Welcome to Q4: Credit Crisis Hangover Continues

Wake up! Time to make the donuts!

Good Monday morning. We begin the week, month and quarter with a world still suffering from the hangover from its prior credit crisis. Wherever we look, we see complications from that binge still causing problems. Indeed, as we look across each of the major asset classes and geographic regions, deleveraging and excess debt remains the dominant input:

Economy:  Appears to be slipping into a slowdown — US GDP between 0-1% is likely. (The mess in Europe will impact the US as well.) My probabilities for a recession have ticked up form 10 to 30 to 50%. Today, we bump them up to 60%. Hard to see what jump starts economic growth in the US.

Earnings: Estimates keep falling as economic forecasts drop, but then again, stocks have fallen as well. The key question remains, will we see a minor drop or a major plummet in earnings. The answer to that informs you whether stocks are cheap or dear.

Federal Reserve:  Monetary policy will not cure what ails the economy, although it can keep a bid under Equities and Treasuries. Before QE3 is announced, the situation will have to get much much worse.

Markets: Down nearly 20%, they have all but priced in your garden variety economic slowdown. What they have not priced in is a major catastrophe — the collapse of a major US bank, a crash in the Euro, a major global recession, or the collapse of the EU.

Bonds: Continue top attract a firm bid from beyond the Fed. The 1% yields on the Japanese bond seems to be the model. Will we see a 1 handle on the 10 year and a 2 handle on the 30? Don’t be surprised if that eventually occurs.

Gold:  Continues to be a trade, not a religion. Anecdotally, people who have told me they are long gold include pretty much everyone but Wall Street Shoe Shine boys, and that’s only because most of them died decades ago.

Sentiment: One cannot help but notice that the dominant fear isn’t a crash, but missing the next rally. Until that changes, a lasting bottom simply isn’t in the cards.

Counter Trend Rally: Markets do not go in any one direction forever. Hence, the many failed attempts at bounces from down 10, 15, and now 20%. But as noted above, that knife catching suggests sentiment is not where a lasting rally is probable. Right now, I see too little fear, not deeply enough oversold, and valuations that are only now starting to become attractive (but not “stupid cheap”). The factors which generate a high probability trade have not yet been formed.

Contrary Plays: But, the above does not mean we cannot see some sort of a bounce mustered — especially with all of the end of Quarter cash raised. But that counter move is likely, we just should not expect it to be more than a week or three and total 3-8%. Hence, a better long side trade is out there, but more than likely from lower levels.

That’s my overview; Let’s watch to see how quickly the market can prove me wrong.

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