Global Market Updates / Special Coverage For Indian Bourses - 16th September 2011 Part 2

Coverage for Indian bourses.
For India, the so called ratings by SnP, Moody's does not matter a least bit, just as is the case for the US. Now the fundamental reasons IMHO are different for both the countries. For US, the thing is that the USD is a global reserve currency and standard currency measure; the US T-Bills hence are nothing but indirect form of Dollars that make the ratings as of now meaningless by all measures. The negative ratings will impact US Dollar if and only if suddenly the world wakes up tomorrow and decides that the US Dollar will not be the standard currency.

Now as I say this, if you are thinking that the same logic can be extrapolated to India and since the Indian Rupee is not a global currency, the rating does have an impact, you are wrong. For India, with the Bonds being backed by RBI and a coupon rate of 6% to 8%, the story is different. Simply because India has not leveraged its currency or any reserves that it holds and has consistently been paying the 6% to 8% coupon rates without any challenges. On the population side, yes we are a 1 billion nation with an approximate per capita GDP of less than USD 1200 per annum and that itself shows that things can't get worst for India as a whole. The consumption story is still pretty strong and to the extent our central bank is paying out the coupons on time and also sitting on piles of forex and gold reserves, things are fine. Over the last 10 years, our coupon rates have been fairly consistent ranging between 6% and 8% regardless of the economic cycles.

Whilst a 6% coupon is considered a blemish by western standards, it is not the case for India [and I am not saying this with a bias because I am Indian. I know India has its fair share of challenges in infrastructure and inclusive growth, governance etc but that is not the scope of these notes]. In the western world, central banks lend at near zero rates [thus factored in the yield of the bonds] and hence 6% will imply a credit spread of over 500 bps [Interest earned by Central Banks = Near Zero whilst Interest paid via coupons on Bonds 6% or more]. As far as RBI is concerned, just have a look at the Repo and Reverse Repo rates for banks! Is the spread between what RBI is charging to banks and what it is paying out as interest on coupons more than even 200 bps? No and hence Indian bonds with 6% or 8% interest rates are very safe and the rating agencies mumbo jumbo is worthless. Let us not forget that these were the very rating agencies that stamped the toxic mortage backed securities prior to 2008 as 'AAA'. In case of India, it is unfortunate that we don't have a single leader who can stand up and announce like Obama 'To hoots with the rating agency upgrades and downgrades - we know what we are' [He can do it because of the strength of USD; we can't do it because more than half od our politicians are busy playing partisan games and the ones who know don't have the guts to say it]

As mentioned earlier, India cannot escape the wrath of this double dip recession that is coming. We are dependent on exports, IT and all of these are going to take a strong hit that will have an impact on our stock markets and economic situation as well. So be it, we still are in a position to grow the economy by over 6% on the back of good domestic consumption. So the core story is intact and we will be the first to get out of the mess as things turn around. The challenge for the ordinary Indians is actually to brace up for a temporary phase of hyperinflation that our government cannot handle effectively. 2014-2015 period will be a bonanza for Indian stock markets yet again and the global crisis of 2012-2013 should be used to accumulate stocks for the bull run. The average salary hike won't exceed 6% to 7% for the next 2 years and if IT and Financial Services are hit, we will have a lot of jobs lost in India as well.

In the interim period, there will be some pullback rallies on Nifty but all rises now are illusory. Every rise must be used to get out of mutual funds and stocks as the writing on the wall is very clear - Nifty will plummet below 4k levels next year and this fall is accelerated because the pending high on Nifty did not come through.

Coming up next is the common man's survival guide for the next couple of years.

Global Market Updates / Special Coverage For Indian Bourses - 16th September 2011

So things apparently seem to be on a song in the Western world yet again. The European bourses had a fantastic counter-trend rally as if everything that happened a few days ago was a nightmare. That incidentally is a fundamental fallacy and the tendency of excessive leverage being used to drive as many short term whipsaws as possible. Dow pulled back above the 11450 zone as expected and rather closed above 11500. On Monday, if the sad Monday streak continues, then it is a routine story. However, if Dow extends its gains and posts a 2nd consecutive close above 11450, then the pullback rally can move all the way to 11875.

First things first, time and again, we see the news saying stress tests have been conducted and banks seem to be ok upto a certain degree. Whilst I am no expert in conducting stress tests nor do I know the exact variables that go into the complex derivative[calculus derivatives for a change and not speculative securities] functions, there seems to be something missing in these tests. I prefer to keep things simple and I do not want to get into any specific bank, but just say a Banco Banca with 1 trillion euros book-value.

Assumptions for Modelling and Analysis
Book-Value = 1 Trillion Euros
  Securities / Assets that make up these 1 Trillion Euros
  0.6 Trillion Accounts Receivables via loans collateralized by real assets like houses, cars etc
  0.4 Trillion via Property and Other Assets that the banks have in their own names
  0.2 Trillion via Cash Holdings itself for day to day operations

As the stress models are used, typically a test is done on the basis of a hypothetical measure of defaults on loans and/or decreasing asset values and/or increasing demand by savings customers to withdraw cash back.

The first and foremost fundamental fallacy is to assume 1 Trillion book value in all scenarios which is wrong. If customers default and the market conditions are not good, the collateral security tends to have value much lower than what is recorded on books and in case of a foreclosure, the western banks typically have a double whammy. One, part of the book value is already eroded as it had discounted for interest income from that particular loan given out. A default implies that the principal and interest to the extent outstanding is knocked down already. Second, the decrease in value of collateral security can hardly mitigate these risks. Now one can argue here that there is an additional hedge taken by the bank in terms of Credit Default Swaps etc; I would like to keep it simple saying that there is a premium attached to the CDS as well and whilst it may mitigate some risks, the bottom line is that the stress test model is partially wrong over here itself.

Second, at any given point of time, the bank is assuming that the savers who have deposited their hard earned cash will only come to the bank for withdrawals for an x%. In case of a strong crisis, there will be a huge demand from savers to withdraw the money from their accounts [after all, in good times, the bank only kept a certain degree of cash and used the rest to lend money to debtors]. As the proportion of people withdrawing money increases, there will be increased pressure on the bank to either borrow from another bank or take some drastic measures. It is in principle unfair for the bank to tell any saver, no you can't withdraw your money now. The greater the pressure of withdrawals, the greater will be the pressure to start taking a hard look at the components that made up the book value.

So these 2 factors alone can lead to a vicious circle of sell-offs in asset classes [all included i.e. interest income, investment income, collateral security vide houses etc] Once stress test models start taking into account all of these factors in unison, it may turn out that a lot of banks that seem adequately capitalized suddenly risk a lot of exposure which right now the world doesn't want to look into and this is what the banks are hoping would happen.

The other factors are that the stress tests are just models that use 'all other factors constant' premise. It does not take into account the currency risks, the risks of huge cashflows that are needed in case of job cuts etc and suddenly, everything that looks ok turns out it is not. This is the primary reason why banks in the past have needed bailouts because the 'assets that back' the risks don't perform as needed and the banks risk total loss of operations.

The other thing to note is that credit that is extended to customers are predominantly done with the hope that business credit will be used to produce goods and services that eventually feed the economic cycle and the wheels keep rolling. The fact is that for the last 10 years and especially after Lehman Brothers, credit growth for business has been paltry. Banks are already sitting on a house of cards that have eroded significant book values and this has hampered business credit. Moreover, the business credit that has been extended has not really grown the economy to vibrancy overall. The Baltic Dry Freight Index suggests that core freight rates have been consistently dropping and now with so much excess capacity in the containerized shipping industry, there is very little scope to increase freight rates. Rather in gloomy scenarios, freight rates will keep decreasing. The fuel surcharges put on the cargo just covers the raise in crude oil prices.

If we start slicing the main sectors, banking and real estate collapses are going hand in hand. Shipping is in a downtrend. With jobs becoming a problem, the auto industry is going through some tough times and only now a drop in steel prices is somewhat aiding the input costs. The pharmaceutical industry, a darling 'alpha' return sector is heading towards a great crisis - next year, all the pharmaceutical majors will see a lot of patents expiring on their billion dollar labels that will force them to convert the patented drugs to over the counter medicines. Once a product is off-patent, any pharmaceutical company can produce a similar one and this is going to be a very turbulent time as all companies want to rationalize costs and get volume shares that will benefit customers no doubt but erode a lot of share-holder value [thereby again leading to banks losing money]

So Banking, Automotive, Pharmaceutical, Transport all are off the list for even normal performance. They are heading towards blood bath. Coming to FMCG, the capacity of factories overall have increased to a large degree and as past research has it, with turbulent times, brand loyalties start dropping. People prefer to save every dollar possible for expenses and hence to rationalize the production costs, big ticket factories will end up producing more and more Private Label products that erode revenues by over 20% to 35%. The customer at the supermarket will of course benefit from these lower prices but yet again, there is a lot of shareholder value erosion in such instances. Electronics and gadgets are going through such revolutionary times that marginal costs and revenues are decreasing significantly with volumes as the prime driver.

So this death spiral is slowly extending itself to all sectors of economy and hence, forcing banks to go easy on business credit. To summarize, this entire news and hoopla about stress tests on banks revealing safety levels is a big fat blatant lie. There is trouble and double dip trouble brewing. If the employment statistics are any clue, already job cuts are being planned, salary freezes being discussed and budgets for next year being rationalized to cope with 'realistic targets' [and one should remember that in good times, a perpetual growth was discounted for in the valuations of companies that in turn were discounted in book values of banks!]

All this blogosfear mumbo jumbo above only covered the retail banking [and to an extent investment banking segment] of the western world. Coming to Sovereign Debt, that is a grossly different story all together. Let us not forget that these countries are already sitting on debt accumulated over the last 15-25 years of which the principal amount is totally unpaid to a large degree in most cases. It is servicing the interest on the principal that has been causing trouble and all the 'successful bond auctions' that we are seeing in news is plain simple robbery of taxes of the normal, gullible hardworking taxpaying citizens.

All that these bonds are doing is borrowing to repay the interest of a borrowed amount of the past! That there will be more interest and principal payable on this is a separate issue. It is just that a drastic daring to say 'Yes there is trouble and we need to slow down' is simply missing. Our great leaders want to show that 'Everything is ok' now. This is akin to a depressed person consuming drugs and 'forgetting' the core issues. Once the drug stops having its influence, the sense that the real trouble is aggravating further will resurface and the great leaders just want to have more drugs. As is known about drugs, with passage of time, one needs more and more drugs to have the 'illusory' effect and eventually a breakdown does take place. We are heading in an accelerated form to a double dip recession and the earlier we come to terms with this, the better it is for us.

Now the other aspect is talking about 'austerity' measures - what austerity measures can a sovereign actually take now with inflation spooking beyond normal terms. As it is unemployment is a major issue and even in the western world, there is acute shortage of teachers and doctors and schools itself to begin with. If people have challenges with jobs, there will have to be more assistance provided for healthcare, public transport, social security and this means that they need more money to need the system. Austerity goes out of the window bang bang bang. So a prudent person should ignore the news, see what are his/her job prospects and prepare himself/herself. The day is not far when there will be a whammy from the government for 'austerity' measures and pat comes the announcement 'With effect from now, there will be no social security!' God help the world in such circumstances.

[There will be a separate article on what we the mango people need to do to take care of ourselves later over the weekend. Inspiration for the same lies in the written works of noted economist Nadeem Walayat and Conquer The Crash by Pretcher Jr]

Continued in Part 2....Coverage For Indian Bourses.

EOD Analysis for 16th September 2011 and Outlook for 19th September 2011

Nifty opened on a good note today following positive global cues and Banknifty extending its gains above 9700. The OI in Nifty futures was relatively lower at open at around 27 million. However, once the profit booking came in, the OI in Nifty futures continued to surge and shot up to 29.5 million in both the fall and subsequent rise. The 25 bps hike was anyways discounted by the markets and the overall impact of RBI news was as good as a non-event. VIX incidentally went below 30 levels but markets are not out of the woods yet.

The close was below 5092 but Nifty may still make an attempt to take out 5150-5177-5196 before heading south. Weakness will be confirmed with Banknifty closing below 9500 and until then Shorts should be initiated with a rise and not just straight up. Critical levels remain unchanged for both upside and downside. The movements are indicating that we may test 4800 levels before the end of this series but those going short on the market through Puts should be very very careful. Options premium are decreasing significantly and despite the right strike and subsequent price action, the Puts may not yield the desired profits.

As of now, upside is capped at 5225 and only a close above 5177 can give more strength. Until then take hedged positions, ideally via futures. If Dow continues the happy Friday and sad Monday streak, then we may see some downside on Nifty on Tuesday. Global market updates will be uploaded over the weekend. Hope you enjoyed the profits on both upside and downside. Thanks for visiting the blog and providing valuable feedback for improvements.

Happy to announce that we have a new blog section now being authored by Harshalji. It will provide a bi-weekly update on Nifty, classical TA and strategies for trading on Nifty. The link to the same is provided on the homepage of this blog (Weavologic For Nifty). Enjoy your weekend and hope to meet some of you on Skype tomorrow for the session by QOji.

EOD Analysis for 15th September 2011 and Outlook for 16th September 2011

Nifty opened on a good note today but the OI in Nifty futures were low at open today. After a quick round of profit booking, Nifty bounced back well on the back of Banknifty extending its gains, Reliance supporting well also helped a lot in the second half and the OI in Nifty futures surged yet again on the upside today clocking about 30.8 million [it was 29 million or so on open].

Now the critical barrier of 5092 is still holding out and only a close above 5092 can bolster the case of bulls. A close above 5092 will open Nifty for a retest of 5150-5177-5196. Today, for the second consecutive day, shorts were royally trapped in the last 90 minutes. A significant gap-down has been filled today after struggling for 3 sessions. Markets are not out of the woods at all but after a long time, finally some premium was restored to September Nifty futures. 5092 is a very critical level but a gap-up can change the equation for Nifty.

As of now, the upside still remains capped at 5225 levels and Banknifty has crossed over 9700 levels marginally.The close above 9700 on Banknifty opens it for a retest of 9750-9850 levels [adjusted close at 9660]. This will probably be determined by RBI action tomorrow and to a certain extent, one can say this is an artificial rise on Banknifty in anticipation of some boosters from RBI. Failure to provide the same will swiftly reverse all gains of Banknifty but weakness can only be confirmed after a close below 9500. Weakness on Nifty will be determined by a close below 4880 only.

Classical TA approach showing an inverse H/S patter with head at 4720 and hence the completion of right shoulder at 5150-5177 levels is very much on the cards. Sell on rise is the preferred strategy but with appropriate hedges as well. The real worry for the markets is the Friday factor tomorrow barring which things should be under control and Nifty complete it's logical path before going down. A close below 4880 will open Nifty for a retest of 4800 and possibly 4720 levels also.

EOD Analysis for 14th September 2011 and Outlook for 15th September 2011

Nifty opened on a muted note in the morning with OI in Nifty futures around 29 mill. However, as we approached the opening of Europe, Banknifty saw a good recovery with support from other top notch counters and the OI to the upside increased to 31 million bringing Nifty above 5k levels twice. At one point of time, Banknifty almost breached 9500 but there was a swift profit booking round of about 100 points in this counter but the pullback from 9390 levels implied some strength and finally saw a close at 9501 [adjusted close at 9472].

Unless Nifty closes above 5092, the bullish stance does not have too much to cheer. On the other hand, the 4900-4920 zone is holding out well for now and further weakness can be confirmed only after we close below 4880. Today's close is indicating that markets have quite a bit of steam left and Nifty may try for 5050-5092 levels once tomorrow.

As far as global cues are concerned, BoE came out with some doctored numbers on unemployment claims. France and Germany are talking behind the scenes and whilst the 2nd bailout of previous bailout may go through, 'orderly' fashion only implies that Greece is set to be the next Lehman of the Sovereign domain. What does 'orderly' imply? Simply put, sell-off Greek Banks and assets with as much market capitalization as possible. Will that happen in these troubled times - an emphatic no. The markets may go on steroids for a temporary phase but the banking sector in general is in for tough times. Due to internal problems of India, it would not be surprising to see some doctored numbers come out and Banknifty may make one valiant attempt to close over 9500-9550 and this will open the possibility of retesting 9750 levels once. However, this is just a temporary phenomenon and markets will fall eventually as the global cues are indeed weak.

For Nifty, a close above 5092 will open the possibility of retesting 5150-5177-5196 but safe to assume for now that upside is capped at 5225 levels. Taking hedged positions is very critical. The last 90 minutes today was a classic case of short-trapping. For tomorrow, one should wait for some clear signals before initiating shorts. The classical TA approach is showing an inverse H/S pattern with head at 4720; this lends credence to a possible bounce up before going down yet again. Please follow the updated counts on Raghuji's blog for clearer support and resistance levels. Markets still favoring 'Sell on Rise' and VIX is high even with so much short-covering.

EOD Analysis for 13th September 2011 and Outlook for 14th September 2011

Nifty opened on a marginally positive note but there was a drop of about 1.5 million in OI of Nifty futures that kept the upside capped. Until here, VIX kept its head low at about 30.3 levels. With some apparent calmness in the 5010-5030 zone there was a sudden sell-off and VIX yet again spooked off to 33+ and OI in Nifty futures surged to 30.7 million. Banknifty is well below the critical level of 9500. On the downside for Nifty, 4911 was not breached but the weakness in markets is apparent. For the last 5 trading sessions now, there is hardly any increase in OI on the upside but huge participation on the downside for Nifty futures.

Today was the 3rd consecutive close below 5092 levels and safe to assume that this will hold until Thursday EOD. Unless we get a close above 5092, interim rises will be used to short. A close below 4880 will seal off the hopes of any further upside. The furious drop from 5169 to 4911 within 4 trading sessions had kept the possibility of seeing above 5k levels once. We have seen it today and may possibly see it once more this week. A close below 4880 will ensure a rapid fire retest of 4800 levels and possibly 4690-4720 levels as well.

Upside is capped at 5225 on Nifty spot. Without support from Banknifty, Reliance and LnT, too much upside won't come through on Nifty. Safe to take short positions on Nifty with hedges. Given the way the markets have been moving, I would not recommend retail traders to participate on the upside with too much trading margin at stake. It is better to wait for a reasonably good rise if it comes through or a close below critical level and enjoy the advantage of shorts.

The remaining part on how we should interpret the moves today and how we should anticipate the unfurling of further price actions can be found on Raghuji's EW Counts section. Critical levels remain unchanged from last week. We are near certain to retest 4800 levels but one should not rush to buy Puts and must ideally allocate only 20% to 30% of trading margins for options.

EOD Analysis for 12th September 2011 and Outlook for 13th September 2011

Nifty opened on a significant gap down and did not show any signs of recovery for a long period of time in the morning. The OI in Nifty futures surged to almost 31 million that accelerated both the fall and the subsequent pull back in the mid-session. This is the second consecutive close below the critical level of 5092. The odds of retesting 4800 levels are now almost at 99% IMHO and possibly a retest of 4720 as well. The scenario will only change if Nifty closes above 5092 on EOD basis now that will once again open the chance of retesting 5150-5177 levels. Upside seems to be capped at 5225 levels for now. VIX almost hit 33 level today and may continue in 31-33 range for this week.

If by tomorrow EOD, we don't cross over 5092 on EOD basis, this will probably be a barrier until Thursday EOD. On the other hand, as long as 4880 levels hold on EOD basis, some interim bounces will come through. From a high of 5169 last week, Nifty tested 4900 levels within 4 trading sessions. So a relief rally towards 5k levels is still on the cards. Lending credence to this is the huge gap-down that we had today which will probably get filled at least to Friday's lows. A close below 4880 will seal the hopes completely and make a retest of 4690-4720 levels near certain. The Rollar effect played out as expected after 46.1 was breached on the upside and the SELL buttons went off en masse.

The steep cuts on Banknifty are absolutely worrying and it needs to stay consistently above 9500 levels to help Nifty achieve some relief. Until there is calm on the European side, it is going to be very difficult for Banknifty to move up. Now as far as the downside is concerned, if 9200 levels are breached on the downside for Banknifty, it will go down all the way to sub-8k levels within 55 trading sessions after breach of 9200 on the downside. All major levels have been indicated in last week's posts. Would just like to conclude for today saying that no hopes for bullish stance unless 5092 taken out on EOD basis.

Global Market Updates Part2 - 11th September 2011

Well, the primary concern is how will things shape up for an emerging country like India. As mentioned earlier as well, in the short and medium term, there is no way India can escape the financial tsunami that is impending. I keep repeating the following point to show that I am only human and am prone to errors of judgement. My call was a new high on Nifty before bending backwards which had 3 conditions; 5408 to hold until 10th-12th August, 5532 to be achieved by mid-September and 5944 to be achieved by mid-October. 2 out of 3 knocked off and given the way Nifty spot is today and the undercurrents that are playing out, we are almost certain of retesting the 4690-4720 levels within the next 45 trading sessions. My initial hypothesis was that if Nifty could hold its head above 5408-5532 levels and make that attempt to take out 5944 in April, we would see 4800 by mid-2012 and if we fail to take out 5944 in mid-Oct, the 4800 levels would probably come around Feb/Mar '12 itself. Both Aug/Sep time and price targets were taken out in a jiffy to the downside and we also hit 4720 on 26th August 2011. The pullback so far has been remarkable but now, for the very short term, action on Nifty would depend on how the retest of 4690-4720 levels shape out.

If we do manage to salvage the wrath of bears over there, then there will be some calm and in case of further carnage, the 2 critical levels are 4450 and 3850. As of now, even in the worst eventuality, I would expect some value buying to come in from a broader segment of people and institutions [given that retail participation in stocks is pretty low in India] and turnaround smartly within 3850 maximum to the downside. Already there is a lot of fear on the bourses and in the 3850-4400 zone, the fear will be excessive to the extent that even trading in Nifty futures and options will go for a toss unlike now where it is just equities that are seeing low volumes. Below 3850, we have to be vigilant and get ready for one more pook at the same levels we had in October 2008. At sub 3k levels, Nifty melted over 250 points and then closed marginally below open at 2525 levels [the low of the day was 2250 odd points]. I did not follow the capital markets at that time and hence what I have with me is just the OHLC chart of the day. I don't personally think we will drop so much and am relatively confident that we won't close below 2525 even in these bear market conditions.

In case we do see these sub-3k and 3k levels on Nifty, I am going to go shopping for as many Nifty Bees I can for sure. It could not get better for me than hunt for assets, evaluate the cash flow models of any stock in Public or Private Equity to get the alpha on my personal portfolio. I am not a CFA but know enough about business metrics to evaluate the proposals brought on by any guy wearing an Armani suit and laying out some spreadsheets to show me how the investment in a venture is going to be. I am a strong opponent of Private Equity [the only thing I like about Private Equity is that it does not subject a business leader to lay out quarterly plans and get the stock price hammered for no reason on the bourses and of course does not keep any shares outstanding for speculation on the exchange. A vast majority of Private Equity deals are nothing but financial engineering of debt and creating alpha by tax shields. It is just a dignified way of setting up IPOs on the bourses that come with a roar on opening bell and then melt down over 80%].

With elections impending in 2014, regardless of where we fall on Nifty, 2014 is certain to bring cheer on the bourses. Even in the grim business scenario, we have enough domestic consumption that a minimum of 6% GDP growth is assured. If the global meltdown indeed comes through as indicated by blogosfears, yet again India and China will be rewarded by smart money. Moreover, if the Indian people start consuming cheap produces from their western counterparts, there will be capital inflows into the country. In due course of time, depending on how much badgering Nifty goes through, I will put my recommendations in here.

For now, the key levels are 4690-4720 and we need to keep a close eye on that. In all likelihood, with a few whipsaws up and down, we will end Sep series from the point where we started. Until then, we need to remind ourselves that Cash is King. Traders should use rallies on Nifty to go short but as indicated in the EOD  Analysis on Friday, in a staggered manner with a hawk eye on 5196 levels. If we close above 5196 levels on Nifty, there might be a pleasant rally from the wounded bulls all the way to 5496 levels [Probability is less than 1%!!!]

Watch out for the Great Indian Banking Paradox coming up tonight.

Global Market Updates Part1 - 11th September 2011

All right so we have a lot of noise regarding Obama's plan to redo the infrastructure and create jobs worth 450 billion dollars. Then comes Europe where the risk of a Greek default is imminent and alternative of quantitative easing is supposedly, being explored by ECB. The central bank of Swiss feels enough is enough of CHF being a 'Safe Haven' currency and decides to fix up the exchange rate. Let us take all of these things in perspective first.

US Infrastructure: Whatever little I know about infrastructure is all about Houses, Office Complexes, Roads and Rail [leaving the service infrastructure like schools and medical care centres just for simplicity]. Housing prices are steadily collapsing despite all the TARP liquidity injections. [A full detail on the anatomy of how bailed banks are profiting from the bailouts is given very well in the ebooks by Nadeem Walayat on Market Oracle]. So given the demand and supply situation of the housing market, the trends clearly show that housing prices are yet to see a bottom in more than 70% of the locations and the rental per unit whilst increasing as of now, will again drop as the next economic slowdown comes again. Roads will probably need some repairs but that is not going to create some great long lasting projects to feed people for life. Rails are in need of some upgradations but it still goes to show that this is not enough. Schools, medical institutions etc are also in need of upgradation and also new creations; fine. However, this entire package still does not spell out in concrete terms, 'How' this plan is going to boost the economy and provide for jobs. Second, it does not spell out 'How will this project be funded'

The answer lies in the past actions; one would be to sell T-Bills which are nothing but IOUs of fiat money. Today the question is who is going to buy these IOUs which by the day are getting worthless. It is just monetizing debt in another form. Mr. Obama in emphatic tone said, 'Every dollar of this will be paid by the US'. Fantastic - for the last 25 years, all US Presidents have been saying the same thing and auction bonds. Somewhere in the basement of some establishment in Wall Street, there are reams and reams of such 'promisary notes' saying this will be paid for. For the last 25 years, US has not repaid a single dime of debt back. All that it has done is issued more IOUs [which are actually paid for by the savers in emerging economies]. The speech was very well concerted and put on a good act on television but DJIA simply decided to correct and melt down 200 points. It is just a matter of time that somebody goes beyond the farce of theatrics and show people the real mirror of US. Completely surviving on debt and more debt and getting away with it on the back of a global currency. One more step towards accelerating the economy to stagflation and eventually deflation. Only thing is that this monetization of debt will bring in a whirlwind of hyperinflation once and then go down the drain. The most prudent thing would actually have been to raise interest rates. Although there would be a knee jerk reaction once, that IMHO is the real signal of a country bracing up for real change.

After the dot-com crash, US has not really been producing or growing GDP by REAL Production of goods and services. All that the institutions have done is brought about a complex web of financial engineering that temporarily levitates the economy to the extent of euphoria and mania and then a bubble bursts crash landing all asset prices and more loss of jobs. I can stick my neck out and say this whole nonsense of debt monetization and financial engineering is going to ruin millions of lives yet again. It is even more troublesome because we have Europe joining the bear party as well.

As I have always maintained, the concept of Schengen is excellent for the EU but the concept of Euro for all the countries are not. Apart from Nordic and a few North Continent countries, a lot of countries are just a few notches beyond some of the top notch emerging economies. The adoption of Euro is now going to be a slick fast double whammy. Sooner or later, either ECB will ask all PIIGS countries to leave the EU or a simpler solution - Germany moves out of EU and goes back to DM and Bund [The Bund is still very much a safe fixed income instrument and as on date, commands a better rating than the US T-Bill]. So overnight a coffee that used to cost 50 European Cents equivalent became at least 1 Euro with the adoption of Euro. Regardless of whether the PIIGS countries go out or Germany goes out, the rest of the PIIGS [and similar countries] will end up now getting coffee at at least 2 Euros equivalent for a cup of coffee.

I had mentioned earlier that the markets and activities provide a precursor to what is actually coming and that news reacts to markets and not the other way around except for Black Swan events like war, tsunami etc. One may recollect that a couple of weeks ago I had mentioned about factories getting ready for some good moves to achieve economies of scale on the Swiss-German border and the Swiss getting serious about real business. I had also highlighted that CHF may be a safe haven but the Swiss stock markets not. Even before any of the events/news of US and rest of Europe, the central bank decided to intervene and bring some correction in the value of the CHF. That such a decision came just about 24 hours before a renowned economic magazine voted Switzerland as the most efficient country to do business is surprising?? No because smart money and markets move well before the 'news' is out. Of course with so many industries cropping up around the Swiss-German border that is a good confluence of German enterprise with Swiss precision and discipline meant that the cost of business had to be lowered.

The writing on the wall is very very clear - all PIIGS countries are bound to fail and fail big time. No austerity measure for now will solve any of the problems that have been accumulated over the last 25 years. The interest accrued is so high that it will take at least 10 more years to just get the interest on these debts off the books [and that implies another 10 years of interest accrued further on outstandings]. If one thinks that news is going to impact this, one is mistaken yet again. Smart money is already aware of the risks associated with these countries and the discount rates on bonds and premiums for CDS instruments is a pretty good barometer of what the markets are expecting. The flaw in the practice of many a hedge fund and institution is that by holding Puts, CDS derivatives to hedge risks against the Long Fixed Income instruments is that 'somebody' is going to pay. Whilst the instrument per say is supposed to pay for the risks but when the sovereign itself is out of the way and the central banks have no solvency, the million dollar question is even if I have a PUT [in any format or instrument] WHO pays? In the initial stages of course there will be payouts but in the end, even the most bearish people holding on to bear instruments will end up with useless paper contracts and values will melt out yet again.

Whilst I am very much a fan of Robert Pretcher Jr and did take some time out to read his classic 'Conquer The Crash' book, some of the recommendations don't hold true today [and the new edition of this book has made the necessary amendments and disclaimers] I am personally not a CFA but investing in a bear market fund is not going to solve the problem for sure. First and foremost for the working people in US and Europe, a middle class family depending on wages from a job need to accumulate USD 10,000 / EUR 8,000 equivalent of hard cash available to personal disposal for the rainy day. I am not talking about the bonds from the central government or a fixed deposit in banks that pay interest. Simply hard cash in home lockers to take care of things when the chaos prevails. The entire web of complex financial instruments and derivatives have assumed such maniac proportion of leverage that margin calls will start getting triggered at the drop of a hat and when margin calls come out, all asset classes will witness a sharp sell-off. How many times in the last 12 years have you seen such a fluctuation in the Dow? Up 300-400 points a day and down 300-400 points a day? Such events occur when it is the 'Beginning of An End'; FTSE roared to almost 5400 in the counter-trend rally last week only to drop back almost 200 points at a critical support line for this week. Likewise for DAX and Stoxx. We are looking at a 50% drop in indices within the next 12 to 18 months. There will be one possible maniac flight to highs in commodities but when margin calls are triggered, all the gold, silver, copper, nickel, steel etc etc contracts will be dumped to fulfill the dollar margin obligations.

This time, all stock indices across US and Europe will melt to below the levels we saw in 2008 post Lehman. Houses, Cars and virtually every luxury item that you can think of will be available for piecemeal rates in a year or so from now. The disrespect for cash in reputed mutual funds is disgusting to say the least. Some of the ETFs are so heavily levered and hold less than 3.5% of the Assets Under Management (AUM) in the form of cash. First and foremost, the margin calls and meltdown in indices will blow up values of the Assets. When customers in panic rush to encash their holdings to salvage whatever little they have left, many a fund will be caught napping. I have been a strong proponent of Gold ETFs myself but now it seems like there is some imbalance between the physical gold available in AUM and production that is coming out. If the redemption pressure starts increasing [which will regardless of whether gold corrects from here or makes a counter-trend rally to a new high] the leveraged ETFs will go for a complete toss. Simply put, a lot of leveraged ETFs have much less physical gold with them than what would be expected based on asset size alone. A wrong hypothesis taken by fund managers is that only x proportion of investors will come to redeem the units at any given point of time. When a financial tsunami comes in, all assumptions go for a toss and a lot of ETFs will simply wash off their hands with clauses in the 'Red Herring Prospectus' or equivalent.

More than ever, cash today is king and I always like this statement that Pretcher Jr made in his book 'Conquer The Crash' ;
Q
I would rather be safe and wrong than exposed and wrong'

Of course I also like the use of the term 'blogosfear' by Nadeem Walayat who keeps critizing people/articles from bears like me and keeps on showing the stealth rally on the bourses post 2008. I do agree that the crash of 2008 gave wonderful buying opportunities which is when people actually started selling big time. However, the impact of the impending crisis is far greater than the one in 2008. Every rise is actually a potential short as far as FTSE, DAX, CAC40, Ibex35 are concerned now. On the other hand, at sub-4k levels every dip on DAX is a strong buy and likewise for FTSE. Some esteemed Ellioticians are hinting at 60% and 70% corrections in index values but unfortunately, they are missing out the perspective they posited in the first place. [I have personally flagged this to both Market Oracle and EWI and am awaiting a response from them] Walayat is going on an extreme saying there will be a strong bounceback after a small correction whilst EWI is predicting a near total financial armageddon. Neither of these 2 extremes are anticipated IMHO. However, smart people will start the buying process at levels given above. For Ibex35, I would peg sub5k levels as a good buy and for CAC40, sub-1800 levels.

Will emerging economies like India suffer and continue to mirror this financial gloom and what is the way forward. Will take a look at that in part2

Continued in Part 2