While sitting on large cash positions, it is prudent to take some time to examine the big picture. Markets all over the world and the vast majority of asset classes remain firmly in downtrends. Powerful counter-trend rallies are to be expected and are overdue. Countertrend rallies can last weeks or months. They will come at some point – we should not let them take our eye off the bear-market ball. We are far from having significant evidence that a lasting bottom is in place.

The Bailout Bill

Since Congress has political risk if they take no action concerning the financial crisis, we can expect some form of a bailout package to pass in the coming days. Once something passes, we can expect a rally in stocks. The market’s initial reaction to the bailout plan on September 18, 2008 was very positive. The reaction since then has been muted. We have come nowhere near the highs made in stocks on September 18, 2008. The market thinks the bailout will help, but is thus far not convinced it will solve all our problems. When something is passed, we should focus on how the market is acting in a few days or weeks, not a few hours.

After passage of a bailout bill, the market will ask:

• How long will it take for the Feds to start buying toxic assets?
• How will they decide what to buy first?
• How much will they be willing to pay?
• Will banks have to take more write-downs?
• Will the program expose problems of greater magnitude than expected?
• Will it work?
• With housing still in a tailspin, will private capital migrate back to banks?

The fact that the questions above cannot currently be answered exposes the lack of detail and clarity in the poorly written and conceived bailout bill. Vague is the operative word. Two of the major problems with the credit markets are lack of trust between financial institutions and poor transparency. A vague bailout bill, which may alter accounting rules, will not provide immediate help on either front. Relaxing standards on mark-to-market accounting will create an environment with even less transparency and trust.

Government intervention will continue for the foreseeable future. Unfortunately, this regulatory risk makes the markets very unpredictable and volatile. New announcements can come out of the blue, making it very difficult to stomach inverse investments or shorts. You can be right on the fundamentals and still experience significant short-term pain during a government-press-release-induced reversal in stocks. Money managers are spending as much time reading the Washington Post as the Wall Street Journal due to the excessive intervention into the “free” markets. Currently, the main driver of asset prices are changes in government policies, which does not inspire a lot of confidence for investors.

If the U.S. government were a publicly traded company, would you invest in it? Assuming the answer is no, then why would anyone believe the government can pull all the right economic strings to alter the course of natural events in a complex global economy?

Regardless of what bills are passed in Congress, the risks for the longer-term will remain elevated. Regardless of the market’s direction in the coming weeks and months, problems in the financial system will remain. Alan Greenspan recently said this was a once in generation financial event. All will not be suddenly be right with the world after a stroke of President Bush's pen.

Economic Weakness Comes Into Focus

Once some form of the bailout is passed, the market will shift its focus to the economy.