Hope and Denial

It won’t be over until the government writes down the debt. Anything short of that is Denial, which is the evil twin of Hope. Moving it around, putting it in a Bad Bank, financing it, subsidizing it won’t matter. It still exists.

And every day the debt is not written down creates an opportunity cost for the economy to recover. This is trading 101. Cut your losses or miss the next opportunity while you are treading water. I know something about denial and treading water.

We All Pay Some Way

When a person cannot afford to pay their bills but hasn’t declared bankruptcy it does not matter. They are effectively bankrupt . No one will extend them credit and they cannot create demand as a consumer. Although they retain the pride of not being declared bankrupt officially, they are as much practically. The longer they live in this state of denial/hope that things will turn around, the longer they will suffer the loss of missed opportunities that may come their way.

The psychological damage is significant as well. Denial creates rationalization, repressed emotions and other things. Coping mechanisms are used to balance the cognitive dissonance, elaborate rationalizations are constructed, etc. It ends with thumb sucking and vodka.

Now substitute the word “company” or “business” for person in the first sentence. The idea is scalable. Our banks and government are in denial.

Raises for Everybody!

What we need to do is either make more money or pay less interest. Raise income or reduce debt payments.

Make more Money:

• Raise income- fat chance real income will go up. Moving right along….
• Print More Money- give everybody a raise on paper.

Lessen Debt Service:

• Restructure the Debt- lessen the payments, everybody walks away miserable but alive.
• Print More Money- cheapen outstanding debt by devaluing it.

Seeing a pattern here? How does the government raise incomes, lessen debt service and maintain its denial? By printing more money. It has to happen, it is happening and it will continue to happen.

GM as a Proxy for Fiscal Prudence.

Watch GM. If they come to a successful deal on a restructure, then we are on the right track. Because as GM goes, the U.S. still goes. If they do not come to terms, then we may be in a banana republic for some time.

Inflation How?

We feel here that even though there will be a lot of fresh cash, inflation will not be a factor at first, due to the lack of money velocity.

No matter how much money the banks are given, they won’t lend for the following reasons:

1. They don’t know what their assets are worth and must shore up balance sheets.
2. They know more bad news is coming in the form of a Commercial Real Estate collapse.
3. Their models for credit assessment of individuals are broken. TRW, Equifax are no different than Moody’s and Ambac. The credit bubble must deflate at an individual level.
4. Anyone worthy of lending to is not interested in borrowing because growth prospects are dim. They are pulling in the reins because there is no domestic demand.

In the first leg of a dollar devaluation, there will be a big fear of inflation. That will be unfounded. The devaluation process will simply slow or stop the deflation at first. Bonds will probably remain strong and the inflation bull’s expectations will be dashed. In the next leg of the devaluation, when countries begin to repatriate their own currencies to heal themselves, we will begin to see real inflation.

The Trade

We are doing nothing except putting money aside for more bad news and have done so for the last 6 months. Smaller banks are offering 3% liquid CDs. We bet that gold would have dropped by not buying it, but were wrong. Most likely we will buy a dip to the 750 area if it comes. Finally, we are shorting the dollar scaling in right now. We are also long the AUD for reasons unknown to us. Except that we think commodities will rally and the dollar will drop, so maybe the AUD benefits. I have a call into Jim Rogers on this one, lol.

We hope to be buying stocks in 2010, starting with Brazil and India.

Hope without action is denial. Denial leads to economic paralysis. Economics is an imperfect science, but it is a science nonetheless.

[Image: Courtesy of the Fark community]

Look Out Below?

As I look at the screen today and see that we are nearing the lows made in November, I remember what a great technical analyst said to me. “Double bottoms are confirmations of significant support. But triple bottoms are meant to be broken.”

How to trade that piece of wisdom? Here is what we are doing in our P.A.s.

1. Get Long -As we approach those previous bottoms we are buying and averaging in on a long S&P position.
2. Triple Bottom Establishment. If there is a bounce after we are in, we will sell scale out.
   2b) if the market trades thru our buys and makes new lows, then we puke, reverse and go directly to number 4
3. Sell Weakness- We will go short the market on new lows, with objective stops determined by previous hourly highs.
4. Schadenfreude- we do not tell our friends if we are right.
5. Corollary- market should not look back for a while. But the longer it remains under the level, the bigger the rally when it finally breaks thru. Start buying later in the year and early next year.
6. Caveat- Remember that we are not technicians , just arbitrageurs with a gambling problem. This is our strategy and we do not recommend it to anyone at any time for any reason.

NEXT WEEK, Continuation of OTC Brokerage Industry Analysis.