Nov 20, 2004

The Money Illusion

Chart posted by Hello

Click on the chart to see a larger image!

A skunk at the party? A dead canary in the coal mine? You bet! If I had to make a list of individual companies that could collapse the confidence-based, global financial system, this bank would be near the top. As I here the story, JPM is the single largest derivatives counterparty in the world (no one but JPM knows this for sure). FNM hedging, hedge fund levering, mortgage lending, emerging markets lending, swaps, currency hedges,... Etc., they do it all. The fact that it is showing such a horrible pattern in what is a great market should make headlines shortly. It could be benign evidence of traders shying away from a stock with a lot of bad exposures and little to gain from a commodity driven rally in a rising interest rate environment but it could also be a sign that something very rotten is happening with a particular trade or counterparty. Maybe it is just FNM but so far JPM trades much weaker than that stock does. Whatever the reason this stock absolutely needs to be watched here.

This is a good step-off point to distill what I see as the core bullish and bearish arguments in the market. Bulls believe that counter-cyclical interest rate policy has worked. It has created some near-term distortions in borrowing and asset prices but in due time these problems will work themselves out as global growth comes in above expectations and perpetuates a virtuous cycle. Bears, however, believe that central banks can not possibly do better than the market at setting interest rates and that any such counter-cyclical policy is creating greater pressure somewhere in the system. Ultimately that pressure will blow up a major money center bank causing the faith that supports our capital markets to disappear. When it does all asset prices will tumble as there is not enough liquidity to support current prices.

While I see both sides of the argument and truly see both of them as correct in the big picture, I absolutely lean towards the bulls case here. This is based solely on my own view of the prevailing psychology. More and more bearish investors that I know and talk to are focusing less and less on individual problems and situations and are obsessed with the idea that the euphoria of 2000 has not met its mirror image yet. True or not it just makes for bad trading and a weak hand. Money is made trade by trade and hanging on to a vague idea that the market needs to head a particular direction is a recipe for losses. Yes, the trading does feel more and more like 99 but it also feels a lot like 95 and 96. To be looking for a disaster here you have to expect the market to be blindsided by a liquidity crunch and so far there is just no evidence that it will ever arrive (see definition for blindsided). I don't think we are in a position to launch the next great bull market but I definitely think we could see renewed involvement from retail investors which can create a very profitable trading market.

If the JPM chart turns out to be a lead indicator of a deeper problem, I will need to reevaluate my stand. That is why I posted it.

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