Hey everyone,

We are seeing a nice bounce in the markets this morning. The S&P500 is at 1485 as I write this(!!!). If you look at the 5 day chart, you will see this could take us back to part way through the crash we saw last week. The market is saved!

To me, this feels like a dead cat bounce – one formed by a pump in liquidity and a jump in premarket futures.

Last week I managed to scalp $1 out of my short position in SDS (entry at $54, exit at $55). I am now preparing to go short again with a buy order in at $53.75. I am not sure if it will reach that high in today’s trading, but I would not be surprised. I am also considering a short position in SKF – double short the financial stocks.

Both of these positions are risky and should not be held for the long term.

Fundamentals Unchanged

However, my underlying belief is unchanged. The US economy is slowing and the housing market is going to get worse, a lot worse, before it gets better.

In my opinion, the consumer is going to get crunched by the following:
– rising borrowing rates as risk is repriced and lending institutions either dry up, or are prevented from selling risky CDOs at riskless values;
– falling home values that prevent refinancing of debt (and hence equity extraction);
– a rise in loan repayments as ARM loans reset and investors are unable to refinance to more favourable terms; and,
– increased fear and feelings of insecurity.

Reduced Consumption and Risk Appetite

All of these will depress consumption and the appetite for risk. As I pointed out previously, the highest level of ARM resets are still on the horizon. The good news is we are into “fear” on the business cycle, so are about half way through the housing correction. I have mentioned previously that some financial pundits have suggested the housing market will be fine by 2008. I am still leaning towards 2010 as the bottom in inflation adjusted terms, with nominal pricing reaching the bottom around 12 months earlier.

Plunge Protection Going Forward

Ultimately, I believe the Fed will step in and flood the market with money over the next six months. This will lift the market to an artificial high. However, if you want a real measure of the S&P500’s performance, price it in Canadian dollars.

As you can guess, I would be surprised if last week was the extent of the correction over the next 2-3 months. If you haven’t already taken up a defensive position, this is a golden opportunity to do so.

For those of you who want a contrary viewpoint, here is an article by Dr Jeremy Siegel about why the market is fairly priced. I have less and less respect for him recently (it was he who suggested Alt-A mortgages would be fine – Countrywide Financial has popped that fantasy), but I still love his ETFs.

Happy investing,


This post is for entertainment purposes only. No part of this post should be construed to constitute investment advice. The author is not an investment professional and assumes no responsibility for any investment activities you undertake. Prior to undertaking any financial decisions, you should contact an investment professional.