see the other side of the response to this equation. Expect extreme intra-day volatility and market capitulation. The stocks I have advocated: GS, JPM, MS and GOOG all are up. Trade them wisely and take profits if you don't have the stomach for consternation. I believe that today will be up initially but either today in the afternoon or tomorrow in the afternoon it will turn ugly 
as professionals take advantage of the uncertainty (we call that the head fake)and they also will advantage of the maddening crowd by exploiting their fear at the first sign of disappointing earnings.If you remember on October 3rd I sent market commentary out at 1:15 saying that the market had passed and the rally would too -- when the market was up over 275 points--it subsequently fell back to earth and crashed. This rally will react in the same way and just as rapid, as somewhat squeamish buyers give up the ghost trying to buy and run for the hills.

About the author

Shawn D. Baldwin is Chairman of the AIA Group (AIA), an alternative investment and advisory firm based in Chicago


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