The Canary Lives, China Humiliates
Last week, the US stock market found a bottom -- with a nice double-digit gain for both the Dow and S&P 500. The question, of course, is whether it is the bottom.
The best part of last week's action was the role that Citi played in the rally. News that the credit behemoth is once again turning a profit provides a "canary in the coal mine" signal that the credit market canary may yet live. I have maintained for a long time that the most important key to recovery in the global meltdown is recovery in the financial system. Once that happens, the lubricant of credit can begin to work its magic both for consumers seeking to buy big-ticket items and businesses seeking to engage in the kind capital expenditure activity that will be necessary to bootstrap this economy.
Obviously, big questions remain; and they are the kinds of questions that need to be addressed not by any single country but rather by gatherings such as the G-20 which are going on even as I write this missive.
One of the biggest issues facing this gathering is what to do about the meltdown in Europe, which I have commented on in previous newsletters. The size and timing of the European fiscal stimulus is at the top of the list along with how much more funding the IMF will be given to dole out to the rest of the world. Germany remains the key -- how far will it be will to go in helping its neighbors and how much inflation will it be willing to risk.
With all of this in mind, I am not yet ready to go long the broad market indices. That said, I have begun to accumulate shares in GE for two reasons.
Buying GE and Dupont
First, among all the companies dragged down by the exposure to financial derivatives, GE is the only company that has a broadly diversified engine of production and growth. If GE can withstand the magnetic pull downwards of its derivatives exposure, it will be an incredible long-term value. Second, as a price under ten bucks, I view GE not as a stock but merely as a call option. As with any call option, I am prepared to lose most or all of my investment because the potential upside reward far outweighs the downside risk.
One other company I think may have more upside than down is Dupont (DD). Dupont is one of the best managed companies over the course of the business cycle and it is near its 52-week low. Layering in is preferable to all in.
China Embarrasses the United States
With China holding about $2 trillion of American assets, they should be rightly concerned about the value of those assets. It was embarrassing for the United States, nonetheless, for the Chinese Premier Wen Jiabao to publicly question the solvency of the US government. That is precisely the kind of embarrassment the US is likely going to have to get used to until our government gets off its knees and stops begging for Chinese money to pay for its budget and trade deficits.
In many ways, however, it is a delicious dilemma that the United States now puts China in. If China refuses to keep buying our bonds, the value of the dollar will plunge, and so, too, will the value of China's foreign reserves held in dollars.
On the other hand, if China keeps buying our debt to prop up the dollar, it faces a strong likelihood that with so much fiscal stimulus and easy money coursing through the US system, inflation is all but inevitable. That, too, will ultimately devalue the dollar and therefore Chinese foreign reserves. So, for the Chinese, the question is whether to cut and run now or hold on and be scalped later. Of course, the problem with the United States getting the last laugh on the Chinese is that it's predicated on turning our currency into worthless paper. Stay tuned!
Bottom Line: As I said last week, this continues to be a short-term trader’s market right now. BUT plot your Long Strategy now for when a bottom is finally discovered. GE and DD are my opening gambits in my own strategy. Obey standard money management rules and quickly cut any losses.
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