Tuesday, May 5, 2009

I am sticking to my story: stocks will chop sideways forever

TO BE NOTED: From Inner Workings:

US Credit Protection at “Only” 44 bps May 5th, 2009
David Goldman

Now it costs only LIBOR +44 bps to buy credit protection for five years against a default by the United States of America. That’s slightly more than half of the peak level of March, when the prospective collapse of the banking system persuaded the market that the US Treasury and Fed might go down with the banking system.

It’s hard to be angry at Ben Bernanke for diving into the water to rescue the US economy when it seemed to be drowning. The Fed extended nearly $4 trillion of its balance sheet to buy dicey mortgage and credit risks, and kept the financial system afloat. By shoving mortgage money into the banking system it helped established a minimum bid for depreciated houses. On the other hand, it is now joined at the hip to a zombie banking system. That’s why the credit of the United States of America fluctuates with bank stocks, a phenomenon few of us could have imagined only a year ago.

What we have in response is neither a bull market, nor a bear market rally, but exactly the opposite: it is nothing in particular. The US economy has nowhere to go. The Fed will not let the financial system dissolve. It is in too far already. It has to keep throwing good money after bad because the weight of the Fed’s balance sheet will drag it down if the rest of the system goes. But the ever-present demand for savings by aging boomers, the depressant wealth effect, and the zombie character of the financial system all militate against a real recovery.

I am sticking to my story: stocks will chop sideways forever, as I wrote on Jan. 8 when the S&P was exactly where it is now. I didn’t believe the crash, and I don’t believe in the upside. What I expect to continue is the volatility implosion.

I expect VIX to settle down into the high ’20s during the next several weeks. Zombies aren’t volatile.

The collapse of volatility is most noticeable in the most volatile stocks, e.g., Citigroup;

The above chart from ivolatility.com shows the plunge in implied volatility on C by roughly half.

For those unclear about how to trade volatility under these circumstances, this instructional video is recommended."

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