The New CS Board

[jumanji0881]

It's a "Risk-On" environment (for now)
Price Instability : http://www.prudentbear.com/index.php/creditbubblebulletinview?art_id=10627
Excerpts:
Not for a minute have I ever believed that the proliferation of derivative trading would end well. When a meaningful part of the marketplace moves to implement hedging strategies (as was the case again last year), the market will immediately find itself both prone to illiquidity and vulnerable to trend-following selling pressure. And, as we’ve seen, when policymakers then aggressively intervene to stem deepening market stress, markets abruptly become susceptible to a destabilizing reversal of hedging-related exposures. The unwind of both hedges and bearish short positions creates a powerful burst of buying power and marketplace liquidity. In short order, dangerously illiquid markets can be transformed into abundantly – I would argue, overly – liquid. And there is nothing like the specter of buying panic associated with a major short squeeze to really empower the markets’ animal spirits. Nervousness and risk aversion are so second-half 2011.

The NYSE Financial Index is already up 13.6% year-to-date. Bank of America has gained 41%, Citigroup 27%, and JPMorgan 15%. Morgan Stanley and Goldman Sachs have jumped 34% and 30%, respectively. The S&P500 Homebuilding index has a 2012 gain of 20.9%. The Morgan Stanley Cyclical index is up 16.0%. The small cap Russell 2000 has gained 12.2% and the S&P400 MidCap Index has jumped 10.5%. The Morgan Stanley High Tech index is already up 14.0%, and the Nasdaq100 closed today at the highest level since early-2001.

It’s a backdrop that had me this week recalling the 1990s. I certainly haven’t heard so much bullish technology chatter since the tech Bubble. The outperformance of heavily shorted stocks also brings back memories of the nineties’ squeezes and all the trading fun and games. In the nineties, liquidity and market distortions were being fueled by the explosion of Wall Street debt instruments and leveraged speculation. The GSEs (chiefly Fannie, Freddie and the FHLB) were there to covertly provide a powerful liquidity backstop in the event of heightened market stress. The market incentive structure was pro-Bubble, and especially toward the end of the decade the marketplace had become rather emboldened from repeated crises resolutions. Today, the distortions are fueled largely by an explosion of Treasury debt and speculative leveraging, with the Fed and global central banks acting conspicuously as market liquidity backstops. Players are again emboldened.

I’ve been at this for awhile, so you won’t hear me calling for the imminent demise of this Bubble. I will, however, continue to warn that when this one blows there will be hell to pay. And what a fascinating juncture for the marketplace to so emphatically embrace risk-taking. Especially with readily available derivative risk protection, it is indeed rational for players to aggressively play the (policy-induced) global risk market rally – with one eye on buying cheap risk insurance. And I will assume the sophisticated global speculators will play this for all its worth (multi-billions, literally) – with an eye on the exits in the event Europe begins to unravel. Policymaker efforts to avoid a system blowup have created a backdrop conducive to a destabilizing speculative blow-off. And the Fed can still somehow trumpet “stable prices.”