Is the Bear Back?

I know I know, it's been awhile. 

I like to hop on here during periods of crisis and share my thoughts.  Overall, things are playing out just like I thought they would.  In the early part of this year I was warning that the markets would begin to roll over in April/May as the ending of QE2 arrived. 

Ironically it was the worsening economic data not QE that finally grabbed the market's attention.  Over the last month things have deteriorated significantly when it comes to the economy. 

What cracks me up here is how Wall St is "shocked" at how the economy has come to a screeching halt.  I sit here and ask myself why are they chocked???? How these idiots didn't see it coming????

Once gas hit $4 a gallon it was pretty much over for the consumer.  We've seen this story before.  Back in 2008 it took about 6 months for the economy to roll over when gas hit $4.   I assumed that the economy would stop a lot sooner this time because unemployment is double what it was back then.

Making matters worse this go around is the fact that the consumers balance sheet is also considerably worse in 2011 vs 2008 asAmericans struggle through the worst economic period since the Great Depression.   The ones that own homes are even more distressed as housing prices continue to drop in most parts of the country on a monthly basis.

When you consider these facts I must ask the question again.....Why is Wall St "SHOCKED" that the economy has stopped???

Ive said it before and I'll say it again:   CNBC and the rest of the pundits fail to understand that we never got out of the recession back in 2009.  The pump monkeys all dove in once the recession was officially "over" according to the BS economic statistics thinking that we will recover like we always have. 

If you timed it right and bought in March of 2009you made a lot of money on this play.  This was a great trade.  Let me emphasize and repeat that: Trade not investment.  The problem is most of the bulls won't treat it as such.  They will overstay there welcome like they always do and give most of it all back as they ignorantly believe that happy days are right around the corner.

What the bulls fail to realize over the longer term is this isn't your typical recession where you stimulate the economy and then recover.  This is a Great depression.....It may be our greatest depression when it's all said and done.  The only way we recovered in any way is because the government SPENT their way out of it. 

They handed out checks like candy to the unemployed and dropped money out of helicopters and into the banks coffers in the form of QE and QE2.

What we witnessed the past 2 years was the largest government financial drug binge the world has ever seen.  In the end they fixed nothing.  Strucurally the economy is a mess.  The losses haven't been taken, and the insolvent banks only remain solvent thanks to fraudelent accounting

The Bottom Line

The recovery is a sham and it's time to be very careful as we near the ending of QE2 on june 30th. 

The drug binge is over folks, at least for awhile.  If you are curious to see what the world might look like without QE2 all you need to do is look at what happened during the summer of 2010 when the first QE ended:

As you can see above stocks dropped 15% after the first QE drug binge ended.  Why anyone would think it would be different this time is beyond me. 

History often doesn't always repeat itself but it often rhymes.  What's absolutely frighting to me this go around is QE2 is ending at a time where the economy is in shambles versus last year where things were relatively stable.

I am sure this keeps Bernanke up at night which is why I think we will see a QE3 in the not too distant future.

Many of the hedge funds are betting that the stimulus will continue beyond June in some form of a QE3 that might not be called QE.  If you look at the bond market that idea makes some sense. 

I say this because the big money wouldn't be diving into treasuries unless they either thought the Fed had their back OR they were scared to death of a deflationary collapse.  I wouldn't be surprised to see the Fed do something like reinvest the money from maturing short term treasuries back into the bond market.

I guess we will know the real reason why we saw a flight to safety into bonds in the next few months. 

So where do we go from here?  Too be honest folks it scares the living daylights out of me.  Without QE the market is going to roll over like a cheap suit which is why I don't think the Fed can stop supporting the economy.

The problem is if the Fed stays in the game it's going to have a very negative effect on our currency which will then create even worse inflation.  $6 gas anyone??

The Fed has a brutala choice to make and I have talked about this for the past couple years:

Option 1

End QE and try to manage a deflationary death spiral.

Option 2

Continue QE'ing and try to manage an inflationary disaster that could potentially collapse the dollar.

Nice choices eh??

Personally, I would go with option 1 and just let it go and get it over with.  As I have said before, lower prices from deflation can be a good thing.  It makes things affordable.  The Fed and the banks are the only ones that want to keep prices propped up because both of their balance sheets are littered with toxic overpriced assets.

I suppose the homeowners would hate deflation as well but I say why do they care?  Most of them are already likely underwater anyway.

As for my investments I remain cautious.  I am hedged short with some high beta names as hedges.  I am also getting a little speculative and shorting the Euro versus the USD via EUO(Warning: VERY risky). 

I remain mainly in cash for the most part even though it may be worthless one day soon.  I continue to choose cash  because I think stocks will get a lot cheaper in the future and you need to have some powder dry in order to take advantage of it.

Bonds look awful here and I would avoid them like the plague.  I own some PIMCO which is out of treasuries which is where I wanna be as this plays out.  Remember folks:  If Bill Gross is running away from treasuries you should too.  He may look wrong now after the recent rally but he will be right in the longer run because this country is bankrupt.

I can't see anything but soaring bond yields in our longer term future.  The Fed may be able to keep the music going a little while longer with more QE in the short term.  However,  longer term time is running out and smartest guys on Wall St know it.  Go read Bill Gross and BlackRock's Larry Fink's latest pieces.  They see the writing on the wall. 

Longer term we are abviously in deep trouble.  Moody's warned theUSA again today that they will look to lower our credit rating if we don't get our fiscal house in order.

The questions to ask now are these:  Is this even possible?  Do we have the political will to pull it off?

I lean towards the answer "no" on both questions.  I hope for the sake of this country I am wrong.

Be safe.