September 2007

Another rancid Whoopee Cushion breeze set Wall Street's pennants aflutter yesterday. And forget about profiting from these stupid little rallies, since they are pretty much over before your data software has drawn more than a bar or two on the three-minute chart. Occasionally there are going to be variations. Like yesterday. There was the usual, psychotic frisson on the opening. But this time the rabid badger got second 'wind' late in the session, powering a 90-point run-up. But who could have been alert enough to catch it? Nearly 300 minutes of tedium had elapsed in the interim, presumably anesthetizing the brains of any traders whose eyes were glued to the screen. Like all rallies these days, this one was about 95 percent short-covering, the rest option hedging and arbitrage. There was nary a bull in sight, save Kudlow. But who needs bulls when you've got a million bears who have been all too eagerly picking tops since August of 1982? Re-Loaded for Bear When the dust settled, Wednesday's intraday DJIA high of 13916 had gotten within a mere 106 points of the record high recorded in mid-July. A move to new all-time highs seem all but guaranteed at this point, but who knows? Perhaps because expectations of this are by now universal, or close to it, there's always the possibility Mr. Market will take an in-your-face detour. In fact, we can think of nothing that would vex bulls and bears alike right now so thoroughly as a swoon of 300 to 400 points. That would give shorts an opportunity to reload the gun they have pointed at their own heads while also throwing bulls off the scent. If this scenario plays out, it would likely be too late to set up a spike on Friday to new all-time highs. Then

The chart below shows what the Fed is up against in trying to resuscitate a U.S. economy already dangerously glutted with debt. The dip at the right edge reflects a decline in money velocity to multiyear lows. What it implies is that the 'multiplier effect' of fresh credit is not working with nearly as much vigor as it did in recent years. When money velocity is high, and customers are ' so to speak ' queuing at the banks' doors to borrow, it is possible for a single dollar of new deposits to engender dozens of new credit dollars throughout the banking system. Because banks are required to hold only a small fraction of each newly deposited dollar in reserve, the rest of it is available to be reloaned and further multiplied by bankers and their clients. But this magical ability to create money from thin air only works to the extent there are borrowers eager to take advantage of it. Let borrowers become the slightest bit skittish, though, and money velocity plunges in the way the chart shows. The result is that lenders find themselves pushing on a string, unable to get customers to borrow. We read that the Fed has gone all out to stimulate the economy, but the effect will be muted at best if consumers are reluctant to binge on credit once again. Far from binging, though, and with home prices falling across the U.S., we think consumers at this point are frightened at the very idea of going deeper into hock. As a result, they can be expected to ramp up savings in the coming months at an extraordinary rate, causing money velocity to fall to levels not seen in many years. What the Fed will do then is anybody's guess, but in theory at least,

Talk about investment hubris getting pumped to the max! Listen to what one market veteran, Amanda Sharp, told a reporter from the Wall Street Journal recently: 'If we were to get a crash or correction, there would be a nice cleaning out,' she says. Would that we all shared Ms. Sharp's brash confidence as we await the inevitable day when the stock market begins, finally, to discount an incipient plunge into recession and the widespread deflation that has gripped the real estate sector. Neither prospect has had much of an impact on shares, at least not yet, but we can bet Ms. Sharp and her ilk have been sharpening their knives, waiting to feast on road kill. The woman was not talking about stocks, by the way, but about art. She is the organizer of a highly successful London event called the Frieze Art Fair and presumably an ardent collector herself. You may have read that the art market is so superheated these days as to make the current surge in stocks and even ultra high-end real estate look as subdued as a 4-H bake sale. How does $19.1 million sound for a stainless-steel cabinet containing 6,136 handcrafted pills? That's what Damien Hirst's one-of-a-kind tchochka fetched at auction recently ' the highest price ever paid for a work by a living artist. As for works by famous dead artists, even some of the heavies ranked near the bottom of the Forbes 400 list might not qualify as serious bidders. How about $72 million for Warhol's 'Green Car Crash'? Warhol Our Pick While we have little doubt that Warhol's iconic paintings will more than hold their own at auctions a hundred or even a thousand years from now, how many more greater fools can there be to sustain their current, vertical

We're convinced that no amount of monetary stimulus can revive the real estate boom at this point, even if the Fed seems determined to try. But suppose we're wrong and home prices take off again? Does anyone actually believe that that would lead the economy back to health? Of course not (Larry Kudlow aside). It would simply postpone a debt deflation that by now has become as likely as�the next recession. Keep in mind that when the Fed eased aggressively following the 9/11 attack, it required 'only' about $2.70 of new borrowing to create a dollar's worth of GDP growth. These days, though, the figure is even worse -- far worse --and has been running well above $8.00. What this suggests is that the task of getting consumers to aggressively ramp up the spending of borrowed money on big-ticket items is going to prove well nigh impossible. While the indefatigable and globally indispensable American shopper can never be completely counted out, it strains the imagination to think that he will be able to outrun the economic avalanche that has been gathering destructive momentum in the housing sector these last few months. Even so, as counterpoint we offer another possible scenario from a friend of ours, John D., whose observations have been featured here before. John is in the commercial construction business in Southern California, and it never fails to astound us whenever we hear from him about how strong the industry has been, and continues to be, notwithstanding the collapse in residential building that has already occurred. John is not exactly an optimist, not by any stretch, but his forecast does leave a bit more room for an escape than ours: A False Spring 'I don't believe a 'housing boom' is about to start,' he writes, 'but just enough good

After pickpocketing widows and pensioners yesterday via a fleeting head-fake on the opening, DaBoyz turned Citi shares sharply south, wiping out half of the ill-gotten gains achieved two days earlier via a very nasty short-squeeze. The stock's 2.5 percent drop does not bode well for the market as a whole, since the banking behemoth is the best proxy we have for the smoke-and-mirrors business that has come to define global commerce, such as it is, in the 21st Century. (Click on image to enlarge) We'd raised the prospect here the other day of a DJIA rally to 15,000, but our heart was not in it, as you may have surmised. In any case, we remain duty bound to look for even the subtlest sign that the bullish outlook has come a cropper. That's what seemed to occur yesterday, when, even with the larcenous head-fake on the opening, Citi failed to pierce the 49.00 high made at the nanosecond apex of Wednesday's short-squeeze. Had that number been exceeded, the stock would have created a promising bullish impulse leg on the daily chart. Alas, it failed to do so. Similarly, the Dow Industrials needed to surpass ' but did not -- July's 14021.95 high to revitalize a bull market that looked to have received its coup de grace back in August. Extra Inch Analytically speaking, the Hidden Pivot method we use shares a simple but very useful rule with Elliott Wave Theory -- namely, that a correction is to be viewed as a correction until such time as its starting point has been exceeded. In this instance, were a DJIA rally to surpass the old record high by as little as 0.01 point, that would suffice to redefine the entire rally from mid-August's low as a bullish impulse leg. But until such time

Is the Dow on its way to new all-time highs? We wouldn't bet against it at the moment, having exited a short position in Citigroup the other day just before it and a whole bunch of other stocks took off. A global leader in the smoke-and-mirrors business, Citi seemed like a perfect proxy for a stock market that continues to waft skyward on a turbocharged mixture of hot air and short-covering. Our colleague Bill Fleckenstein would seem to agree. Fleck notes that Citi's structured-credit portfolio has put the banking behemoth in the thick of global credit angst, through such investment vehicles as its Beta Finance, Centauri and Dorada. Concerning just one of them, Beta Finance, Citi's boilerplate notes that leverage is 'only 14.24 times.' 'Thus, Citigroup, a leveraged entity, owns a gaggle of leveraged S&Ls,' writes Fleckenstein. All of them, he says, are down close to 20 percent. Fleck's complete article can be accessed by clicking here. Whatever problems Citi eventually may face as a consequence of its exposure to the structured-credit world, investors appear to be blithely unconcerned at the moment. Yesterday the stock gave up only a dime of Tuesday's spectacular gains, suggesting it may be consolidating for another thrust. If so, the rally would need to come today or tomorrow to keep the short-squeeze going. The chart below shows why. For a rally to achieve the status of bullish 'impulse leg,' we require that it surpass two prior peaks without a pause of more than a day. As you can see, Citi has exceeded one prior peak but not the second, 49.00, which it merely tied at the peak of yesterday's rally. If the downturn continues today, it would imply the rally lacks guts and that short-covering had become more or less exhausted. Still, given our bullish

Although it was no trick to see yesterday's Fed-induced short-squeeze coming, it took imagination to anticipate its rabid ferocity. We had advised shorting into any buying panic because it was bound to end with the question 'Okay, what now?' hanging over Wall Street. And so it has, probably, even if it takes a few more days for the lack of a satisfying answer to that question to touch off an avalanche of buyer's remorse. It might even take another bloody short-squeeze like yesterday's to set up a proper selloff, since the Dow Industrials will not be ready to do the Right Thing ' i.e., a 10,000-point death spiral ' until the very last ounce of panic-induced buying has been wrung from the bears. Assuming any still survive. We dodged the bullet ourselves after coming in short Citigroup yesterday with some October 45 puts that had been acquired near the top of Friday's rally. When we bought the puts, we believed our timing to be perfect, since entry came when Citi shares were topping just pennies from a promising Hidden Pivot rally target. Our position did become briefly profitable when Citi fell hard on Monday, but we should have learned by now that a day or two's respite is about as much pleasure as bears are going to get from this now 25-year-old bull market. We exited the puts early in the session for about what we'd paid for them, intending to reshort the stock at higher prices. By day's end, however, Citi was looking so feisty that we let the clock run out without shorting anew. A Psychotic Lunge That doesn't mean we've changed our minds about the stock market being an historical short sale somewhere near these levels. But we are not about to simply 'lay 'em out' willy-nilly

Place your bets, folks! We've heard good arguments both for and against a Fed easing today but think the odds favor the doves. One of our regular correspondents, Erich Simon, actually expect the Fed to tighten ' a very distant longshot, in our view ' and we have reprinted his comments at bottom. One middle of-the-roader is Don Luskin, an acquaintance from our PSE options-floor days who now runs a company called Trend Macroclytics. Don had an op-ed piece in the Wall Street Journal last Thursday headlined 'The Greenspan Myth'. Expecting the essay to come down hard on the former Fed chairman, we were disappointed to see that it merely attempted to refute the widespread belief that Mr. Greenspan should be viewed as a hero for supposedly helping to prevent various crises of the recent past from turning disastrous: Long Term Capital Management, Mexico, the 1987 Crash, Russia and the 9/11 terror attacks. Don makes a pretty persuasive case that Mr. Greenspan in each instance was too late with too little and that market forces eventually did the job, but the essay was less convincing in concluding that the Fed chief's overrated heroism should not be invoked to push his successor, Mr. Bernanke, into an unwarranted easing. Don sees the U.S. economy as too robust at the moment to warrant Fed intervention, and on that point we would differ sharply; for, nowhere in Don's tally of the U.S. economy's supposed strengths does he even acknowledge the potentially grave troubles that currently beset the real estate sector. Greenspan to Blame Immediately below is the response we sent to Don. As Rick's Picks readers would expect, it eschews the genteel politeness toward Mr. Greenspan that writing op-ed for the WSJ requires. We dispense with such niceties not only because Mr. Greenspan's theoretically challenged

We've been enthusing about gold one rally at a time for more than a year, but it may be time to loosen up and imagine bigger possibilities. Our minimum upside objective has been 736.80 ever since the December Comex contract was trading in the low 690s. However, someone in the Rick's Picks chat room asked an obvious question the other day: 'What then?' We responded initially with a somewhat timid target of 768.90, but we're starting to think that this target, too, deserves a 'What then?' We don't need to tell anyone that bullion's price action has been more than a little encouraging lately, and that there are good reasons for this. For the first time in decades, gold is moving strongly higher not because some world-shattering geopolitical event such as the 9/11 attack, or the U.S. invasion of Iraq, has spooked it, but because of a more generalized fear that the financial markets are in deeper trouble than anyone knows how to fix. Nor can they be fixed as far as we're concerned, and so the forces pushing gold higher at the moment should not be expected to abate any time soon. (Click on pictures to enlarge) That said, we remain skeptical of predictions that gold's price eventually will surge into the stratosphere (meaning upwards of $2000 an ounce). Although that's not inconceivable, the odds it will happen must be weighed against the prospect of a worldwide credit deflation that completely wipes out personal savings. And that is exactly what will occur when the $500 trillion (per BIS) derivatives bubble collapses, as it someday must. The implosion would draw its very power from the deleveraging, or marking to market, of the entire, very thinly collateralized $500 trillion edifice of credit money. Squatters in Aspen In the wake of such a