Trader’s Narrative

With the exception of bankers and their lobbyists, the financial crisis has also been hard on everyone. No single group feels more besieged from the outside and beset by fretful soul-searching from within than economists. They are scrambling about to come up with not only explanations of what happened but also to build better models that will predict and therefore, prevent, future crisis.

There is an overflowing bookshelf by now composed of books trying to explain to a shell shocked public what just happened. A great one that I reviewed a few months ago, and highly recommend, is Bailout Nation by Ritholtz. Another that I’m reading now and will review shortly is The Cost of Capitalism by Barbera.

An interesting idea getting traction now is from Geanakoplos, a partner at Ellington Capital Management and a professor at Yale. While the interest rate or liquidity cycle is well known to everyone, Geanakoplos posits that the leverage cycle is even more important. He explains:

… when banks set margins very low, lending more against a given amount of collateral, they have a powerful effect on a specific group of investors. These are buyers, whether hedge funds or aspiring homeowners, who for various reasons place a higher value on a given type of collateral. He called them “natural buyers.”

Using large amounts of borrowed money, or leverage, these buyers push up prices to extreme levels. Because those prices are far above what would make sense for investors using less borrowed money, they violate the idea of efficient markets. But if a jolt of bad news makes lenders uncertain about the immediate future, they raise margins, forcing the leveraged optimists to sell. That triggers a downward spiral as falling prices and rising margins reinforce one another. Banks can stifle the economy as they become wary of lending under any circumstances.

Source: Wall Street Journal

While this is persuasive, it isn’t all that new or innovative. During the first bubble of the millennium, many called for the Fed to increase margin requirements on trading accounts to curb rampant speculation in technology shares. Being against intervention, Greenspan muttered something about free markets and offshore asset flows and didn’t do his job. We’ll never know if the first bubble and subsequent crisis would have been averted had the Fed removed the punchbowl before everyone got tipsy.

Right now, the leverage cycle is fighting against the interest rate cycle. The Fed has instituted a new carry trade which has decimated the US dollar and awakened the great gold bull. As the two giant cycles battle it out, the economy and the stock market hang in the balance.

For economic and market news and to see what you may have missed last week, check out the list below. It is just a few choice examples from news.tradersnarrative.com:

• What Does Climate Change Have to do with Goldman Sachs?
• Barry Ritholtz Podcast Interview
• Five Pitfalls of Developing Traders
• KKR Goes Public Through IPO Backdoor
• Get a FREE Subscription to Financial Magazines
• Spotting Trend Reversals With MACD
• Obama’s Financial Reform
• End of Nortel - Sale to Nokia & Delisting
• Buffett: US Economy In “Shambles” .. No Signs of Recovery Yet
• What is the difference between a triangle and a pennant?
• Free trading videos
• Volcker Not Calling Shots in Financial Reform
• Central Banks Can’t Control the Market

For the complete list, follow the graphic below:

And remember to check back regularly since there are interesting links added throughout the week.

Week Ahead

We’ve fallen below the lower trend line of the wedge formation. Are the bears reasserting themselves? Is this a headfake before the market continues to shock everyone by going up again?

Check out these links from this weekend’s reading list at news.tradersnarrative.com:

• Ritholtz: Financial Crisis Far From Over
• Reverse Head & Shoulders Forming?
• 3 Questions Before You Start Your Trading Day
• Get a FREE Subscription to Traders Magazine
• An Encouraging Straw in the Wind
• Soros: We averted a financial collapse
• Get Your Exclusive Invites for SkyGrid
• US Moves to Regulate OTC Derivatives
• Oil prices about to plunge again?
• The Unbearable Lightness of Nassim Taleb

Follow the link below to get much, much more:

And remember to check regularly since there are new links added everyday.

Week Ahead: Dull Market About to Get Exciting

Hurry, there is still time to get FREE access to Elliott Wave

To see what you missed, here are a smattering of the articles from this week’s reading list at news.tradersnarrative.com:

• Michael Lewis Prescribes Testosterone to Wall St. Elite
• Baltic Dry Index’s bounce is misleading
• Average 2008 Wall St. Bonuses - higher than 2000!
• Long term chart of the S&P 500 earnings
• Geithner vs. the American Oligarchs
• Think Like the Herd, But Don’t Follow the Herd
• Paul Wilmott’s views on Wall St. Bonus
• Buffett’s metric says it’s time to buy
• McGraw Hill Drops Barry Ritholtz’s Book Critical of S&P role in financial crisis

And remember to check regularly since there are interesting links added regularly throughout the week.

Believe it or not… welcome to the new bull market. Calculating from the depths of the November spike down (741.02) the S&P 500 has now rallied 20%+. Which means that technically, we are now in a very young bull market. The bear market lasted around 408 days and cut the index by more than half (52%).

Whether it survives to become a powerful bull or dies stillborn as merely an especially strong counter rally, is another question. One that at the moment no one can truly answer. But we’re seeing more and more signs that things look ok:

• historical 10 year returns
• Ford valuation model
• previous bears coming on board: Fleckenstein, Leuthold, Ritholtz, Kass
• etc.

Here’s another: the McClellan Summation Index has now curled up to form a bottom. And from a level last seen in 1998:

We may get confirmation of this nascent bull market in a few months time from other sources like the Coppock curve. But until then, only the brave (or foolhardy) should apply.

The picture shows one of the famous “Osborne” bulls that dot the landscape in Spain. They were originally used as massive billboards to advertise a sherry made in Jerez (a region in Spain) by the name of Veterano. After a law prohibiting the advertising of alcohol the government tried to take them down but there was an outcry from people who had by then come to see them as a cultural icon. A compromise was reached were the red lettering of “Veterano” was covered with black paint.

Interesting factoid: many of the statues have a couch or mattress directly under them as the folklore goes that couples that um… couple, under the sign will receive the fertility of a bull and conceive a child.