Saturday, January 30, 2010

Odds of Correction Are Extreme, Yet Some Go For Leverage, Guess Who is on The Other Side of That Trade

Would you invest in the stock market after it has gone up over 60% from its lows in less than a year? The odds are staggering that a correction is in the cards. Some foreign markets are up over 100%. Please see our global ETF tracking live. It makes very little sense to be in equities at all, unless one is a fool or hedged at extreme, or knows exactly what will happen (as certain financial companies do).

SPX long term chart:

Mish Shedlock believes that US and foreign equities are going to take a huge haircut. He thinks that real estate returns are likely to be negative, perhaps quite significantly. "Returns on fixed income will vary huge by quality. Junk bonds and municipals are likely to get clobbered. High quality corporates held to maturity will be OK".

To those who use leverage:

Incidentally, in the same piece Mish discusses the fact that the state of Wisconsin has just given the nod to use leverage on their pension plans. Wisconsin believes that there is a free lunch. There is no such thing and anyone who believes it is indeed a fool.

"Use of leverage self-sows seeds of its own failure. Even if the trade is a good one, leverage will eventually cause problems. [...] one needs multiply the size of the trade knowing every pension plan in the country, is doing the same thing, to the tune of hundreds of billions of dollars (or more). [...] Who is on the other side of trade? Let me ask it a different way: What happens to all those geniuses who believe in the "free lunch theory" when the trades start to go the other way?I will tell you what happens - Goldman Sachs and hedged funds not involved will bet against it, in size. The system inherently takes advantage of leverage and weakness. That is what sunk Bear Stearns".

Japan Similarities:

(please click to enlarge, this is Japan)

Mish also mentions that fundamentally, the S&P 500 can easily fall to 500 or below. Alternatively, stocks might languish for years. He cites the Japanese Stock Market being 25% of what it was close to 20 years ago. "It does not pay to be fully invested here, regardless of what the stampede of bulls say. These are the same bulls who were saying exactly the same thing right at the October 2007 high".

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