Tuesday, 24 March 2009

Troubled Assets to enter Convalescence

The Treasury plan was announced early yesterday and received Mr. Obama’s personal endorsement (it was a bit risky leaving it entirely in Tim Geithner’s hands). The US Treasury revealed that it is becoming one of the world’s largest hedge funds with a new "scheme" designed to give the troubled assets more time in the sanatorium to convalesce. The private partners to the scheme (assuming that they do in fact come in), such as Bill Gross at PIMCO and BlackRock, who might have an astounding six cents per dollar of "skin in the game", stand to benefit with a 50/50 split on any upside, and if things don’t go well - no prizes for guessing this bit - the taxpayer can add another few hundred billion to the tab for rescuing Wall Street.

The good news for the scheme is that there might eventually be some kind of market value set for the troubled assets - the bad news is that the market value will almost inevitably be rigged in the short term and in the longer term, when the deflationary forces have not been so easily re-channeled into burgeoning inflation (that’s still something for us all to look forward to but not for quite a long while yet), the authentic price at which many of the more exotic structured instruments such as CDO squared’s may finally "clear" may be close enough to zero that the taxpayer will have taken a wholly asymmetric risk in this shameful business.

So does the market continue to rally from here? As Keynes once famously said in a different context "Markets can stay irrational longer than investors can stay solvent". I think in the current context the immediate risk is to be on the short side, but longer term the risk is to buy into the asset convalescence myth. In line with the material which I presented last week regarding the bursting of the US banking bubble (also now available at SeekingAlpha ), the recovery path for the US economy is unlikely to be V shaped and to the extent that chart formations in the key markets reveal such V shaped patterns they will be treacherous on the long side.

We are almost certainly heading into a period where bipolar disorder syndrome will be a useful characterization of the way traders react to developments on the TALF, earnings releases, employment data and the trends in global trade and output - which at the moment are heading south at an alarming rate.

My comment from yesterday’s column regarding the likely reaction to the Geithner plan proved to be quite prescient.

The 840 level on the S&P 500 should present a formidable hurdle on the upside which is why I have suggested targeting 825/30 on any initial enthusiasm that accompanies the announcement.

The intraday high on the S&P 500 Cash index was 823.37 and I would certainly be increasingly cautious on the long side if the index moves closer towards 840 today. I would also suggest stalking opportunities on the short side in the ETF’s for the financials as the euphoria subsides.

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