Personally I’ve found this has been the most interesting period I have ever experienced in the financial markets. Volatility, policy adjustments and expectations have changed so much over a period of a few months … it’s absolutely breathtaking to watch. Coming from one of the steepest declines in modern stock market history we’ve also seen one of the fastest and steepest rises in stock market history.

Countless people have opined about the causes of the crash and what were the principal drivers (such as the fall of Lehman Bros) while others are even suggesting the US government’s announcement of the TARP made things worse by raising fears/uncertainty and causing the tailspin.

Ha, I have my own newly minted theory. 

All these events people are pinpointing are really missing the big picture I believe. The Fed (generic for Western central Banks) caused the crash as far as I’m concerned. It lost control of events and ended up in reactive mode….. not a good place to be in when trying to quell a crisis.

What makes me think it was the Fed?

From the very beginning of 2008 the Fed seemed reluctant to believe that anything serious was happening (other than a traditional slowdown) and didn’t appear greatly troubled by  a recession and banking system issues. Rate cuts weren’t forthcoming quickly enough and appeared penny pinching and meager. Shockingly, back in July last year both the ECB and the Fed suggested they were concerned about inflationary consequences down the track. Seeing the inflation rate breaching the top of the target range the stupid ECB actually raised interest rates by 25 basis points. It also began openly telling the markets that its new objective was the removal of direct loan assistance to the banking system by early 2009. Never wanting to be left out in the warmth, when there’s a chance of participating or initiating a huge policy error, the Japanese monetary authorities also began to talk the tough inflation talk (as if there was one).

The Fed in particular should have read the tea leaves quickly and moved interest rates down to zero as early as the 1st quarter. Instead they moved too late and finally ‘got it’ in Nov/Dec introducing all sorts of new measures that would not have been needed if they had understood the problems earlier.

In my opinion the Central Banks basically blew it. They  blew it by getting us into the crash through very low interest policy at the beginning of the decade causing asset price inflation and  then blew it by not understanding just how deep in the dung heap we were in once the correction set in. 

Stabilization took time and it was only after the bank stress tests results were announced in the US that the market began to regain some balance. This was also when the markets began to think things weren’t going to be as bad as originally thought.

It seems to me that from then on the Fed finally took back control.

What we’re seeing now, I believe, is a giant correction to the Armageddon trade. I also think there is the possibility that we will see asset prices much higher than people expect. There are still plenty of asset managers around the world that are nowhere near fully invested.

The central banks are basically panic stricken and frightened stiff (shell shocked) by acting too quickly in removing liquidity from the system. Global liquidity, or rather the oceans of liquidity, we’re currently seeing sloshing around the system is unprecedented by every measure. From banking assistance, such as easy money from the CBs at zero interest rates, collateral demands from CBs of the banks that could be seen as virtually non-existent (exaggerating, but not much), direct loans to specific firms and industry sectors, fiscal spending programs… you name it and it’s there. There has never been a period in world history like this one with so much liquidity floating about.

As a trader I like simple themes and this one happens to be a very simple theme.

Just as central banks erred in being too slow when markets were heading south, they’re also going to be too slow in taking the punch bowl away. So with my money I have placed bets on various sectors that have been doing well and I think will continue to do well in what I call this trading sweet spot.

I am continuing to place bets on technology plays, aviation (yes really), the US G4 cell network, broad GDP plays such as shipping that were beaten down heavily and pigs-can-fly trades. Pigs-can-fly trades are stocks such as the US banking sector that were massively beaten down in the crash. In fact any sector that was massively beaten down could be a great play (with care).

I also like the Asian (not Japan, in fact anything but Japan) story and see this market eventually much, much higher than its 2007 highs. Asian countries’ currencies are basically linked to the US Dollar through pegs and fixed exchange rates. Normally some adjustments are taken in currency movements however in their case they have to be taken through asset price adjustments as they continue to avoid currency appreciation.

Here’s my very big bet in the pigs-can/will-fly category.

Seeing the Fed is massively interested in reflating asset prices we will one day soon see the US banks actually mark the toxic shit that they have on their books upwards. You think I’m crazy, right? I’m not. If that does happen we will see a buying frenzy that it could be massive even from the recent huge upward correction we’ve seen in the US bank sector.

I also love biotech, however this sector is really not for the faint of heart. You need to selectively choose 20 to 30 stocks that have a story behind them and hold, as 80% will fail, 10% will do moderately well and 10% will take off like a rocket at light speed. In this sector I particularly like what I call the “fat people” sub-sector, which are firms trying to come up with genetic testing in potentially high growth areas. For example how well would a genetic test would sell if they can tell fat people what foods they should avoid so as not to develop heart problems in (early) later years. Such a test could be worth billions and the products will be offered away from the regular government controlled health insurance plans so people will buy them with their own money.

This is truly the Rambrandt of markets for people that like to go long stocks; it’s a masterpiece of a melt up. We’re seeing huge amounts of M & A activity all around the world. Toxic crap is finding bids and moving up higher, stock issuance is on a grand scale and firms are replenishing bruised balance sheets. The markets have in fact absorbed billions on billions of low-grade paper with the effect that everyone has received a bailout. It’s bailout heaven.

How long will it last? Who knows but it’s great fun as the CBs again have made even the average trader appear to be a genius.

One thing I know though: it won’t last and although I know I won’t be the first person off the Titanic, I also won’t be the last in this new Keynesian world.

In other words the Dow at 20,000 and the $100 tomato is starting to appear as a real possibility. Think about that.

The one doing most of the talking is a chap by the name of Rick Santelli. It’s all delivered in the best ‘gangster’ accent, and if nothing else is a rapid-fire introduction to the concept of ‘moral hazard’.

Highlights include:

“How many of you people want to pay for your neighbor’s mortgage that has an extra bathroom and can’t pay their bills? [Boos on the floor] President Obama, are you listening?”

“Do you think I want to take a shower every hour? The last place I’d want to live is DC.”

A tip of the hat to Jakob for the find.

UPDATE: Jakob has swung by and pointed out the Obama administration’s response, available here.

Santelli has responded to the response here.

The whole spat is getting nasty, with people arguing that the White House is directing personal attacks at members of the press (and private citizens, too). Gibbs does come across as a precious little snowflake. And he clearly doesn’t get the concept of moral hazard.