The Two Headed Monster

What an interesting day today folks.

One of the first thoughts that I had at the end of trading today was remembering an article that I had read recently around the market action seen during the late 1970's stock market.

There were a series of inflationary and deflationary panics that rattled the nerves of investors during this time. 10%+ moves in gold in either direction were not uncommon as the market worried about the prospects of both economic monsters. This period of destabilization was finally cured when Volker took interest rates into the teens in order to kill inflation.

I am starting to wonder if this is what we may be starting to see in today's market. The one key difference seen today versus the 1970's market is the volatility in equities. Perhaps we should expect this in today's market that's filled with hedge funds, day traders, and speculators?

There are two trading trends that have clearly developed over the past two months: The deflation trade and the inflation trade.

The deflation trade(which we saw last week) is dominated by rising treasuries(lower yields), falling stock prices, and sharp sell offs in things like the metals and other commodities. You also tend to see a stronger US dollar.

The inflation trade that we are seeing this week is a complete inverse of the deflation trade. Treasuries tend to crash(yields up), stocks soar, and commodities flourish. The US dollar tends to remain weak.

Which trade is correct? The market hasn't decided in my view. Its very apparent that Wall St is divided on how this all plays out. Inflation appears to be the big worry if the economy recovers because there are too many dollars floating in the system as a result of the reckless bailouts.

All of this spending makes the bond market very nervous. Take a look at the 10-year today:

My Take:

You can look at this in two different ways. The bulls will say yields always rise when the market soars in order to make bonds attractive vs. stocks. The bears would say that our national debt is spiralling out of control, and the bond market is in the process of making money more expensive in an attempt to put an end to our ridiculous spending.

I think there is a compelling arguement for the bearish explanation. Look at the news that has come out this week in terms of spending: Obama appears hell bent on ramming through the $1 trillion healthcare legislation. The US deficit just hit $1 trillion for the first time in history. Finally, the bailouts continue to flow out of the Fed like water.

Our government has shown ZERO fiscal responsibility.

Bottom Line:

I think that treasuries have sold off much harder during the move higher this week then they should have relative to stocks in a normal market. The resulting higher yields are catastrophic for the housing market.

This could stop any recovery(COUGH) in its track.

My only advice in this type of market is to make sure you are diversified! I own treasury shorts and metals as a hedge against my short positions in stocks. Going long equities is still too risky for my taste.

All it will take is one large financial time bomb and the longs will run for cover because there is no fundemental reason to be long!

We might have seen that financial time bomb tonight with the CIT news after hours:

"WASHINGTON (Reuters) - U.S. officials are still exploring providing government assistance to CIT Group, but are increasingly concerned that conditions at the lender have deteriorated too far, according to a source familiar with government talks.

The source said Treasury Department officials are concerned that CIT's liquidity crunch has worsened over the past few days and that government aid would not effectively put the lender on a path to recovery.

A resolution for the lender's liquidity problems is expected in the next 24 hours and could end in a bankruptcy filing, the source said, speaking anonymously because the situation is still fluid."

Uh oh.

That's really ugly. 1 million small businesses depend on this firm for liquidity.

BE CAREFUL and stay nimble folks. This is an extremely dangerous market that can change on a dime.