Sep 1 2011

The stock market has performed its oversold levitation bounce. Most of which I have not participated in and which is now too late and, as always, too extended. Volume was typical for August – ie non-existent. Apart from “oversold bounce”, there is absolutely no underlying reason for the bounce. Economic news has continued to deteriorate – but, as usual, headlines about it are spun into cotton candy. Credit/funding markets are continuing to worsen in Europe but everyone is on vacation there so who cares.

I suspect the real reason for the ramp in the last few days has been the expectation/certainty that the Fed will announce a new QE program. Only the insiders who rig these markets know what it will actually be but the volume in equities indicates that equities will not be the beneficiaries.

One rumor I have seen – – is that Obama/Fed/Fannie/etc will announce a massive homeowner refinance plan. The flow of funds is complicated – but basically the Fed would end up offloading a bunch of mortgage-backed securities to Fannie (ie govt) while buying longer-term Treasury debt in order to lower the yield curve. The immediate winners would be homeowners. The losers would be renters, future taxpayers, and owners of MBS (mostly future retirees via pensions). Politically, this is the sort of game the DC pols will love – and good for the Fed/Wall St too because they can avoid the spotlight here of being the “decision-maker”. Economically, the results would be disastrous for owners of MBS (who would find their existing bonds – currently trading over par – called in – at par and will be forced to reinvest the proceeds). Longer-term, this would create a credit crunch for housing. No one would finance new mortgages so housing prices will ultimately decline to cash-only prices. Banks will deteriorate sharply if they lose their steep yield curve. I suspect this creates a huge post-crash opportunity – in mortgage REITS – NLY, HTS, CMO, CIM may be some names. Whichever ones have the fewest losses on their current MBS portfolio and the most cash available to scarf up MBS’s that sell at distressed prices if too many owners dump them. Watch these names up to Sep 21. That may be the day they crash and become good long-term buys.

Another rumor – – is more direct. The Fed will simply sell gobs of short-term Treasuries and buy long-term ones. But in this case, Treasury would have to actually issue more 20-30 year bonds and fewer ST bills – for the Fed to have enough supply to be the only buyer. Again, bank balance sheets would deteriorate pretty sharply. Supposedly the biggest beneficiary would be 30 year bond owners – or TLT. In reality, this would also drive another big gob of free speculative money into commodity futures. Poss some spillover into projects re PM’s, rare earths, agriculture, energy.

Who’s to say. But some things here to track.


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