The King

My Outlook on the Economy and Stock Markets

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Last year, trading was easy because the market went up for the most part. So you just need to pick up some great momentum players and some good under valued stocks. Short ETF buyers got killed for most of the time. But now the market is confusing every one with it's up and down movement. It is searching for a direction. Different pundits are telling different things. One expert says that there won't be a recession, another says that we are heading for a deep recession and yet another expert says that we are already in recession (he might have lost lot of money in stocks  ).

Right now we are in a situation where it is extremely difficult to predict which way the economy and the stock markets will move. In this situation, it would be best to sit on the sidelines and watch the story unfold. That's what the Goldman Sach's seem to be doing as per one of their chief strategist in a TV interview a few days back. Being a compulsive trader taking part in a trading competition, I can't sit idle waiting for the market to decide where it should go. Sitting on the side lines is good if you don't want to lose the money but it may not help you win a trading competition. Some one is going to make good calls and forge ahead of others. Don't forget that one can make money even when the stock market is going down. So if I want to win this competition I need to make some bets based on the information I have .

I personally feel that the credit crunch will get deeper and deeper. I am not sure how much the Fed's easing actions are going to contribute towards overcoming the credit crunch. The main problem at this moment is that investors have lost confidence in some fixed income Securities and Credit rating agencies. They no longer trusts triple A rated Securities. So there are fewer and fewer buyers for fixed income assets. The banks are facing huge financial losses and they are reluctant to lend money to any firm. All the companies involved in the mortgage business are scrambling to raise cash and not many companies are willing to lend money. The possibility of credit rating downgrades for mortgage insurers is the biggest threat looming around. We are not sure if these bond insurers are going to be able to raise money before the rating firms down grade them. We are also not sure how much time the rating firms are going to give to these firms to raise the capital. Warren Buffett came out with an interesting bail out offer which these firms are likely to reject. These firms are in a trap now. They are still trying to get a better bail out package. The outcome of the bail out of these firms is going to have big impact on the stock market. Every one is holding their breath about which event is going to happen first : The bail out or the ratings down grade. Let's examine the two scenarios in detail.

Scenario 1: Mortgage Insurers get bailed out and there is no ratings downgrade
The stock market will get a HUGE bounce from this event. The stocks of financial firms are likely to witness a big rally. The mortgage insurers will have a dead cat bounce. People holding the fancy SKF will pledge to themselves that they will never buy short ETFs again. The financial firms will trim their losses because their CDO holdings stop bleeding further. These financial firms are unlikely to see good revenues in near future because investors will continue to be skeptical about the CDOs. So I think that even though the financial firms may avoid disaster, they will have very little to cheer about for a long long time. I will stay away from the financials for a few years. These firms are likely to lay off some people to improve their bottom line. That doesn't seem good for the economy. This will signal the beginning of a recession. As for the stock market, it may again enter a period of confusing direction (just like now) after the initial rally. So the volatile markets are here to stay for a long time.

Scenario 2: Mortgage Insurers get downgraded by Rating agencies
If this thing happens, what's going to stop the hell from breaking lose ? This may lead to stock market crash and Fed intervention. The economy will surely enter recession immediately. Of course the government may then come out with a bail out plan which will result in conditions mentioned in Scenario 1 which means slow growth, loss of jobs and gradual recession. I don't even want to imagine a case where the Mortgage insurers get down graded and still no one helps these firms. That will be dreadful to think and it may not happen.

So it looks like in either scenario, the economy will see some job losses and slower growth that result in prolonged recession starting from the second quarter.