Bear Rally

I suspect that we could have some sustained rally in the next couple of months. The US situation in Q3 is not as worse as feared (and it should not given that the main fiscal drag from reduced stimulus, e.g., payroll tax cut, won't come until the new year). Eurozone might find some temp bandit and would still have at least three months before the ultimatum on EFSF anyway. China has tried to signal support for its banks (none of its big 4 banks will go bankrupt anyway; that won't be an option for Chinese government, even though they are technically bankrupt, as in BOA and Citi situation). So it is possible this rally could run till after early November. So from a trading point of view, or from a professional money manager point of view, it might be wise to cover shorts and even load up a bit on risky high beta names with low bankruptcy risks. 

However, the bigger question is whether this is the end of this round of bear market? I doubt it. As mentioned in an earlier post, US recession is likely, given Republican's political interest. The Fed probably won't deliver a big QE3, if any (maybe 200 billion more bond buying). It is completely hopeless yet that Eurozone may eventually come up with necessary solution, but that will happen until things already become extremely dire. China has fiscal powder this year to boost up its growth (note that it ran budget surplus in the first half of 2011, like every prior year, which becomes budget deficit by year end, because of fiscal injection). But it should know that too strong a boost will only provide the precursor for an even more dramatic fall a few years down the road. Also, China's ill is nearly terminal (which may take decades to cure), because it is structural. No country ever has 33% or lower consumption portion of their GDP and no country ever has more than 50% GDP as investment. It has to fire tens of millions, if not much more, and then move them into service and consumption related sectors. It also has to resolve the issue of how to pay for the bill from massive misallocation of capital. If it is through financial repression as they did the last time, that will only make its economy even more imbalanced. The best solution may be selling all the SOEs and use the proceeds to build medicare, social security, and free education system. But since SOEs are the fat cows the monopolize Chinese industries and that the elite use to milk for their own pockets, that is politically infeasible.

So it is probable that the short sighted market will rally hard in the next couple of months, only find itself extremely disappointed at the start of next year. 

On a higher note, it is not impossible that the US will become much better than what it is now in 2013. If a Republican is elected into the White House, he is likely to renege on the campaign rhetoric that is only used to confuse people and make things worse. Once they have the rights to govern, unless they are extremist (they might as well be, at least up to now) who want to destroy the most powerful republic on earth, they are likely to raise taxes (especially capital gain and estate taxes), build infrastructure, and do some other right things such as reining in the big banks and financial industry.  Romney would be wise enough to do some of those. If Obama cannot do anything right and disgrace the most powerful position in the whole world, then it is not a bad idea that he gets booted. If Obama does get reelected, there is some chance he will finally show some teeth and do what is right. After all, most presidents only do what they strongly believe in during their second terms. So it is no inconceivable we could have a relative bull market in 2013. 

To end this note, I steal the following quoted lines from Mr. Paul:

"First of all, bank regulation is important even in the absence of bailouts. Don’t trust me, trust Adam Smith. Scotland invented modern banking; it also invented modern banking crises; and Smith, having witnessed such a crisis, favored bank regulations, declaring that

Such regulations may, no doubt, be considered as in some respect a violation of natural liberty. But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments; of the most free, as well as or the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty, exactly of the same kind with the regulations of the banking trade which are here proposed."

So no one can be more eloquent than Adam Smith, the father of capitalism, about the issue. In fact, it would be a real pity to see a great country like the US being destroyed for the political interest of a few and send it to the class of Brazil in the 70s. Without such a great country to back them up, how would the moneyed elite keep their wealth. For now, they are free riding the American republic to the extreme. 2013 may be the time for them to make a choice. But whatever will happen then, we probably are destined to enjoy some dark days in the next year. That does not mean you cannot make money ;=). Bearish or bullish, there is always an angle to make money. Only the complacent lazy investors, which is the majority, hope for bull markets to make money.