A Framework For the Next 6 Months

After reviewing some video interviews on the internet this weekend where some of my favorite market commentators are featured - re: Jim Rogers, Peter Schiff, Marc Faber, etc. and then also reading the internet commentary from Bill Cara, Bill Fleckenstein, John Hussman, etc. - I realize that I am now in a different camp from basically everyone whose opinion I most trust. I figure that it is important to outline my general view now. Not for its predictive value, but to be able to look back 6 months from now to see how I reconciled uncertain outcomes ex ante amid a huge divergence of opinion - both bullish and bearish.

Again a quick summary of both sides of the coin here:

Bulls - Indicating that this is a once in a lifetime buying opportunity for bank stocks as they have never been so attractively valued. Federal Reserve will ease throughout the remainder of the year sending the market to new highs - re: 15K on the Dow, etc. Solution - buy financials.

Bears - This is friggin armageddon incarnate. Dow will finish the year below 10K, many financial firms will go bankrupt - re: Countrywide, WAMU, maybe Bear Stearns or another major broker, etc. Solution - buy gold buy gold buy gold.

And now my outlook (Ben) -

I see the market bouncing here off the 200 day moving average where it found price support after the fed intervention. I am not sure how long the market will rally. I also expect the Federal reserve to ease aggresively for the remainder of the year bringing the Fed Funds rate down to 4.25% or lower. I expect the massive weakness in housing and the credit markets to dictate the action for the remainder of the year. I think we will see accelerating foreclosures and continuing home price declines as mortgage rates continue to spike (Jumbo loans at least) and many mortgages begin their adjustable reset period.

The take away is that we are going through a classic debt deflation / liquidation scenario, where asset must be sold due to excessive leverage and inability to service the underlying debt. This cycle must be permitted to run its course in order to reach a stable level for asset prices - mainly real estate, although the credit markets and equity markets will likely follow suit.

How do we play this in the market? I think you have to keep doing what has been working since January 2007 - that is short financials and anything related to real estate. Market has still not bounced quite enough, but after a rally of a couple weeks near the former highs there should be a fabulous opportunity to get short again on WAMU, CFC, and several of the mortgage insurers via put options. I have no desire to short the overall market when the underlying fundamentals for the real estate market / credit markets are this poor.

WAIT - I haven't mentioned gold or precious metals as part of the outlook - whats going on? Any buying of gold or precious metals over the next six months is what I believe will be a value play. I expect metals price to correct significantly - potentially falling 10-20% over the coming months. Gold bulls are basically frothing at the mouth as this point because Fed easing is expected to create an imminent run on the dollar and a zoom in the gold price from the $650 level to over $700 again.

I believe this to be wishful thinking. In the difficult stock market that awaits us I believe that investors abroad and at home will be seeking the safe haven of US treasuries despite the poor underlying fundamentals of the Dollar and the Solvency of the US government. As a result I think you have dollar strengthening continued amid the clamor for treasuries.

For those that do not feel comfortable shorting stocks or trading put options I think that raising cash on this next rally will be important because it will give you some firepower to acquire high dividend yielding quality stocks when the firesale time does arrive.

It was great to layout these expectations. I can't wait to see how things unfold.

-BG