Monday, August 8, 2011

Monday Post #3: Epic day on stock market

If you thought you would never live to see another day like we saw during the 2008 Financial Crisis, today you learned never to say never.

Today's -634.76 plunge in the Dow Jones Industrial Average (DIJA) was the 6th largest absolute point drop in DJIA history and it followed last Thursday's massive 500 point drop.

Of the five previous and larger historical drops, four came in 2008 and one back in 2002.

All the gains from QE 1 and QE 2 (whose entire purpose according to Ben Bernanke on CBS's 60 Minutes was to inflate the stock market and create a wealth effect) is now gone.

Politicians and the establishment are looking for a scapegoat for today's stock massacre. And all eyes are on the ratings agency Standard and Poor's.

But America’s credit rating was punished by S&P because US politicians failed to reach an adequate solution to the country’s massive debt woes which are nearing 100% of GDP. The deal to raise the debt ceiling did nothing to significantly deal with the debt issue.  10 years from now America will have a $26 Trillion dollar debt instead of a $28 Trillion debt... big whop!

That's why S&P downgraded.

World governments have gone on the offensive against S&P, slamming the rating agency and trying to discredit the firm’s financial calculations without acknowledging the underlying premise– that America lacks a credible plan to deal with its crisis.

But the one defender of S&P has been PIMCO's Bill Gross, the hugely successful bond fund manager and the co-chief investment officer of the company's flagship, the Total Return fund, which has $158 billion in assets.

Gross says S&P has said what everyone is thinking but afraid to say it for fear it would insult the US administration. Because let's face it... everyone criticized S&P over being far too late to properly rating the subprime mess.  At least they have the guts to finally step against the tide of conventional sycophantic wisdom and tell everyone even a modest part of the whole truth.

Said Gross:
  • "I have been criticizing them and Moody's and Fitch for a long time. Moody's and Fitch are on the "S" list. I think S&P finally demonstrated some spin. S&P finally got it right. They spoke to a dysfunctional political system and deficits as far as the eye can see. They are enforcing some discipline. My hat is off to them."
So what comes now?

The G7 finance ministers have pledged to take any steps necessary to calm markets and “avert collapse in world confidence.” But here’s the thing: All governments can do is print, borrow, or steal from taxpayers via taxes.

These are exactly the policies that created a loss of confidence to begin with, and now they are pledging to restore confidence by doing the exact same things. If they take action, the situation will only get worse. If they don’t take action, the markets will panic and the situation will only get worse.

Trillions of dollars are sloshing around in the financial system right now desperately seeking some modicum of safety. With the wave of downgrades and money creation that’s coming, few asset classes look stable.

Thus as nevous investors panic, Gold and Silver will start to look even more attractive to a lot of investors.

And in a shocking turn of events, a member of the JP Morgan staff (Colin Fenton) came out with a client note that predicted Gold hitting $2,500/oz before year end:
  • "Gold and sugar have potential to run a lot higher. It has been clear for weeks that the prompt CMX gold price has been building in a rising probability of a reflaring of financial crisis, gaining by 9.7% since June 30 as the MSCI World Equity index dropped by 10.1%. The correlation in daily price changes between these two assets has dropped to –0.09 from +0.29 over the prior year. Gold’s correlation against TIPS has doubled to 0.35 from 0.18. Against Italian and Spanish 5-year sovereign CDS prices, the gold correlation has moved to 0.27 and 0.32, from 0.07 and 0.04, respectively. Before the downgrade, our view was that cash gold could average $1800 per oz by year end. This view will likely now prove to be too conservative: spot gold could drive to $2500 per oz or higher, albeit on very high volatility."
The US Federal Reserve meets tomorrow.

Will they act to try to counter the negative psychology in financial markets with some  from of QE3?

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