Mar

23

 Nothing bad ever happens.

The lesson finally being learned by participants in the financial markets is that even though there may be short-term problems, in the end everything will be OK. We constantly hear talk of recession, depression, inflation, deflation, and stagflation, but in the end none of them really happen and everything ends up OK. Then there are the Asian crisis, LTCM blow up, Internet bubble, terrorist attacks in New York City, and oil prices rising seven fold. In the end everything ends up OK. As for the current favorite crisis of pundits, that there is a housing bubble that was fueled by sub prime loans, I can really only say one thing. Don't worry. In the end everything will end up OK.

I think there are a few reasons for this, outside of the easy argument that America is the freest land in the world and therefore the spirit of the free human being will rise up to conquer all problems put in front of it.

First is central banking. This is a relatively new phenomenon in the world, and took 70 or so years to figure out. But since Mr. Volker stepped up the Federal Reserve has basically come to understand what needs to be done to keep the financial peace in times of crises. The '87 crash, the S&L crash, the devaluation of the dollar, a huge deficit, and an Internet bubble are just a few of the things the central bank has seen come and go and yet managed to help make sure in the end everything was OK.

Despite all this, I constantly am reading research from highly paid economic consultants criticizing the Fed and laying out how the latest Fed plan is doomed to send us all back to a farming economy. This has been a main theme since I started in this business 18 years ago. But over that time there has really only been one constant, that the Fed didn't mess up and in the end everything was really OK. The most contrarian trade you could have made over that entire time was to say, no, I think the Fed knows what it's doing and I'm going to stay long the United States of America and buy any dip I can get my hands on. This trade has worked pretty well.

My second argument has to do with the hero aspect. Nobody makes a name for himself in Wall St or any other street by claiming the status quo is OK. One must make an outlier claim and have it come true in order to move up in the mass respect line and increase one's bonus. For the S&P trader, there is nothing like making money on the short side since you get to strut around happy that you made a lot of money on a day the headlines are riddled with how much wealth was erased from the market that day. I've yet to hear anyone proclaim that they were so long here that it's coming out of their ears, yet it seems I hear that about being short on a weekly basis.

This is one of the reasons the markets do not follow through on the downside very long. Everybody wants to be the hero and as soon as there is any break in the market, they are all very short very quickly. There is a reason Dr. Mark Faber's Boom Doom and Gloom report still has subscribers and its writer is invited to every investing conference and is included in the annual Barrons round table discussion despite the fact that he has been bearish on the Hang Send Index since about the 6000 level in 1993. People love the hero mode, even if it doesn't work.

Now, let's think about the implications of this theory for the stock market. If the stock market is a current valuation of the discounted cash flows going out to just about infinity, then why would anyone ever sell? Certainly there will be blips along the way in terms of economic growth and the like, but if all is going to be OK in the end, then aren't these future cash flows on a constantly upward path? And if it's these total cash flows and not just some short term ones that are being discounted, then why ever sell?

The market has learned this over the past 25 or so years now, which helps explain why the stock market goes on record tears of X straight up months without an X% correction. The world has come to understand the reality.

For those contrarians out there, this writing should be the best thing you have ever read. You can now conclude that if the world has discounted the fact that everything will always be OK and therefore the market will never go down, then there is a lot of danger ahead. If no long term risk is being discounted into the market, then certainly there is a huge risk/reward in the favor of betting on that very downside. To this I say yes, be short S&P. I know I am. Because I can see very clearly that the credit bubble the Fed engineered in order to combat the undoing of the late 90s stock market bubble is now going to come back to haunt them as housing prices fall 50%. And the Fed will have to cut rates to sustain growth despite the fact that inflation is picking up (See CRB RIND Index). Also, let's not forget that Niederhoffer and the rest of the greedy vol sellers need to see the vix go to 40 so they can all blow up again. On top of that the USA is losing its dominance in the world as China is emerging with cheaper, better, and hungrier capitalists to replace us. The question remains however, will my P&L be OK?


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