End of Bull Market in Volatility

Submitted By Michael Krause
Volatility is done. In other words, the bear market is over - or at least the exciting or scary part, depending on your perspective. And if I am wrong, the final bottoming period will be much less eventful and dramatic than what we've come to see. Yes, I'll be a "fool" to say it.

Upon reading today's news of the US Treasury deciding to purchase $250 billion in equity related stakes of banks, my first reaction was this: "Slick!" Why? Paulson sold the congress a bill of goods assuming the primary method of bank capitalization based on purchase of debt/house assets. Now they changed the game and evoked the TARP bill's alternative measures (equity stakes) as the de facto primary method of credit market support.

It's a hard strategy to argue with, however. It achieves the purpose of bank capitalization and at least leaves the taxpayer with something, without explicitly speculating on a bottom in housing as I suggested that the original main "bill of goods" did. Furthermore, considering fed policy is generally aligned to facilitate wealth transfer to its subject banks, the taxpayer owning a direct stake in this government subsidized 'wealth transfer' effectively redistributes it back to the taxpaying public.

At the expense of some extra treasury debt burden, we are essentially allocating some XLF Financials ETF to the taxpayers at large. As the fear trade is coming off, long term treasuries are losing their bid. I've consistently harped on the US debt burden as having a real impact, and historically low interest rates being unsustainable. This doesn't change, and may depress valuations of all assets going forward. As extra support for my cause, I perceive the markets are collectively slowly realizing that all of this extra monetary supply will have inflationary impact on a long term basis.

The deflationary trade that buying long dated government risk free debt symbolizes is obviously losing its luster. I am toying with the idea that buying commodities and commodity related stocks here - silver and crude most appealing (as they have actual industrial and physical use) - are a good hedge going forward at these levels ($11 for silver, $80 or so for crude).

The worldwide coordinated addition of monetary supply to offset recent credit market destruction is bound to eventually find its way back into the system. The unified approach to solving our credit market failings that we have witnessed this past week by the world's most developed nations sends a clear signal: credit markets will be restored no matter what. It does not pay to be bearish anymore on broad equities because of this. Even if we turn negative GDP for the next half year, the market will find a way to price PE and valuation farther into the future.

Courtesy of dryships.com, the above chart shows the recent plummeting demand for shipping services as credit facilities have been pulled, as banks have been hoarding cash to provide a capital buffer against uncertainty such as Lehman's CDS settlement which ended without devastating sequence on Friday. Now that these type of events are a thing of the past and CDS are soon to have their own exchange which remedies counterparty risk, it is a fools bet to expect further chaos in the face of government policy show of hand.