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Mark 2 Market Weak End


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If you don't mind Doc, I'll kick off today.

 

 

Repo and liquity are favourite words around here, but are both very hard to define and understand. Well no more with this piece which I read on another board.

 

For the financially challenged among us (like me) please explain what exactly it means for the Fed to be injecting liquidity, and how that liquidity gets into the stock market.

 

The Federal Reserve injects liquidity into the U.S. financial system primarily by conducting open market operations with broker dealers and money center banks. These operations involve buying U.S. Treasury and federal agency securities like treasury bills and treasury notes from these institutions, which then have excess liquidity to do things such as lend it out to customers for consumption and business purposes.

 

These operations have names like reverse repurchase agreements (the Fed buys t-bills at a discount to face while agreeing to sell them back in around 30 days), which provide temporary liquidity and coupon passes (the Fed buys short term notes of a specific issue with no recourse), which provide more permanent liquidity.

 

Outside of these operations, the Treasury Department in consultation with the Fed can provide liquidity indirectly and affect the yield curve by purchasing longer term bonds. The Fed can also directly lower interest rates, specifically the discount rate: the rate charged to depository institutions on loans form their Federal Reserve Bank?s lending facility (the discount window). The Fed can also lower reserve requirements regarding the amount of funds that depository institutions must hold in reserve against deposits made by their customers (they can lend more money).

 

Using these tools, the Federal Reserve influences the demand for and supply of balances that depository institutions hold on deposit at Federal Reserve Banks (the key component of reserves) and thus the federal funds rate--the rate at which depository institutions trade balances at the Federal Reserve. Changes in the federal funds rate trigger a chain of events that effect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables, including employment, output, and prices of goods and services.

 

As the excess liquidity filters through the system, other types of activity increase such as mortgage and corporate lending. Where does our government get the money to buy these securities? They print it.

 

Normally the resulting lower interest rates and excess liquidity spur economic activity. But there are two components of exchange. The Fed can do much to affect the first, the supply of money which we have described above. It can do very little about the second, however, which is the velocity of money. The velocity of money is the propensity to spend the cash once it is there; it is the demand for cash. Just because there is more money doesn?t mean people have to spend, lend, or invest it (these increase the velocity of money). They can save it (this does not). In order for an increase in the supply of money to have a stimulative affect, the velocity of money must stay at least constant.

 

This is the problem that the Fed is worrying about now and Japan has been suffering from for the last several years. There is little doubt that lower interest rates and excess liquidity has created mounds of debt. There is much doubt that it is spurring higher economic activity because the overall velocity of money has dropped commensurately with the increase in the supply. The catch is that higher debt causes the velocity of money to go down.

 

The Fed has little influence over people?s propensity to invest or save the excess liquidity. Normally lower interest rates not only encourage people to spend more on consumption, but also to seek out alternative investments to fixed rate securities, such as stocks. As mentioned, the aggressive increase in the supply of money over the last several quarters has not had this effect to the extent necessary to stimulate satisfactory growth.

 

In order to affect the velocity of money, the Fed has been thinking outside the box and has suggested, through papers written by some Fed staffers, that they may employ some very unorthodox methods. The Fed knows that a higher stock market through the wealth effect may increase the velocity of money. The Financial Times reported in January that the Fed has mulled over the possibility of directly buying stocks, corporate bonds, and even real assets such as commodities. Another method suggested is a stamp tax on currency. Sit down before you read on. This would involve a tax to hold currency. Deposit your cash at the bank, and they will charge you 1% a month to hold it!

 

Why has the velocity of money stalled? In my mind you can sum it up in two thoughts: high debt and over capacity.

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OH, Ile leed it offf hear. Heers tha deel. I ust too oan CIEN til Maril Linch tolded me too sell it at 5. Now thay tolded me to hold it at 6.50 atfer eye solded it at 5. Can sumson pleez splane too me howe eym spozed to hold it atfer eye solded it? :blink:

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Compuware warns of lower earnings. Compuware warned Friday that its second-quarter earnings will slip from the same period last year, as sales are expected to fall off as much as 13 percent

 

http://aolpf5.marketwatch.com/news/story.a...46E7F19C543%7D&

"The company's stock fell 1 cent to $6.38 in after-hours trading. Compuware shares rose 29 cents to close at $6.39 in the regular Nasdaq session."

 

Fricken weird. Being a bear is getting downright depressing.

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After the 1987 crash, I became very bearish. I thought it was the crack of doom for the world economy, much as the 1929 crash foreshadowed far grimmer events in 1931.

 

But one thing which really got me going was reading in the New York Times coverage of the crash about some guy who had bought $30K worth of puts the week before, and turned them into $300K. Oh, the envy. I was short the week before the crash, too, but covered my position at 4:00 p.m. on Friday Oct. 16th before Black Monday, because I thought the selloff had gone far enough. I didn't know what a real "market clearing event" looked and felt like. Now I was desperate to grab those "lost opportunity" profits in the worst way. I deserved that $300K killing too, if not more!

 

Well, I held short until Oct. 1988, when the rising market forced me out. I finally went long again in April 1989 when the Fed started easing interest rates.

 

What did I do wrong? The biggest error was expecting lightning to strike twice. The 1987 crash was an historic event, equaled only by the 1929 crash. "Historic events" don't repeat for our convenience, so that those who missed it the first time can get a prompt second crack at it.

 

Frankly, I wonder if the 2000-2002 slide was the greatest shorting opportunity of our lifetime. The 31-month, 50% slide in the S&P has been exceeded only by the deeper 1929-32 bear market. Is it realistic to expect this historic event to repeat again, so soon?

 

Those who missed shorting in 1929-32 got a second chance from March 1937 to March 1938, when the market crumbled 50% in less than 13 months. But this was not as deep or prolonged a downtrend as the Big Kahuna of 1929-32. You had to be more nimble to catch it. Not that many did. And none who had held short from 1932, because they were long since blown out by the vicious 5-year, 372% rally into 1937.

 

My best guess is that the next "business cycle scale" shorting opportunity will occur sometime during 2005-2007, when the bills come due for the 2004 "re-elect the incumbents" campaign, and the economy turns grim again. But it will not last as long as 2000-2002 -- maybe 12-18 months -- and will not be as deep.

 

Moreover, if interest rates are rising then as I expect, it will be more costly to finance short positions -- margin interest, put time value, futures premiums, depending on your vehicle.

 

What bothers me about the stock market is that it may get squeezed between conflicting pressures. The ongoing mania and overvaluation are pushing it down. But officially-sponsored inflation can drive up earnings. (Earnings were SOARING during the 1973-74 bear market ... they just got valued at a lower P/E). High dividends and margin interest rates make it unbearably costly to hold shorts for long.

 

It's possible that bonds will suffer a more sustained bear market than stocks. The same inflation that props stock earnings just erodes bonds all the faster. If you're looking for an "historic event" that hasn't happened yet, the bond market is one place to look on the short side. And possibly the gold market on the long side (driven by a coming "historic event" in the dollar).

 

Anyway, these are just thoughts about the possible timing and vehicles for the next big shorting opportunity. Your views on timing may be different (such as "right now"). That doesn't make this a bullish troll, though.

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Hi Calculus-

 

As always when copying from another source, please post only a snippet, say a paragraph or two, and a link to the source. That way we avoid copyright problems. This post was quoted earlier today in one of our threads. It came from somewhere.

 

By the way, there are seem to be a few misstatements and oversights, leading to a bit of confusion, in the article. It ignores the most important component of FOMC operations, direct and exclusive dealing with the Gang of 22. The post actually emphasizes economic effects,which are irrelevant to the effects on the stock market, which responds immediately and directly to changes in liquidity. It also erroeneously implies direct effects on longer term rates. The market sets long term rates and is often at odds with open market operations and Fed Funds rates.

 

The Fed itself actually does a pretty good job of describing its operations on the NY Fed website if anyone is interested. They do leave out the part about how they indirectly manipulate the stock market. :lol:

 

http://www.newyorkfed.org/pihome/addpub/omo.html

 

Many tanks!

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OK, coboy posted a portion of that article earlier today on IDS. It was from minyanville.com. Again, please post a snippet, and link to the article or get permission from the publisher for posting articles in their entirety. Much ass grassy ass.

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