The Dirty Harry Market

"I know what you're thinking, "Did he fire six shots or only five?"  Well to tell you the truth in all this excitement, I've kinda lost track of it myself.  But being this is a 44 Magnum, the most powerful handgun in the world and would blow your head clean off, you've gotta ask yourself one question, "Do I feel lucky?" Well, do you - punk? - Clint Eastwood as Dirty Harry

I just love this quote. talk about the ultimate tough guy.  The story as some of you may remember continues where he picks up the bad guy's shotgun and walks off.  The robber asks, "Hey, I gotta know", at which point Harry turns around, points the Magnum at the guy's head, pulls the trigger and there is just a click, no bullet remains.  Then with a smile he walks off.  I won't repeat what the bad guy says.

This sort of sums up the opening of the year which I am terming The Dirty Harry Market.  Oil prices continue to crater, stock markets vacillate violently and the mood is generally one of concern and uncertainty (what else is new).  In the first five trading days of the year the market moved more than 1% in four of them and twice more than 1.7%.  Volume on the up days is lower than that of the down days (not a good sign) and this rally is look long in the tooth.  Furthermore there is finally some realization that high yields do equal risk as the spread between investment grade bonds and high yield (or junk) bonds has started to widen considerably in the past few months (see chart below).

As a large amount of money invested in the high yield market was allocated to oil and gas ventures it is clear that the drop in oil prices is having a dramatic effect on the cost of capital.  Undoubtedly a large portion of this debt will become worthless as borrowers will not have the capacity to repay these loans with oil down around $46 a barrel.

So the question that we have to ask ourselves as investors is "Do we feel lucky?"  "Well do you?"  While the United States economy seems to be in relatively good shape (particularly when compared to the rest of the world) there are still major concerns regarding the rest of the world.  Can the United States pull the rest of the world out of their problems or will the rest of the world's problems drag the United States' tepid recovery down with them.  In my blog last week I mentioned that the United States is in a liquidity trap but as a good friend of mine commented it may be more about a leadership trap than a liquidity trap and I have to say that I agree.  Without any clear leadership in the White House and with elections coming up next year it seems that the United States economy is drifting rudderless and the seas are becoming rough.  Pity we don't have Mr. Harry to clean up the rot here but unfortunately life is not at all like the movies.

With this as a backdrop there has to be a proper draw down it is just a matter of when.  Not that I am hoping for one it is just that history always repeats itself and with three years of one way tickets to heaven it just seems like an investment in the stock market is akin to taking a chance that Dirty Harry's gun is out of bullets.  Furthermore make sure that any investment offering a high yield is covered with sufficient collateral as otherwise I would expect that only five bullets were used!