Reflections of a credit junkie

Let's assume that the rally since March has been a liquidity inspired:

a) squeeze of a very short market from the lows

b) followed by another squeeze of punters trying to pick the top (that would be the H&S that should not be named)

c) followed by underweight equity fund managers being squeezed, and,

d) then followed by retail investors beginning to believe a new bull has arrived (sentiment indicators push to levels not seen since Lehman was alive and well and gambling in every speakeasy this side of the Arctic circle).

And let's also assume that I've been arguing that turning off the liquidity tap will have a disproportionate impact on the market. With the abundance of fundamental factors suggesting the market is now overvalued, gravity will take hold. Hence my bearish trading stance.

What's wrong with the picture then? What's missing?

A mate of mine suggested that the credit implosion in over. Bernanke has put a stop to that - as long as you are happy with US government credit (hmm - think USD), then being long a big US bank at a historically attractive credit spreads and funded at zero rates is a pretty compelling trade. Wells Fargo might have a lot of negative equity home loans on its books, but it will be recapitalised, and as a debt holder you will be fine. Extrapolate that theme to the investment grade universe and you have an anchor for the market to rally around.

I'm trying to brief (perhaps at the expense of clarity but treat this as a French existentialist piece - it's about colour not deconstructionist drivel). What then for a market where the risk of a deleveraging, forced selling, credit implosion has been taken out?

Well, on balance, it might well be that equity investors remain underinvested. Weakness will be bought into. Worse still for an underinvested sod like myself, we might now be at the bottom of the new trading range. The market could bust higher from here in an exuberant capitulation - and then retrace back to today's levels.

To take Marc Faber's point - in a world where interest rates are zero and investment grade keeps crunching in, investors have to push up the risk curve.

And the non-confirmation in the various markets that we are seeing at the moment? Simply, a little profit taking in a thin market for all those banks that have sat through the March lows.

It's a worthy (if broadly painted) argument. For mine, I remain of the view that we are in for a pull back (in tune with the next 6 months of pain in the US mortgage markets). But perhaps a revisit of the lows is out of the question.