I Spy a Large Trading Opportunity-How You Can Too (Part 1)

06/16/2008 12:00 am EST


Timothy Morge

President, MarketGeometry.com

Looking for a trade when you have an opinion is a double edged sword: If you are correct, it can be the most rewarding trading experience, because you not only make money, but your opinion was proven correct; but if you are wrong, your trading instincts and abilities are generally hindered because traders tend to hold their opinions in front of them as a shield and often ignore the cues that tell them that they are wrong-thus their losses on positions taken when they have an opinion tend to be much larger and more damaging to their capital base.

In general, I try to approach each market, each day, with no opinion and as I do my market analysis, I try to let the market show me that it is going to do something-or nothing. I like the market to 'play the first card' before I get interested, because I know that detachment keeps me at my highest level of focus and I am less likely to force a trade. But I would be less than honest if I said I never had opinions or that I never went looking for trades with an idea in mind. Like all traders, I am human, and I do have opinions. I do my best to recognize when I am looking with an opinion already formed and then I make certain I 'look both ways before I cross the street' (or attempt to enter the trade).

In the past eighteen months or so, the financial news has been dominated by the plight of the poorly performing mortgage portfolios and the worsening economic conditions in the United States. The Fed Chairman has gone out of his way to lower rates and speak soothing words to an increasingly nervous public, hoping to dampen the effects of this lending crisis on the economy. Almost all economists have focused on this dilemma, to the point where some high profile economists and bond portfolio managers have been calling for four percent 'zero down payment' mortgages for the masses as a fix for the housing industry. Because of my extensive economic background, I, too, have spoken out about the real danger of this situation-for example, in an interview on MSN, I highlighted the Muni Bond Auction held in New York State that attracted NO buyers. The response from people that viewed that interview was incredible: People could not believe that the State of New York could hold a Municipal Bond Auction and no buyers would show up, at any price!

We are at a crossroads in this country and perhaps in all of the Western Societies, as the economic torch may be passing to the emerging giant countries: China and India. The demand for resources from these new emergent economies dwarfs any economic policy changes the United States might make; in effect, we are no longer the masters of our own destiny.

Though I have been highlighting the dangers of the lending crisis in this country for some time, I have been pointing out a much larger and more dangerous crisis that has been unfolding in front of our eyes for the past four or five years: The tremendous growth of the money supply in this country and its eventual inflationary effects. After the September 11th terrorist attack, Alan Greenspan and the Fed began printing money at an unprecedented rate. And because Mr. Greenspan had ceased publishing the wider measures of money supply growth (specifically, M3 and its components and derivatives) and has been pointing to the very narrow M1 measure of money in circulation as the proxy for monetary growth, the public and most economists have been lulled to sleep. The Fed has been saying that M1, (once it has been massaged and adjusted by the Fed), has been growing at about three to four percent on an annualized basis, which is about in line with the questionable measures of inflation the United States government has been publishing over the same time frame.

But for those that know where to look and how to do the simple math, the components of M3 are still published monthly and are available on the regional Federal Reserve web sites. This much wider measure of the money supply shows a very dire picture: M3 has been growing at 17-20 percent for more than the last three years! This translates to core inflation of 20 percent or more. And if you have been buying basic groceries, gasoline, healthcare and all the other necessities that I purchase for my family of four, you'll know that in the real world, prices of the basic necessities have more than doubled in the past four years. Now couple this huge growth in inflation with falling housing prices, falling purchasing power and lower or stagnant wage growth and you have a real recipe for disaster. But cutting interest rates and talking positive is not going to solve these problems. These problems faced Fed Chairman Paul Volcker and he gave the United States economy the prescription that cured it-in his words, we had enjoyed the fun of the party, now we had to pay with the pain of the hangover. In the face of mounting criticism, Volcker began raising interest rates, slowly getting the money supply in circulation under control until he had wrung out inflationary pressures. Once inflation was under control, the economy and its components like housing prices and wages began to recover.

More in Part 2 tomorrow.

Tim Morge

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