July 26, 2008

Let's Keep the Economic Downturn Lasting as Long as Possible

At least this is the likely outcome of the current regulation imposed by the SEC and Britain's FSA. They are targeting "short sellers" and saying they are leading to erratic and unjustified market trepidation and volatility. The idea is that short sellers are "shorting" equities in droves and doing what is called a "naked short", this is when a short seller shorts a stock without first officially borrowing the stock. They thus imposed rules that say this can no longer happen.

While I agree laws should not be broken, there are laws that already disallow this to some measure, this type of legislation at this stage of an economic downturn is unhelpful. Markets are living dynamic places with, for lack of a better term a heartbeat and a soul (not in the same vein as the one provided for us by God) but a conscience and self awareness. That said, typically in a downturn you will see a leg down followed by a relief rally, followed by a leg down etc. until you see this giant massive capitulation and this will be the firm floor the market will put in to build off of.

This Chart of the USD/JPY is a good example of what a down trend looks like. You can clearly see the relief rally that took place during the month of December. However, you see the massive capitulation from the end of December through the middle of March. I'm slightly overstating massive capitulation but you can see where the market is searching for a bottom. Once it found the bottom in the beginning of March you can see it begin to recover and form a nice uptrend.

Now I'm not suggesting that the Dollar is going to get stronger versus the Yen, in fact my feeling is the exact opposite, but I wanted to point out this chart as an example.

With the regulation put forth in the last week we are not likely to see a capitulation where the market has an opportunity to find a bottom. Instead, because of the terrible fundamentals in the US and the increase of regulation we are likely to see a slow bumbling economy and stock market over the next few years.

It is the same with Housing, we are trying to prop up banks and the Housing sector and instead of values for houses massively falling all at once they will slowly be nibbled away over a greater period of time.

When I was younger, and would get in trouble, my Dad would always ask my brother and I if we wanted a spanking or to be put on restriction. We learned very quickly a spanking, though painful, was over quickly and we were outside playing, restriction lasted longer and was more annoying. All of this supposed help in the form of government intervention is exactly like being put on restriction for the next 3-5 years. I would much rather go through some pain in the next 6-18 months then sit and watch out the window over the next 3-5 years waiting for the time I can go out to play. But that is just me. Good luck in the market.