THE FED JUST DOESN'T GET IT!

.............................Within 30 minutes, the DJI was down more than 300 points for the day, and about 400 points from the high of the day. There was an urgent rush to safety, meaning U.S. Treasury securities, which we have been recommending since July. The 10-year T-Note soared, as its yield plunged below 4%. The 2-Year T-Note yield plunged below 3%. This shows a flight from money market funds to the safety of U.S. Treasury securities. The big, smart money was running scared.

We admit that possibly right now the 25 additional point cut would not be that important. After all, the losses in the credit markets may be as high as $500 BILLION, except that the owners of the paper haven’t admitted it. The only tool the Fed has to try to ease the pain is to lower interest rates substantially. The failure to act forcefully now sends a very negative message, namely that the Fed members are totally out of touch, just as we have said all year long.

Ultimately, the Fed chairman is responsible. In August he was oblivious to the seriousness of the situation. A meeting with several big hedge fund managers, x-Treasury Secretary Rubin, and Hank Paulson woke him up. But apparently, he went back to sleep.

He is a timid college professor. His biggest challenge in the past was in the classroom. He apparently doesn’t have the courage, nor the market knowledge, to handle what we consider the largest global credit crunch in the history of the world.

As the passengers of our economic ship, we found out today that our captain is deaf, dumb, and blind. Why don’t they go out and speak with business owners, or CEO’s of mid-size firms? Right now we need someone able to fix the financial market mess. That takes the most astute, experienced individual, and even he might not be able to do it.

Sorry to be so blunt. But this is no time for learning on the job.

The morning after the Fed announcement, before the market opening, the Fed announced another bombshell. Here is what we wrote in our SMARTE TRADER service that day:

The Fed and other central banks got together before the opening today to ambush the short sellers. The Fed, together with the central banks of Europe, England, Switzerland, and Britain announced a joint effort to bring relief to the frozen credit markets. Even the Bank of Japan and the Swedish central bank issued statement supporting the plan. Unfortunately, the effort will have a smaller chance than a snow ball not melting in hell.

The Fed said it would launch a "temporary term auction facility" that banks can use to secure loans at its discount window. There will be two auctions of up to $20 billion each in short-term funding next week. The Fed will open foreign exchange swaps for up to $20 billion with the European Central Bank and up to $4 billion with the Swiss National Bank, whatever that means. Another $20 billion auction will be done in January. Well, if you understand what they are going to do, then you are smarter than we are.

I just look at the amounts ($20 billion) and the amount of losses the banks hold on the derivatives, which is several hundred billion dollars, and shake my head. The European Central Bank on certain days has been putting as much as $100 billion into the banking system there. How can they expect these small amounts to work? It’s a joke.

What should they do? Instead of saying $20 billion, they should give a huge number, like $500 billion. That would restore confidence. Everyone would know that the $500 billion would not be used, which is the best part of the solution. It’s like insurance of your stock brokerage account up to $10 million, although you may only have $100,000 there. The much larger amount gives you confidence.

So, what did the Fed get for its surprise attack? The DJI was up about 270 points in the first 10 minutes of trading. From there the index erased all of its gains, declining 383 points from the high to a loss of around 111 points, before interventions brought it back into the black. This action shows that the big money shares our negative assessment of the Fed’s move and took the rally as just another opportunity to sell short.

Considering that one analyst called the central bank action “the most important since 9/11,” the result is pretty poor. It could be that tomorrow more buying will come in, but it won’t be into the financial stocks. By this time, the big, smart traders realize that the financial sector dug its own grave with excessive speculation and leverage. It had nothing to do with normal business. Therefore, no one should feel sorry for these companies.

Now even the supporters of the Fed chief say he should leave. Trying to trick traders and whipsaw them is not the job of the Fed. They should seek stability instead of creating instability, uncertainty, and doubts about the ability of the Fed to handle the challenges.

The Fed is targeting its “Fed Funds rate” at 4.25% now, but all the government’s debt instruments, except for the 30-year bonds, have lower interest rates. This is a very unnatural state of affairs. The Fed has to get in gear with market forces. The bulls now talk about a “soft landing” for the economy. Yes, and it will be in quick sand and mud, and possibly a brick wall after that.

It is now obvious to me that we face a very long and possibly deep recession. Furthermore, we will see a bear market that few think is possible. A 50% decline in the DJI (from this year’s high) is a good possibility. But it will take time. 

There will be bank failures, forced mergers, and governmental bailouts. Our largest financial institutions will see significant portions of their stock owned by foreign entities before it’s over. The U.S. is now continuing the path of its long-term decline into irrelevance, which started in the year 2000. The world’s power will shift to China in Asia, Russia in Europe, and the Arab Emirates in the Middle East.

The above is the bad news. The good news is that although it is beyond our power to stop big bear markets, we have always found excellent ways to prosper from bear markets. And this is the opportunity we offer to our subscribers. The next several years can bring you greater profits than the bull market of the past 5 years.

THEY DO RING A BELL ,although a little late!

Excerpt from Wellington Letter December 5, 2007

.........................The rally from August to October was the “distribution” rally, which lured the less sophisticated money managers into the market, and gave Wall Street the buyers onto whom they could unload.

This means that from now on there will be less support for the market. Wall Street found the “bagholders” and Wall Street firms are now free to make money on the short side. In fact, GS can now become outright bearish in its forecasts without hurting its own portfolios.

In the meantime, the Wall Street people on TV are still bargain hunting, as they have been doing all the way down. I prefer not to try to catch a falling knife. But then, maybe I am not as smart as they are. But I don’t use the excuse for losses either, namely “we are in it for the next 5-10 years.”

THE STOCK MARKET: Year-end window-dressing

The bulls are becoming more careful. Even they are starting to recognize that there is more to the current credit market problems than just a few subprime mortgages blowing up.

The reality is that we are seeing the greatest credit contraction in the history of the U.S., one which is still in the early stages. Credit contractions are brutal. There is usually no place to hide, except ultimately T-bills.

We are now approaching the year end. This year it will be very volatile, more than usual. The under performers will be sold, as no one wants to show them in their year-end portfolios. That includes all the financial stocks and the homebuilders.

Excerpt from Wellington Letter Oct 30, 2007

....................................Treasury Secretary Paulson just said:  "Yet, the problem today is not limited to subprime mortgages as the number of homeowners having trouble making payments on prime mortgages is also increasing.”

In a speech Monday night, Bernanke softly echoed this, saying, "...despite a few encouraging signs, conditions in the mortgage markets remain difficult."

Do you see how they try to soften their assessment of the dismal and dangerous conditions in the financial markets?

In the year 2000, the implosion of the Internet stocks started the bear market. We heard the same arguments at that time, namely that the sector was too small to infect the entire stock market. At the time that the NASDAQ plunged, some other stock sectors were supported for another 10 months, disguising the big selling in the rest of the market. As it turned out, the stock market produced the greatest wealth devastation in history over the next 2.8 years.

However, there is another reason for strength in the tech sector. You see, many other sectors have exposure to the subprime and derivative mess, either directly or indirectly. But technology is not related to that and is a purer way to profit from economic growth without the burdens of the credit implosion. Tech has been supporting the market, along with energy and basic materials. When these sectors top, then you have to become very cautious. Watch these stocks closely:  RIMM, GOOG, CSCO, HPQ, and AAPL. Nothing is insolated from a credit market freeze up over the longer term.

The future’s markets are now predicting that there is a 100% likelihood that the Fed will cut rates at the end of this month (Halloween). However, last week some analysts said the Fed might even raise rates. Be careful how you handle the advise of ‘experts.’ It’s your money. We predicted without doubt that the Fed will cut rates. Now we make another contrarian forecast: the Fed will cut rates, but the market will decline, probably sharply, thereafter.

Why would that happen? The bulls who suddenly realize that the severe problems of July have not been resolved, and have even worsened, will take any buying surge as the last opportunity to sell. They can’t easily sell into a declining market. By the end of the month, the smarter investment professionals will be nervous and will have a sell list prepared. 

The reason that virtually every analyst is still bullish is strong economic growth abroad. Yes, U.S. firms doing business internationally are reporting great profit and sales growth, but stagnation in the U.S. As investors, our decision is whether U.S. growth is unimportant for the world, or whether it is. Can we really assume that a weak U.S. economy or recession will not drag economies around the world with it?

The U.S. is about one-third of world economic activity. The problem we foresee is the repercussions in China when U.S. demand suddenly declines by 10%. To the Chinese, that would seem like a depression.

Excerpt from the WELLINGTON LETTER, Oct. 15, 07 issue

.......................................The rally since August was engineered and manipulated. The volume was much too low to suggest that it is a normal continuation of a bull market. A rally after a plunge on lower volume is the hallmark of a “secondary top,” which is then followed by a more serious, and longer term decline. The “rising wedge” formations on the charts of several broad indices are ominous. The NASDAQ rising wedge was just penetrated to the downside, which strongly suggests that the top is in place, and that a meaningful decline is ahead. The prudent investor will act accordingly.

A major support for the markets in 2007 was the merger & acquisition game, especially from Private Equity firms, which bought larger and larger firms with the debt financing the banks virtually threw at them. At the Milken Global Conference early this year, some of the CEO’s of the major PE firms said that they had never seen such easy credit conditions.

One said that if in the morning they decided they needed $20 billion, they would have it by the end of the day. That money was used to buy the stock of companies they acquired. The shareholders would get the money, and plow it back into the stock market. That game is now over. Suddenly, the $500 billion injected into the stock market in this way over the past year will not be there.

Reality can be postponed, but it can’t be repealed!

THE FED: SPECULATING ON THE NEXT MOVE

Excerpt from the WELLINGTON LETTER, Oct. 15, 07 issue

BEAR MARKET!  Excerpt from the WELLINGTON LETTER, Aug. 6, 07 issue

....................................On Saturday, one editor of a major financial publication said that investors should not worry. He said he stayed invested during the 1987 crash, almost panicked, but eventually stocks got back. And in the year 2000, he stayed invested, and eventually stocks came back. Well, if your investments strategy is to stay with an 80% wipeout as in 2000-20002, then you better have a rich sugar daddy.

What’s worrisome to us is that there