What to Cheer About?

Watching market reaction sometimes is like watching an emotional woman, swinging between fear and relief without much patience or long-term view. I find it amusing when the market roared in a best day in a year after soothing words from Mr. Bernanke promised a more flexible and nimble FED, hinting further rate cut. I just don't know what to cheer about for any average investor.

Rate cuts, since used by Greenspan, has been welcomed by the wall street (note it's the street) as a bail-out and pain-killer in times of problems. This is because of their short-term interest (keeping the job, getting bonus) is directly linked to that. Having such an semi-insurance policy, the stock market also takes more risks than it normally should.

The rate cuts, unfortunately, isn't a medicine without side effects. Seriously speaking, the current housing market has its roots back to days when Greenspan cutting rates aggressively to alleviate the market melt-down by the Internet Bubble in early 2000s.

The current rate cuts underway may provide some essential liquidity to the banking industry, so in a sense, it will help financial industry to stabilize. But it can't change the fact of a slowing economy that has a possibility of recession. They are like pain killers, can't really kill the germs and can't really cure the disease. And isn't the fact we need more and more pain killers means we are really in a bad situation?

So far the ARM resetting rate is at 45 billions per month or so. That has already caused couple big investment banks to write down tens of billions of bad debt and oust their CEOs (what a shame they got away with millions of compensations still). Towards year-end, the ARM resetting rate will double to about 90 billions per month, assuming the percentage of going-default-subprime-mortgage is the same (which is a quite reasonable assumption), much more write-downs will happen on the horizon. We are just at the beginning of an avalanche.

No matter how FED trying to save it by cutting rates, the credit crunch will continue and impact the rest of the economy in a more pervasive way. Besides FED, those SIVs are also jokes. Buffet said "not only you cannot turn a toad into a prince by kissing it; you also cannot turn a toad into a prince by re-packaging it..." It's a shame financial industry again uses cryptic derivative product names. Investors should be aware that the emperor wear no cloth after all, no matter how beautiful words he describes it.

Human nature has little changes since day one. That's also the blessing for smart investors who can override and resist spontaneous feelings like fear, greed, euphoria, and relief. In the next 12 month or so we'll see more market reactions like that, and we should not be surprised.