Sunday, July 13, 2008

Government Intervention Redux

Top Line: We do think that the market has finally put in a short term low on Friday. We're looking for a corrective rally that will get us out of this hugely oversold condition.

[Editor's note: Thursday evening our internet provider decided to drop us, ok, it was probably related to a storm that came through here. We apologize for missing the post.]

And, we would like to answer your question, Erick, but there won't be time to give you a full answer. So, let's give you some highlights and as we get into this rally phase we can discuss the possibilities of "history" repeating just before we get into the next decline.

The volatility indexes are based on the premium in put options. What makes a put have premium and what is premium? Well, if the market is going up, there is little incentive to buy puts and in fact it might be reasonable to sell them as an investment strategy. In either case, the value of the options is squeezed and therefore the premium is tiny. This action pushes the value of the volatility index down.

Your question has to do with buying puts Before a crash. What we are talking about is when the crashlike event is occurring and people have decided they Have to have puts because the market is going to zero. This is when the volatility indexes explode in price and they give us that very necessary information that puts are being purchased with no regard to price. When fear rules, we need to be selectively buying stocks. More as we approach those moments in September or thereabouts.

But, tonight there is a large news item out there that we must discuss...yes, you have already heard the news if you had the radio on but we do need to talk about the government getting involved we say Intervention Redux...

This move on a Sunday evening just before the Asian markets open is out of the same playbook that we saw when Bear Stearns was purchased by JP Morgan. Back then, we saw the Fed and the Government get involved to get the deal done. They were in the background guaranteeing the deal. This time, we're not so sure what's going on. We wonder what they are thinking when they get involved with the Fannie and Freddie mortgage situation.

We see that one of our favorite journalists has given us some editorial comments on the "bailout" so we'll give her a chance to present some of the important thoughts. Gretchen Morgenson from the NY Times gives us, "The Fannie and Freddie Fallout".

The news that the two GSEs would be "rescued" was greeted with a pop in the futures as they opened this evening. Now, will that hold as we get to the open in the morning? We kind of think it will as we have been calling for a trading low over the past couple of weeks. The main idea is that the market will have a sharp, some would say violent, up move that will last for a handfull of trading days.

One other "little" item that came out late last week was the news about the failure of IndyMac, yes, it's because of the mortgage market. This is a very large player that is now Out. The FDIC is now going to provide some guarantees for the depositors, not all of them will be made whole due to the limited amount that the FDIC covers.

FSI: 85.91 (Thursday's number was 87.88)

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