6 Questions Every Trader Wants Answered
1. Why did the Fed cut the discount rate rather than the Fed Funds rate?
The Fed’s injection of liquidity into the system has not been filtering down
to the smaller institutions in the most trouble because the big boys are soaking
up and hoarding all of the funds. This was a measured move to hit that segment
of the problem.
2. What is the downside to the Fed lowering interest rates?
The Fed has refused to cut interest rates so far for two reasons. First,
there is concern about inflation being at the top of the tolerable range. That’s
a real fear. Second, and related, the Fed fears further erosion of the dollar.
Lower interest rates lead to capital exodus and a lower dollar — therefore more
inflationary pressures as imports become more expensive. So the Fed has
exercised caution — now thrown to the winds as the markets approach meltdown.
3. What is the Fed likely to do in September? Will it work?
The Fed will cut, and probably by 50 basis points in September, but that will
push the dollar further towards crisis. The bigger problem facing Bernanke is
the slowdown in key areas of the global economy. The worst spot is Europe. It
has been a bright shining light the last year or so but it is clearly in trouble
now and that’s bad news for American and Chinese exporters. Another big emerging
problem is inflation in China, which has hit a 10-year high. That’s a bubble
ready to burst. No American Fed is now capable of stemming the global tide one
way or the other. Still a third problem is a wave of “exploding ARM†mortgages
that will need to be refinanced in the Fall. Many won’t have enough equity in
their homes for the refi and that’s a time bomb waiting to happen.
4. Ben Stein got a lot of ink and TV chatter downplaying the significance
of the sub-prime meltdown last week. Is he right?
The U.S. sub-prime market may be small in absolute terms, but its meltdown
has not only national but global reach. If Ben Stein was right, the other Ben —
Bernanke — would not be throwing so much credit and liquidity at the markets. If
Ben Stein was right, Countrywide would not have run down its $11 BILLION line of
credit in a heart beat. Conclusion: Ben Stein is dead wrong.
5. What was all of last week’s chatter about “moral hazard�
That’s an Econ 101 concept that journalists really sunk their teeth into. In
this case, it describes a system where high risk takers will not be punished by
the financial markets for their behavior because the government is riding to the
rescue — and that encourages more risky behavior than is optimal for the
economy. In simple terms, we’ve had a situation where mortgage lenders and banks
have been doling out money and repackaging the loans and offing them immediately
— which lowers the incentives to check credit and terms carefully. Bernanke
deserves more damns than praise for playing a pivotal role in this process.
6. Has the market found a bottom for now?
Despite ending the week with a bullish bang, the upward trend is clearly
broken, technicals are accurately reflecting difficult fundamentals, and traders
face more risk to the downside than up. Bernanke’s gambit is a mere ice cube in
a bigger meltdown. Cash is king for the conservative mind and the short side is
the best side for speculators.
By the way, whenever you hear someone describe this market’s down drafts as
“buying opportunitiesâ€, chug a beer. You’ll be drunk all the time between now
and Xmas.
This Week’s Big Market Movers
The macro calendar is exceedingly light this week. Look for earnings reports
to be the big mover. Lowe’s
(
LOW |
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PowerRating) should be interesting on Monday.
Toll Brothers
(
TOL |
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News |
PowerRating) on Weds.
Trade of the Week: Fannie Mae & Freddie Mac
Democrats want to Fannie and Freddie to be able to issue bigger loans and
more loans and be the lender of last resort in the mortgage market. Reps and the
Bushies think that is a really bad idea, in part because this government
agencies are subsidized and therefore compete unfairly in a free market.
Ideology aside, the Dems are likely to have their way on this issue as the
problem continues to deepen and broaden. Both Fannie Mae
(
FNM |
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Chart |
News |
PowerRating) and
Freddie Mac
(
FRE |
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PowerRating) are showing sharp technical improvement as traders
handicap this debate.
The China Effect
The globe’s financial market meltdown has pushed China off the front pages
and TV for now, but that doesn’t mean there hasn’t been some interesting news
over the last week. Here’s my list of the most important elements of the China
effect over the last 7 days:
- The Iron Lady Does Product Safety: Wu Yi, China’s so-called “Iron
Ladyâ€, has been appointed to head a Cabinet-level panel on food and product
quality. This may be really good news because it may signal Wu’s transition
from the top trade negotiator role to a more domestic task better-suited to
her personality. To put it bluntly, Wu has been the major impediment to any
type of trade breakthroughs each time she and Treasury Secretary Paulson have
met at their much ballyhooed but so far totally unsuccessful summits. Top
level Chinese have realized this and this may be a way of getting Wu out the
door. - The Latest Chinese Bridge Collapse: A near 1000-ft bridge under
construction in Central China collapsed and killed over 50 people. Speculation
has it that inferior building materials may have been the culprit. This raises
the broader question of the quality of building materials we are importing
from China to build our own infrastructure. One rumor, for example, has it
that much of the steel in the recent renovation of the SF-Oakland Bay Bridge
is coming from China. On the plywood issue, it turns out Chinese plywood is
studded with formaldehyde which can be released as a toxin into homes. Low
quality cement raises foundation issues. (More to follow on this) - Beijing Cuts Air Flights: This from the Associated Press — “China’s
aviation authority, citing safety concerns, has announced plans to scale back
flights at overstretched Beijing airport and a ban on the founding of new
airlines before 2010.†That’s all well and good given overcrowding at the
Beijing airport but the Financial Times did notice a bit of a “protectionist
flavor†to the ban — with airlines that use Chinese-made regional jets getting
an exemption.. This is indeed typical Chinese protectionism. - Chinese Inflation: The inflation rate in China has now hit a
ten-year high. This is big news for the rest of the globe, to which China has
been exporting deflation for years now. Runaway inflation in China would be
enough in and off itself to roil world financial markets. Watch this one
carefully! - Media Crackdown: And last but not least, in typical Chinese fashion
again, China’s response to its wave of defective products has been to crack
down on reporters that issue any “negative†news about these events. What a
country.
The International Scene – Technical Take
There has been a complete deterioration in international markets. The ETFs
below indicate almost every region of the world is now a short. The biggest bad
news here is that Europe is going back into a tank it has spent too many years
in. The Continent has been a key part of the global economic boom, but that now
is in reverse. One big problem has been a too strong euro because of Chinese
currency manipulation
Country or Region |
ETF Symbol |
Action |
| U.S. | SPY | Short |
| Europe | EZU | Short |
| Europe S&P Eur 350 | IEV | Short |
| Germany | EWG | Neutral to Short |
| Emerging Markets* | EEM | Long to Short |
| Asia 50 ADR | ADRA | Short |
| China 25 | FXI | Long |
| Japan | EWJ | Short |
| Australia | EWA | Neutral to Short |
| Korea | EWY | Long to Neutral |
| India | IFN | Long |
| Latin America | ILF | Long to Short |
| Brazil | EWZ | Long to Short |
| Mexico | EWW | Short |
| Gold | GLD | Long |
*Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary,
India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan,
Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
Peter Navarro is a
business professor at the University of California and the author of the
best-selling investment book “If
It’s Raining in Brazil, Buy Starbucks†and the business shelf bestseller "The
Well-Timed Strategyâ€. His latest book is “The
Coming China Warsâ€.