How Do Things Look?

Happy Presidents day! If you had the day off then I hope you enjoyed it. The Daytona 500 was more than a bit disappointing yesterday as my favorite driver, #29 Kevin Harvick, dominated all day and was in the lead at the end of the race two times but fell victim to yet another race restart to lose. Oh well.

How Do Things Look?
I put together my tax information for the accountant today, got a 10 round work out in even after my speed bag popped, and read a bunch of items I had wanted to check out. After reviewing what I had done last year trading wise I started to look for some trades I wanted to make but I quickly figured out that things are a bit crazy right now and I need to step back and take in the big picture.

Regular readers know I hardly ever make short term plays as day to day fluctuations make my stomach hurt. How I pick investment ideas is I try and figure out some things that HAVE TO HAPPEN (for a variety of reasons) and then get in front of that expected move. Macro analysis to me is much easier than micro management and it usually leaves you plenty of time to reposition if necessary. With this in mind I wanted to throw out a few big picture items I have settled on and offer my ideas on how I will play them. This is NOT INVESTMENT ADVICE and the best way to lose money is to do anything I do! I offer this as a thought exercise and a peek into the inner workings of my mind (picture a wheel with a hamster running laps!).

Global Debt Issues
The most obvious attention grabber right now is the global debt concerns. Greece leads the discussion right now, but the already forgotten Dubai problems are rearing an ugly head:

Dubai World said to propose debt repayment options: reports
TEL AVIV (MarketWatch) -- Dubai World, the holding company within the emirate, may be offering its creditors 60 cents on the dollar as part of an effort to reschedule $22 billion of debt, media reports say.

That is a huge haircut.

Some other headlines:
Spanish government struggles with crisis message
20% unemployment in Spain and they are certain they will not have a crisis. I am not so sure.

Goldman Sachs Shorted Greek Debt After It Arranged Those Shady Swaps
Goldman back in the news as they helped Greece paper over debt and perhaps understated Greek debt issues. If the Euro zone gets mad enough perhaps they will ban GS?

Key Point: Debt issues are coming to the surface and resolution is unclear right now.
Ways to Play: A weaker Euro is a policy goal right now so expect the Euro to fall further. EUR/USD level of 1.2 is my target at this time but that is not too far away, probably not enough of a move to interest me. I could pair that trade with buying UUP as well, but again the move is not going to be a huge one and also it would likely be shorter term than I would like because....

US States are Basketcases
While everyone has their anti-Europe hats on right now, one may want to look under the hood at US State finances before poking fun at others.

Mish Shedlock has been all over this angle and he has far too many quality articles to cover here. One that is repeated many times:
New Jersey on Edge of Bankruptcy
The song remains the same for California, Michigan, Ohio, Nevada, and many other states.

Key Point: US Federal Government will have to enter the state municipal bond game as well as craft other rescue measures on a state by state basis.
Ways to Play: Well that depends and it goes into the next point......

FED Will Have to Re-Enter the Mortgage Market in 2nd Half 2010
I have spent a bit of time on the FED augmented housing market and MBS in particular. While the FED is basically done with MBS purchases, the FHA has been on steroids taking up the slack. With blank checks for losses Fannie Mae and Freddie Mac are still issuing mortgage debt by the boatload.

Calculated Risk has a good compilation of mortgage rate projections for the Spring:
Predictions of Mortgage Rates After the FED Stops Buying
Guesses run form the tiny (maybe 35bps) to the large (>200 bps) average mortgage rate jumps. I am on record for a 150-200bps rise.

No bank wants to issue this stuff and investment appetite for anything with "housing" in the name is still zero. After a weak spring selling season I expect the FED to come back into the market with MBS buy program 2.0.

Key Point: More money printing and a further corruption of the FED balance sheet. With the above point about State aid this augers for QE 2.0 as well and plenty of "liquidity" programs on the way.
How to Play: I think a pure anti-dollar play will be tempered by the currency woes of other nations limiting the upside as discussed above. Printing presses on full speed will usually be good for gold and silver so GLD and SLV make sense here. Playing metal miners can add some serious volatility to your portfolio, but add to the upside potential should this idea pan out. Check out The Golden Truth site and Gold Versus Paper for some great miner research.

Putting It All Together
I have not discussed GDP, Unemployment, Retail Sales, or a bunch of other metrics. I think that number watching at this point will take a back seat to Government Policy watching. Markets all over the world have made it clear that open ended backstops and bailouts are going to have to be explicitly stated or things are going to get attacked. The actions of the past 2 years will make it impossible for any government to step back from that policy.

I will be honest, not much looks good to me right now. The major reason for this is another longer range forecast I have been trying to wrap my head around.

I think that in this year 2010 we are going to see something truly dangerous and it will represent gambling on a whole new level. What do I mean? Consider the following:
-Too much bad debt is the central issue the world over
-Dumping that debt will lead to DEFLATION and you know how Keynesian thinkers view that evil thing

What I am going to predict in broad strokes is the application of the never fail plan of "Good Bank, Bad Bank" but for the debt markets as a whole. This will include:
-Ban on CDS trading for states deemed "under attack"
-Full backstop by US government for State debt; full backstop by Euro zone for Euro countries. Both backstops will be in place for the "Good Debt"
-"Bad Debt" will be termed something like "Long Term Restructuring Class Debt" or what have you and then set it aside off the balance sheet of respective players
-Ratings agencies will rate all "Good Debt" AA or better and will have the blessing of the countries to which it belongs
-New loans made at near zero interest for pressing needs (like California, Greece)
-All countries/states in order to participate in the global war on deflation will have to sign some kind of pledge to rein in spending and pay off debt; after signing they will act as before

There are more parts but I think you see where I am going.

You may be surprised to see that I am not thinking along the lines of an all out money printing plan. I think that would be both ineffective and would cause a panic. This kind of smoke show, while an act of desperation on level of running the printing presses, will be viewed much more benign. It will buy time and markets will go ballistic to the upside on the plan.

Long term of course this is indeed playing games with money that does not exist hoping that one day it will all add up. I think the "success" of the application of such a plan on the US banking system will be viewed as the working paradigm. Of course this is all on the surface, but it should play well for a while.

Longer term I think this will be the last gasp effort before default/devaluation. Things that will tip the balance include violent protests by the unemployed in various countries; Union and state employee walk outs/sit outs causing huge disruptions; Rogue state devaluing on their own; Failed US bond auction, etc.

This is a work in progress so I would appreciate any feedback the readers would like to offer.

Have a good night.